• Lex Specialis

An Analysis of Force Majeure and MAC During a Pandemic

- Utkarshini Rai


Introduction


Force Majeure is one of the first principles taught in the tort law class. It translates into French for “superior force” i.e. something that cannot be reasonably anticipated or controlled. Commercial contracts usually include an ‘act of god’ clause in order to apply this principle and excuse either or both parties from performance of the contract. Another common clause in terms of contracts in the Material Adverse Change (“MAC”) clause. They are relevant for a business that has an incomplete agreement to purchase or acquire an entity but an unforeseeable circumstance has a material adverse impact on the said entity or the whole transaction itself. MAC clauses can be said to be applied before closing of the deal i.e. in the agreement stage whereas Force Majeure is applicable in relation to the terms of performance of the contract after the completion of the initial deal.


Usage of the Clauses


For a party to seek relief from performance under Force Majeure, it is essential for the contract to include the clause. Depending on the wording of the clause, it generally suspends instead of cancelling the performance of the affected contractual duties and exempts a party from the liability imposed thereafter. Once such an event ends, the affected party will be required to perform their obligation, otherwise resulting in breach of contract. Hon’ble Chhattisgarh High Court has also said that where there is no reasonable likelihood of the act coming to an end in the near future, the parties shall have the right to terminate the agreement. It is also necessary to establish that the Force Majeure act was the only cause of non-performance of contractual obligations, and would be able to do so under normal circumstances. A company undergoing insolvency proceedings, for example, cannot rely on this clause to seek exemption. Some contracts may also mention that despite such an event, the parties must take reasonable steps to mitigate the effect of the act on the contract. The clause can only be invoked after that.


MAC clauses are important from the perspective of Mergers and Acquisition (M&A) transactions. They provide a sort of safeguard to the purchaser or acquirer to refuse a transaction if events take place which are materially detrimental to the entity being merged or acquired, or change the circumstances of the signing of the contract significantly. They are inserted in a contract to insulate the parties from sudden and serious financial setbacks. This is why they are commonly seen to be invoked under situations which affect the economy at large with foreseeable long-term detriment. A good illustration would be the financial crisis of 2008-09 which saw a sharp increase in the number of invocations of this clause. The current Corona virus crisis also seems to be progressing on the same economic trajectory.


Legal Application in Times of Corona


Natural disasters are usually the subject of such clauses. But they’re usually limited in time and are confined to a particular location. Contrastingly, the Corona virus infection has turned into a global pandemic which has resulted in almost all the governments issuing travelling restrictions and lockdowns. Naturally, contracts which involve mandatory travel or transportation of perishable but non-essential goods would by default come under the defence of Force Majeure clause. But that is subject to the question, whether the clause covers a pandemic or not. In India, the Ministry of Finance was quick to issue an office memorandum in February itself which by effect declared that the pandemic can be treated as a natural calamity and therefore would invoke force majeure in terms of contracts. The guidelines for such invocation were laid down by the Hon’ble Supreme Court in Energy Watchdog v. Central Electricity Regulatory Commission & Ors. The raging issue of rent payment was dealt by the Hon’ble Delhi High Court while relying on the above mentioned case, in Ramanand v. Dr Gireesh Soni wherein the Court stated that a Force Majeure clause may allow the tenant to claim that the contract has become void and surrender the premises. But in the absence of any clause giving respite to the tenant, any monthly dues would be payable to the landlord. The Hon’ble Bombay High Court has also ruled, while dismissing a commercial arbitration petition, that the “lockdown cannot come to the rescue of the Petitioners so as to relieve them from their contractual obligations” i.e. it cannot be a legal basis for termination of a contract.


Furthermore, common law has two major defences regardless of the presence of these two clauses i.e. the Doctrines of Frustration and Impossibility. The former is applied when an unexpected event happens which removes the reason for performance of contract or makes it worthless. Taylor v. Cladwell introduced this doctrine where a music hall was burnt down by an act of god and hence, rendered useless the contract for renting it. The latter excuses performance of contract when an unforeseeable event destroys the subject matter of the contract itself. This was used in the case of the Reagan administration firing the air traffic controllers which had been on strike. The loss of jobs was seen as an unforeseeable event under their insurance contracts and therefore, excused its performance. For example, the English contract law does not have an express Force Majeure provision per se, but depends on the presence of the clause in the contract. So, the parties may rely on the doctrine of frustration.


Regulation 23(1)(c) of the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2017, prescribes that states that the parties can be excused from the contractual obligations under a contract if it becomes impossible to meet the conditions for reasons which are beyond reasonable control of the parties. Further, Section 56 of the Indian Contract Act, 1872, which deals with the doctrine of frustration of contract prescribes that any act which by reason of some event, if occurs after the contract is made and which was not preventable by the promisor, makes the contract void.


However, from an M&A perspective in India, the MAC provision specifically needs to include pandemic or epidemics to be invoked in such circumstances. The fact that judicial precedents have been few here also does not help. One of such judgements was in Nirma Industries Ltd. and Anr v. Securities Exchange Board of India wherein the Supreme Court confirmed that SEBI can permit the withdrawal of an open offer (under the Takeover Regulations 1997) only where the impossibility of performance can be framed within the criteria specified in the relevant statutory provisions, strictly read. This was relaxed in the amended version of the Regulation in 2017, as stated above. US courts’ judgments rely upon durational significance and long-term impact of the event before providing relief by invoking MAC clause. The Delaware Court of Chancery allowed the purchaser to invoke MAC on the grounds that the target entity suffered with a sustained loss of performance after a 25% decline in revenue flows. Indian courts may take cues from them while dealing with cases involving materiality of events.


Conclusion


In the Indian jurisdiction, any impact of COVID-19 may be covered as a force majeure event provided that the parties invoking the same shows that reasonable steps towards mitigating the same have been taken and as a result no alternate means for performing the obligation is left. Further, in absence of force majeure clause or MAC clause in any agreement, does not bar the party's right to invoke them. In such a scenario, a party may resort to Section 56 of the Indian Contract Act, 1872 to take the defence of the doctrine of frustration. In cases of the contract being rendered useless, the parties may also rely on the ‘termination clause’ specified in the contract. MAC clauses have been uncommon up till now, so one would have to wait for the courts to make a new ruling in order to formulate a principle for its application and invocation.


Endnotes

1. Prakash Industries Ltd. v. Union of India, 2012 SCC OnLine Chh 35.

2. (2017) 14 SCC 80.

3. Ramanand v Dr. Gireesh Soni, RC. REV. 447/2017.

4. Standard Retail Pvt. Ltd. v. M/s. G. S. Global Corp & Ors, Commercial Arbitration Petition (L) No. 404 of 2020.

5. [1863] EWHC QB J1.

6. AIR 2013 SC 2360.

7. Akorn Inc. v. Fresenius Kabi AG, 2018 WL 4719347, at 47.

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