6 Things To Know About Handling Contract Disputes In The COVID-19 Era

Vinson & Elkins LLP

Recently Victoria’s Secret captured headlines that had nothing to do with the retailer’s famous fashion show.

Victoria Secret’s parent company, L Brands, and private equity firm Sycamore Partners (“Sycamore”) exchanged lawsuits after Sycamore sought to walk away from its pending acquisition of the lingerie company. Sycamore claimed that Victoria’s Secret had experienced a “material adverse effect” as a result of the coronavirus pandemic, allowing the private equity firm to terminate the deal. Ultimately, the two sides agreed to ditch the $525 million transaction and ended their litigation.

Such disputes are becoming increasingly common. With COVID-19 continuing to wreak havoc on businesses, companies are invoking clauses in their contracts that might excuse them from their obligations.

In the M&A arena, acquirers like Sycamore are citing material adverse effect (“MAE”) provisions in an attempt to renegotiate or terminate signed deals. A MAE clause generally provides that an acquiror is not required to close if an event occurs that has, or is expected to have, a material adverse effect on the seller’s business or financial condition. At least ten lawsuits in which parties involved in mergers have invoked MAEs have been filed in the Delaware Court of Chancery since the beginning of April.

“We were just at a hearing this morning in which a judge said that he had never been busier than he had been in the past two months despite the fact that the court is not having in-person hearings,” said Michael Holmes, co-head of V&E’s complex commercial litigation practice.

But it’s not just MAE clauses that are being put to work. Businesses across industries, from live entertainment companies to energy producers, are invoking “force majeure” — “act of God” — clauses, notifying their counterparties that they cannot fulfill their duties because of COVID-19. In some cases, lawsuits have ensued, and more are expected in the months ahead.

“People are renegotiating their contracts right now, or are attempting to,” said V&E litigation partner Marisa Secco. “There are various scenarios where a renegotiation may not be worked out right now, and the impact will come later down the road, or claims that have not yet come to fruition will be filed in the next three to six months.”

Holmes and Secco, along with fellow V&E litigation partners Chris Duffy and Phillip Dye, recently sat down to discuss MAE and force majeure clauses, and how to effectively present a case in a COVID-19 contract dispute. The following are some highlights from their discussion:

Material Adverse Effect

Increased specificity related to COVID-19 in MAE clauses does not necessarily eliminate MAE disputes

The potentially devastating impact of the pandemic on a company’s operations is far more evident today than when the pandemic first hit. As a result, many parties are now specifically allocating pandemic risks when drafting MAEs. But even with this increased specificity, there can, and likely will, be disputes over the interpretation of these clauses.

The Victoria’s Secret lawsuit is a case in point. In the retailer’s acquisition agreement, the parties identified exceptions to what would be considered a MAE, including a pandemic. Nonetheless, Sycamore pressed ahead with its attempts to terminate the deal.

“There are several cases pending now involving MAE provisions that either addressed pandemics broadly, or COVID-19 specifically, where the parties still wound up in court because they couldn’t agree on what the provision meant after they signed the deal,” Duffy said. “Just because we are now well into the COVID era does not mean that MAE disputes arising from the business impact of COVID will start to disappear. If buyers want to get out of a deal, they still may come up with arguments.”

Expect decisions by the Delaware courts, and by courts across the country, that will provide more clarity on the meaning of a MAE

To date, there haven’t been many decisions in MAE cases. And there has been only one case — Akorn Inc. v. Fresnius Kabi AG — where the Delaware Court of Chancery found that a material adverse effect had occurred in a merger deal.

“But over the course of the next few months, as these cases work their way towards trial and then towards a decision in Delaware, we’re going to get some further guidance from the courts on how to interpret MAE clauses,” Duffy said. “We may soon have a much broader set of decisional case law to work with in future MAE disputes than what we have in front of us now.”

Force Majeure

You’ve received a force majeure notice — start asking questions

When adverse economic conditions upend contractual expectations, there will inevitably be parties that seek to invoke force majeure, even if they’re not entitled to be excused from their obligations.

“There are a lot people who just want to get out of their contracts because the economics of the deal have turned against them. They say to themselves, ‘I know, I’ll send a force majeure notice. There’s an epidemic. I’m not going to perform my contract,’” Dye said. “A lot of people are sending out force majeure notices when the truth is either they’re not really prevented from performing, or the event is not a covered event because of the way the clause is written.”

For those on the receiving end of a force majeure notice, it’s important to ask the following questions to determine whether force majeure applies: Is the pandemic covered by the force majeure clause? If so, is the activity that is not being performed as promised something that actually is being prevented by the covered event? Is there a specific exclusion in the force majeure clause for that performance? What are the notice requirements — was the notice sent within the specified deadline?

“Once you’ve considered all those things, you want to preserve your position,” Dye said. “You want to respond to the other party, particularly if you think that there’s some deficiency in their force majeure clause.”

Drafting or renegotiating a contract? Pay attention to the force majeure clause

Force majeure clauses have historically been viewed as an afterthought. No more. The coronavirus outbreak and the business disruption it has caused underscore the importance of focusing on force majeure when drafting or renegotiating a contract.

Looking ahead, parties seeking to boost the chances that their inability to perform will be excused should specifically reference the COVID-19 pandemic on the list of events that would qualify as force majeure. In addition, the COVID-19 pandemic should be identified as unforeseeable and unpredictable. The reason: in many states, even if an event is specifically listed, courts require that a party claiming force majeure demonstrate that the event was not foreseeable.

“We’re in a situation where there is an event going on that might prevent your performance for another 18 months,” Dye said. “You really have to address the coronavirus as a specific event that excuses performance.”

How to effectively present a case in a COVID-19 contract litigation

Overcoming the obstacles to getting to court requires serious planning

The COVID-19 pandemic has made a significant impact on the court system. Live hearings have been paused, and jury trials have been postponed. Given such obstacles, getting into court requires substantial legwork.

“You need to find out how your court is operating. Are they doing phone hearings? Are they doing video hearings? What is the platform? When will the court hear these cases? And what types of cases are they continuing to hear? Are you facing an indefinite continuance?” Secco said. “You have to be nimble. You have to accept whatever the court is willing to do and somehow press that this is an emergency matter despite the fact that there’s a pandemic.”

In a COVID-19 world, speed matters even more

COVID-19 and the resulting restrictions it has placed on the court system have raised the bar for litigants to obtain preliminary relief.

“There may be some instances where courts are reluctant to grant expedition motions, where in the alternative world, were we were not in the midst of a pandemic, those motions might have been granted because it would have been easier to get things done,” Duffy said. “If you want to get into court in Delaware, and get your case tried on an expedited basis, you want to really move quickly in doing that and not sit on your hands.”

A party seeking to prevent a counterparty from terminating a contract needs to go to court to seek a temporary restraining order as soon as it is clear that an out-of-court resolution cannot be negotiated. Delaying may undermine any claim of irreparable harm.

“On the flip side, if you are a party who has had a temporary restraining order filed against you, you need to be quick to move the court to dissolve that temporary restraining order,” Secco said.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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