COVID-19: Investors During the COVID-19 Triggered Force Majeure

by Abha Kashyap Managing Patner

Every aspect of global commerce has been impacted by the COVID-19 Pandemic. Businesses and the investors involved are no exceptions. While the governments around the world are imposing strict limitations and restrictions on its citizens in order fight the virus, the economy on the other hand is suffering overwhelming losses. Contractual obligations are becoming impossible to perform forcing the parties to invoke the clause of force majeure which allows the parties to avoid liability in case of non-performance of a contract. The force majeure clause which is usually included in all the long-term contracts only covers governmental policies and Act of God (natural disaster). COVID-19 on account of being declared a pandemic has been notified to be treated as natural disaster. Therefore, force majeure can be invoked in lieu of COVID-19 by parties. (For more information about Force Majeure, please refer to: https://www.kpalegal.com/covid-19-force-majeure-and-contracts-in-the-face-of-a-pandemic-global-view/)

It has become essential to draw a distinction between a contract which has become “impossible” to perform and a contract that is merely impractical due to increased cost and/or effort. Corporations and individuals have started using this clause as a way to wiggle out of unfavorable old contracts. Hence, determination of mitigating factors or substitution in order to avoid invoking force majeure is integral.

Several corporations dealing with private equity funds which were not finalized before the imposition of the lockdowns and restrictions are considering triggering the Force Majeure Clause or Material Adverse EffectClause in the transaction documents. Many are taking this opportunity to walk out of the deal altogether further worsening the condition of the global economy and market.

Being one of the fastest growing economies, India has been recognized as the ideal market for investors and venture capitalists. In 2019, India saw an investment of INR 1,211 billion (growth: 60.5 per cent) in the form of private equity investments with internet, computer software, utilities, financial services and transportation among the top gaining sectors. Additionally, India successfully materialized 616 deals with an average deal size of INR 1,967 billion. For India's venture capital industry, 2019 was a milestone year with $10 billion deployed into startups.[1]

Disruption in the market due to the coronavirus outbreak is dampening the overall economic activity, affecting the operations and economic health of startups. While startups, being the most vulnerable and susceptible to the volatile market risks, are responding to the chaos with belt-tightening measures, investors and venture capitalists have taken multiple steps at a firm and a macro level, to either withdrawn their funds or by helping the startups navigate through the current crisis. Investors are extending support to startups in multiple aspects, including technical advisory, mentoring, business continuity assistance and in some cases, financial assistance as well.

In only a month’s time (March 2020), Foreign Institutional Investors (FIIs) and Foreign Portfolio Investors (FPI) have withdrawn around Rs. 63,000 crore ($8 billion) from the Indian market. Additionally, around Rs. 53,000 crore have been withdrawn debt segment, taking the net outflow to more than One Lakh Crore in just a month bringing the Indian market to its knees. One third of the Indian equity market is controlled by the foreign capital which is why this withdrawal of foreign capital is hitting the India currency Rupee hard which has crashed 5% in a month.[2]

On the other hand, the overwhelming withdrawal of foreign capital is not unprecedented as a similar trend was witnessed by the nation during the 2008 global crisis.

Investor Trends AmidCOVID-19 Outbreak

Investors have been put in a difficult situation; their investment has been put into a venture that has partially or completely stalled with no estimation of when things will come back on track. In order to secure their investment, continue their work with the start-ups and help the company they have invested in, it is integral for the investors to keep certain things in mind:

1. Investors should ensure that their contracts and agreements with the start-ups are properly analyzed and assessed. This can help avoid unnecessary financial liability, point out clauses requiring re-negotiation and prevent the party from taking undue advantage of the situation.

2. Staying connected in this digitized world has never been a task and the investors are taking full advantage of the technology and are continuing to interact virtually via video conferencing with the entrepreneurs. Many accelerator firms and venture capitalist are also taking to the podcast platform to reassure and provide guidance to Start-ups.

For e.g. Brinc, a venture capitalist is hosting their Spring 2020 accelerator programs entirely online. Kalaari Capital is hosting a virtual ‘Open Office Hour’ with prominent investors.In an attempt to actively partake in the digitization regime, Startup India also organized a webinar which was joined by around 1300 people to start a dialogue about business continuity in the current scenario.

3. Investors are recommending that the startups re-examine and re-assess their developmental plans and also revisit the financial projections to make the possible adjustments for better control over cash burn. They have also been advised to integrate the available tools and resources into the regular workflow and ease the transition while maintaining the productivity. While every investor has been consistently dedicating a significant portion of their time to handhold existing portfolios to get out of the existing crisis, some have decided to continue the evaluation of new proposals in the slowing down investing landscape.

For e.g. Matrix Partners India hosted a call for founders with the managing director, Matrix Partners China and have shared an article which talks about the startups' lesson from China in the wake of Covid-19 crisis.

4. The current climate has the fight-or-flight response triggered among investors. While companies are looking for investment and help during this time, existing investors are looking for a way out. It is necessary to obtain legal advice and opinions to analyze each contract, business proposal and project. This can help find ways to reduce the financial responsibility of the investor, understand how to negotiate a deal to the investor’s benefit and how to aid stalled businesses. This one step can help find alternatives to pulling out investments in a crisis.

Given the above, it is clear that it has become necessary for investors to pull away from the natural “flight” response and understand how to secure their investment without immediately thinking of pulling out of the company. This not only can cause the businesses to collapse but would make all the time, energy and effort of the investor futile.

[1]www.investindia.gov.in

[2]www.deccanherald.com/business

Originally published on www.kpalegal.com on 11th April 2020