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Coronavirus - Private equity and the pandemic: Contractual considerations - Global

  • Global
  • Coronavirus - Contractual issues
  • Corporate

28-07-2020

As the fallout from Covid-19 has spread and evolved, the thoughts of most of the nation have been either with the frontline workers battling the virus on the coalface or the source of their next pub-pulled pint or G&T with friends. If you’re anything like me, you will start the day thinking of the former and end it thinking of the latter! Conflicting priorities aside however, spare a thought for the folks in charge of record keeping and contract management in any given business organisation, for whom the coronavirus pandemic has created a logistical nightmare.

Often contracts are heavily negotiated before being signed and then put away in a draw and forgotten about, with day-to-day implementation of that contract being more relationship-based and dependent upon the practices and interactions of the parties thereto. Now is the time for sponsors and portfolio companies to call upon their contract managers to dig out and dust off their contracts, as relationships with customers and suppliers become more fraught as the pandemic impacts supply and demand and cash flows become stretched. Now is the time that the devil in the detail really does come out to dance.

This sixth article in our bitesize series focuses on the considerations relevant to contractual arrangements during the Covid-19 pandemic from two perspectives: firstly, what should businesses be doing now, and secondly, what can businesses do going forwards to future-proof their contractual arrangements.

Immediate Actions

First and foremost, and at the risk of stating the blindingly obvious, it is always useful to have a copy of the relevant contract when considering its terms! Obvious though it may be, this is often an issue, the significance of which is only appreciated when the parties need to know the detail of particular contractual provisions. Hard copies of contracts are often left half signed, undated, not scanned in as soft copies, lost within large organisations, forgotten by teams that have moved on or moved to implement the day to day practicalities of that contract. All understandable, but the issue has been exacerbated during the lockdown brought about by the pandemic, which has resulted in teams being unable to access their offices and files in person. The horse may have already bolted in relation to this issue, but to the extent possible, contract management teams should endeavour to consolidate copies of contractual arrangements in central, electronically accessible files.

Considering now the specifics of contractual arrangements, there are two aspects to think about: the first being the detail of key contractual terms and provisions and the second being the broader issue as to whether a contract as a whole has become incapable of performance. Most recent discussion has focused on the latter of these two areas but from a practical, day to day perspective, business managers will be concerned about the detail of provisions and how to make these work for the business during the pandemic, particularly if a long-term relationship with the counterparty is important. 

Key Terms

1. Minimum order provisions: terms which oblige a business to purchase a certain volume of goods or services without exception will be particularly onerous during a period in which demand for those goods or services have significantly decreased. Whilst it may be difficult in ordinary circumstances to renegotiate such provisions, it may be that suppliers are experiencing difficulties obtaining their own supplies to satisfy their own contractual commitments, so there may be scope for a commercial discussion with counterparties to reach an arrangement that is mutually beneficial;

2. Payment terms: many businesses are experiencing cashflow issues arising from the effects of the pandemic, including the temporary closure of non-essential businesses and the need to meet on-going commitments. This has significant implications for the broader economy where the cashflow issues in one business have a knock-on effect on the suppliers to that business as a result of its inability to meet payment commitments and so on down the supply chain. Whilst cashflow management techniques are one way to part solve for these issues, businesses should consider reviewing the payment terms in their contractual arrangements to determine whether there is any possibility of e.g. extending the period before payment is made to suppliers or, where the relevant business is a supplier itself, enforcing more regular invoicing rounds or strict adherence to maximum credit periods, in each case working within the confines of the terms of the agreement to ensure commitments are met but in a way that works to the advantage of the relevant business. Care should be taken to review payment terms in detail to confirm whether there is any ability to vary prices, pass on cost increases, include additional charges to reflect the costs involved in supply or to factor in exchange rate fluctuations. Being fully au fait with the detail of the provisions will at least enable businesses to plan more effectively;

3. Insolvency provisions: contracts will often contain default provisions which are triggered by the insolvency of one party and entitle the other party to terminate the contract when those provisions are triggered. New legislation (the Corporate Insolvency and Governance Act 2020) brought in to address the uncertainty created by Covid-19 and the challenging environment for businesses has resulted in changes to the way that parties can exercise insolvency-triggered rights and has restricted the ability of parties to rely on termination provisions. Sponsors and their portfolio companies should familiarise themselves with their rights under contractual arrangements and establish whether there are adequate alternative means of protection that can be relied upon e.g. termination provisions triggered by late payment (as opposed to insolvency) or retention of title provisions;

4. Variation and termination provisions: there may be contractual terms that sponsors and their portfolio companies wish to vary to address the impact of the current pandemic on the execution of that contract. Any variation to the terms of an agreement will usually require the consent of all parties so it is advisable to seek engagement with counterparties as soon as possible, as it may take some time to negotiate a variation that is acceptable to all parties. Conversely, termination rights of each of the parties are usually set out in detail in a contract and the terms of those rights will have to be considered in the specific circumstances to establish whether they are triggered in the current circumstances e.g. a termination right may arise as a result of a failure by the counterparty to fulfil its contractual obligations, but may be negated by force majeure provisions (discussed below). As noted above, certain termination rights that are insolvency-triggered are temporarily suspended by the Corporate Insolvency and Governance Act 2020 so care should be taken when seeking to exercise rights. Contractual terms should be reviewed and considered in the round and in practice, discussed with the counterparty to agree a way forwards if the relationship is one that the parties wish to develop in the future;

