“You don’t want to be complacent. You always want to be ahead of the curve.” Dr. Anthony Fauci, M.D., Director of National Institute of Allergy and Infectious Diseases.
As the coronavirus outbreak continues to wreak havoc on markets and industries in the U.S. and around the world, businesses are now confronting significant and unique challenges. Successful navigation of these challenges will require thoughtful and comprehensive planning. Foley has created a multi-disciplinary and multi-jurisdictional team, which has prepared a wealth of topical client resources (see Foley’s Coronavirus Resource Center) and is prepared to help our clients meet the legal and business challenges that the coronavirus outbreak is creating for stakeholders across a range of industries, including automotive, manufacturing, technology, solar, hospitality and travel, healthcare, food, fashion and apparel, and sports & entertainment.
At the center of the financial impact is the growing disruption to worldwide supply chains across many industries. China is the world’s second largest economy, and so the effect of the coronavirus extends – much like the coronavirus itself – far beyond its borders. In fact, according to Fortune.com, by the end of February, 94% of Fortune 1000 manufacturers had been hit with disruptions as a result of the coronavirus.1
Among possible new legal requirements for businesses are the provisions of H.R.6201 titled the Families First Coronavirus Response Act (the “Act”), which the United States House of Representatives passed on March 13, 2020. This bill is one of what appears will be a number of pieces of federal legislation coming from Washington designed to deal with the unprecedented events triggered by the outbreak of COVID-19. A summary of the Act, which still requires passage by the Senate and signature by the President, is located here. In addition, many employees are now working remotely, in-person K-12 and higher education classes have been suspended across the country, and federal and state government’s response to the outbreak continues to evolve. In an unprecedented move, seven counties in the San Francisco Bay Area have issued “shelter in place” orders, which will last from March 17, 2020 through April 7, 2020. The orders aim to limit the spread of COVID-19 by ensuring people self-isolate as much as possible while still allowing for essential services to continue. It is expected that some other state and local governments will follow suit. .
Looking Ahead: What Claims May Come
Given the uncertainty of the effects of this pandemic, it can be challenging for companies to look beyond how to overcome the issues presented by the virus today. Even still, in-house counsel should begin considering what claims may arise when the storm passes and the damage of the coronavirus comes into clearer focus.
Here are some of the potential claims an in-house counsel might expect to see in the wake of the coronavirus outbreak:
1. Tort Claims Against Companies
On Monday, March 9, a Florida couple still aboard a Princess Cruise ship brought suit in California against Princess Cruise Lines Ltd., alleging more than $1 Million in damages. The couple alleges, among other things, that the cruise line failed to warn passengers of the potential exposure to COVID-19 and that the cruise line was negligent in failing to have proper screening protocols in place to test for infected passengers.
In-house counsel should be prepared for more suits, including class actions, similarly alleging negligence against companies in the hospitality industry and beyond. In addition to cruise ships, this may also arise for sporting event spectators in large arenas, attendees of conferences, patrons of hotels, and church congregations, who are exposed to the virus.
While these negligence claims may or may not be ultimately meritorious, dealing with them will require resources – both in terms of in-house counsel time and outside counsel spend. To strengthen a defense should any such claim arise, where postponement is not possible, a company hosting a large event may want to consider seeking waivers from attendees, inquiring about recent attendee travel and the travel of close family, screening for fevers, offering online options, making hand sanitizer and hand washing stations readily available, and discouraging physical touch (e.g., handshakes).
2. Supply Chain Issues
Right now, many supply chain executives are in scramble mode, looking to keep the goods flowing smoothly to the extent possible. However, as the coronavirus shuts down manufacturing hubs and interrupts the global movement of components and raw materials, this becomes more challenging.
a. Force Majeure/Commercial Impracticability Disputes.
Already, many suppliers have sent force majeure or commercial impracticability letters, notifying customers that the supplier will not be able to meet its contractual obligations.
Force majeure provisions are common contractual clauses that relieve a party from liability for a failure to perform under a contract where such performance was prevented as the result of certain enumerated circumstances, like acts of God.
Commercial impracticability is a concept under UCC § 2-615 that excuses delays in delivery or non-delivery if performance has been made impracticable by the occurrence of a contingency the non-occurrence of which was a basic assumption on which the contract was made or by compliance in good faith with any applicable foreign or domestic governmental regulation or order whether or not it later proves to be invalid.
