Managing the Commercial Impact of the Coronavirus: Implications for Oil & Gas
“We are in a phase of preparedness for potential pandemic . . . Let’s focus on what we can do and need to do, which is prepare.” (~ Dr. Mike Ryan, WHO Executive Director of Health Emergencies Programme, quoted during a recent press briefing)
The coronavirus (provisionally named SARS-CoV-2, with its disease being named COVID-19) has now been documented in six of the world’s seven continents (sparing only Antarctica), in more than 70 countries and territories. More than 90,000 cases have now been documented across the globe, killing nearly 3,200 people.
In the United States, the coronavirus has impacted domestic and foreign travel, as the Centers for Disease Control and Prevention has issued a Warning – Level 3 (Avoid Nonessential Travel) for travel to China, Iran, South Korea and Italy, and has issued an Alert – Level 2 (Practice Enhanced Precautions) for travel to Japan. Many businesses have imposed restrictions on employee travel, including Twitter, Amazon, Salesforce and Nike, in addition to scores of manufacturers and professional service firms.
Though it originated in the important worldwide manufacturing hub of Wuhan, China, the spread to other major economic centers further impacts the global economy and supply chains in ways not seen since the SARS outbreak in 2003. Investors reacting to the coronavirus have caused extraordinary fluctuations in the stock market, reflected in the Dow’s record-breaking end-of-February plunge and its subsequent volatility. Energy stocks have been hit particularly hard in recent weeks. In an effort to calm investors and help protect against the economic impact of the coronavirus, the Federal Reserve made an unscheduled half point interest rate cut, which appears to have caused a rebound in some markets.
At the center of the financial impact is the growing disruption to worldwide supply chains across many industries. The impact is being acutely felt in the oil and gas industry, where oil and gas prices, already low, are likely to decline amid worldwide travel restrictions, quarantines and a general reduction in economic activity due to the virus. Additionally, in the energy sector, which is truly international and relies heavily on international sources for its supply and manufacturing needs, the impact has been immediate.
And, it does not end with stock prices and the supply chain. Meetings and conferences are being impacted, with the most recent cancellation being the oil and gas industry’s CERAWeek conference in Houston. This is yet another indicator of how much the coronavirus outbreak is impacting the oil and gas industry.
Now is the time for companies operating in the oil and gas industry to develop and execute effective response plans to the coronavirus outbreak in order to mitigate risk and prepare for any operational interruptions. This should include a careful assessment of your contracts.
Force Majeure and Supply Chain Operations. Amidst the coronavirus outbreak, companies are relying more and more on force majeure “outs” to either delay, suspend or even cancel contractual obligations.
Force majeure refers to a legal doctrine under which a party may be relieved from liability for non-performance if circumstances beyond the party’s control prevent the party from fulfilling its obligations under a contract. Even if a contract’s force majeure provision does not reference “disease,” “epidemics,” or “quarantine” specifically, other generic language such as “acts of God,” “acts of government,” or “other circumstances beyond the parties’ control” could be relied upon. The coronavirus outbreak presents a somewhat unique situation in that it includes both a naturally occurring component (the virus itself) and a government action component (including the quarantines and other measures put in place in response to the outbreak).
China has taken direct steps to attempt to provide some relief for companies and businesses. In fact, on January 30, 2020, the China Council for the Promotion of International Trade announced that it would offer “force majeure certificates” to “exonerate companies from not performing or partially performing contractual duties by proving they are suffering from circumstances beyond their control.”1 However, whether this certificate has any impact will depend upon the governing law and the specific language of the parties’ force majeure clause.
In early February, China’s biggest LNG importer – China National Offshore Oil Corp. (CNOOC) – suspended contracts with a number of suppliers for at least February and March, invoking force majeure.Total SA and Royal Dutch Shell PLC, two of those suppliers, promptly rejected such claims of force majeure.2 Suppliers are understandably anxious about the contractual precedent that successful force majeure declarations would establish.
Companies should carefully review the force majeure provisions in their contracts to determine whether they apply. Any party seeking to invoke a contractual force majeure provision must usually show that there are no alternative means for performing under the contract. In most cases, increased costs and economic circumstances alone will not be sufficient to prevail on a claim of force majeure.
Companies should also consider the following actions to identify, assess and manage the risk to the supply of materials and parts necessary for their business:
- Communicate with Critical Suppliers. Companies should consider proactively reaching out to key suppliers to determine what level of inventories they are carrying, what potential subcomponents of such parts or materials may be or become in short supply, and what actions the suppliers are taking to prepare. Further, companies should redeploy resources in order to build additional banks of parts or materials and/or onboard alternative suppliers, in each case if feasible from an operational, timing, and cost perspective.
- Monitor Customer Demands. Companies should monitor customers to ensure that they will comply with their contractual obligations, including timely payment for equipment, parts and materials supplied to the customer. For those customers with a greater risk of nonpayment (for example, an OE who may suspend production under a certain program), companies should analyze contractual payment terms. Companies should then evaluate whether to seek to enforce remedies available to a seller of goods under the Uniform Commercial Code, including demands for adequate assurance of payment or a change in payment terms.
- Review Allocations. Companies should review allocation requirements and obligations to multiple, competing customers for potentially scarce materials as manufacturing operations ramp back up.
M&A Agreements. Companies who are parties to definitive M&A agreements should review any “Material Adverse Change” (MAC) clauses, and representations and warranties, to assess the potential impacts of the coronavirus on their transaction. For attorneys drafting and reviewing definitive M&A agreements now, care should be taken in crafting or reviewing appropriate MAC clauses, representations and warranties, and other provisions to take the potential impacts of coronavirus into account. On the buy side, enhanced focus on supply contract due diligence is recommended.
Reporting Requirements. Public companies should review and make accurate required disclosures, in the event that business operations are impacted such that a reporting requirement is triggered. All companies who are parties to credit agreements and other financing arrangements should review existing MAC clauses, and potential impacts on the borrower’s financial covenant compliance, in order to determine whether any proactive conversations with lenders may be warranted.
Insurance. Companies should review insurance policies to determine possible coverage in the event of a business disruption, and comply with all applicable notice requirements.
Employment Concerns. The challenges for any business facing coronavirus or any other disease outbreak involve a multitude of conflicting legal obligations. Under the Occupational Safety and Health Act (OSHA) and similar state laws, employers have a general duty and obligation to provide a safe and healthy work environment, even when the work occurs outside the employer’s physical premises. Furthermore, under these health and safety laws, employers must not place their employees in situations that are likely to cause serious physical harm or death. Conversely, overreacting by implementing broad-based bans and making business decisions about employees that are not based on statistical realities could get an employer sued under laws that prohibit discrimination based upon disability (perceived or real) and national origin, among others. Properly planning for and implementing plans to deal with the coronavirus is legally and operationally complex. For more information on specific action employers should take, please click here.
In summary, it is important for companies in the oil and gas industry to take additional steps now in order to mitigate their risk of suffering negative impacts from the coronavirus. For more information about this, please contact your Foley relationship partner. For additional web-based resources available to assist you in monitoring the spread of the coronavirus on a global basis, you may visit the CDC and the World Health Organization.
Click here for Foley’s Coronavirus Resource Center for insights and resources to support your business during this challenging time.
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1https://www.chinadaily.com.cn/a/202002/17/WS5e4a38eaa31012821727818d.html
2https://uk.reuters.com/article/uk-china-health-total/frances-total-rejects-force-majeure-notice-from-chinese-lng-buyer-idUKKBN200216
