Commercial Impact From the Coronavirus Outbreak – Review Force Majeure and Material Adverse Change Clauses, and Potential Insurance Coverage

By Eric L. Kintner and Robert F. Kethcart

Businesses across a wide range of industries are grappling with how to address the practical and legal concerns that have been created by the COVID-19/coronavirus outbreak.  Businesses have started asking when and how they can terminate their agreements due to the outbreak and whether insurance may be available to cover cancellation charges or loss of income.  Below are some general thoughts on typical force majeure and material adverse change clauses as well as potential insurance coverage.  The wording in agreements and insurance policies is often nuanced, and the impact of the outbreak on any one business is fact specific, so we recommend reviewing the actual language and facts with your advisors.

Force Majeure

This clause is often cited by parties to a commercial or financial agreement that seek to terminate or excuse performance due to events like the coronavirus outbreak.  A typical provision might read:

Neither party shall be liable for any failure or delay in performance of its obligations under this Agreement resulting directly from fire, flood, or other acts of nature; war; strike or work stoppage; civil disturbances; acts of governmental authorities; or any other cause beyond such party’s reasonable control. The affected party shall (i) give prompt written notice to the other party of the nature and date of commencement of the force majeure event and its expected duration, and (ii) use commercially reasonable efforts to avoid or remove the force majeure event as soon as possible to the extent it is able to do so.

The burden of proof will be on the party seeking to invoke this provision to show that the coronavirus outbreak fits within the enumerated force majeure events and such party’s performance failure or delay resulted directly from the outbreak.  For example, governmental travel or quarantine restrictions would seem to fit within the enumerated “acts of governmental authorities.”  It may be difficult to trigger this clause based solely on the catch-all “other cause beyond such party’s control” because courts often apply a rule of contractual interpretation that the specific language controls the more generic language, and thereby seek to limit the catch-all language to those kinds of events specifically listed earlier in the provision.

Businesses with agreements that may be impacted by the outbreak should promptly review their agreements in order to assess their rights and obligations.  For example:

• Review force majeure provisions to determine whether the current coronavirus outbreak is covered and whether either party has a right to terminate the agreement or delay performance if the provision is invoked.
• If the outbreak is covered, ensure that notice requirements have been met, which may be a prerequisite to a party being able to trigger the force majeure provision.
• Seek to open communication lines between the parties to mitigate potential losses, such as whether alternative arrangements or waivers of fees may be appropriate.
• Evaluate whether force majeure notice received from one party, such as a manufacturer or downstream supplier, may trigger a force majeure event requiring notice to another party, such as downstream suppliers or customers.
• Remain vigilant in reviewing governmental restrictions and monitoring new governmental announcements to help assess impact on contractual commitments.

For companies entering into new commercial agreements that are concerned about the need to terminate the agreement in the future due to the coronavirus outbreak, special attention should be given to these force majeure clauses.  In addition to including “diseases” or “epidemics,” consider including additional language that would excuse a party’s performance if “commercially impracticable” due to an event not within the reasonable control of the party seeking to claim force majeure.  If this language cannot be added, consider whether the parties might agree to reduce or eliminate any minimum goods or service requirements in the event the outbreak causes a general economic downtown or business losses.

Material Adverse Change

Some M&A and financial agreements allocate risk among the parties if there is a material adverse change to the business or its prospects.  For example, a purchase agreement may condition the closing of the purchase of the target’s business on not suffering any material adverse change.  In addition, a term loan agreement may require the borrower to represent and warranty that, at the time of any future disbursement, there has been no material adverse change in the borrower’s financial condition or assets of the borrower.  Material adverse change clauses often exclude general economic downturns that have broad application, so it is usually necessary for a party seeking to invoke any material adverse change clause to show how the party’s business has been uniquely impacted by the coronavirus outbreak. Companies that are considering entering into new M&A or financial agreements should assess whether the coronavirus outbreak would likely have a material adverse impact that is unique to its business or prospects, and whether termination of the agreement or some other remedy should be available in such event.

Insurance

Businesses facing the prospect of cancellations, disruptions and losses because of the coronavirus outbreak are asking whether these losses would be covered by their insurances. Whether a loss is covered depends on several factors, including the kind of insurance coverage, the kind of loss that is at issue, and the specific terms and conditions of the insurance policies, which often vary. However, there are several lines of insurance that could potentially apply and should be considered.

Event Cancellation Insurance

Some businesses that schedule large meetings and events purchase event cancellation insurance to protect against potential losses caused by needing to cancel, postpone, or cut short the event, or due to reduced attendance, as a result of a “covered event.” Coverage under these policies for cancellations or disruptions due to the coronavirus outbreak is possible, but not automatic. Standard event cancellation policies often include infectious or communicable disease exclusions. And even if a business purchased a communicable disease endorsement or “rider” on its policy, these endorsements frequently include additional exclusions that may preclude coverage for losses resulting from the coronavirus outbreak. Thus, it is important to evaluate the actual language in the policy. If losses resulting from the coronavirus outbreak are not clearly excluded, then event cancellation insurance may respond and provide coverage for some of these losses.

