29 April 2020 3:04 PM GMT
The global eruption of the COVID-19 pandemic has dented International trade to a great extent which is both, the basis and the product of globalization. The pandemic has hampered businesses and trade across the globe with its spill overs passing on to the indigenous businesses as well. In order to curb the spread of COVID-19, various measures such as Lockdowns, restrictions on movement...
The global eruption of the COVID-19 pandemic has dented International trade to a great extent which is both, the basis and the product of globalization. The pandemic has hampered businesses and trade across the globe with its spill overs passing on to the indigenous businesses as well. In order to curb the spread of COVID-19, various measures such as Lockdowns, restrictions on movement of goods and sealing of borders have slowed down the economy across the globe, leading to a historic downward demand and supply of goods and services.
Recently, the World Trade Organization (WTO) has developed two plausible scenarios with regards to the effect of the COVID-19 pandemic i.e. in an optimistic scenario, the volume of global merchandise trade will fall by 13% in 2020 compared to 2019 and if the pandemic is not brought under control, and governments fail to implement and coordinate effective policy responses, the decline could be 32% or even more than that.
The World Health Organization (WHO) declared COVID-19 as a "pandemic" on March 11, 2020. The COVID-19 pandemic has taken the entire world hostage in less than four months and the global economy has been hit the hardest with governments across the globe implementing stringent policies including lockdowns to control the COVID-19 outbreak. The United Nations Department of Economic and Social Affairs has stated that the COVID-19 pandemic is disrupting global supply chains and international trade with numerous countries closing their borders during the past month, the movement of people and tourism flows have come to a screeching halt. In India, the Ministry of Finance has issued an Office Memorandum on February 19, 2020, recognizing the disruption of the supply chain across borders as well.
COVID-19 has had a crucial impact on the performance of proposed cross border transactions that were in the diligence/bidding stages as due to the recent downturn in global trading markets, the procurement processes have been delayed or even cancelled in some ongoing projects because of COVID-19. Furthermore, there is a strong possibility of contracts being terminated due to unprecedented situations, as parties are not able to carry out their contractual obligations due to borders being shut down or due to self-isolation.
Another adverse effect of the pandemic is that certain suppliers under a cross border transaction may fail to perform their obligations since COVID-19 has prevented them from exercising their contractual obligations. By taking advantage of this pandemic certain parties may even try to renegotiate the significant terms of the contract citing COVID-19 as the basis. For instance – parties may try to negotiate the volume and price of materials exported from or imported into affected areas owing to the shift in demand and supply.
Price of goods and services have declined due to fall in consumption and manufacturers are also considering cutting output of the same. The pandemic crisis has triggered large erosion of demand globally. One such instance is the historic drop in crude oil prices. An additional complicating factor is the growing number of export prohibitions, which some WTO members have introduced to mitigate critical shortages at the national level. As per the WTO's note on Export Prohibitions and Restrictions, as on 23.04.2020, 80 countries and separate customs territories have introduced export prohibitions or restrictions as a result of the COVID-19 pandemic. It is pertinent to mention here that prohibitions and restrictions on cross border transactions, may in the short run lower domestic prices for the goods in question and increase domestic availability. However, these measures will lead to a reduction in the global supply of the products concerned and importing countries without the capacity to manufacture these products would likely suffer. Furthermore, the restrictions initiated by one country may end-up triggering a domino effect which in turn will have a drastic impact on cross border transactions.
It is undisputed that the present situation is unprecedented and most parties aren't accustomed to tackle such a situation. The pandemic has led to two situations wherein its effects can be tackled i.e. where the agreement for cross border transaction has been executed prior to the outbreak of COVID-19 and the second situation being where such an agreement has not yet been executed.
For those agreements that have been executed prior to the outbreak of COVID-19, an honest attempt must be made to peruse the contractual provisions thoroughly that can allow any form of relief to the affected party. One such provision is a force majeure (FM) clause. By invoking the FM clause, the affected party may be absolved from performance of its obligations without being liable to pay any liquidated damages as long as the pandemic subsists. Under a well drafted agreement for cross-border transactions, an FM clause would include the specific events that would fall under the definition of FM, which would include epidemics and/or pandemics and such a definition would acceptable across jurisdictions. In the absence of a FM clause, parties may rely on the Doctrine of Frustration which has been a long standing principle under the common law jurisdictions. Further, while invoking the FM clause, it is significant to consider whether the relevant force majeure event qualifies as a force majeure event in all the concerned jurisdictions around which the concerned cross border contract revolves. We have experienced that parties have invoked the FM clauses even when there is no real impact on the transaction. For instance, all major ports in India are operational, however several suppliers have refused to ship goods to India in view of COVID-19 and such refusal may lead to contractual and legal consequences.
Secondly, if Mergers and Acquisitions (M&A) form a part of cross border transactions then keeping in mind the present scenario, the M&A transaction would invariably fall under a cloud of vagueness owing to a disruption in the supply chain as explained previously. In such a situation the affected party may resort to seek shelter under the contractual provision of Material Adverse Change (MAC). In agreements for cross border transactions, what would constitute an MAC is often negotiated between the parties and the same is subject to numerous exclusions, which might vary from case to case. It is therefore essential that a careful examination of the MAC provision is carried out in order to determine whether the same is specific to a COVID-19 like situation or not. For an MAC provision to be enforceable, it is pertinent that the trigger for invoking the MAC clause is not subjective, failing which the parties would have to engage in time consuming and expensive litigation.
