International arbitration in 2021

COVID-19-related disputes: trends and predictions

How will COVID-19 shape the disputes landscape over the coming year?

COVID-19 shaped and upended almost every facet of life across the globe in 2020, and arbitration is no exception. In addition to its pervasive impact on arbitration procedure (discussed in trend 1), COVID-19 has given rise to new disputes, many of which are being – or likely soon will be – resolved through arbitration. As with the pandemic itself, COVID-19-related arbitration disputes have come, and we expect will continue coming, in waves.

First wave: force majeure, frustration and MAC

Unsurprisingly, the first wave hit those industries that are most directly and severely impacted by COVID-19, including, for example, aviation, retail, real estate, oil and gas, and fintech. Many companies have found themselves unable to fulfil their contractual obligations due to government restrictions, including national lockdowns and closure of borders. While some have been able to renegotiate contracts or reach agreement on deferring performance and/or payment, many others have been unable to resolve amicably the disputes arising from the consequences of COVID-19.

The resulting disputes often revolve around questions of force majeure/frustration and material adverse change (MAC) provisions in contracts, or similar legal doctrines that may excuse performance.

Force majeure

Some jurisdictions (such as China and Japan) recognise force majeure as part of their civil law, while others (such as England and Wales, and New York) require an express contractual provision. In either case, a party may be excused from performance of  contractual obligations affected by causes outside the party’s control, possibly including the pandemic.

Frustration

Frustration can excuse obligations on the grounds of an unforeseen event that makes performance impossible (eg contracts for the supply of goods that can no longer be produced due to government measures shutting down plants). One issue expected to arise in this context is whether the second and third waves of COVID-19, and the attendant recurring lockdowns and restrictions, are sufficiently ‘unforeseeable’ to support a frustration claim.

MAC

Commonly used in M&A, MAC clauses allocate to the seller the risk of something happening before closing that has, or at some time in the future may have, a materially adverse effect on the business. MAC clauses are often used as a basis for renegotiation – sellers are willing to renegotiate terms to avoid litigation uncertainty and the associated reputational damage of a claim.

Supervening hardship/change of circumstance

In some jurisdictions (typically civil law jurisdictions), a party may be able to terminate a contract where its performance becomes too burdensome as a consequence of the COVID-19 outbreak.

Economic impossibility

Statutes also may provide for economic impossibility, incapacity or delay to allow withdrawing from or amending the contract, including postponing deadlines. Contracts also may contain express terms to this effect, as well as price review and change of law clauses.

Courts and arbitral tribunals worldwide have grappled with COVID-19-related disputes involving the above clauses. While most arbitrations remain confidential, courts have delivered some important judgments that serve as useful precedent, including as persuasive jurisprudence for arbitral tribunals, in an area that is largely untested. For example, the English High Court has decided COVID-19-related cases claiming force majeure in the aviation sector (in which it found on facts that there was no force majeure) and MAC in the fintech sector (in which it laid down important standards for when a MAC occurs). Similarly, the Delaware courts saw a number of MAC disputes in the retail sector, including the dispute over LVMH’s obligation to complete its acquisition of Tiffany’s, and a number of other disputes are presently ongoing.

Interestingly, some States have officially declared COVID-19 to constitute a force majeure event, and China has issued force majeure certificates to companies that seek to excuse non-performance. Meanwhile, the UK government issued non-binding guidance on ‘responsible contractual behaviour in the performance and enforcement of contracts impacted by the COVID-19 emergency’ in May 2020, which may assist parties and adjudicators in determining what constitutes reasonable behaviour in the wake of COVID-19 disruptions. The weight given to such State guidance in a dispute remains to be seen.

Subsequent waves: earn-out disputes and construction arbitration

In addition to disputes caused directly by COVID-19, further disputes are likely to arise from the economic turmoil accompanying the pandemic.

One example is disputes arising from ‘earn-out’ clauses, which provide that the seller of a business will receive future additional compensation if the business achieves certain agreed-upon financial goals. A common mechanism in many M&A transactions (particularly in the life sciences sector), earn-out clauses have a reputation for generating disputes, and arbitration has become a primary forum for the resolution of these disputes. COVID-19 disruptions have led to divergent views about the risks to a particular business, resulting in a surge in the use of earn-out provisions across a number of sectors as a way to move forward with a transaction in the face of such uncertainty. More earn-out clauses mean more opportunities for parties to disagree on whether they have been triggered. Thus, 2020’s wave of COVID-19-induced earn-out agreements may turn into 2021’s (or 2022’s) wave of earn-out arbitrations.

Construction arbitration – particularly in the transportation, renewable energy and telecom sectors – is another space to watch for the consequences of COVID-19’s disruptive force. As discussed further in trend 6, COVID-19 is expected to cause a myriad of problems for major construction projects, ranging from potential insolvency of major contractors and crucial supply chain vendors, to ongoing travel restrictions that disrupt ‘fly-in, fly-out’ employment models for projects, to uncertainty and instability in the credit market, upon which large construction projects depend.

So far, the continuation of government protection programmes, the personal impact of the pandemic and the cost involved in bringing proceedings have all contributed to keeping the surge of disputes expected by some at bay. However, as the pandemic is brought under control, government protection schemes are lifted, and agreements to defer or reschedule performance or debt expire, we expect parties to look at their options closely and more disputes will crystallise.

Quantum issues across the waves are likely to raise further challenges

We also expect COVID-19 to lead to significant disputes around novel quantum issues. Parties may seek to rely on the impact of COVID-19 to either reduce or increase the damages they seek from contract breaches that happened just before COVID-19 (or in its early stage). Respondents may argue that the pandemic would have led in any event to the contract being rendered ineffective or less profitable; and claimants operating in sectors that benefited from COVID-19 may argue that they should be compensated for the massive additional profit they lost because of the breach. Valuations also will likely become more difficult, as questions of whether to take into  account a company’s COVID-19-caused loss,  or  how reliable historic cash flows are in a post-COVID-19 future, give rise to new complexities in the already difficult task of assessing damages in complicated cases.

Impact on investment arbitration

COVID-19 has also had an impact on investment arbitration. While government lockdown measures destined to control the spread of the pandemic that impacted business may (at least temporarily) be justified under doctrines such as state of necessity (or treaty exceptions such as public health measures),  the  failure to take measures compensating for the impact of such measures or the pandemic itself may breach positive obligations to grant fair and equitable treatment or full protection and security (or be potentially discriminatory if some sectors receive relief and some do not). We have also seen some governments invoke the pandemic as a pretext to reform certain sectors – for example, electricity in Mexico where alleged concerns over the reliability of privately owned renewable energy sources have led to measures prioritising the dispatch of thermal plants owned by the government’s state-owned utility. Other governments have proposed or taken measures in the pensions sector in order to allow early withdrawal without considering the consequences such early withdrawal would have on the overall economics of protected pension fund administrators. The potential for COVID-19-related investment claims is discussed further in trend 6 below.

In short, the impact of COVID-19 on the arbitration landscape goes well beyond the growing comfort with virtual hearings and streamlined processes, as the pandemic’s consequences can be expected to alter every stage of the dispute life cycle – giving rise to new claims, novel issues of liability and damages, and expanded opportunities to challenge the enforcement of awards.