The COVID-19 crisis has impacted businesses in most industries and in most developed countries.   In particular, companies are trying to decide if the effects of the pandemic, together with the associated governmental shutdowns on wide swaths of the economy, provide their business with the ability to terminate or excuse performance under an existing contract, or provide a contract counterparty with the same opportunity.  In the merger and acquisition context, parties have already begun to utilize the effects of the COVID-19 pandemic as an excuse to walk away from a deal.

Force Majeure Claims

Force majeure literally means “a superior force” and historically referred to events beyond the parties’ anticipation or control that intervened to make contract performance impossible – including acts of nature, such as hurricanes and fires, and acts of people, such as strikes, riots and wars.   One key factor in analyzing any agreement, including a purchase or merger agreement, is whether the agreement includes a force majeure clause at all.   Force majeure clauses vary widely, but they typically list specific events relieving contract performance and end with a broad “catch all” such as:

“Neither party shall be liable to the other for failure to perform an obligation to the extent such failure was caused by acts of God, terrorism, riots, civil disorder, strikes (except those caused by a party’s employees or agents), war, or any other act outside the parties’ control which could not be avoided by the exercise of due care.”

Less frequently, the force majeure clause will include language such as “disease, epidemics and pandemics” in the laundry list.  The current COVID-19 pandemic has made drafting of a force majeure clause, or a material adverse effect (“MAE”) clause, critical in M&A agreements.   A seller will obviously want to make sure that the COVID-19 crisis is not an excuse for a buyer to terminate the agreement, and should specifically provide so in the agreement by removing language providing that an epidemic or pandemic is per se a force majeure event, and/or perhaps by stating the opposite.   Conversely, a buyer will want to make sure that if the COVID-19 crisis is not resolved, or worsens, that at some point the buyer should not be required to consummate the transaction.   While under Texas law, a party seeking to invoke a force majeure clause is not required to exercise reasonable diligence to perform or overcome the event constituting force majeure unless the clause expressly requires them to do so.[1] If it does, the party must exercise “such diligence as an ordinarily prudent and diligent person would exercise under similar circumstances.”[2] Whether a party exercised reasonable diligence is a fact-intensive question that is decided on a case-by-case basis.[3]

Foreseeability

If agreement includes a force majeure clause does not include epidemics, pandemics or the like, the parties will have to determine if the clause’s ‘catch all’ provisions would be triggered by COVID-19.  Texas courts have held that those provisions only excuse events that were unforeseeable at the time of contracting.[4]   Because general market fluctuations are foreseeable, economic hardship, standing alone, is usually not enough to fall within a typical force majeure clause that does not include specific epidemic or pandemic language.  COVID-19 was probably not foreseeable itself, but one could argue that epidemics and diseases are generally foreseeable, especially in light of prior outbreaks of H1N1, SARS, MERS, and swine flu, and the parties should have specifically provided for that contingency in the contract. Additionally, parties who entered into contracts after January 2020, when the virus began to attract worldwide attention, will have a more difficult argument that COVID-19 was unforeseeable than those who entered into the contracts earlier.

Impossibility-of-Performance Defense

If a purchase agreement does not contain a force majeure clause, or it cannot be read to cover COVID-19, a party may still have the ability to have its performance excused.  The Texas Supreme Court has adopted impossibility-of-performance defense set out in Section 261 of the Restatement (Second) of Contracts.[5] That defense is available when the parties entered into the contract on the basic assumption that an event would not occur but it occurred anyway.[6] “Determining whether the non-occurrence of a particular event was or was not a basic assumption involves a judgment as to which party assumed the risk of occurrence.”[7] Needless to say, the party seeking relief must not have been at fault in causing the event to occur.    An impossibility of performance claim has higher hurdles than a typical force majeure claim, as unlike in a force majeure case, the party claiming impossibility must show that they made reasonable efforts to surmount the obstacle to performance, and performance is excused only it is impracticable in spite of such efforts.[8]   Additionally, the impossibility defense applies in fewer situations than most force majeure clauses. Texas courts have previously upheld it in only three scenarios: (1) a person who is necessary for performance of a contract dies or becomes incapacitated; (2) the specific thing necessary for performance is destroyed or deteriorates; or (3) a change in the law makes performance of the contract illegal.[9]

