Coronavirus—Contract Material Adverse Change Provision
One of my earliest orchestral memories is playing the “Surprise” Symphony, formally known as Symphony No. 94 in G major, by Franz Joseph Haydn. Like the second movement of many symphony, the Surprise Symphony’s second movement starts with a soft and playfully gentle tune. The surprise comes when several measures into the movement, the entire orchestra plays an unexpected, loud chord.
Haydn, an 18th-century Austrian composer, didn’t include the loud chord in his original manuscript. He added it later. A newspaper critic described it as a “beautiful shepherdess who, lulled to slumber by the murmur of a distant waterfall, starts alarmed by the unexpected firing of a fowling-piece.”
An audience member hearing the Surprise Symphony for the first time provides a good foil for all of us as we first experienced coronavirus (“COVID-19”). The audience has relaxed and settled into their seats. After all, audience members just sat through the symphony’s first movement. Some audience members may have started to daydream. The symphony’s loud chord abruptly brings everyone back to reality, as COVID-19 has done for all of us.
Unfortunately, most real estate purchase contracts weren’t up to the task of addressing circumstances as unexpected as a swiftly moving world pandemic. Although many contracts have force majeure clauses, few real estate purchase contracts do. Fortunately, most contracting parties recognize the need to cooperate in these extraordinary times and are collaborating to amend contracts, so they work for everyone.
This article is part of a series discussing COVID-19 and real estate law. Previous articles are available in my Bach to Business blog. This article discusses how parties can negotiate material adverse change provisions in commercial real estate purchase contracts, given COVID-19.
Typical Commercial Real Estate Purchase Contract Provisions
Commercial real estate contracts usually include a due diligence period during which the buyer can cancel the contract. Typically, the buyer can get most if not all of its deposit back if it cancels before the end of the due diligence. Usually, the closing occurs less than a month after the end of the due diligence period.
Since the buyer’s deposit isn’t at risk for long, most real estate purchase agreements don’t have a broad force majeure or material adverse change provision. Instead, the contract will address a few extraordinary events that might be in a force majeure clause. Frequently, these include only condemnation or casualty involving a significant part of the property.
Instead of a material adverse change clause, most contracts also will require that the seller continue to operate the property consistent with its prior practice. A few contracts include occupancy or revenue benchmarks that the seller must maintain. However, the underlying purpose of those provisions is to excuse contract performance if there is a material adverse change.
Crafting a COVID-19 Material Adverse Change Provision
Standard real estate contract clauses don’t assign risks or address the parties’ needs for COVID-19. Therefore, parties must include COVID-19 specific language in new contracts and add that language to existing ones.
In Adding a Coronavirus Force Majeure Provision to Your Contract, I discussed adding COVID-19 specific force majeure clauses to contracts. Also, parties should examine the seller covenants and closing conditions regarding property performance to assure that they recognize possible COVID-19 developments.
Before creating a COVID-19 specific material adverse change provision parties should determine:
Current CDC recommendations and legal requirements
Foreseeable future changes (e.g., stay-at-home order for states without one, employee quarantine, layoffs, reduced sales)
What contract representations, warranties, covenants, or conditions would be impacted by known or foreseeable COVID-19 concerns.
If the contract has been signed, has that risk already been allocated?
How the parties want to allocate COVID-19 risk, including whether to reallocate risk that has already been allocated
The remedy (e.g., contract termination, excused performance) for a COVID-19 development
I don’t think any party should be penalized for following a government law, order, or recommendation, even if some people question whether the recommendation. Parties also should be encouraged to make reasonable business decisions to protect the health and safety of their employees and customers and that it’s wrong to penalize parties for those decisions.
However, parties must decide how they believe it’s best to allocate risk for their transaction. Contracts signed when both parties have knowledge of COVID-19’s impact now, and in the immediate future, may allocate risk differently than parties to a contract signed earlier.
Sample COVID-19 Material Adverse Change Provision
Below is a sample COVID-19 contract provision that addresses the developments that otherwise might trigger material adverse change provisions in contracts.
The parties acknowledge that due to the world COVID-19 pandemic, Seller or the Property may become subject to government order or recommendation to restrict operations or that Seller may determine that it is required under OSHA or advisable to protect the safety of employees and tenants that Seller curtail or limit Property operations. For example, only Seller may limit or curtail the use of recreational and other common areas, in-person leasing activities, or non-emergency maintenance inside residential units. The parties further acknowledge the Coronavirus Aid, Relief, and Economic Security Act (CARES) or other laws, government orders, or lender restrictions may prohibit commencement or continuation of eviction or collection activities, or that court closures may delay evictions or collections actions. The parties further acknowledge that Seller may layoff or furlough employees or become obligated to make payments under the Families First Coronavirus Relief Act (Families First). As a result of the foregoing, the Property could experience decreased economic occupancy, reduced revenue, or changes in amenities, staffing, leasing efforts, or maintenance levels. Notwithstanding anything in this Agreement to the contrary, Seller’s compliance with CARES, Families First, or government laws, orders, or recommendations or Seller’s other reasonable determinations directly or indirectly arising out of the COVID-19 pandemic, shall not constitute a breach of nor entitle Buyer to any relief or remedy under this Contract.
The clause starts with having the parties acknowledge the COVID-19 pandemic. Then, the clause lists several circumstances that might occur for the property under this contract. Finally, a broad exculpatory provision excuses changes in business practices or property condition resulting from the COVID-19.
Parties should tailor their contract language to meet known developments and the parties’ specific needs. However, the structure of 1) acknowledging the situation, 2) describing what might happen, and 3) exculpatory provision should allow for risk allocation that works for most contracts.
© 2020 by Elizabeth A. Whitman
Any references clients and their legal situations have been modified to protect client confidentiality
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