Commercial disputes and COVID-19 – a business perspective September 2020

By COLM TONGE, Published in COVID-19 Contract Law

As business unusual continues around the world, the interpretation of commercial contracts has become even more complex. Nobody anticipated the impact that the pandemic would have on businesses and the economy through government enforced lockdowns.

rgad

When parties enter a commercial contract, it is unlikely that either intends to default from the outset. It is usually a difference in interpretation of the contract that leads to the dispute. However, the pandemic has caused a host of new complications in meeting contractual obligations. The uncertainty around commitment, ability and timing to deliver, different jurisdictional requirements and unprecedented surges in demand leading to market price changes has impacted supplier performance, sometimes opportunistically or even dishonestly. There are also issues with the quality and specifications of what is being supplied in these challenging circumstances. Many sale of business and M&A transactions, which started before the full extent of the pandemic became known, have now hit a wall in terms of pricing, future expectations and suitability of business models. Disputes are arising due to purchase price adjustment mechanisms based on expectations of future profits, kicking in.

The industry sectors most directly affected by the pandemic are air travel, hospitality, property holdings and anywhere people work in close contact, for example, manufacturing, construction and mining.

The viability of the passenger air travel business model is in serious doubt. Business travel is being discouraged and individuals are being encouraged to holiday in their own countries to limit the virus spread. It may be some time before people are prepared to travel internationally again, given the heightened risk of contracting the virus in airports or planes, complicated travel requirements and risk of quarantine or isolation away from home if there is an outbreak. The airline industry faces significant challenges to bring back customers within the economics of a new business model where one third of seats may be vacant. Logically, the cost of air travel would rise substantially and only the fittest of airlines will survive to serve the wealthiest passengers.

All hospitality-related activities including accommodation, food and drink, leisure, events, conferences, casinos, theme parks and the like have been impacted hugely already. Any industry which relies on foot traffic, occupancy or attendance can expect to feel the effects for some time to come. How these venues function will need a complete overhaul.

Empty spaces in office parks and malls were already a feature of the South African landscape and this trend will snowball as people increasingly opt to work from home and shop online. Property companies will need to prune from their portfolios assets that do not perform in the new regime.

Previously labour intensive industries were designed to maximise efficiency. Now they have to redesigned to prioritise health and safety, which will certainly be at the expense of efficiency or require increased automation. The consequences for profits and jobs are obvious.

Ironically, while the operations of financial services companies are among the least affected, there are major ramifications for insurance companies in particular and the decline in profit will surely be felt across the board. The extent of insurance coverage under Business Interruption clauses of commercial policies is a drama that is playing out in courts all over the world. Commercial insurance policies will need to be rewritten to be clear on precisely what events are covered – lockdown was never conceived by the policy writers.

Contracts, particularly cross-border, need to be re-assessed urgently to take account of previously unforeseen factors. More flexibility is required to reflect the new playing field and lead times between ordering and receipt of goods and services will need to be reassessed. Some contracts include escalation and pricing mechanisms which will need to be revisited for practical implementation. The drain on the time of management, already overstretched, will be significant. An organisation's reputation will be more important than ever, and there will be a consequent barrier to new entrants competing in traditional markets.

There are elements of all business models that will be redundant in future. Many existing businesses would not have met the investment criteria under the new rules. We can expect higher prices, lower profits, more consolidation, less competition and significant job losses. Not good news for consumers, and regulators will need to make allowances. After 50 years of increasing globalisation, the reduction in international travel will be mirrored by industries reverting to more reliance on local supply, to limit the risk of outbreaks elsewhere disrupting the supply chain. This could also lead to a diversification of resources and production such as smaller, more geographically spread facilities.

A robust assessment of future supply requirements and sourcing is urgently required. Special attention and resources need to be applied to assessing the risk of, and the resolution of, commercial disputes. And commercial contracts will need to be revised to reflect the changes in the dispute risk profile due to the pandemic.

Tonge is an Independent Forensic Accountant and former big 4 partner based in Johannesburg.