5. Force majeure: the ability to rely on force majeure provisions to excuse a failure or delay to perform will depend on the governing law of the relevant contract. Comprehensive guidance on force majeure provisions globally can be found here, but in general, in some civil law jurisdictions it may be that the concept of force majeure is provided for in the civil code whereas in other jurisdictions, particularly common law ones, a specific contractual provision will be required. In the latter case, the effectiveness of such provisions will depend on their specific terms, but usually require that the inability of any party to satisfy its contractual obligations must be as a result of no fault of that party. In particular, the definition of what constitutes a ‘force majeure’ is key, as some contracts may include an exhaustive list of scenarios which may include or exclude pandemics such as the one we are currently experiencing, whereas others may be broader in scope. Force majeure clauses will also only usually provide a get out of jail free card where performance of an obligation is impossible as opposed to simply more difficult or expensive. As such, it will be important to consider the terms and circumstances before relying on force majeure provisions to avoid contractual obligations e.g. if the reason for failing to satisfy a contractual commitment is a lack of available workforce, consider whether it would have been possible for that workforce to operate remotely; and

6. Notice provisions: during the period of lockdown when access to offices is restricted, it would be advisable to notify counterparties to key contracts that notice details need to temporarily change e.g. to the general counsel at their email address. Ironically the practical difficulty around this is actually giving notice of the change to the notice provisions, as the other parties to the contract are likely to be in the same position and therefore unable to collect any notice sent to their address. In these circumstances it would advisable to speak to contacts at the relevant counterparty to agree a workable solution.

Frustration

The legal doctrine of frustration may provide a means to completely exit a contract (but not suspend performance of obligations thereunder) where a contract does not include appropriate termination or force majeure provisions, or the current situation falls outside of the scope of those provisions. A contract may be frustrated in circumstances where an event occurs after the contract has been formed and is so fundamental as to go to the very root of the contract, does not result from the fault of either party to the contract and renders performance of the contract impossible, illegal or fundamentally different to what was contemplated by the parties.

Whilst the effects of Covid-19 have produced a rise in the number of contract parties exploring reliance upon the doctrine of frustration, sponsors and their portfolio companies would be well advised to look to the detailed terms of their contracts in the first instance. Where possible, engaging with contract counterparties in the first instance and maintaining a dialogue through trying times is likely to produce a more measured solution (e.g. temporary suspension of a contract) than a complete termination (as would be the result of replying on the doctrine of frustration), and will facilitate better long-term relationships.

Future-proofing

As many businesses are now discovering, there is no point in getting the red pen out after signing on the dotted line. Whilst it is never possible to cater for every eventuality when drafting contractual arrangements, it is important to ensure that proper thought is given to how the performance of the contract and the business environment may change over time and how best to address that in advance.

Here are some tips to consider adopting in the future, having learned some difficult lessons as a result of the pandemic:

  • Contract Management: always ensure that copies of key contractual arrangements, including customer and supply arrangements and leases, are saved electronically in central files which are accessible remotely;
  • Pricing provisions: consider including provisions in new contracts which allow for price variations or additional charges and expenses to be levied in circumstances where e.g. supply costs have increased or to account for exchange rate fluctuations;
  • Flexibility: to the extent possible, seek to build in flexibility around key terms e.g. the ability to vary volume commitments or limit the duration of the agreement and provide for a rolling extension of the term;
  • Force Majeure: ensure that the terms of force majeure provisions are comprehensive and are not exhaustive in scope. If the intention of these provisions is to provide relief in unforeseen circumstances, then they should be sufficiently broad to accommodate situations that may not have occurred to the parties during drafting; and
  • Practical matters: consider the practical effect of binary provisions such as notice clauses or obligations requiring travel or physical meetings. These may not always be possible and as the world adapts to remote working it will be useful to have alternatives in place.

Contracts come in all shapes and sizes and there is no one size fits all approach that can be adopted to working through current issues or seeking to future-proof arrangements. The key take away from this note is that it is crucial to ensure that proper thought is given to contractual terms at the time they are entered into and to include the commercial teams in negotiations to ensure provisions work from a practical perspective. Contractual arrangements are not a lawyer-only domain, or a piece of paper intended to gather dust in a draw. As the effects of Covid-19 have shown, contracts and their terms are brought to life in difficult circumstances and in some instances, can have a major impact on the success or failure of a business where terms are unduly onerous or have not provided sufficient protection for the contracting parties. Circumstances change over time and business contracts should be capable of reacting to those changes in a commercial and considered fashion.

Next week, as part of our on-going series, Ben Jones and Richard Kyle will turn their gaze to the future and share thoughts on the opportunities, issues and challenges coming down the line for private equity investors and portfolio businesses by way of introduction to a series of more specific articles considering the future for the sector.