As the dust settles on this epidemic, in-house counsel might expect to see breach of contract claims related to whether or not the exercise of force majeure/commercial impracticability was appropriate or whether performance was truly prevented. Disputes surrounding termination may also arise in cases where a buyer exercises a contractual right to terminate a contract if the force majeure event extends for too long of a period.
b. Expedited Freight.
Once manufacturing ramps up again, in-house counsel could also be seeing disputes regarding which party is responsible for expedited freight related to shipping delays caused by the coronavirus.
c. Allocation Issues.
In addition, as multiple buyers fight for a limited supply, there will be fights about how that limited supply should be allocated across customers and whether certain projects or customers should receive priority.
d. Quality Concerns.
As companies scramble to keep supplying products, in some cases, those companies are using alternative suppliers or back-up manufacturing lines to maintain operations. In the future, in-house counsel may see quality issues and warranty claims as a result.
In-house counsel can get ahead of these issues by maintaining ongoing communication with business teams as to expectations regarding supply, quality, allocation and freight.
3. Insurance Coverage Disputes
Given the potential severity of the economic impact of coronavirus, businesses will no doubt look to their insurance coverage as a source of mitigation. While we anticipate that many claims will not be covered by standard insurance wordings, we do recommend a thorough review of available coverages and a conversation with an insurance attorney or knowledgeable broker if there are any questions.
a. Business interruption policies.
The most obvious source of insurance recovery may appear to be from a business interruption policy (if one exists). Unfortunately, most business interruption insurance requires some sort of physical injury or physical damage as a trigger to coverage. In other words, the coverage is typically designed to apply where a physical event (e.g. a building fire) shuts down operations for a period of time. It is unclear if a claim can be made that is premised upon the physical illness of people necessary for business operations, but this issue can be examined on a policy by policy basis.
b. Commercial general liability insurance
In addition to seeking first party coverage for business interruption, businesses may need to seek indemnification from insurers for third party tort claims related to coronavirus. By way of example, customers or others may raise tort claims that a business was negligent in maintaining a clean environment and as a result of that negligence, the claimant has contracted coronavirus. While the ultimate merits of these claims are not really relevant, what is relevant is whether insurers will see the potential for coverage and provide a legal defense. While these types of claims could be pled in a way that triggers coverage (or the potential for coverage), there is also a chance that the claim would be excluded from coverage under a pandemic exclusion, a force majeure exclusion, or even a biological or pollutant exclusion – depending on how broadly the exclusion is drafted. As soon as a business becomes aware of an actual or potential claim of this nature, they should immediately review their coverage and consider tendering notice to their carrier.
c. D&O insurance policies.
Directors and Officers (“D&O”) insurance is really designed to provide protection to individual executives for alleged wrongdoing, and to provide protection to businesses that have to indemnify individual executives for wrongdoing. D&O insurance often includes coverage for certain securities claims and even for HR claims. As with all insurance, the insured must review their policy to determine the scope of coverage. It is possible that this coverage may be triggered by the coronavirus pandemic. Examples of possible claims situations include: shareholder derivative suits against management for mismanaging the crisis; individual claims against directors or officers for breaching their legal duties related to the crisis; or even HR claims arising out of an unsafe workplace (although these may also fall within a client’s liability coverage). The potential wordings of D&O policies are numerous, and the potential claims are equally numerous. Any claim that purports to attribute liability to the management of a company should be examined carefully to see if insurance coverage may apply.
For more information, please contact the author of this section, Michael Kasdin, or your Foley relationship partner.
4. Considerations for Directors and Officers of Insolvent Companies
As the coronavirus outbreak continues, companies will no doubt feel both operational and financial strain. Set forth below are the top considerations for directors and officers of an insolvent company.
a. When a corporation becomes insolvent, there is no value in equity. In this case, creditors take the place of shareholders as the beneficiaries of the corporation’s residual value.
b. As a result, the duties (e.g., care and loyalty) of officers and directors of an insolvent corporation expand to include creditors as well as equity.
c. What factors are considered in determining solvency or insolvency? If either of the following is demonstrated: (i) corporation’s assets, fairly valued, do not exceed the value of its liabilities (balance sheet test); (ii) corporation is unable to pay its debts as they come due (equity test).
