Editor’s notes: during the Chinese New Year 2020, the coronavirus disease (COVID-19) pandemic broke out and spread at a terrific speed. On 20 January 2020, the National Health Commission of China classified pneumonia caused by the COVID-19 virus (hereafter COVID-19 pneumonia) as a category B infectious disease under the Law of the People's Republic of China on Prevention and Treatment of Infectious Diseases, and decided to take preventive and control measures of category A infectious diseases. Due to the COVID-19 pandemic, many cities in China have implemented lockdown measures and travel restrictions, delayed resumption of work, and compulsorily cancelled tourism products. Globally, it has been declared a public health emergency of international concern (PHEIC) and many countries and regions have imposed entry controls. The pandemic has not only impaired people’s lives, health, living and national economies, but also put obstacles to the negotiations, interim periods and closing of many M&A transactions involving complicated contract performance periods, volumes and timelines. Having analyzed COVID-19 impacted cases and drawing upon experience, the Investment and M&A Team of our firm has identified common risks in and proposed solutions for different transaction phases based on M&A timelines, in an attempt to facilitate the steady progress or orderly termination of M&A transactions. This article is the first half of a two-part series and mainly analyzes M&A transactions that have already been affected by the pandemic; the second half, A Checklist of Investment and M&A Transactions during the COVID-19 Pandemic, will be coming soon.

1. Project overview and the questions posed

Company A is the sole shareholder in the target company, which is a chemical product manufacturer and processer based in Hubei. The target company is domestic-funded and holds a core license required for the industry (expiring at the end of February 2020 and needing an extension). However, it has been carrying on business in debt for a long time and sunk into operational difficulties. A large number of creditors are concerned, involving loans from financial institutions, hundreds of creditors associated with private lending, and accounts paid to and received from Company B (which operates in Wuxi). There are pending proceedings between Company B and the target company with respect to their creditor’s rights and debts. Company B has been dedicated to the industry for years and gained advantages. In order to integrate industrial resources for mutual benefit, it has been agreed after rounds of negotiation that Company B will gain control of the target company by acquiring 80% of its equity which is owned by Company A; Company A will keep 20% equity participation, and the original team of the target company will carry on with their main operational duties. The interested parties signed a transaction agreement late December 2019 and made the following commercial arrangements:

✔ Company A will urge the target company to extend its core license by the end of January 2020, and Company B will apply for the withdrawal of the action by the end of January 2020;

✔ Company B will pay the first instalment to the jointly managed account by the end of January 2020, dedicated to repay the debts owed to creditors of private lending;

✔Starting from January 2020, Company B will dispatch a senior officer to the premises of the target company to participate in its decision-making and jointly manage its certificates, licenses, company seal, and USB Keys.

To maintain the project’s confidentiality and facilitate the analysis below, the description of the transaction has omitted or modified some details.

As the Chinese New Year is approaching, neither of the parties has strictly followed the above arrangements. Only the target company has made repayment arrangements with its many creditors, setting out strict repayment dates based on the dates the instalments shall be received under the transaction agreement. At this moment, as Hubei is under lockdown, the actual controller and legal representative of the buyer, Company B, along with the company’s financial officer, is held up in Wuhan after arriving there in January to negotiate about the transaction. They have not brought with them the USB Key needed for making bank transfers and therefore cannot make payments online (although Company B has pooled the purchase fund).

Company B is now requesting urgent legal assistance from us as regards the following questions:

✔Can Company B terminate the transaction under the circumstances of the lockdown due to the COVID-19 pandemic?

✔If Company B cannot terminate the transaction and losses are incurred by the creditors due to the target company’s late repayments under their arrangements, how do Company A and Company B share such losses?

2. Analysis of a contingency plan for the project

After going through all contract terms, debtor-creditor relationships and all parties’ performance in relation to the transaction, we present a basic analysis below:

2.1 There is no dispute over the fact that the COVID-19 pandemic constitutes a force majeure event.

As a public health emergency, the COVID-19 pandemic is objectively unforeseeable, unavoidable, and insurmountable in nature. Legally, it is considered a force majeure event. There is no dispute over this fact in the legal profession.

The Notice on Duly Conducting Trial and Enforcement Practices by People's Courts in the Period of Prevention and Control of the Infectious Atypical Pneumonia (F [2003] No. 72) (now expired) published by the Supreme People's Court on 11 June 2003 still offers some guidance. It provides that if the government’s and relevant authorities’ administrative measures to prevent the SARS epidemic have directly resulted in the impossibility of contractual performance or if parties to contracts become completely unable to perform under the impact of the SARS epidemic, for any disputes thus arise, the provisions of Articles 117 (Force Majeure) and 118 (Notice of Force Majeure) of the Contract Law of the People’s Republic of China shall apply.

