The Doctrine of Unforeseen Circumstances
The economic impact and uncertainties related to the spread of COVID-19 might put pressure on business agreements, especially M&A transactions nearing signing or closing. It comes as no surprise that actual and potential business repercussions of the COVID-19 pandemic have prompted parties to try to walk away from a deal that suddenly appears less appealing than before the pandemic. Aside from force majeure, the most commonly used argument to go back on existing deal terms has been unforeseen circumstances.
In the Netherlands, courts may modify or terminate a contract based on the doctrine of unforeseen circumstances (article 6:258 Dutch Civil Code). In essence, this doctrine contains the following elements:
- the occurrence of an unforeseen event;
- as a result of which continuation of the contract in its current form cannot reasonably be expected; and
- the risk related to the unforeseen event cannot be deemed to be borne by the party relying on the doctrine of unforeseen circumstances.
The burden of proof is high. As an example, Dutch courts considered the worldwide financial and economic crisis of 2008 an entrepreneurial risk, which did not justify the modification or termination of business agreements.
COVID-19 and Measures Taken in Response May Constitute an Unforeseen Event
An event qualifies as unforeseen if it has not been taken into account in the contract either expressly or implicitly. In addition, the event must occur after the parties entered into the agreement.
In the Netherlands, the World Health Organization (WHO) reported the first case of COVID-19 on February 27, 2020. On March 11, 2020, the WHO characterized COVID-19 as a pandemic. On March 15, 2020, the Dutch government declared a lock-down to curb the spread of the virus.
There is no general rule on the date up to which the pandemic would still be considered a future event. Similarly, parties can disagree on whether the impact of the pandemic had been discounted in the contract, either implicitly or explicitly by, for example, inclusion of a material adverse effect clause (MAE). This is a question of contractual and contextual interpretation. In the Netherlands, the literal meaning of a contractual provision is not always decisive. Based on the specific circumstances of the case as put forward by the parties, the court will assess what the parties could reasonably understand a provision to mean and what they could reasonably expect from each other on that basis.
In general, Dutch courts accept that the spread of COVID-19 and the government measures taken in response could qualify as unforeseen circumstances.
Private Equity Firm Ordered to Execute SPA
In one of the first pandemic-related cases, Nordian v. J-Club, the Amsterdam District Court ordered the private equity firm Nordian to proceed with the signing of a share purchase agreement (SPA) and rejected the firm’s argument that it could not be expected to sign in view of the pandemic.
The buyer Nordian was selected through a controlled auction after the firm submitted a binding offer with fully committed financing. Nordian and the sellers entered into a signing protocol on February 28, 2020, which provided for the signing of an SPA in agreed form. The parties were obliged to sign the SPA as soon as Nordian obtained representations and warranties insurance.
On March 19, 2020, after the Dutch government declared a lock-down, Nordian tried to abandon the deal. The sellers brought summary proceedings to secure Nordian’s signing of the SPA.
Nordian cited “unforeseen circumstances” and argued that the sellers could not expect the SPA to be signed in its agreed form in view of the circumstances resulting from the pandemic. The court dismissed this defense. The potential consequences of the pandemic for the target had been discussed between the parties prior to execution of the signing protocol. In the context of this discussion, the purchaser had not opted to negotiate an MAE clause. Through the discussion and the decision not to include an MAE clause, the court found that the parties had taken into account the consequences of the pandemic. Therefore, in this case the pandemic was not an unforeseen event, and Nordian was ordered to sign the SPA.
The Contractual Allocation of Risk and the Pandemic
Another fundamental element of the doctrine of unforeseen circumstances is whether the unforeseen event is such that continuation of the original agreement cannot reasonably be expected. Circumstances that may give rise to judicial intervention include a severe disruption in the balance of the parties’ contractual obligations.
The Principle of Sharing the Pain
In Tennor v. McCourt Global Sports, the Netherlands Commercial Court ruled on the question of whether a break fee was payable despite the pandemic. A letter of intent (LOI) had been signed with respect to the acquisition of a 50-percent stake in an equestrian show-jumping business. The LOI contained a EUR 30 million break fee. The buyer decided not to pursue the transaction and argued that the break fee should be reduced in light of the pandemic.
