Suffering with investment finance - how to negotiate business finance contractual obligations during Covid 19?
Finance during Covid-19
Many of our client businesses have already expressed their concern at having to satisfy bank loans or meet conditions of hybrid loan equity agreements at the due date or at all. This article deals with renegotiating contractual terms before court litigation or reaching an early settlement during proceedings.
On 7 May 2020, the UK government issued - Guidance on responsible contractual behaviour in the performance and enforcement of contracts impacted by the COVID-19 emergency (“The Guidelines”). The guidelines by the government demonstrate the importance of the widespread concern in the UK that businesses may not be able to perform their obligations under their contracts. The issuing of soft law by the UK government in the form of guidance is an additional negotiating tool in dealing with financiers.
Although the objective of UK guidelines is not binding law, it is a valuable negotiating tool, and if negotiation fails, it will be considered by the courts in reaching judgements. The purpose of the guidelines is not to override contractual terms. The primary government purpose in issuing the guidelines is encouraging responsible and fair enforcement of contracts which businesses should use to their advantage in court or in renegotiating contractual terms.
The guidelines will be most persuasive in the absence of a contractual clause dealing with a pandemic event, including a force majeure clause.
Business Finance Contracts
What are your legal options in fulfilling contractual finance obligations during Covid-19?
There is no blanket immunity from contractual obligations because of the ongoing global pandemic.
As in regular times, your first point of call will always be the contract itself, and there are two main options to consider:
● A force majeure clause; and
● The doctrine of frustration.
What is a force majeure clause?
The first thing to note is that force majeure clauses can be used by both parties to benefit their position. Namely, a force majeure provision could work in a way that is unfair to the business. However, a company could also use a force majeure clause to renegotiate favourable contractual terms.
Covid-19 has created a volatile investment market and the impact on the economy has resulted in some investors and investees alike being unwilling or unable to fulfil their contractual obligations. However, it is trite law that mere market volatility alone cannot be a relevant event for a force majeure clause.
Is Covid-19 a force majeure event?
The purpose of a force majeure clause is to protect the parties from a breach of contract claim if they are unable to perform their obligations because of an event that is outside their control as precisely drafted [1]. Therefore, whether Covid-19 is a force majeure event depends on the wording of the force majeure clause.
Typically, in long-form force majeure clauses, there is a list of specific events including pandemics and epidemics, which would cover Covid-19.
Sometimes force majeure clauses cover an act of government; in this case, it would depend whether the government intervention is a recommendation or whether, for example, a business is forced to close. The government have issued these guidelines on businesses forced to close.
Since the courts will be generous in their interpretation of a force majeure clause considering the unprecedented circumstances, businesses are in a stronger negotiating position than usual.
The force majeure clause covers Covid-19 – what now?
If pandemics or epidemics are covered, the next question to consider is the impact on the investor/investee’s ability to perform their contractual obligations.
Usually, the force majeure clause will refer to the action that had the effect of triggering the breach, i.e., prevent, hinder or delayed performance. For example: In renegotiating contractual financing obligations, a business could ask for more time to meet payment because the impact of Covid-19 has delayed its ability to make payment.
Each action is separate and has a different threshold to meet:
● Prevented - Prevented performance is the highest threshold and means that it must be either physically or legally impossible for the party to perform its legal obligations.
● Hindered - Hindering a contractual obligation is a lower threshold and is covered by performance being substantially more difficult, if not impossible.
● Delayed - Delaying performance has the lowest threshold. It is only necessary to demonstrate that the delay in complying with the contract has been made substantially more difficult due to the prevailing circumstances.
In court, the party seeking to rely on a force majeure clause must show that their difficulties are as a direct result of Covid-19; and that there was no reasonable mitigation that they could have taken.
If successful, either party may be excused from their obligations under the contract if the force majeure event is indefinite and may be entitled to restitution or the agreement may be frustrated which I will discuss further below.
In the circumstances where the force majeure event is temporary, then the parties may be granted more time by the court to fulfil their obligations or be afforded a right to termination.
Whether you are an investor or investee in a contract, if you are seeking to invoke a force majeure clause in litigation proceedings, you must also comply with any procedural requirements which may include giving notice.
Force majeure clauses generally
Force majeure clauses have much broader application than just in investor/investee contractual obligations. Consumer protection laws protect consumers from unfair force majeure clauses, including a right to refunds.
There is no force majeure clause in the investor/investee contract – what do I do?
If no force majeure clause exists, another option is to rely on the doctrine of frustration.
Business is frustrated
Frustration
The frustration of a contract occurs when:
An event which completely changes the nature of the initial objectives and the obligations of the parties to the contract occurs. It must be an extraneous supervening event. (See also: National Carriers Ltd v. Panalpina (Northern) Ltd [1981] AC 675)
The event that caused the radical change cannot be due to the action or inaction of either party.
The purpose of the contract must be rendered infeasible due to the event, not just more challenging such as being more expensive.
In most circumstances, a supervening event must not have been in the reasonable contemplation of the parties. Typically, if the conditions in which the event giving rise to the frustration is foreseeable and could have been, adequately dealt with in force majeure clause, then the doctrine of frustration will not apply. However, there is no general presumption that just because an event was foreseeable, it cannot frustrate the contract.
The common law doctrine of frustration is applicable to any business circumstance including leases; the hiring of a music hall; building contracts; war; and international freight shipping.
There is no doubt that frustration would apply to Covid-19. Still, it should be a last resort post negotiation legal remedy as it is a complex contractual doctrine which is unclear in its general application.
Frustration brings all obligations to an end under the contract, and this may not always be desirable to the contracting parties. Further, the courts will rarely make an order for frustration.
Note that even if the frustrating event arising from the pandemic or epidemic were reasonably foreseeable at the time of entering the contract, the parties may still rely on the pandemic event, even if it should have been dealt with it in the agreement. Whether frustration will apply will depend on the individual circumstances of each case.
If frustration is established, then - The Law Reform (Frustrated Contracts) Act 1943 governs claims for restitution from contracts cancelled by frustration. (See Goff J.in BP Exploration (Libya) Ltd v Hunt (No. 2).
What action should I take if I have difficulty paying back a loan or an investor is withholding payment due to Covid-19?
The starting point will always be the contract, so get some proactive legal advice on the terms and any force majeure clauses to help you renegotiate for a delay in your obligations or in very exceptional circumstances terminate the contract entirely.
Consider the - UK Government issued Guidance on responsible contractual behaviour in the performance and enforcement of contracts impacted by the COVID-19 emergency.
Take early advice since there could be avoidable consequences to your business resulting from defaulting on your finance contracts - whether the investment is in the form of a loan or some other kind of loan/equity hybrid financing.
Should negotiations fail you want to make sure you kept a documentary record of why performance was difficult or delayed, and the steps taken to mitigate your losses
[1] Chitty on Contracts 33rd Edition (2019) Vol 1, Part 4, Chapter 15, Section 8 15.152
To obtain an accurate, personal opinion from a lawyer about your case or matter please contact us on (020) 7305-7491 or at support@pailsolicitors.co.uk we would be delighted to assist you. The writer is a digital + IP Disputes lawyer, owner and principal solicitor at PAIL® Solicitors. Peter Adediran's specialist niche areas of practice are digital business SMEs and IP, both contentious and non-contentious.