Confirmed cases of the Coronavirus (COVID-19) are now approaching 285,000 as of 21 March and appear likely to continue to increase significantly.
Uncertainty over the ultimate extent and impact of the pandemic has led to the greatest fall in financial markets since the global financial crisis in 2008. Recessions in several European countries and elsewhere have been predicted. The Organisation for Economic Co-operation and Development (OECD) has predicted that COVID-19 will lower global GDP growth by one-half a percentage point for 2020 (from 2.9 to 2.4 percent1.
In the UK government's budget on 11 March the Chancellor, Rishi Sunak, acknowledged that the virus would have a “significant impact” on the UK economy, even if it would be “temporary.” In addition to promising "Whatever extra resources our NHS needs to cope with coronavirus" the Chancellor introduced significant support for the workforce and to support in particular smaller businesses. In a coordinated move with the government, the Bank of England has reduced interest rates to 0.25% - their lowest ever level, introduced a new loan scheme for businesses, and taken steps to increase the supply of credit in the economy. Since the budget, on 16 and 20 March, the Chancellor has announced much greater financial support measures for businesses and workers.
Against this backdrop we address in this article aspects of the pandemic which are relevant for the boards of UK companies to consider as the full business impact of the pandemic emerges. We look at:
And we conclude with a checklist of points for boards of directors to keep under review.
Corporate administration, reporting and disclosure requirements
In February the Financial Reporting Council (FRC) published guidance for companies2 on disclosure of risks and other reporting consequences in year-end accounts arising from COVID-19.
Companies are legally required to disclose principal business risks in their financial statements. The FRC is advising companies to carefully consider what disclosures they might need to include in their year-end accounts, which will be particularly relevant for companies trading in or with China. The degree of risk depends on the company's circumstances of course. Particular risks could be associated with operations in or supplies coming directly or indirectly from China for example.
The guidance states that where mitigating actions can be taken against COVID-19, these should also be reported alongside the risk itself. As well as inclusion within a company’s disclosures of principal risks and uncertainties, the carrying value of assets and liabilities might also be affected with a need to perform additional impairment tests and adjust year-end balances.
Further, group auditors must evaluate and review the work of component auditors in producing the group accounts3. The FRC has also issued guidance in this area "to help group auditors take practical steps to navigate the audit challenges presented by coronavirus"4.
With regard to London Stock Exchange listed companies, they are obliged to disclose inside information under the EU Market Abuse Regulation, and, for AIM companies, broadly parallel obligations under the AIM Rules for Companies. This is non-public information which is precise in nature and relates directly or indirectly to the company or its securities and which, if made public, would be likely to have a significant effect on the price of the company's securities.
The disclosure must be made as soon as possible - there are only very limited circumstances in which the disclosure can be delayed.
The following are some examples of matters which might amount to inside information in relation to COVID-19. Whether any matter actually does constitute inside information however is a matter for decision by and judgement of the board, properly advised.
Companies do of course have the option of holding their shareholder meetings electronically, subject to complying with sections 308-309 and 333 of the Companies Act 2006. Stock Exchange listed companies must also observe rule 6.1.8 of the Financial Conduct Authority’s Disclosure and Transparency Rules. In any case, some listed or large private companies still favour actual meetings organised as a showpiece event. However, already people are being advised to avoid large gatherings and travel.
21 clear days’ notice by a company to its shareholders is required for an AGM and 14 days clear notice for most other general meetings. Clear days means not including the day the notice is given or the day the meeting is held. Companies can rely on provisions in the Companies Act and in their articles of association which deem notice to have been received by a certain time (usually 24 or 48 hours after posting). In addition to the notice, however, accompanying documents for the AGM such as the annual accounts may need to be printed and sent.
It is not legally required for all directors to attend the AGM. A quorum of directors should as a matter of best practice be there.
In a possible era of poor attendance larger companies may wish to stream their AGM on their website. However shareholders who are not physically present at the meeting are not actually attending it and so cannot vote on any resolutions.
Corporate borrowing and financial arrangements
If a company has banking facilities the Covid-19 outbreak may have consequences for the stability of the company's borrowing.
Commonly, working capital for a business is provided through overdraft or revolving credit facilities (RCF), the former repayable on demand and the latter usually linked to a wider funding facility. If the cash flow of the business is under pressure, it is important to maintain a dialogue with the bank to avoid a sudden withdrawal of the overdraft or RCF. If with a RCF an event of default has occurred under the wider facility the lender may refuse further RCF withdrawals or terminate the RCF and the wider facility. Careful management of working capital is important at the best of times but critical in these circumstances with the COVID-19 effect unpredictable and possibly with us for some time.
COVID-19, or its consequences for a business, may itself constitute an event of default as a material adverse event under a facility. However lenders are unlikely to call in their lending on this basis alone, being more interested in the actual effect of COVID-19 on the particular business, its cash flow and ability to repay any fixed term borrowing. In this regard close attention should be paid to whether the company is in actual or potential breach of any financial covenants. Such breaches are likely to be of great concern to lenders particularly if they are not forewarned.
