1. Introduction

The ongoing Covid-19 pandemic has had undesirable effects of significant magnitude on both individual businesses and the overall industry. Therefore, contracts concluded before the advent of the crisis — specifically the parties to those contracts — are expectedly at a different footing from where they had begun.

Be that as it may, the contractual obligations that bind these parties cannot be escaped easily. In this context, performance may only be avoided in case of impossibility, or frustration under the provisions of the Contract Act, 1872; or where a contractual clause expressly allows it — as discussed hereinafter.

  1. The concept of “material adverse change”

 Most commercial contracts are neither negotiated, executed or performed in a day. They are negotiated heavily and contractual performance is a process that takes place over a certain duration especially in the context of mergers and takeovers. Therefore, it is quite likely that the conditions under which the contract had been entered into have been so fundamentally altered over this duration that one party seeks to escape the contract.

In such situations, a material adverse change (MAC) clause is useful in allocating and mitigating the risk of such a fundamental change, and further providing an exit option from the transaction should such a change take place. However, it must be borne in mind that courts have consistently stressed that a MAC clause is not an option to be utilised in event of “buyer’s remorse” and therefore, there is a high bar to the actual use of these clauses.

Another category of clauses that operate similarly are force majeure clauses invariably incorporated in contracts. However, the fundamental difference between a MAC clause and a force majeure clause is that the former is not necessarily invoked only where performance becomes impossible, although the latter is expected to operate only in circumstances where performance is rendered impossible.

Further, a standard MAC clause is vague and may include within its fold any class of changed circumstances; whereas a force majeure clause ordinarily specifies events such as natural disasters. Notwithstanding, a MAC clause may be drafted in any contractual terms as the parties may deem fit, and the courts give effect to these terms while deciding what constitutes a “material adverse change” and whether such a change has taken place.

  1. The tests of materiality

Although a finding that “material adverse change” has occurred depends largely on the factual matrix of the specific case as well as on the wording of the MAC clause, there is at least one jurisdiction that has a fairly defined standard of what suffices as material. Therefore, in the US, although it has been observed that “the notion of a materially adverse event is imprecise and varies both with the context of the transaction and its parties and the words chosen by the parties”[1], there exists otherwise adequate case law on the subject.

However, even in the US, courts are generally reluctant to allow the parties to escape their contractual obligations — renegotiation or other alternatives are preferred — because business contracts in the nature of mergers and acquisitions, financing agreements, etc. are all heavily negotiated in the first place. Thus, in IBP Inc. Shareholders Litigation, In re,[2] in the context of an M&A transaction, where the MAC clause was worded broadly (with no explicit carve-outs for any industry-wide changes, etc.), the Court still observed that,

“even where a material adverse effect condition is as broadly written as the one in the merger agreement, that provision is best read as a backstop protecting the acquiror from the occurrence of unknown events that substantially threaten the overall earnings potential of the target in a durationally-significant manner. A short-term hiccup in earnings should not suffice; rather the material adverse effect should be material when viewed from the longer-term perspective of a reasonable acquiror.”

Herein, we find two emergent principles:

(i) That the change should be “substantial”.

(ii) That the change should have a “durationally-significant” effect.

The same principles have been reiterated in a series of cases, notably Akorn Inc. v. Fresenius Kabi AG[3] and Frontier Oil Corpn. v. Holly Corpn.[4]

In the Indian context, there have been hardly any rulings (if any) on the invocation of a MAC clause wherein it could be determined what constitutes a “material adverse change”. Therefore, courts are reliant either on the Takeover Regulations, or upon the provisions of the Contract Act, 1872.

With respect to the former, Regulation 23(1)(c) of the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, provides that, any open offer can be withdrawn in circumstances where any condition stipulated in the agreement for acquisition attracting the obligation to make the open offer is not met for reasons outside the reasonable control of the acquirer, and such agreement is rescinded, subject to such conditions having been specifically disclosed in the detailed public statement and the letter of offer.

However, in interpreting and applying this provision, the Supreme Court ruled that the provisions of the Takeover Code were to be given a strict interpretation, and that withdrawal was permitted only in circumstances of impossibility.[5] Clearly therefore, the grounds for excusing performance are not much different from those permissible under the Contract Act, 1872.

