The extent of the coronavirus outbreak has truly presented an extraordinary time for commerce, not only within the United States, but also on a global level. The global market economy is currently facing unprecedented repercussions, which places businesses in uncharted territory for predicting performance and meeting ongoing demands. However, in examining the impact of prior public health emergencies, we can hopefully gain some level of predictability and take proactive measures to get ahead of the curve and minimize the negative impacts of an almost certain distressed economic reaction to the COVID-19 outbreak. SARS or “severe acute respiratory syndrome” was a viral respiratory disease of animal origin caused by the SARS coronavirus (SARS-CoV). Between November 2002 and July 2003, an outbreak of SARS in southern China infected a total 8,098 people, resulting in 774 deaths reported in 17 countries. Based on China’s role in the global economy, the SARS epidemic disrupted production in the travel (airlines), manufacturing, supply chain, retail and technology industries. With China’s growth in the global economy since 2003, companies in these industries (and others) should anticipate similar, if not increased, disruption and potentially distress in production.
As the coronavirus outbreak continues to develop, now is the time for companies in all industries to consider proactive measures to help mitigate their risk and prepare for how they will deal with the fallout from the coronavirus. As opposed to reacting to positions imposed by lenders, vendors, and other business parties, an effective proactive plan under a distressed scenario should include establishing an interdisciplinary crisis response team to identify, assess, and manage the risks presented. The team should include personnel from purchasing, operations, quality, finance, and legal.
Signs of financial distress may include: (i) decreased revenue, (ii) late shipments, (iii) decline in production; (iv) increased production costs; (v) diminished communications or “radio silence”; (vi) changes in behavior regarding timing, amounts and methods of payments; (vii) changes in behavior on invoicing and purchase orders; (viii) decreased availability from lender under lines of credit; (ix) shrinking borrowing base for asset-based credit facilities; (x) loss of a key customer or vendor; (xi) shrinking margins; and (xii) overall distress within the particular industry.
Keeping the lines of communication open is one of the most important steps a company can take when entering into a distressed scenario. Regular phone calls and emails with your lenders, suppliers, customers and vendors is essential.
Force majeure refers to a legal doctrine under which a party may be relieved from liability for non-performance if circumstances beyond the party’s control prevent the party from fulfilling its obligations under a contract. Force majeure provisions can vary greatly. While most force majeure provisions are unlikely to list disease, epidemics, or quarantine specifically, many include general provisions covering such things as natural disasters, “acts of God,” “acts of government”, or “other circumstances beyond the parties’ control.” Any party seeking to invoke the force majeure provisions in its contract generally must show that there are no alternative means for performing under the contract, as increased costs alone will not be sufficient to prevail on a claim of force majeure. But what if you don’t have a contract with the party that is applying pressure against you? Or, what if your contract does not have a force majeure clause? You may still have options! Many states have developed common law equitable defenses that excuse a party’s breach due to nonperformance caused by forces beyond the party’s control. For example, states such as California, New York and Texas each recognize and have enforced doctrines referred to as “impossibility of performance” and/or “frustration of purpose”. In each instance, the breaching party can be excused from its obligations where the cause of the breach is beyond the party’s control, the circumstances of the intervening event were unforeseen by the parties at the time the agreement was entered into, and/or the intervening event changed the circumstances of the agreement to the extent that the purpose of the agreement could no longer be accomplished.
Under standard business operations, the company’s board of directors and “C-suite officers” owe fiduciary duties to the company’s equity stakeholders. However, when the company enters the “zone of insolvency” (i.e., starts to experience one or more of the warning signs listed above), management’s fiduciary duties shift from the shareholders to the company’s creditors. Management must be very careful in the decisions that it makes on behalf of the company during times of distress. A failure to observe the proper action could expose members of the company’s management team to personal liability for breach of fiduciary duty when not acting in the best interests of the company’s creditors.
When you spot a customer in distress (e.g., lingering and/or growing receivables balance, delayed payments, sporadic amounts paid, oddly grouped invoices, decreased communications), unless you are under a binding, term of years contract that cannot be modified, you should consider switching payment conditions from net of receipt to pay on delivery or cash in advance. Again, communication is key.
Public companies should review and make accurate required disclosures, in the event that business operations are impacted such that a reporting requirement is triggered under the SEC’s “34 Act”. All companies who are parties to credit agreements and other financing arrangements should review existing MAC (material adverse change) clauses, and potential impacts on the borrower’s financial covenant compliance.
Companies should review insurance policies to determine possible coverage in the event of a business interruption, and comply with all applicable notice requirements. Put your carrier on notice as soon as you experience the potential for making a business interruption claim. Click here to review the top five considerations regarding insurance coverage.
In summary, it is important for companies in distress to take steps now in order to mitigate the negative impacts from the coronavirus. 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. To receive this content directly in your inbox, click here and submit the form.