It is of course always important for a borrower to communicate fully with its lender and it will usually have to provide regular financial and business information under the terms of its facility. In addition to specific information requirements there will usually be an obligation to provide such further information "as the lender shall reasonably require". It will be interesting to see whether banks develop any specific COVID-19 information request policies.
It is to be hoped that lenders will adopt a supportive approach to businesses adversely affected financially in the current crisis and the government is encouraging this, as witness by the support given recently both in the budget and by the Bank of England.
Commercial contract considerations
Businesses should review their main customer and supply contracts to assess whether they can be cancelled or are being inadvertently amended or rights waived as a result of COVID-19. The following paragraphs address some particular legal grounds on which these consequences could occur.
Force majeure: If a contract contains a force majeure provision, depending on its precise wording, it will excuse a party from its obligations if it cannot perform for reasons beyond its control (say excusing a Chinese supplier in lockdown from performing its contract). For such a provision to be enforced for COVID-19 it will be necessary that (a) the language of the provision adequately covers the COVID-19 pandemic, (b) the pandemic caused the supplier to be unable to perform its obligations and (c) there is no exemption from the application of the provision. An example of such an exemption would be a requirement that the supplier takes all reasonable endeavours to mitigate the result of the force majeure event (for example by sourcing its raw materials elsewhere) and it fails to do so.
All will depend on the wording in the contract around the force majeure remedy. For example is there a strict time limit within which to notify the force majeure event? Or is a party who successfully relies on force majeure relieved from its obligation to supply or only entitled to delay performance? In cases of disagreement between the parties legal advice will be necessary.
An important factor with force majeure provisions is to know which country's law governs the contract and the local circumstances applying to the obligations under the contract. Different countries (and their courts) are reacting differently to the COVID-19 pandemic. Not only may legal interpretation of the force majeure provision differ from country to country but measures taken to deal with COVID-19 in different countries may affect affect the application of the relevant force majeure provisions themselves5.
Finally, in businesses which are consumer facing force majeure provisions in their terms of business will have to meet standards of fairness as set out in consumer legislation (notably the Consumer Rights Act 2015) - an example of a potentially unenforceable provision could be a concert promoter purporting to have the right to cancel an event for force majeure without providing any refunds to customers.
Frustration: In the absence of a force majeure clause, it may be possible (though difficult) to argue that the contract has been "frustrated" through the consequences of COVID-19. For this common law remedy to apply the claiming party has to prove that current unforeseen circumstances make it impossible for the contract to be performed or that performance would be radically different than envisaged when the contract was entered into. In practice the courts take a narrow approach and it may be difficult to invoke frustration short of, say, state imposed restrictions rendering performance of the contract impossible.
If frustration does apply, the Law Reform (Frustrated Contracts) Act 1943 allows recovery of monies paid under the contract before it was discharged, subject to an allowance for expenses incurred by the other party.
Contract parties should be careful in discussions with COVID-19 hit suppliers or customers that they do not, either through their actions or by what they regard as informally agreed solutions, amend or waive rights under a contract unless they have fully thought through the consequences. Many contracts will provide that any amendments or waivers have to be in writing to be valid but care should be taken in this area. Any significant accommodation should be recorded in a legally binding agreement in writing (never a casual email exchange!) making clear that any further rights are reserved.
Considerations for acquisitions and disposals
It is widely expected that the COVID-19 worldwide pandemic will result in a substantial downturn in mergers and acquisitions globally and signs of this are already emerging. Share prices around the world have already been hit by their steepest falls since 1987. In these circumstances the most prudent course for many sellers and buyers will be to suspend any transactions which they are involved in for now.
However, for those transactions which are proceeding, detailed due diligence is very important. In line with the disclosure and reporting requirements referred to above6 buyers should insist on information about the impact of COVID-19 on the target's financial performance together with forward projections, the extent of possible business interruption and the business continuity measures in place. In an auction sale this information should be included in the deal data room.
Further information which should be provided or reviewed in this way includes:
Material adverse change (MAC) clauses are often included in acquisition agreements where there is a delay between signing and completion. MAC clauses typically allow the buyer to withdraw from the deal without liability if there is a change in the business or its financial performance before completion which is material and adverse. Whilst the coverage of a MAC clause will depend on its precise wording, commonly an exemption will be included to the extent that the event giving rise to the material adverse change affects generally the industry in which the business operates - and of course COVID-19 will. Further, in bids for public companies governed by the Takeover Code it is very unlikely that the Panel would allow a MAC to be invoked as a result of COVID-19.
For acquisitions which have not yet been signed a MAC will not cover COVID-19 as the parties are already aware of the pandemic. However the buyer may be able to negotiate a condition precedent specifically related to a COVID-19 consequence as opposed to a generic condition relating to the virus.
A further common feature of agreements with a delay between signing and completion is a series of pre-completion covenants given by the seller governing how the business will be run before completion. The parties should agree any specific COVID-19 related provisions as part of these covenants.
It is difficult to see how acquisition agreement warranties can adequately protect a buyer who is uneasy about COVID-19. Warranties are by definition to protect against unknown risks so the buyer may have difficulty pursuing a claim due to its awareness. In addition a seller would undoubtedly argue that the price paid for the business factored in COVID-19 and therefore the buyer could not show in its claim that it had suffered any loss.