During the COVID-19 pandemic, the China Council for the Promotion of International Trade (CCPIT) published the Notice on Applying for COVID-19 Force Majeure Certificates on 30 January 2020. Companies that are unable to perform or perform as scheduled international trade contracts due to the impact of the COVID-19 pandemic may apply for a force majeure certificate. An online certificate platform has also been released. Based on information obtained from CCPIT’s WeChat official account, CCPIT Wuhan Office, as a local issuing agency of CCPIT, has urgently issued the province’s first 8 “force majeure certificates” for local companies by 3 February. All of the 8 certificates regarding force majeure facts are applied for by large publicly listed companies as regards contract amounts ranging from several dozens of millions to over a hundred million dollars, with the largest amount concerned being over 2 hundred million dollars.

2.2 Substantive and procedural elements are involved in applying force majeure to a specific transaction.

In view of applicable legal provisions and relevant judgments made during the SARS epidemic, we understand that transaction parties affected by the COVID-19 pandemic need to consider the following substantive and procedural criteria when judging whether they can seek to be excused from liability for breach by claiming the COVID-19 pandemic as a force majeure event:

(1) The circumstances shall be unforeseeable, unavoidable, and insurmountable: the force majeure event takes place after the execution of a contract and before its performance, during which the affected party has not delayed in performance.

Following the SARS outbreak in 2003, the Research Team of Beijing No.2 Intermediate People's Court promptly carried out research and published the results entitled Properly Handling Cases in Which the SARS Epidemic Constitutes Force Majeure Exemption. The results set out that it is important to strictly examine force majeure events in order to prevent debtors from evading their contractual obligations by claiming force majeure and using the outbreak of SARS as an excuse. Strict criteria should be met for the SARS epidemic to constitute a force majeure event:

✔ The SARS epidemic as objective force majeure circumstances must take place after the execution of a contract and before its performance;

✔ If the SARS epidemic affects a party before the execution of the contract or takes place during a party’s delay in its performance of the contract, the SARS epidemic may not be considered force majeure;

✔ In addition, the SARS epidemic as a force majeure event must have affected the normal performance of the contract.

In this case, the transaction agreement was signed in December 2019. At the end of 2019, the media started reporting about viral pneumonia, stirring public discussions on a small scale. However, as we understand it, the first warning of the contagious nature of the disease was given by Zhong Nanshan on 20 January 2020, and Wuhan did not implement the lockdown measures until 23 January. When signing the transaction agreement, the parties as a part of the general public could not foresee that the pandemic would spread at such a tremendous speed and give rise to a series of preventive quarantine measures. Accordingly, the substantive criterion of the “unforeseeable” nature of force majeure is met on the part of Company B as the parties to the transaction could not foresee the pandemic when concluding the agreement.

After executing the transaction agreement, Company B promptly pooled the transaction fund to its corporate account. However, due to the quarantine measures implemented in Wuhan, relevant persons from Company B were unable to visit the bank where it had opened its account, located in Wuxi, to facilitate transfers. Without the USB Key, they were unbale to make online transfers to a business account either. Although the transaction agreement was signed at the end of December 2019 and Company B had had sufficient time to fulfil its payment obligations under the agreement before Wuhan went into lockdown on 23 January, the first instalment payable by Company B was due at the end of January 2020 and therefore Company B was not in default at the time it became confined in Wuhan under the circumstances. It is thus feasible for Company B to claim force majeure.

(2) There should be a direct causal link between the force majeure event and the nonperformance.

Article 180 of the General Provisions of the Civil Law (which was promulgated on 15 March 2017 and took effect on 1 October 2017) provides that if a party is unable to perform its civil obligations due to force majeure, the party shall be released from civil liability. If the law provides otherwise, such other provisions shall prevail.

In judicial practice, it is necessary to check whether there exists a direct causal link. For example, the civil judgment [(2013) LSEMKZ No. 14] given in the retrial of the housing lease dispute between Dalian Pengcheng Holiday Damu Co., Ltd. and Dalian Zhengdian Watch Co., Ltd. states as follows: “The notice issued by competent government authorities under the impact of the SARS epidemic on halting business related to wild animals only affected part of Zhengdian’s business activities and was not sufficient to cause the “direct” or “complete” impossibility of performance of its lease with Pengcheng; it is thus not sufficient to find that the termination of the contract between the parties was caused by force majeure.”

Back to this transaction, there is a direct causal link between Company B’s inability to pay as scheduled and the travel restrictions imposed as part of the measures to prevent and control the COVID-19 pandemic.

(3) In procedure, the affected party should fulfil its notice obligation in order to mitigate the other party’s loss.

Article 118 of the Contract Law provides that if a party is unable to perform a contract due to a force majeure event, such party shall promptly notify the other party so as to mitigate the loss that may be caused to the other party and shall provide evidence of the force majeure event within a reasonable period.