d. Because the range of persons and entities who could claim to be beneficiaries of an officer or director’s fiduciary duties to the corporation changes once an entity is insolvent, the “zone” really describes a situation in which there is a risk of becoming insolvent. As a result, the risk of having an additional constituency as the beneficiary of the fiduciary duties (that is, the creditors, ahead of the shareholders) must be taken into consideration.
e. Duties of care and loyalty are required in the case of insolvency.
f. Duty of care governs a director’s decisions in managing the corporation. The focus of this duty is the process by which decisions are made, rather than the substance of the decision or its eventual outcome. Duty of care requires the exercise of care that an ordinarily careful and prudent person would exercise under the same or similar circumstances. It is important to document that you made decisions after obtaining information and considering the information, as well as having obtained advice and having considered the advice.
g. Duty of loyalty requires that officers and directors act in the best interests of the corporation, subordinating other (business and personal) interests to that of the corporation. It also requires a good faith belief that actions taken are in the corporation’s best interests. The duty of loyalty mandates that the best interests of the corporation and its shareholders take precedence over any interest which is possessed by a director, officer (or controlling shareholder), and is not shared by the shareholders generally.
h. Directors and officers can be held personally liable for breaches of fiduciary duty. Steps to avoid personal liability:
i. retain specialists;
ii. be mindful of related-party deals;
iii. do not resign in haste;
iv. act in good faith;
v. conduct critical review of financial statements;
vi. monitor and conserve cash; (vii) perform credit or leverage analysis; and
vii. act and engage (do not react).
i. DOs and DON’Ts to Avoid Personal Liability:
i. DO NOT use funds withheld for payroll and other “trust fund” taxes to pay corporate expenses;
ii. DO NOT incur any new obligations you do not reasonably believe will be fulfilled.
iii. DO NOT provide inaccurate or misleading information to lenders.
iv. DO assure that appropriate oversight is in place to actively monitor use of cash, including review of and adherence to budgets and projections.
v. DO undertake analysis and estimation of value of business, including evaluation of assets and contingent liabilities.
vi. DO assess status of each major creditor constituency and determine points of leverage/risk for each.
For more information, please contact the author of this section, Ann Marie Uetz or your Foley relationship partner.
5. Employment Issues
a. Worker’s Compensation Claims.
Workers compensation is designed to provide 100% of medical expenses and partial wage replacement for workers who are injured (including disease) in the course and scope of their employment. Whether an employee who contracts the virus or is eligible for workers compensation will largely depend if the employee can demonstrate they contracted it while in the course and scope of their employment. That may not be easy.
b. Invasion of privacy claims.
Such claims may arise from a variety of state and federal anti-discrimination laws as well as the privacy laws and normally would suggest an employer not communicate specific health information about a particular employee. However, these are not normal times. We suggest in the case where an employee who has contracted the virus or has been clearly exposed but is currently asymptomatic is to immediately contact your local public health agency and obtain their guidance as to who to tell and how to communicate it. It is likely they will want to take the lead in communicating the information that will then provide the employer with a modicum of protection against the claim of invasion of employee privacy rights.
c. Discrimination claims.
There is potential for discrimination claims that might arise from coronavirus. Simple advice is to not treat some employees differently. For example, do not limit your requests for employees to stay home or self-quarantine to older or pregnant employees, or to employees of specific races or national origin. Develop an approach that treats all employees even-handedly and stick to it.
d. Negligence claims for exposure to the coronavirus.
To the extent there is workers compensation coverage, employers would be immune from any negligence lawsuits from their employees.
For more information, please contact the author of this section, Mark Neuberger, or your Foley relationship partner.
6. Corporate / Securities Considerations
a. Relief from Strict SEC Periodic Reporting Deadlines for Public Companies.