Insurance for business interruption
It is not clear that existing business interruption insurance policies will cover interruption caused by COVID-19. The legal uncertainties, including the relevant case law to date, and the significance of different types of wording in the conventional "damage" and non-damage extension policies is examined in detail in an existing Clyde & Co article on our website – see "Briefing Note: Coronavirus (COVID-19) and Business Interruption Cover" (21 March 2020)7.
If a business interruption policy does cover the outbreak of disease, it is usually subject to the disease being declared a ‘notifiable human disease’. COVID-19 was declared a notifiable human disease by the UK Government on 5 March so that interruption of business due to COVID-19 prior to this date may not be covered. Furthermore if a business is closed as a precaution against COVID-19 but before being legally ordered to do so cover may not be available.
Recently the magazine Insurance Age questioned a number of insurers, including AXA, RSA, Allianz, NIG and Ageas about how they would respond to business interruption caused by COVID-198.
AXA confirmed it would only cover diseases already specified in insurance contracts and did not word its contracts to refer to a general class of notifiable disease.
AXA said in a statement:
“In general, when our Business Interruption policies provide an extension in cover for infectious diseases, they list the diseases by name. Only for those diseases will they compensate for financial losses resulting from premises having to close. Our wordings don’t refer to a general class of notifiable diseases, but they name each disease individually. When Covid-19 was added to the list of notifiable diseases in England, it did not change policy coverage.”
The others either stated that their current policies would not provide cover or gave equivocal answers.
The ABI issued a statement on 17 March confirming its view that "the vast majority" of firms will not be covered for business interruption by COVID-19 as their policies will cover property damage only9.
A detailed examination of issues to be borne in mind with regard to UK employees is beyond the scope of this article but is the subject of two Clyde & Co articles that are available on our website – see "Coronavirus – key points for employers" (19 February 2020)10 and "Coronavirus update for UK employers" (12 March 2020)11.
However it should be noted that, in addition to other regulatory obligations protecting employees section 172 of the Companies Act 2006 provides that directors must in acting in the way most likely to promote the success of their company have regard (amongst other matters) to the interests of the company's employees.
Our articles referred to above address the following issues against this backdrop and the COVID-19 pandemic:
The government has also published guidance about COVID-19 for employers in relation to virus affected employees12.
In addition to the measures supportive of small and medium size business created by the 11 March budget13, the lowering of interest rates and the further measures announced on 16 and 20 March, the government has published "Coronavirus (COVID-19): guidance for UK businesses"14. This document explains what the Department for International Trade (DIT) is doing to provide support to businesses impacted by COVID-19; explains that the DIT can provide advice on alternative suppliers globally and through UK Export Finance (UKEF) invites businesses to seek support through guarantees to assist with bank loans to support cash flow difficulties. UKEF can also provide guarantee support to overseas buyers, including Chinese customers, wishing to finance UK purchases.
Checklist of points for boards of directors to keep under review
We offer below a checklist of matters arising from COVID-19 for directors to keep under review – we hope this is helpful.
Our Coronavirus Information Hub
For more information on how we can help with reviewing your insurance and on your responsibilities towards employees and the public, we suggest that you refer to our Coronavirus Information Hub.
In the meantime, please do not hesitate to contact us if your business is impacted (or is likely to be impacted) by COVID-19.
1 OECD Interim Economic Assessment "Coronavirus: The world economy at risk" 2 March 2020 https://read.oecd-ilibrary.org/economics/oecd-economic-outlook/volume-2019/issue-2_7969896b-en#page1
2 "FRC Advice to Companies and Auditors on Coronavirus Risk Disclosures dated 18 February 2020. https://www.frc.org.uk/news/february-2020-(1)/frc-advice-to-companies-and-auditors-on-coronaviru
3 A component auditor works on the financial information of a significant part of the group's business which will be used in the group audit. A component auditor may be a part of the group audit engagement team's firm in a different location, a network firm, or another firm.
4 ICAEW Know-How Coronavirus (Covid-19): Considerations for Group Auditors. https://www.icaew.com/-/media/corporate/files/technical/audit-and-assurance/audit-and-assurance-faculty/considerations-for-group-auditors-impacted-by-coronavirus-guide.ashx
5 China has issued numerous "force majeure certificates" which purport to exempt local exporters from fulfilling contracts with overseas buyers as a result of COVID-19. There is doubt as to whether such certificates have force in courts outside China. Western companies are drawing up UK and US jurisdiction contracts in order to be able to sue for non-performance outside China
6 See "Corporate administration, reporting and disclosure requirements"
8 See article by Sian Barton in Insurance Age dated 9 March 2020 https://www.insuranceage.co.uk/insurer/7500931/axa-confirms-coronavirus-business-interruption-coverage
9 See twitter statement https://twitter.com/BritishInsurers
13 See coverage in https://www.gov.uk/government/news/coronavirus-covid-19-guidance-for-employees-employers-and-businesses for a summary of these measures