With COVID-19 reaching its peak in some jurisdictions, and the true economic costs becoming clearer, business leaders need to start to shift their focus from the here and now to the opportunities and challenges that they may face in the next new normal, ensuring the strategic decisions made now can position their businesses for the future.
As business leaders consider their plans for short- and long-term stability and resilience, it’s now clear that business contracts, arrangements and relationships are a core foundation for all business activities and response strategies. The ability to understand legal rights and obligations in the web of contracts that govern all aspects of businesses and their supply chains has never been more important.
However, when KPMG professionals informally polled over than 1,600 tax and business leaders during our recent webcast, only 58 percent said their organization had integrated the analysis of legal issues into their COVID-19 business continuity scenarios and associated response planning.
Indeed, as COVID-19 took hold globally, many business leaders I work with have found themselves similarly challenged. They’re working to develop strategies, plans and tactics that can build and maintain resilience at a rapid pace and with incomplete information for decision making. But as it runs its course, we can expect that an organization’s business contracts will be increasingly seen as a core foundation – and asset – of a business, and that the legal issues and analysis that surround them will command more attention in planning for the post-recovery world.
Amid the current conditions, the legal issues that many business leaders are dealing with fall into three broad categories: commercial resilience, operational resilience and financial resilience.
This set of issues centers on how business can be conducted as usual, or as close as possible, in extraordinary times.
For example, with travel restrictions and physical distancing policies in place, the ability to conduct business electronically has become critical. Does your organization’s constitution and governance require in-person board meetings? Does the jurisdiction allow contracts to be executed with electronic signatures? Does a witness need to physically observe a contract’s signing? Do court filings require original, hard-copy documents? Do regulatory filings need to be made in person?
Requirements for physical presence can obstruct virtual activity, but we are already seeing signs that governments, regulators, courts and other authorities are becoming more flexible with these requirements. Those companies that have already invested in updating their governance and processes to permit electronic business conduct are potentially in a stronger position to comply with regulations and ensure any new legal arrangements are enforceable.
The enforceability of rights and obligations under existing contracts can also create issues as many companies try to manage the impacts across their global supply chains. Legal counsel are increasingly looking at the legal concept of force majeure and whether COVID-19 qualifies as a force majeure event — that is, an unforeseen circumstance out of a party’s control that prevents them from fulfilling a contract’s terms and thus releases them from or suspends their obligations.
While many companies are not immediately seeking to exit contracts, legal teams are examining options for the long term and this includes analyzing case by case whether force majeure applies. To invoke force majeure:
China and India are the only two countries with specific legislation that governs force majeure, and in the case of China it has asserted that COVID-19 is a force majeure event for many contracts under its jurisdiction. France and Spain have tabled specific emergency legislation with the similar effect.
The legal concept of frustration is also under review. This is a more technical, judicial right that releases a party from a contract when events make it impossible for them to fulfill their obligations or significantly change what they were meant to do under the contract. However, it is more difficult to assert frustration to terminate contracts than it is to claim force majeure. Given the new attention being given to force majeure in the current situation, these clauses are getting more focus when new contracts are negotiated.
A second set of issues involves the legal underpinnings for keeping the business efficient and productive, which includes managing relationships with employees.
Companies also need to ensure they can continue to comply with their governance requirements in a virtual environment, for example, when board, advisory board and shareholder meetings must be held in person. The ability of management and compliance functions to do their jobs remotely is also important.
As noted, however, it appears likely that many regulators will be reasonable about enforcing time-driven regulatory requirements, such as those for annual general meetings, in light of the current conditions. Nevertheless, it’s important for organizations to make the proper disclosures to update shareholders and other stakeholders about the operational and financial impacts of COVD-19.
Information flows are another area of focus amid the current disruption. Many organizations are challenged to keep communication channels open among employees, suppliers, customers without running afoul of personal data privacy laws.
In the past few years, data, cyber security and resilience of IT systems have become top priorities, and the current environment has highlighted their importance even further. In particular, many organizations are concerned over the ability of their systems to withstand cyber threats with high numbers of employees newly working from home.
While there are no set answers about the best way to manage these issues, organizations might be able to mitigate any adverse legal consequences if they can show they acted properly and prudently to manage risks in this extraordinary context.
Financial resilience issues focus the legal lens on the organization’s capital management plan, including its capital, debt and equity, cash restructuring and plans for growth. In particular, the speed of COVID-19 has greatly affected financing transactions and mergers and acquisitions (M&A) in progress. This is prompting many organizations to review material adverse change clauses, especially where mergers and acquisitions are concerned.
Material adverse change clauses, which became common after the 2008 financial crisis, allow contracts to be exited or renegotiated when material changes in circumstances occur after the contract was executed but before the transaction is complete. Whether these clauses apply in the current situation depends on how the clause was drafted and the specific impact on the transaction.
Material adverse effect clauses play a similar role in the context of financing transactions. These clauses give parties the right to suspend or terminate a capital raise and release underwriters or brokers from their obligations in the event of default and breaches of covenants. In the current environment, it’s important to remember that these clauses generally are only triggered when an event actually occurs, and not on the expectation of a future event.
As many companies seek to build their bridges to the post-recovery world, they should not expect things to simply revert to their pre-COVID-19 state. The current environment has put significant pressure on supply and demand and highlighted the complexity and interdependence of business and modern supply chains with multiple parties and multiple tiers. As companies plan for the future, they need to take into account the requirements and sensitivities of both their customers and their community of suppliers.
Above all, organizations should avoid making short-term decisions, based on technical legal rights, which may help their business now but might damage business relationships and arrangements in the months ahead.
I also expect this will help drive significant transformation of legal functions themselves. As many legal teams have struggled to retrieve the information their organizations need efficiently and effectively, this has laid bare the weaknesses of current legal operating models that rely predominantly on human capital and paper-based systems.
By contrast, those companies that have already invested in automated business models, centralized contract lifecycle management systems and the like can much more readily sort and analyze contracts based on force majeure clauses or other features, or seek to ensure that “business as usual” operations in terms of business contracts of an organization can continue to be finalized and executed in a virtual world. I believe we will see more such investments in centralizing, automating and streamlining core legal functions – and the start of genuine legal transformation - when the current situation abates.