Force majeure and coronavirus
When times are good, the force majeure clause is a large block of text that many readers are happy to skip. Now that COVID-19 has hit the global economy like a meteor strike, it is time to dig in and understand what force majeure means for each player in an infrastructure project.
The threshold question is: does the COVID-19 pandemic constitute a force majeure event?
This may seem obvious, but in fact it is not safe to assume that a global pandemic automatically qualifies as a force majeure event. In a thousand contracts, there are a thousand slightly different frameworks for how force majeure works. Anyone can have an opinion on how force majeure should work, but the executed definitive agreements for each project govern how force majeure does work.
At its core, force majeure has three central elements. First, the event must be unforeseeable. This means that if a contract is entered into after the pandemic was already in progress, COVID-19 should be specifically named in the force majeure clause to indicate an intentional allocation of risk.
Second, the event must be outside the control of the affected party. For COVID-19, this element of force majeure is indisputably clear. It is important to avoid contributing to the event through negligence or misconduct. If a government mandate requires that work crews be reduced by 50% in order to reduce density, and a construction site is shut down for failure to comply with the rule, then the misconduct could negate that party’s ability to claim force majeure.
Lastly, force majeure is about the impossibility of performance, not the inconvenience of performance. In the aftermath of Hurricane Harvey, for example, shipping in the Gulf of Mexico came to a standstill, and equipment could not be delivered to projects in Texas and Louisiana. Global shipping costs also increased due to the hurricane’s supply disruptions. European or Asian projects could not reasonably declare force majeure for a hurricane that made landfall in the United States. Global price increases, although unforeseeable and outside the control of the parties, are simply commercial risk.
For COVID-19, a strong force majeure claim should articulate the link between the pandemic and the impossibility of performance: that a government order makes it impossible to carry on with manufacturing or construction work, that permitting approvals have slowed down due to closure of government offices, that equipment has been delayed or that it is no longer possible to continue work while complying with employee health and safety regulations.
These three concepts are the theoretical underpinnings of force majeure, but things get messy when theory meets practice.
Since parties often use precedent documents to streamline negotiations, a poorly drafted force majeure clause can get passed down from deal to deal like a defective gene. A poorly drafted version might, for example, simply list “acts of war, severe weather, work stoppages” without specifying that force majeure includes all events that are unforeseeable, outside of the control of the affected party, and prevent the performance of the contract. If that is the case, COVID-19 can only qualify to the extent it can fit into one of the listed categories, such as “work stoppages,” “supply disruptions,” or “acts of a governmental authority.”
Further, some recent contracts have specifically excluded supply-chain issues from the force majeure definition. This was intended to allocate risk for the Trump administration’s tariffs on imported solar modules, but the effect can be wider depending on the specific language.
Effects of Force Majeure
Force majeure is an excuse. Specifically, it is an excuse to delay or modify performance.
If a supplier or construction contractor declares a valid force majeure event, then the delivery milestones will be extended without penalty.
If a project owner declares a valid force majeure event under a power purchase agreement, then the project will typically be excused from selling power for the duration of the event. For projects that have not yet commenced commercial operations, the guaranteed milestone dates will usually be extended day-for-day.
There can be a downside to declaring force majeure because many contracts have a termination right for extended force majeure. Depending on whether a termination right arises after 90, 180, 365 or some other number of days, it can be a gamble to declare force majeure in the face of an event as uncertain as the COVID-19 pandemic.
Most contracts have a deadline for declaring force majeure, so it is not always possible to wait and see whether the benefit of excused performance is worth the termination risk. Contracts vary widely in terms of the window for declaring force majeure. Some windows start when a force majeure event actually occurs, while others are triggered by a party’s awareness of an impending force majeure event. Some windows last for only 24 hours, while other windows remain open for weeks.
In the absence of certainty, many companies have chosen to send preliminary notices that a force majeure event may occur. This is a good way to maintain transparency while also reserving the right to declare a force majeure event at a later date.
When a project owner receives a force majeure notice from one of its contract counterparties, there are two actions to take immediately.
The first step is to respond to the notice with a reservation-of-rights letter.
The second step is to determine who else needs to know that a force majeure notice has been received. Lenders and investors are almost always on this list, and power purchasers, interconnection providers, construction contractors, equipment suppliers, site owners and governmental authorities may also need to be notified. The timeframe for reporting can be as short as 24 hours, so it is important to think quickly and review all of the relevant contracts for potential knock-on effects.
Material Adverse Change
There is one obligation that is never excused: the payment of money. This is why loan agreements usually do not have force majeure clauses.
In fact, loan agreements have the opposite: borrowers must always repay the loans on schedule, but lenders have material adverse change provisions that allow lenders to stop making disbursements.
The material adverse change provision gives lenders a leverage point to bring the borrower back to the negotiating table. Lenders will want to know how force majeure events might affect the project timeline and economics. Depending on the facts of each project, lenders might agree to extend certain deadlines, or they might require partial prepayments or otherwise change the commercial terms before resuming disbursements.
In most financing documents, an event of force majeure or a material adverse change would not, by itself, trigger an event of default. However, failure to notify the lenders could be a breach of the reporting requirements, which can lead to an event of default. Even in the absence of a clear material adverse change, it is better to keep lenders and investors informed as the
COVID-19 situation evolves. Clear and consistent communication is critical to a strong working relationship, and in times of crisis there is simply no replacement for trust.