The NCC noted that the parties had not discussed the impact of the pandemic. However, the LOI included a waiver of claims with respect to the fee. The NCC stated that “the COVID-19 circumstances, at least in the short term, are so exceptional and disruptive that it may be hard to say they were provided for.” The NCC nevertheless saw no need to answer this question and ruled that the pandemic did not make it “unacceptable for the claimant to demand strict performance by the defendant.”
The NCC reached this conclusion based on the principle of sharing the pain. This notion appears in Dutch literature as a possible solution to preserving the contractual balance. The NCC ruled that the break fee—despite the potential impact of the pandemic—should stand: “If the fee were to be reduced in any business downturn, the fee’s purpose—comfort and confidence to get the deal done—would not be accomplished.” Consequently, the allocation of risk provided for by the LOI withstood the pandemic-induced stress test.
Unsuccessful Buyer’s Remorse
A similar decision was reached in Coltavast v. Metroprop (only available in Dutch), which concerned a real estate transaction. Metroprop was supposed to acquire two properties in Coltavast’s real estate portfolio. The transfer was scheduled for March 31, 2020. The sales contract did not cover financing arrangements. Metroprop had difficulty arranging financing and requested that the transfer date be postponed, which Coltavast refused. The matter was brought before a judge in Amsterdam for injunctive relief.
Metroprop argued that it was unable to arrange financing due to the pandemic, and that the value of the properties had decreased as a result of the crisis. In this case, the court accepted the pandemic as an unforeseen circumstance but upheld the contractual allocation of risk. The court ruled that Metroprop—as a professional party—should have been aware of the financing risk and found that Metroprop had failed to act expeditiously with respect to procuring financing for the transaction. The court suspected that this was a case of buyer’s remorse and ordered Metroprop to pay the purchase price and proceed with the transfer.
In Municipality Enschede v. Real Estate Developer (only available in Dutch), a real estate developer tried to renege on its obligation to acquire several plots of land from the municipality of Enschede, citing unforeseen circumstances. The court noted that the pandemic arose after the developer had defaulted under the sales agreement, alluding to the artificial nature of the unforeseen-circumstances defense, and upheld the contractual allocation of risk.
Postponement of Closing Due to the Pandemic
So far, in only one instance did a court allow a minor modification of the contract. In Care v. Vision (only available in Dutch), the court ordered the closing date to be pushed back by two months.
The parties, both specialists in laser eye surgery, signed a sales agreement early March 2020 for the takeover by Vision of Care’s activities. Closing was scheduled for April 1, 2020. On March 17, 2020, the clinics of both parties had to close as part of government measures to contain the spread of the COVID-19 virus. On March 24, 2020, Vision tried to postpone closing by at least six months and renegotiate the sale terms, citing inter alia unforeseen circumstances. Care lodged summary proceedings to enforce the closing of the transaction.
During their negotiations, the parties did not discuss the pandemic, and Vision had not insisted on including an MAE clause in the sale agreement. In the opinion of the court, the pandemic as a whole was not unforeseen at the time of the signing of the agreement; however, the court found that the government measures related to the pandemic were. Noting that Care’s business was mandatorily closed at the time and that Vision was ineligible to receive financial relief from the government, the court ruled that Vision was not reasonably required to close the transaction at the initially scheduled date of April 1, 2020. The court continued, however, that because Care’s clinics had meanwhile reopened and its turnover recovered, Vision could be required to proceed with the closing of the transaction. The court ordered Vision to close the transaction by June 1, 2020. Given that the judgment was dated June 19, 2020, this meant in effect an order to close as soon as possible.
The reference in the court’s reasoning to Care’s recovered turnover after reopening appears to suggest that Vision perhaps could have had successfully avoided the closing if Care’s operations had not bounced back. However, even though the court allowed a minor modification of the SPA, it is unlikely that Vision would have been let off the hook entirely in a more unfavorable recovery scenario.
Conclusion
Deal and business certainty is key. Dutch courts are reluctant to terminate or modify a business contract based on the doctrine of unforeseen circumstances. If the parties discussed the pandemic or if the contract contains an MAE clause, the court will most likely find that the parties have taken the pandemic into account in the contract. In addition, the courts tend to uphold the contractual allocation of risk, despite the impact of the pandemic, and have no patience for buyer’s remorse. The one case in which a court allowed the contract to be modified is likely a one-off exception to the general rule.
This article reflects circumstances through mid-August 2020, when the article was submitted.
