Impact of COVID-19 on ongoing and future M&A negotiations: Force majeure and unforeseen circumstances under Dutch lawCoronavirus: Impact on M&A in the Netherlands
In the previous article (“Impact of COVID-19 on ongoing and future M&A negotiations”) we set out the key aspects to consider before withdrawing from negotiations. In this article, we will explore the implications of COVID-19 on transactions that have signed (sale and purchase agreement/SPA) but not completed, for example because certain (regulatory) approvals must be obtained. More specifically, we will focus on what the options are under Dutch law to use the concepts of force majeure (overmacht) and unforeseen circumstances (onvoorziene omstandigheden) to: withdraw from the transaction and terminate the SPA between signing and closing, rejecting a warranty claim and/or a claim for non-performance of obligations.
Force Majeure (Overmacht)
The Dutch Civil Code (article 6:75) sets out the circumstances under which a party to a contract may invoke force majeure as a ground for default. In an M&A context, the defaulting party could attempt to use force majeure as a defense for the purpose of rejecting: a warranty claim, a claim for damages and/or a claim for non-performance of its obligations. This may apply if the default or failure is not caused by the defaulting party’s fault nor for his account pursuant to the law, the contract or generally prevailing opinions (verkeersopvattingen). The following ground rules should be taken into consideration when assessing a force majeure defense:
- force majeure will in most cases be linked to (temporary) impediment to perform;
- inability to make payments will normally remain for the account of the failing party. As such, invoking force majeure to withhold payment will likely not succeed;
- if performance is onerous, but not impossible, there can be no force majeure;
- there can – in principle – be no force majeure if the balance between the performances of the parties is disturbed as a result of for instance price changes;
- there can be no force majeure if an obligation may be performed in different ways and the impediment only applies to one way of performance;
- the impediment may not be due to the fault of the defaulting party;
- impediments which were foreseeable at the time of conclusion of the agreement, the defaulting party should have taken such impediments into account when entering into the agreement and these will generally not qualify as force majeure;
- insolvency or other financially distressed situations will generally not qualify as force majeure;
- industrial disputes and strikes will generally remain for the account of the defaulting party; and
- legal restrictions and regulatory measures (domestic or foreign) could result in force majeure. This may be different if the government restriction is linked to a single person or entity.
Force majeure is a defense against a claim for damages whereby the burden of proof rests with the defaulting party. Based on established case law, the threshold for invoking force majeure successfully is high. However, COVID-19 does present a unique set of circumstances which could justify a force majeure defense due to its unusual nature, the global scale and the unpredictability of the outbreak. However, the outcome of such a dispute will invariably depend on the specific circumstances of the case.
For agreements entered into after the COVID-19 outbreak, the situation may be different. Given that the outbreak must now be considered a fact of public knowledge, the contracting parties should agree on a risk allocation which considers – and accordingly addresses – the impact on the relationship between the parties. A failure to do so, will make it difficult for a defaulting party to attempt invoking force majeure under Dutch law, as the consequences of COVID-19 would have been – to a large extent – foreseeable when the parties entered into the agreement.
A successful defense by the defaulting party based on force majeure will have the following consequences during the force majeure period: a claim by the non-defaulting party for specific performance, i.e. to complete the transaction and/or a claim for damages will be rejected. Although the non-defaulting party’s corresponding obligations are generally not affected by the force majeure event, said party may suspend performance of its own corresponding obligations under the SPA (e.g. seller’s obligation to transfer the shares or purchaser’s obligation to pay the purchase price) or even terminate the SPA for default, but without being able to claim damages. Unless agreed otherwise, the defaulting party itself may not terminate the agreement. This means that if the force majeure event no longer exists, the non-defaulting party may again demand performance of the agreement.
As stated above, the main principle of Dutch contract law is freedom of contract. Most commercial contracts contain clauses which allocate risk to one of the parties. Allocation of risk can be captured through various mechanisms, such as in warranties, limitation of liability clauses and specific force majeure clauses. Some SPA’s exclude an appeal on force majeure altogether by one or both parties waiving their rights under Article 6:75 DCC. As such, a Dutch court will generally order the defaulting party to pay damages, or award any other remedies that parties have agreed upon in case of a breach.
Force majeure clauses may, but do not need to, include lists of defined force majeure events (exhaustive or not). Accordingly, the parties to a contract are free to include examples of what may constitute a force majeure event, such as epidemics or pandemics, and to agree on the implications of occurrence of such event. Whether or not such clauses can be invoked in light of the outbreak of COVID-19 is a matter of contractual interpretation. A force majeure clause should always be drafted in a clear and unambiguous manner. In the absence of any definition or agreement on force majeure, Dutch courts will take all facts and circumstances into consideration to determine if a failure is attributable to the defaulting party.
Unforeseen circumstances (onvoorziene omstandigheden)
The recent outbreak of COVID-19 may also cause the parties to seek a change in the relevant contractual clauses. Under Dutch law courts may modify the effects of a contract, or set it aside in whole or in part, at the request of a party on the basis of unforeseen circumstances. The unforeseen circumstances will have to be of such nature that the other party cannot expect the contract to be maintained (unmodified). It is established case law that this requirement is not easily satisfied.
The Dutch law concept of unforeseen circumstances is of a mandatory nature and the right to request a court to amend or terminate the agreement as a result thereof cannot be set aside contractually. As a result, parties to an SPA can always request the court to dissolve the agreement in whole or in part, for unforeseen circumstances, despite the fact that most SPA’s stipulate that parties waive such rights.
Whether or not the circumstances were actually foreseeable for parties at the time of entering into the agreement is not the decisive factor. More importantly, the assumptions of the parties at the time they entered into the agreement and whether or not they wanted to cater for the unforeseen circumstances in the agreement (whether explicitly or tacitly) must be taken into account. The question whether the parties actually meant to cater for a specific circumstance is ultimately a matter of contract interpretation.
Examples of unforeseen circumstances can include a serious imbalance between the value of the various mutual obligations, sudden scarcity of raw materials, extreme inflation, changes in governmental policies, the fact that the agreement lost its purpose and exceptional circumstances such as wars and natural disasters. Unforeseen circumstances can only concern future events. This means a party to a contract concluded after the COVID-19 outbreak will most likely not be able to invoke unforeseen circumstances, if at that time the consequences of the outbreak were reasonably foreseeable (eg. when it would reach the Netherlands and known prior consequences in other countries).
The question whether the COVID-19 outbreak qualifies as unforeseen circumstance depends on the interpretation of the agreement and which future events are actually catered for therein. The difficulty in predicting the outcome of such a dispute is supported by several published verdicts rendered in relation to the various bird flu outbreaks in the past.
Dutch contract law weighs substantial importance on the agreement reached between the contractual parties. Accordingly, Dutch courts are reluctant to set aside binding agreements on grounds based on force majeure events and unforeseen circumstances. Contracting parties must closely scrutinize the agreed allocation of risk (for instance when drafting force majeure clauses) between them before entering into an agreement, as ultimately, the agreed allocation of risk set out in the agreement, will likely be upheld. This holds especially true for agreements concluded after the outbreak of COVID-19.
COVID-19 could result in a party not being able to perform its obligations under the SPA, either in part, in full or only at substantial cost. Whether the risk of such an impediment should be borne by the defaulting party depends to a large extent on the language of the agreement, the interpretation thereof and the circumstances of the case. The implications of COVID-19 on M&A contracts will – as indicated above – ultimately have to be determined on a case-by-case basis.