The SEC has enacted an order granting conditional regulatory relief and assistance to public companies affected by COVID-19. Under the order, companies are given 45 additional days to file quarterly reports on Form 10-Q and annual reports on Form 10-K that otherwise would have been due between March 1, 2020 and April 30, 2020. The primary condition for obtaining this relief is that the company must first file a current report on Form 8-K (or, for a foreign private issuer, on Form 6-K) to disclose the conditions caused by COVID-19 that prevent timely reporting. This report is due by the later of March 16th or the original reporting deadline that cannot be met. Companies using Form S-3 or Form S-8 (or both) will remain eligible to use those forms in reliance on the relief order if they were current and timely in their public reports as of the first day of the relief period and if they actually file the subject reports within the 45-day relief period. When the SEC enacted its relief order, Chairman Clayton reminded all public companies to update their published risk factors and the “known trends or uncertainties” disclosures in their Management’s Discussion and Analysis of financial data to account for the actual and expected impacts of the coronavirus on their businesses. This exhortation applies to companies that choose to avail themselves of the reporting deadline relief and also to companies that choose to file their reports on the original deadlines. Reporting companies will want to avail themselves of the existing safe harbor from liability for forward-looking statements in making these novel disclosures. In our view, the need to pause and think critically about risk factors and MD&A is, in itself, a reason to file a Form 8-K so as to obtain the SEC’s timing relief. In a future publication of this series of coronavirus advisories, we will provide guidance to companies relative to appropriate risk factor and MD&A disclosure pertaining to coronavirus events and circumstances.
b. Recently Closed M&A Agreements.
To the extent an acquired business underperforms in 2019 as a result of one or more impacts of COVID-19, buyers and their counsel may be fly-specking representations and warranties and other conditions to paying deferred consideration, to assess whether any claims or setoffs may be asserted against the selling company. Representations regarding customer and supplier relationships may receive special scrutiny, as well as covenants regarding maintenance of such relationships. Earnouts, which are a source of friction and disputes even in normal times, might be anticipated to give rise to additional negotiations regarding performance and achievement, and whether the COVID-19 impacts should factor into the achievement of any post-closing milestones.
c. Signed – But Not Closed – M&A Agreements.
To the extent definitive M&A agreements have been signed but one or more of the conditions to closing have not been satisfied, in-house counsel might anticipate claims and friction in the event one of the parties fails to close because it is unable to satisfy one or more closing conditions in a timely manner, or one of the parties terminates an agreement based on an asserted “Material Adverse Change” or other failure to satisfy a closing condition or meet transaction milestones and deadlines. Arguments regarding whether COVID-19 impacts provide any excuse for the failure to perform, or should suspend a party’s obligations temporarily, can expect to be asserted. Similarly, closing balance sheets and working capital adjustments are going to be especially tricky, given the impacts of COVID-19 on accounts payable and receivable, customer deposits and other areas impacting liquidity.
d. In-Process M&A Agreements.
In-house counsel who are negotiating M&A agreements currently can expect new and detailed fights over representations, pre-closing covenants and closing conditions including the timelines and conditions of any governmental or third party approvals, which can be expected to be delayed significantly in today’s environment. Seller’s in-house counsel should seek to negotiate flexibility and optionality to the greatest extent possible. On the Buyer side, fulsome representations on the impacts of COVID-19, in addition to normal financial condition representations, should be carefully negotiated. Timelines should be clearly stated in such a way that performance of conditions to closing can be clearly measured. This will include substantial negotiation over Material Adverse Change /Effect (“MAC” or “MAE”) provisions, including whether COVID-19 impacts are carved out as a known and current condition or whether a MAC/MAE provisions can be exercised if conditions materially worsen with respect to the target seller after the M&A agreement is signed. As stated above, negotiation of working capital adjustments is expected to be exceptionally tricky, especially in setting “normal” target working capital. Sellers should also expect to be asked about their internal controls, plans, and protocols for handling COVID-19’s impact – if sellers have not given this thought or developed policies and other measures with which to address COVID-19’s impact, in addition to substantial focus on compliance, employment and supply chain issues, as part of the due diligence process in the COVID-19 era of deal-making.
e. Credit Document Considerations.
The impacts of COVID-19 on financial covenant compliance, and whether any adjustments should be made to covenant calculations based on these impacts, will be a matter of discussion and potential dispute between borrowers and lenders, depending upon the relevant language of the credit documents. Many agreements include language regarding covenant adjustments in the event of a change in GAAP, but do not address the unique circumstances posed by current COVID-19 conditions.
For more information about recommended steps, please contact your Foley relationship partner. For additional web-based resources available to assist you in monitoring the spread of the coronavirus on a global basis, you may wish to visit the CDC and the World Health Organization.
Foley will continue to keep you apprised of relevant developments. Click here for Foley’s Coronavirus Resource Center for insights and resources to support your business during this challenging time.