Thirdly, a major restriction placed by government authorities across the globe is declaration of lockdown to contain the spread of COVID-19. This lockdown is supplemented by various restrictions such as sealed borders & restrictions on movement of labor leading to non-delivery of goods and services. A lockdown in essence is a directive given by the government/government instrumentality which has led to a complete disruption in the supply chain for cross border goods and services. Most agreements for cross border transaction contain a provision for allocation of risks and costs in case of a change in law subsequent to entering into the agreement. Usually, in cross border transactions the parties have already chosen the jurisdiction they would be subjected to which in turn would mean that any change in law outside of such jurisdiction would not allow any relief to the affected party. However, in the preset scenario, given that the entire global economy has been battling with the COVID-19 pandemic, the restrictions are predominantly the same across all jurisdictions. Therefore, in agreements that contain such a change in law provision, attempt must be made to carefully scrutinize the provision and place the lockdown and related restrictions under its ambit and to do this it is essential that the change in law provision be examined carefully as there may be situations where a change in law in a particular jurisdiction is not considered a change in law in the other one.
Finally, in case there still exist certain ambiguities, the affected party can resort to terminate the agreement for the cross border transaction. Whether or not a termination right will be available to the affected party will depend heavily on how such a provision under the agreement has been worded. A party seeking to enforce a termination right in light of COVID-19 should cautiously consider whether the relevant conditions/pre-conditions under the agreement to terminate have been met and should also look to ensure full compliance of other corresponding procedural requirements.
The second situation is one where the agreement for cross border transactions has not yet been executed. In this situation, first and foremost both parties must resort to articulate drafting of the provisions with respect to the COVID-19 pandemic, by clearly defining the risk allocations between the parties which in turn may assist the parties to limit the adverse effect of the COVID-19 outbreak.
Secondly, if an M&A forms an integral part of the proposed agreement for cross border transaction then it is essential that the most precise possible definition of the materiality threshold desired by the contracting parties is drafted in order to avoid any dispute with regards to the MAC clause.
Thirdly, if under the agreement, the parties are required to fulfill certain Condition Precedents (CP) in order to give effect to the operative part of the agreement, the parties must consider whether the CPs proposed to be inserted in the agreement can be satisfied in light of the prevalent conditions. For instance, a CP under the agreement that requires the parties to undertake certain compliances in respect of the applicable laws of both jurisdictions and internal policies, would most likely not be fulfilled owing to the lockdown restrictions that have been imposed across jurisdictions thereby not allowing the parties to attain the necessary approvals required as a CP. Further, if the parties execute an agreement for a cross border transaction under the present prevailing circumstances without inserting any necessary provisions specific to the pandemic, then after execution of such agreement, a party would not be able to take shelter of FM clause since COVID-19 would then be considered as a foreseen event.
Fourthly, for agreements which are yet to be executed/drafted, efforts must be made to incorporate the allocation of risks associated to change in law between the parties and corresponding reliefs must be provisioned for the affected party keeping in mind the definition of change in law across both jurisdictions. Furthermore, with regards to termination of the agreement, it is strongly suggested that a specific clause with respect to termination owing to COVID-19 be inserted.
It is therefore evinced that the rampant outburst of the COVID-19 pandemic is having a crucial impact on global trade in several aspects and has left the parties to a cross border transaction in a baffled state. As discussed above, if the agreement with respect to the cross order transaction is in the pre-signing phase, then the executing entities may attempt to propose and reconsider key aspects of the agreement by incorporating the short term and long term effects of the COVID-19 pandemic. Whereas if the agreement for the cross border transaction was executed before the outbreak of the pandemic, it is critical that a careful examination of the abovementioned contractual provisions be taken up at the earliest along with compliance of the procedural aspects that come along with it. By doing so it would be possible to mitigate the risks arising out of such agreement and would most certainly allow the affected party to be placed at a better footing to tackle the effects of this pandemic.
In addition to the above, the International Chamber of Commerce (ICC) has issued certain guidelines for business entities which include –creation of a business continuity plan to ensure that the business can keep running in the event of stricter guidance, the nomination of a response team to stay apprised of advisories from local authorities and revising operations accordingly, implementation of a reporting method to maintain accountability, contacting suppliers and contractors to advise them of changes in procedures and adopting a flexible and opportunistic approach to adapt business practices to respond to new challenges that may arise.
Therefore, it is needless to say that the COVID-19 pandemic is here to stay for some time. However, if certain measures as discussed above are taken at the earliest then prevention of the after effects of this pandemic can be dealt with strongly and during the process business entities engaged in cross border transactions will most certainly pick up new tricks of the trade which will change the way to conduct the international business post-COVID-19 for sure.
Rajdutt Shekhar Singh is Partner at Singh & Associates and Anand Pratap Singh is an Associate at Singh & Associates. The authors views are personal.