With respect to the Contract Act, 1872, Sections 32 and 56 respectively describe the relevant law. Section 32 provides that in case of contingent contracts, the contract in question becomes void when the contingency event in question becomes impossible. On the other hand, Section 56 provides that contracts become void when performance is rendered impossible. The cumulative effect of these provisions is the embodiment of the common law doctrine of frustration of contract.

Further, as briefly discussed earlier, force majeure clauses included in contractual terms may specify events such as natural disasters, Acts of God, or any such circumstances that are not within one’s control, as grounds for excusing performance of a contract. These clauses find wider application than MAC clauses in India. For instance, it was held in Satyabrata Ghose v. Mugneeram Bangur & Co.[6] that,

“the law of discharge is to be governed solely under the terms of the Contract Act, 1872. Parties may be absolved from the further performance of an obligation if the whole purpose or basis of a contract was frustrated by the intrusion or occurrence of an unexpected event or change of circumstances which was beyond what was contemplated by the parties at the time when they entered into the agreement.”

With respect to the invocation of force majeure clauses, the Supreme Court stressed on certain principles that were to be kept in mind in Energy Watchdog v. Central Electricity Regulatory Commission[7]. Summarily stated, these are:

(i) That the conditions leading up to invocation of the clause should be beyond reasonable control of the parties.

(ii) That parties must have taken all reasonable efforts to perform their contractual obligations.

(iii) That the force majeure event should have been unforeseeable.

(iv) That the force majeure event renders the performance of the contract impossible.

It is only upon fulfilment of these principles that a contract may be avoided in India.

With respect to Covid-19 in particular, while various government agencies have officially designated the pandemic a force majeure event for the purposes of avoiding contractual obligations,[8] these circulars and memoranda are not binding; although they may still be persuasive in proving that a force majeure event has indeed occurred which excuses performance of contract.

  1. Is the Covid-19 pandemic a “material adverse change”?

Whether the Covid-19 pandemic amounts to a “material adverse change” for the purposes of avoiding contractual obligations is, as stated previously, dependent on the specific set of factual circumstances.

Nevertheless, in case of a standard MAC clause, it is unlikely that Covid-19 will suffice as an MAC event when scrutinised with respect to the Indian standard (wherein the standard tends towards impossibility). However, it must be kept in mind that most contracts also include force majeure clauses that may allow parties to avoid the contract, thus providing relief to parties who would otherwise suffer greatly from the effects of the pandemic.

  1. Conclusion

In light of the foregone discussion, it is amply clear that the law relating to use of MAC clauses in India is fairly underdeveloped. The required standard for avoiding performance tends towards impossibility of performance (as applicable in case of force majeure, or under statutory provisions). Therefore, the Indian courts may look to the principles evolved by courts in other jurisdictions — notably the US — in deciding whether a “material adverse change” has taken place. However, as the situation stands, despite the direness of the pandemic situation, contracting parties seeking to escape their contractual obligations on the grounds of Covid-19, remain almost entirely at the mercy of the terms they had previously negotiated for, as well as the facts and circumstances of their respective situations.

Managing Partner, Corp Comm Legal.

†† Student Researcher (3rd year law student, HNLU, Raipur).

[1] Frontier Oil Corpn. v. Holly Corpn., CA No. 20502, 2005 WL 1039027 (Del. Ch. 2005).

[2] 789 A 2d 14 (Del Ch 2001).

[3] No. 535, 2018 (Del, 7-12-2018).

[4] CA No. 20502, 2005 WL 1039027 (Del. Ch. 2005).

[5] Nirma Industries Ltd. v. SEBI, (2013) 8 SCC 20.

[6] 1954 SCR 310.

[7] (2017) 14 SCC 80.

[8] Prashanth Shivadass & Priyanka Yavagal, Force Majeure – The Sudden Apprising, The SCC Online Blog (12-2-2021, 10:06 p.m.), <https://sccblog-linux.azurewebsites.net/post/2020/06/16/force-majeure-the-sudden-apprising/>.

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