COVID-19, a disease caused by the novel coronavirus, has now spread to at least 70 countries, including the United States. Our thoughts are first and foremost with the families of those directly impacted. In addition to the human cost, the virus has impacted transportation, manufacturing, supply chains and public markets, and may dramatically impact the global economy. These disruptions raise significant legal issues, and we are advising companies on a wide range of matters as they evaluate risks and develop plans to address these impacts. This alert addresses contract performance issues and public company disclosures.
Impacts on Contract Performance
The uncertainty about the severity of the COVID-19 outbreak has already had major commercial impacts in the United States, including travel restrictions and cancellations of conferences and other large events. These disruptions raise questions about when contracting parties will bear risks from non-performance.
Under basic principles of U.S. contract law, an event beyond a party’s control may excuse its performance under a contract. Some contracts expressly allocate risks for such events, often—but not exclusively— in “force majeure” clauses. Whether a superseding event excuses a party’s performance will depend on a host of factors, including:
- The specific contract obligations at issue;
- How directly those obligations are impacted by the event;
- The precise language of a force majeure clause or other provision allocating risk; and
- Governing law
Imagine, for example, a cancelled public conference. A vendor that had agreed to provide on-site services at the conference but who is now locked out due to a quarantine will have different arguments than a company that had agreed to provide online customer support services for the same event.
Myriad variations in the facts and contract language can affect who bears the risk of non-performance under a contract. Below are key considerations:
- Force majeure clauses vary widely. Some force majeure provisions are narrow, describing only particular events that might qualify. Others are broad, describing any event or condition beyond the parties’ reasonable control.
- Some force majeure clauses excuse performance only if the occurrence “prevents” performance or makes it “impossible.” Accordingly, a force majeure clause might not excuse a party’s obligations if performance remains possible but is now simply more financially burdensome or requires the party to bear more risk.
- Force majeure clauses will be read in the context of the entire agreement. Other provisions—such as representations and warranties, covenants, termination rights, change in law clauses, material adverse change provisions and indemnity requirements—can also allocate risk between the parties and may therefore also bear on whether a party’s performance is excused.
Frustration and Impracticability
- The common law defenses of “frustration of purpose” and “impossibility” (more often called “impracticability”) may excuse performance. The Uniform Commercial Code adopts similar principles for sale of goods contracts.
- Frustration of purpose can apply when a supervening event fundamentally changes the nature of a contract and makes performance worthless to the other party.
- Impracticability may excuse performance that has been made excessively burdensome by an unforeseeable supervening event not caused by the party seeking to be excused.
- If a contract already expressly spells out when supervening events would excuse performance, or otherwise allocates risk between the parties, these doctrines may be unavailable as defenses.
- If a party demonstrates its intent not to perform under a contract, this can give rise to anticipatory breach, excusing the other party from its own performance obligations.
- For this reason, in addition to considering its own ability to perform, a party should consider whether its counterparties can and/or will meet their obligations under the contract.
- Companies should evaluate what insurance rights might cover losses arising out of a party’s inability to meet its contractual obligations. Depending on the policy and specific facts, business interruption insurance policies may provide coverage.
- Indemnity rights under contracts may provide relief from claims arising from commercial disruptions.
Notice and Communications to Counterparties
- Parties considering any of the above issues should carefully review the notice requirements in their agreements. Failure to comply with formal notice requirements—which may require prompt notice and regular updates—can prejudice a party’s ability to excuse non-performance or secure indemnification.
- Beyond the strict letter of an agreement, early communication with counterparties may help avoid disputes and promote coordinated solutions.
For companies facing the possibility that they will be unable to perform under existing contracts, or the risk of non-performance by counterparties, proactive and prompt review of relevant contracts, and early communication, may be critical. And companies who are currently negotiating agreements should consider whether to include provisions expressly allocating and mitigating the commercial risks from COVID-19.
The COVID-19 outbreak may also raise public company disclosure and other securities concerns.
SEC Guidance on COVID-19
In a January 30, 2020, statement discussing proposed amendments to management discussion and analysis (MD&A) disclosure requirements and the use of financial metrics, SEC Chairman Jay Clayton also noted that commission staff would monitor COVID-19 developments and may provide specific guidance “regarding disclosures related to the current and potential effects” of the virus. We previously analyzed the proposed SEC disclosure changes and the January 30 statement about COVID-19 here.