Recent M&A Application

In Omar Khan et al. vs. Cinemex USA Real Estate Holdings, Inc. and Cinemex Holdings USA, Inc., Cause No. 4:20-cv-01178, filed in U.S. District Court, Southern District of Texas, plaintiff Omar Kahn entered into multiple purchase agreements to sell his Star Cinema chain of movie theaters to defendants Cinemex.    After an investment bank marketed the business in December 2019 and January 2020, the parties entered into an exclusivity agreement for the potential sale of the business, and ultimately binding (or so Mr. Khan thought) purchase agreements on March 10, 2020.   The parties were aware of the COVID-19 pandemic at that time of the purchase agreements’ signing, although perhaps not fully of its severity, and had evidently reduced the purchase price as a result.  However, at the time of entry into the contract, most states and local jurisdictions had not entered ‘stay at home’ or similar orders, including the State of Texas, where Mr. Kahn’s theaters are located.   The Star Cinema purchase agreements did not include a force majeure clause but did include a condition to closing that included a “material adverse effect” or “MAE” provision, but the MAE provision in the purchase agreements specifically excluded “epidemics, pandemics [and] outbreaks”.    Cinemex notified Khan that it would not close the transaction ‘in light of COVID-19 related fallout”, claiming that it was excused from performance because it did not have pre-closing access to Star Cinema theaters and employees as required under the purchase agreements.    Because there was no specific force majeure provision, Cinemex included claims of impossibility, impracticability, illegality, frustration of purpose and commercial frustration.   While the case was pending in the U.S. District Court for the Southern District of Texas, both Cinemex entities who were parties to the purchase agreements declared bankruptcy on Saturday, April 25, 2020.

Conclusion

Whether COVID-19 is a valid excuse for not performing or delaying performing under a purchase agreement is heavily dependent on the facts of the case and the contract language at issue, requiring a particularized analysis.Parties should not rely on ‘boilerplate’ force majeure or MAE clauses and should clearly draft provisions that protect their respective interests.


[1] Sun Operating Ltd. P’ship v. Holt, 984 S.W.2d 277, 282–83 (Tex. App.—Amarillo 1998, pet. denied).

[2] See El Paso Field Servs., L.P. v. MasTec N. Am., Inc., 389 S.W.3d 802, 808 (Tex. 2012).

[3] Id.

[4] E. Air Lines, Inc. v. McDonnell Douglas Corp., 532 F.2d 957, 990 (5th Cir. 1976) at 990; TEC Olmos, LLC v. ConocoPhillips Co., 555 S.W.3d 176, at 184 (Tex. App.—Houston [1st Dist.] 2018, pet. denied).

[5] Samson Exploration, LLC v. T.S. Reed Props., Inc., 521 S.W.3d 766, 775 (Tex. 2017); Centex Corp. v. Dalton, 840 S.W.2d 952, 954 (Tex. 1992).

[6] Samson Exploration, 521 S.W.3d at 775 (quoting Restatement (Second) of Contracts § 261 (1981)).

[7] Tractabel Energy Mktg., Inc. v. E.I. du Pont de Nemours & Co., 118 S.W.3d 929, 931 (Tex. App.—Houston [14th Dist.] 2003, no pet.) (quoting Restatement (Second) of Contracts ch. 11, introductory note (1981)).

[8] Sherwin Alumina, L.P. v. AluChem, Inc., 512 F. Supp. 2d 957, 973 (S.D. Tex. 2007); Restatement (Second) of Contracts § 261 cmt. d (1981).

[9] Phillips v. McNease, 467 S.W.3d 688, 695 (Tex. App.—Houston [14th Dist.] 2015, no pet.); Tractabel Energy Mktg., 118 S.W.3d at 931.