The law governing the financial agreement applies to the question whether COVID-19 is an event of force majeure which may justify the debtor's failure to perform its contractual obligations.
Under Belgian law, a force majeure event is traditionally defined as a fortuitous event that makes it impossible for the debtor to perform his obligations. The majority of the doctrine considers that the impossibility to perform should not be absolute, but rather should be assessed in good faith. Case law is more divided.
A force majeure event temporarily or definitively discharges the debtor but does not allow the courts to adapt the contract and no party can be forced into renegotiation. When the obstacle is temporary, the contract is only suspended.
COVID -19, and more precisely its impact on the financial markets and/or on the financial situation of a debtor, may constitute a case of temporary force majeure which allows the suspension of certain obligations resulting from financial agreements governed by Belgian law.
If the financial agreement contains a clause of force majeure, a careful review of its terms and of the factual elements affecting the debtor must be undertaken.
Material Adverse Change/Material Adverse Effect
MAC and MAE clauses are present in a wide variety of financial agreements such as loans, financial leases, bond issues and underwriting agreements.
MAC/MAE clauses may be:
- a condition precedent of a contractual undertaking of one of the party (such as the funding or the underwriting); or
- a breach of a representation which could lead to an event of default; or
- an event of default.
Whether the outbreak of COVID-19 and its consequences fall within the scope of a MAC or MAE clause needs to be assessed on a case-by-case basis. We have learned from past events that an event impacting the market in general rarely qualifies by itself as a MAC/MAE because most of the MAC/MAE provisions are not merely triggered by the occurrence of global adverse economic conditions but require that the material adverse changes also specifically relate to the debtor’s situation.
Standardized documents such as the facility agreement from the Loan Market Association define a Material Adverse Effect as:
“Material Adverse Effect means a material adverse effect on:
- the business, operations, property, condition (financial or otherwise) or prospects of the Group taken as a whole; or
- the ability of an Obligor to perform its obligations under the Finance Documents]/[its payment obligations under the Finance Documents and/or its obligations under Clause * (Financial condition) of this Agreement; or
- the validity or enforceability of, or the effectiveness or ranking of any Security granted or purporting to be granted pursuant to any of, the Finance Documents or the rights or remedies of any Finance Party under any of the Finance Documents.”
When the parties do not expect a return on their investment in the short-term, a temporary event might also not be considered as a MAC/MAE.
Covenants and Event of Default
Several covenants usually provided for in financial agreements may be breached as a result of COVID-19. Most likely to be impacted are business covenants and financial covenants in particular those with an earnings component such as EBITDA. A cessation of business is likely to constitute an Event of default.
The standardized LMA Facility Agreement provides for a cessation of business clause which reads as follow:
“Any member of the Group suspends or ceases to carry on (or threatens to suspend or cease to carry on) all or a material part of its business [except as a result of a Permitted Disposal or a Permitted Transaction].”
A temporary suspension of business is therefore sufficient to cause an Event of Default. The Change of Management clause could also be triggered in case of illness due to COVID-19 if no adequate replacement management may be put in place within the appropriate timing.
The standard LMA Facility Agreement contains the following clause:
“• or • ceases to be employed by [the Parent]/[the Company] or to devote the time and attention to the business, trade and offices of the Group or perform the functions required under the terms of [his/her] Service Contract and a replacement person approved in writing by the Majority Lenders (such approval not to be unreasonably withheld or delayed) has not given a legally binding acceptance to an offer of employment and resigned from [his/her] existing employment within • days of that cessation. This Event of Default shall also apply to any replacement person as if references in this Clause to • or • were references to that replacement person and references to Service Contract were references to the service contract of that person].”
Most of these Event of Defaults may be cured during the Clean-Up Period, if any, provided it is long enough to overcome COVID-19 outbreak.
Business Day and Payment Disruption
Be careful to review the definitions of “Business Day”. Often, “Business Day” is defined to be a day (other than a Saturday and a Sunday) on which banks are open for business in [list of locations].
This definition does not cover, in our opinion, situations where employees work from home as a result of a business continuity plan. The solution would be different if the authorities would declare that banks or other financial institutions must remain closed for a certain period which would affect their operations and payment systems. In such a case the obligations will be due on the next Business Day. Interests will accrue on the payments postponed. If the delay of payment is not an event of default pursuant to the financial agreement, only ordinary interests will be due. Whether a debtor may validly refuse to pay these interests is to be assessed on a case-by-case basis. Only if the situation is a force majeure event, or if the request for payment of the interest is an abuse by the creditor of its rights, will the interests not be due.
Construction and Services agreements
Particularly in the context of project financing, the continued validity and the performance according to schedule of construction and services (particularly O&M) agreements are essential in order to comply with the terms of the finance documentation.
The principles of Belgian law described above apply to construction and services agreements, subject always to the terms of the contract. However, two particular points of attention should be borne in mind for these types of agreement.
The first concerns the concept of force majeure. Whilst construction and services agreements often include detailed contractual definitions, these have traditionally defined force majeure in terms of impossibility to perform obligations, and thus do not fundamentally depart from the default definition under Belgian law. Some contracts, however, define force majeure on the basis of a closed list of events (with force majeure including only e.g. war, terrorist attacks, hurricanes, tsunamis, …). In recent years we have seen a slight increase in the use of the latter type of definition. The result may be that a party is genuinely unable to perform its obligations yet falls outside the closed list and so cannot claim relief due to force majeure. Such clauses may however create legal uncertainty for both parties since, in relatively extreme circumstances, it may be held in bad faith and an abuse of right for the counterparty to hold the affected party to obligations which are genuinely impossible to perform.
A second point of attention is that contracts often impose strict time-limits to give notice of force majeure. Where notice is not given within the time-limit, the affected party may either not be entitled to invoke force majeure at all (which is in practice rare), or may only be entitled to invoke this as from the date of its notice (which is more common). A late force majeure notice may leave a party in a position where it cannot perform its obligations yet is (temporarily) denied the relief provided by its force majeure clause.
Belgian law does not recognize the theory of “unforeseeability”. Therefore, if the performance of a debtor's obligations is not rendered impossible but only more difficult or more onerous by circumstances for which he is not responsible and which were unforeseeable at the time of conclusion of the contract, he may not bring an action for renegotiation of the contract or ask for its termination.
It is the intention of the legislator to recognize this theory in the new Belgian civil code, but the legislative process is for now in limbo, though not due to the COVID-19 outbreak.
At most, the debtor will be able to invoke an abuse of rights from the creditor to obtain some adjustments to his obligations.
How should financial counterparties react?
First, parties should carefully review their contractual documentation in the light of the specific situation of the debtor to assess whether COVID-19 could lead to an Event of Default but also to have a clear view on the definition of Business Days and on the scope of the commercial and financial covenants. Parties to construction and services agreements are well advised to systematically review their contracts so as to ensure that any force majeure notices are given in good time.
Based on this review, creditors and debtors should monitor the effect of COVID-19 on the financial ratios and other covenants.
Parties should of course favor pursuing a mutually agreed solution including renegotiation in good faith of certain provisions and/or definitions to adapt contractual terms to the present situation rather than to risk the uncertainties of a dispute regarding good faith or the doctrine of abuse of right. They should try to avoid abrupt termination of the agreement on the basis of force majeure, MAC clauses or other Event of Defaults.