Travel Insurance

Since the coronavirus outbreak began, we have seen reports of a spike in travelers seeking cancellation coverage under travel protection plans. However, most travel protection plans do not cover losses caused by events that were known or foreseeable at the time the protection plan was purchased. They also typically do not cover losses caused by an epidemic. As a result, travel protection plans purchased after mid-to-late January 2020 likely will not cover travel cancellations as a result of the coronavirus outbreak.

Business Interruption Insurance

Business interruption insurance, which is often purchased as part of a business’s commercial property insurance, can provide coverage for lost business income (frequently defined as net income plus certain operating expenses, such as rent and payroll) and associated extra expense (typically defined as expenses incurred to avoid or minimize the suspension of business) during a period of business interruption. This coverage is typically triggered when the policyholder sustains “direct physical loss of or damage to” insured property because of a covered peril. Many commercial property policies also include an extension for contingent business interruption insurance, which is triggered by direct physical loss of or damage to the insured property of a customer or supplier.

There is no uniform rule across all jurisdictions about when there has been sufficient “physical loss of or damage to” insured property to trigger business interruption insurance. Several courts have determined that structural damage to insured property is not necessarily required; instead, it can be sufficient if contamination or conditions such as gasses or bacteria render property temporarily or permanently unusable or uninhabitable.

Commercial property policies also often provide an additional coverage for lost business income and associated extra expense when a “civil authority” prohibits access to the premises of the insured. Insureds in the healthcare, hospitality, retail and entertainment industries often have coverage (sometimes sub-limited coverage) for losses resulting from communicable or infectious diseases, murders or suicides that occur at or near the premises of the insured.

Thus, businesses that suffer business disruptions because they are located in or near areas where people have contracted the coronavirus or that suffer supply-chain disruptions because their suppliers or customers are located in or near areas where people have contracted the coronavirus, should consider and evaluate whether the particular facts might be sufficient to trigger business interruption coverage under their commercial property insurance policies.

Businesses concerned about the risks occasioned by communicable or infectious disease outbreaks should also consider whether to purchase “communicable or infectious diseases” coverage, either at this time or when their policies come up for renewal.

Commercial General Liability Insurance

Businesses are also concerned about the possibility of claims by guests or customers who claim they acquired the coronavirus because the business allegedly failed to exercise reasonable care in reducing the chances of exposure to coronavirus or allegedly failed to adequately warn about the risk of exposure. Commercial general liability (CGL) insurance policies protect businesses against claims by third-parties for suits seeking damages because of bodily injury resulting from alleged exposure to harmful substances or conditions. So long as a business acts reasonably and does not recklessly or intentionally subject its guests or customers to exposure to the coronavirus, these CGL policies should respond with coverage (both defense and indemnity) for these claims in the absence of uncommon exclusions.

Workers Compensation Insurance

Businesses may also face claims from their own workers who acquire the coronavirus. Workers’ compensation statutes and insurance generally cover occupational diseases and injuries. While many states’ workers’ compensation statutes generally exclude “ordinary diseases of life” from the workers’ compensation system and insurance programs (e.g., a common cold and the flu), if an employee can establish a direct connection between acquiring the coronavirus and the workplace, there may be a valid argument for workers’ compensation insurance coverage. If workers’ compensation coverage is not available, commercial general liability coverage might still be available.

Errors & Omissions (E&O) and Directors’ & Officers’ (D&O) Liability Insurance

Businesses facing potential losses and claims due to the coronavirus should also consider potential coverage under E&O and D&O insurance policies.

Many insureds in the healthcare industry have E&O insurance coverage that protects against claims and damages that a healthcare provider faces because of bodily injury resulting from the provision of, or failure to provide, healthcare-related services. These policies may provide coverage if a patient or other guest to a medical office or hospital (other than an employee) were to claim they acquired the coronavirus as a result of visiting the medical office or hospital.

Similarly, a business, or the business’s officers or directors, could face claims from third-parties or stakeholders (shareholders or members) based on allegations that the business’s officers and/or directors and/or employees were negligent or failed to take appropriate measures to respond to the coronavirus outbreak or to protect against a risk of injury at a business-related event, resulting in losses to third-parties or to the business. Most D&O policies contain exclusions related to claims arising out of bodily injury; however, the wording of these exclusions is not uniform and should be given a strict and narrow construction under the laws of most jurisdictions. Thus, D&O policies may provide coverage for the costs and liabilities associated with these potential claims, particularly if the claims seek only economic damages.

Conclusion

The coronavirus outbreak has rightfully caused businesses to consider whether they can terminate their commercial or financial agreements, and whether they have insurance that may cover their potential losses. The answers to these questions will depend on the particular language in the agreements and the insurance policies. It is important to analyze the language of these agreements with the business’s trusted advisors and experts. This will put the business in the strongest position to maximize its options with its business parties and insurers, and minimize its potential losses.