Following our recent update on how start-ups should deal with COVID-19 (see here), we have put together another update on impact of COVID-19 on investment transactions from investors’ perspective. Whilst the previous update did touch upon the impact of COVID-19 on the founders / company from a deal making point of view, we now propose to set out certain aspects investors may need to consider while undertaking investment transactions primarily in the private equity and venture capital space.
COVID-19 has been declared as a pandemic, creating an unprecedented global emergency situation. This has forced countries and cities to go into complete lockdown (in some cases, indefinitely) derailing global economies across sectors barring a few. The world economies are bracing up for a recession with no definitive timelines on potential recovery.
From a deal making standpoint, there are several new elements investors ought to take into account while evaluating / implementing deals. We believe the impact of COVID-19 will be felt both short term (for the purposes of analysis of certain constructs such as material adverse effect, force majeure or identified conditions subsequent) and long term (for the purposes of specifically considering impact of COVID-19 on the performance of the company, specific warranties on pandemic events or the like). This update focusses on certain of these aspects and what investors could consider to mitigate risk.
From an investor’s perspective, the provision on force majeure assumes significance on two counts: (a) prior to closing of a deal if the investor wishes to walk away from the deal; and (b) existing deal in respect of the ability of the company / founders’ ability to fulfil their respective obligations towards the investor.
Although the construct of ‘force majeure’ may be interpreted variedly under civil law and common law, in the Indian context force majeure is primarily governed by the Indian Contract Act, 1972 (“ICA”). Typically, Indian courts have interpreted force majeure provisions quite narrowly such that the particular event in question should specifically fall within the ambit of ‘force majeure’ as defined under the contract between the parties.
In our experience, typical investment agreements do not have specific references to pandemic / epidemic events within the scope of the definition of force majeure. Having said that, it is arguable that the construct of ‘act of god’, which is quite prevalent in standard force majeure constructs, is wide enough to cover such pandemic / epidemic scenarios. This view, however, should be taken cautiously as there is not enough clear jurisprudence yet on whether virus outbreaks could be attributable to ‘acts of God’. Although, for the purposes of existing COVID-19 crisis, Government of India has set a sort of precedent whereby Government has allowed force majeure provisions to be invoked in an internal memo circulated on the ground that disruption of supply chain due to spread of COVID-19 is a ‘natural calamity’. Of course, each case is unique and the language of force majeure provision needs to be evaluated in more detail to arrive at a conclusion.
On the opposite side, the company or its founders may consider invoking the doctrine of frustration under Section 56 of the ICA. The doctrine of frustration makes an agreement void if it becomes impossible to perform the same. However, the challenge for any company / founder would be the burden of proof to establish that the outbreak of COVID-19 has changed the very fundamental of its contractual arrangement, making it ‘impossible’ for them to perform their obligations.
Given that most of the due diligence these days are through virtual data rooms, we do not foresee the timelines around review of information getting impacted significantly.
However, the scope of due diligence needs to be revisited from a fresh perspective i.e. it would be necessary to understand the way the pandemic has affected the target company’s financial prospects and what contingency planning has been done. An investor may need to ensure that its diligence on the target business extends to:
- insurance policies taken by the target and specifically the coverage, including business interruption;
- the ability of the target to perform, suspend or walk away from obligations under material contracts, including exercising force majeure or similar provisions;
- exposure of the target business (including its key customers and suppliers) to such jurisdictions which are highly impacted by the COVID-19 pandemic or similar pandemic / epidemics in future; and
- overall impact of travel restrictions, quarantine measures and government-mandated closures on the target business and its revenue generation.
Pre-Closing Covenants and Conditions Precedent
For new deals, investors may consider including condition precedents for specific COVID-19 or similar findings identified during the due diligence process. Investors may also need to evaluate scenarios to provide for specific provisions ensuring that targets’ obligations to operate outside the ordinary course of business in order to deal with the impact of the outbreak (including implementing remote working policies) should not be considered as a breach of stand-still covenants during the period between signing and closing.
If a long-stop date is already in place and completion is unlikely on account of COVID-19 or similar pandemic, investors to evaluate if they would like a specific right to terminate or readjusting the valuation in relation to COVID-19 or other similar pandemic.
Material Adverse Effect
- Existing Contracts:
The impact of COVID-19 on material adverse effect (“MAE”) provisions in existing contracts would need to be determined on a case to case basis taking into account the following:
- Scope of the MAE provision: If the scope of the MAE provision is broad enough to include pandemic or epidemic risks within its ambit, then the MAE clause may be triggered; and
- If the impact of the COVID-19 materially and directly effects the status quo of the operations of the target, then the MAE clause may be triggered.
2. Agreements under Negotiation:
The investors should consider specifically addressing the prospective impact of risks involved by readjusting the valuation.
Representation and Warranties
The investors may consider seeking additional representations and warranties in relation to the target’s mitigation and business continuity planning from an operations perspective. Also, the investors may consider obtaining representation and warranties insurance which may cover the losses sustained from COVID-19 related disruptions.
Governing Law and Dispute Resolution
Provisions suggested in line with the above are interpreted and enforced variedly in different jurisdictions. For example, the force majeure provision has been transcribed in the civil law legislations, however, the same has been interpreted as a principle in the common law. Therefore, the investors should deliberate upon selecting the applicable governing law accordingly.
 Energy Watchdog Vs. Central Electricity Regulatory Commission & Ors., (2017) 14 SCC 80
 Office Memorandum No. F. 18/4/2020-PPD, dated February 19, 2020 of the Government of India, Ministry of Finance, Department of Expenditure, Procurement Policy Division.
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