On February 19, 2020, the commission issued another statement on the topic, reiterating that the situation is “dynamic” and “the actual effects may depend on factors beyond the control and knowledge of issuers.” Nonetheless, because “how issuers plan and respond to the events as they unfold can be material to the investment decision,” the commission urges company management to engage with their audit committees and outside auditors to evaluate disclosure and accounting issues arising from COVID-19. Moreover, the SEC’s statement specifically noted that issuers “need to consider potential disclosure of subsequent events in the notes to the financial statements in accordance with guidance included in Accounting Standards Codification 855.” The commission further remarked that issuers with specific questions about whether and how to disclose information about the effects of COVID-19 “are encouraged to contact SEC staff,” where “[r]elief may be available on a case-by-case or broader basis.”
On March 4, 2020, the SEC issued further guidance on disclosure issues as part of a grant of conditional regulatory relief for issuers (covered below). This additional guidance includes the following:
- Companies and other related persons should consider their activities in light of their disclosure obligations under the federal securities laws. For example, where a company has become aware of a risk related to the coronavirus that would be material to its investors, it should refrain from engaging in securities transactions with the public and should take steps to prevent directors and officers (and other corporate insiders who are aware of these matters) from initiating such transactions until investors have been appropriately informed about the risk.
- When companies disclose material information related to the impacts of the coronavirus, they should take the necessary steps to avoid selective disclosures and to disseminate such information broadly. Depending on a company’s particular circumstances, it should consider whether it may need to revisit, refresh or update previous disclosure to the extent it has become materially inaccurate.
- Companies providing forward-looking information in an effort to keep investors informed about material developments, including known trends or uncertainties regarding the coronavirus, should take steps to avail themselves of the safe harbor in Section 21E of the Exchange Act.
Exercise Caution If Commenting on Business Effects of COVID-19
Given the uncertainties about the geographic dispersion, severity and ultimate consequences of COVID-19, public company officials should exercise caution if they choose to comment on how the disease might affect their business prospects.
- Issuers should only communicate using a Regulation FD-compliant channel (guidance about complying with Regulation FD can be found here and here).
- As with any public statement about possible future events, issuers should ensure that appropriate cautionary language is included.
- Issuers should be aware that any statements that declare or imply that management does not believe that COVID-19 will have a material effect on future financial performance may be considered a re-affirmance of any previously issued guidance. Thus, issuers should evaluate carefully if they are in an informed position to reaffirm guidance and wish to do so, and carefully examine any language used to discuss the topic.
- Where issuers have commented about the effects of COVID-19, they may need to consider providing further updates if conditions materially change.
We encourage issuers to consult with counsel on whether impacts from COVID-19 implicate additional risk factors, MD&A or other disclosure obligations in the company’s specific circumstances.
SEC Provides Conditional Regulatory Relief
In its guidance issued on March 4, 2020, the SEC announced “conditional regulatory relief for certain publicly traded company filing obligations under the federal securities laws” in light of the impact of the coronavirus. According to the commission’s order, publicly traded companies may be provided with an additional 45 days to file certain disclosure reports that would otherwise have been due between March 1 and April 30, 2020, subject to certain conditions, including a report on why the relief is needed. Additional extensions or relief may be extended as circumstances warrant. A more detailed discussion of the regulatory relief can be found in our related alert.
As with other extraordinary events or developments, companies should consider specific risks that they may face from this outbreak, whether related to the supply chain, customer behavior or other factors, and then, if warranted, ensure these risks are identified or covered in the risk factors in periodic filings. Many companies are adding to the “natural disaster” risk factor and have also updated international business and/or supply chain and clinical trial risk factors as well. Companies with significant operations in China or other heavily impacted regions may consider additional risks specific to their circumstances.
The situation with COVID-19 is evolving, and companies should continue to monitor government communications and guidance from the SEC and other regulators. The extent to which companies are impacted will vary, and it may be premature to develop detailed crisis-response plans. However, companies should consider identifying their main potential vulnerabilities and areas of impact, assign responsibilities for monitoring government communications and guidance, develop clear communications channels with both employees and decision makers and develop continuity plans to address reduced work force or other disruptions to the business. As a general matter, companies should be reviewing and refining their disaster recovery plans on a regular basis.