As the COVID-19 coronavirus outbreak continues to increase, it is likely it will have a profound impact on agreements, including credit agreements. Thus, ensuring welfare of financial institutions and companies is paramount.
The outbreak is hitting companies in every industry and jurisdiction. As a result, impacted borrowers are taking drastic action to manage their outgoings, carve out liquidity and preserve cash. Given the situation, companies and financial institutions are questioning if they are able to perform their obligations under an existing credit agreement.
In order to give a conclusive answer to this question, it is essential to know the legal provisions that regulate the force majeure and act of God event, the unforeseen events theory, the possible termination clause, and the material adverse change clauses, among others. This analysis must be carried out on a case-by-case basis, so the affected party must identify the contractual provisions that have been or may be affected by COVID-19.
The MAC/MAE Clause: Material Adverse Change or Material Adverse Effect
Events giving place to a force majeure are commonly regulated under commercial agreements through the material adverse change (“MAC”) or material adverse effect (“MAE”) clauses. The financing documents are not the exception. The MAE/MAC clauses are included in order to allocate risk among the parties in the event of a “material” adverse change or effect occurs to a business, and are essential to the lender for envisaging protection against unforeseen “material” changes that could arise to the borrower’s financial situation, market fluctuations, among other cases. The negotiation of these type of clauses is normal, even if borrowers may have a view of MAC clauses as a burden imposed to fully commit to the loan.
To identify whether a MAE or MAC clause can be triggered due to the novel coronavirus crisis, it is a case-by-case analysis that shall be assessed through the specific terms of the agreement. Either to avoid performance of a party without incurring in liability, or to allow a party to terminate a financial commitment, it is fundamental to identify the terms, conditions or events set forth in the credit agreement. For this, it is of utmost importance to identify whether the definition or clause of MAC or MAE is focused on the financial condition, the general ability of the borrower to meet its obligations and assets of the borrower or if within the definition, the general economic or political conditions in the country where borrower does business. And also, if systemic risks related to contiguous disease, as pandemics, epidemics and public health crises, are included.
To that end, MAE/MAC clauses, in many cases, are contained within loan commitments twofold: (i) as a condition of the lender to fund, in which borrower needs to represent that no MAE/MAC has occurred to disburse the funds; and (ii) as an event of default at the occurrence of a MAE/MAC, which might allow the lender to terminate and accelerate the loan.
For a MAC clause to be applicable, the invoking party would customarily need to demonstrate that the outbreak (COVID-19) has had a substantial “material” adverse impact on the borrower’s financial condition or operations to perform its obligations, during a significant period, due to general economic or political conditions in the country where the borrower does business or a systemic risk related to a contagious disease. This can only be invoked if the definition of MAE/MAC contains the above conditions in the credit agreement. In this scenario, the invoking party shall abide by any notice requirements associated with the terms of the MAC clause or the financial documents.
Accordingly, while unlikely but possible, if a borrower wishes to invoke the MAE/MAC clause, it must prove that it is unable to perform its obligations (of payment). On the contrary, if the MAE/MAC definition does not refer to economic or political conditions or systemic risk, it would make difficult to the borrower to invoke the occurrence of a material change.
Another relevant device in the context of COVID-19 is the authority to terminate the credit agreement, which consists of granting the right to one of the parties or any of them (usually to the lender), from a certain date or at any time, as applicable, to unilaterally terminate by notice to the other party, the right to dispose of the credit (normally applicable in revolving credits or with multiple provisions). This is possible even when the other party complies with its obligations. If the agreement was terminated by one of the parties, the credit amount that the borrower would not have used would be extinguished, but the borrower would not be released from paying the commissions and expenses corresponding to the non-provision of the loan, unless otherwise stipulated. The termination of an agreement does not imply an early expiration.
Force Majeure and Act of God
Sometimes, the debtor of an obligation may be prevented from fulfilling it for reasons not attributable to it. For example, when an event is outside the domain of your will or control, could not have been foreseen or even anticipated or could not have been prevented. The force majeure or act of God is then defined as an unpredictable, general, absolute and sometimes definitive obstacle that empowers the borrower to not fulfill its obligation without liability. The legal principle behind these figures is that no one is obligated to the impossible. According to the Federal Civil Code, no one is obligated to the “Act of God” clause, except when it has given cause or contributed to it, when it has expressly accepted that responsibility, or when the law imposes it.1
In view of the above, parties to existing agreements should first identify the contractual provisions that have been or may be affected. Specifically, it is relevant to identify if the credit agreement foresees terms regarding force majeure and an act of God event, and identify and review the jurisdiction and governing law clauses. In addition, parties need to assess whether the novel coronavirus outbreak constitutes or could reasonably constitute a force majeure or an act of God event that can excuse a party from its contractual obligations.
The force majeure and an act of God event need to be carefully analyzed. It is of utmost importance to identify whether the agreement includes a force majeure and an act of God definition and if the outbreak can reach this threshold, or if parties need to fall back to the applicable legislation definition.
The right to invoke the force majeure or an act of God event can be waived, as long as it does not affect the public interest or third-party rights, the borrower has not given cause or contributed to it, and the resignation is expressly provided for in the agreement.2 In the event that the agreement does provide for the events of force majeure and act of God, contractual procedural obligations in relation thereto must also be carefully understood. In particular, parties shall be aware if a notice of procedure is to be followed to excuse a party’s non-performance and if an estimated time is considered for the duration of the event, or if after an elapsed period a termination can be triggered.
However, if there is no specific contractual provision in relation to force majeure or an act of God, parties may invoke an absence of liability for failure to performs its obligations due to the impossibility of complying with such, by virtue of Mexican law. For this purpose, the applicable Civil Code shall be invoked, which foresees the force majeure and act of God terms (that for practical purposes are synonyms since the same are attributed to the same legal consequences).
The existence of either can be demonstrated whenever nature, acts of men, or acts of authority, are unpredictable. The existence of such events is not attributable to any of the parties and the effect is the physical inability of a party to fulfill any of its obligations. In this scenario, under a credit agreement, the borrower may invoke such event to be released of or suspend its obligation without liability. Likewise, lenders can invoke such events to be released of making disbursements to the borrower, to avoid incurring liability for its failure to comply with its contractual obligations (i.e., damages, default interests or conventional penalties).
On the contrary, whereas certain local civil codes provide for the application of the Unforeseen Events Theory, also known as the rebus sic stantibus principle—which protects any of the parties allowing the affected party to recover the balance between the contractual obligations to be performed by the parties, or where appropriate, request the termination of a credit agreement whenever an unforeseen act occurs— this cannot be invoked for a credit agreement due to the lack of regulation within the Federal Civil Code.
It is worth mentioning that certain local civil codes provide for the application of the theory of unforeseen events, also known as the rebus sic stantibus principle, which protects either party, allowing the party affected by certain unforeseeable circumstances to regain the balance between contractual obligations to be performed by the parties, or when deemed appropriate, request the termination of the credit agreement in the event of an unforeseen act. However, this is not the case of the Federal Civil Code, under which credit agreements are regulated as a supplementary law to the General Law on Securities and Credit Transactions. In view of the above, articles 1796 Bis and 1796 Ter of the Civil Code for Mexico City and corresponding of other entities, would not be applicable, at least to credit agreements.
However, there are limited possibilities that the COVID-19 outbreak could exempt any of the parties from their contractual obligations in a credit agreement by arguing a case of force majeure. In general, under Mexican law, an event of force majeure would imply the absolute material impossibility of complying with an obligation, unless specifically stated otherwise. Financial "distress" would not qualify as such. However, there could be many more possibilities for COVID-19 to become an event of force majeure that could be invoked as a circumstance that exempts the fulfillment of contractual obligations, such as, if the Federal Government in Mexico, in addition to the resolution that establishes the preventive measures that must be implemented to mitigate and control the health risks associated with the SARS-CoV2 virus (COVID-19) published by the Federal Government, continues to publicly acknowledge the event through federal decrees that limit commercial and social activities.
Legal Issues to Consider
The COVID-19 coronavirus outbreak in Mexico implies risks for parties in credit agreements. In this scenario, the specific terms of a credit agreement should be evaluated in order to determine the applicability of a MAE/MAC clause or the termination clause, or whether a force majeure or an act of God event can be triggered to exempt the fulfillment of any contractual obligation.
Credit institutions have spoken out about the difficulties that companies face in punctually fulfilling credit commitments. In response to this, they have determined to support by partially or totally deferring principal and/or interest payments. In this sense, balances may be frozen without interest charges. Likewise, they could apply the facility for any modification to credit agreements that implies a change in the risk profile of the borrower or the operation and that does not imply a partial or total deferral of capital and interest of more than four months with the possibility of two additional months.
We recommend a preventive legal analysis of relevant obligations arising from credit agreements that could be affected by the outbreak to determine the necessary measures to be taken.
This is only a preliminary view of the issues, which we will update according to changing circumstances.
If you wish to receive periodic updates on this or other topics related to the pandemic, you can be added to our COVID-19 “Special Interest” mailing list by subscribing here. For any other legal questions related to this pandemic, please contact the Firm’s COVID-19 Core Response Team at FW-SIG-COVID-19-Core-Response-Team@mayerbrown.com.