The civil judgment [(2010) BMZZ No. 1073] given in the second instance trial of a dispute under the construction contract between Kaifeng Xingjie Real Estate Development Co., Ltd. and Kaifeng Education Building Engineering Company states as follows: “Besides, if a party is unable to perform the contract due to a force majeure event, such party shall promptly notify the other party so as to mitigate the loss that may be caused to the other party. The Education Company has not submitted valid evidence that it has fulfilled its notice obligation, and therefore shall bear the consequence of its failure to provide evidence.”

During the COVID-19 pandemic, Wuhan government published a notice on “closing outbound traffic” on 23 January. Within a reasonable period following such notice (or within the notice period set out in the transaction agreement), Company B is advised to promptly notify Company A and the target company about the impact, along with evidence of the force majeure event (such as the notice on travel restrictions issued by the government), and to propose an initial solution to facilitate emergency consultation between the interested parties.

At the same time, Company B needs to keep relevant evidence, including without limitation:

✔ Records of communication: in the course of negotiation, it is important to keep written records of the communication (for example, by communicating by written notice as set out in the transaction agreement) and other written records such as delivery receipts, emails and facsimiles;

✔ Government orders: such as government orders to lock down cities, close roads, suspend construction, impose quarantine, and expropriate property. If no written document is available in special circumstances, an alternative could be to keep video records;

✔ Hospitalization or quarantine certificates: if an individual debtor or the actual controller of a transaction or a key person affecting the timely performance of contractual obligations needs to be hospitalized or kept in quarantine due to infection or suspected infection, it is important to keep proofs such as hospitalization certificates, diagnoses, discharge certificates, and quarantine certificates.

2.3 The application of force majeure clauses does not automatically lead to the termination of transactions.

As regards this transaction, the primary desire of Company B is to terminate the acquisition transaction by claiming force majeure. However, according to applicable laws, applying a force majeure clause to a specific transaction does not necessarily have the legal consequence of contract termination. The effects of force majeure application include the following:

(1) Exemption from liability in part or in whole

Article 117 of the Contract Law provides that a party who is unable to perform a contract due to force majeure is exempted from liability in part or in whole according to the extent of impact of the force majeure event, unless as otherwise provided by law. In other words, liability for inability to perform is exempted only to such extent as the transaction is affected. Liability can be exempted either by postponed performance or to the extent of the affected part (rather than the whole transaction).

The civil judgment [(2018) J No. 4 MZ No. 2272] given in the second instance trial of a dispute under the lease contract between Xiangyuan Wuyang New Century Co., Ltd. and individuals Wang Shuwen and Guo Hongwei states as follows: “the tenants in this case had been operating a hotel not long before it had to be closed down in April 2003 for 5 months as part of the measures taken to control the SARS epidemic. The SARS epidemic was objective circumstances that were unforeseeable, unavoidable, and insurmountable at the time of contract execution and therefore is considered a force majeure event. During the impact of the force majeure event, the tenants have no business revenues and shall be duly exempted from their obligation to pay rent for 5 months.

In the above case, the force majeure applied only to the 5 months that it had affected, and therefore the liability for such affected part (namely 5 months’ rent) was exempted. However, in this acquisition transaction, Company B is affected to the extent that it is unable to fulfil its payment obligation during the lockdown of Wuhan, whereas its ability to pay is not prejudiced or lost. Accordingly, it is reasonable to release Company B from its obligation to pay by the end of January 2020 and postpone the fulfilment of such obligation. But it is not a sufficient ground to exempt Company B from its payment obligation or to terminate the transaction agreement.

(2) Contract alteration or termination

As provided in Article 94 of the Contract Law, a contract may be terminated only when force majeure has rendered it impossible to achieve the purpose of the contract.

In trying the appeal in relation to a dispute under the lease contract between J.PI Travel USA, Inc. and Changjiang Overseas Cruise Travel Co., Ltd. [(2007) EMSZZ No.47], the court held that “as regards the extent of impact of a force majeure event on the contract, a contract may be terminated by a party unilaterally only when the force majeure event affects the achievement of the contact purpose; if the force majeure event has not affected the achievement of the contract purpose, the parties to the contract have no legal right to terminate the contract. Whether a force majeure event can be claimed as the ground for unilateral termination of the contract also depends on the impact of the event on the contract purpose.”

In this transaction, the force majeure event has not affected the achievement of the contract purpose at this stage. Company B has the right to postpone the payments, but it is not advisable to terminate the contract by misapplying force majeure.

2.4 Efforts should be made through proper consultation to mitigate loss whether the transaction agreement is terminated or not.

Released from liability by law, a party affected by force majeure may still not be able to completely avoid loss and only look after its own interests in a M&A transaction. The force majeure clauses in the General Provisions of the Civil Law and the Contract Law have not specifically provided for the sharing of loss caused by force majeure. In practice, each party would usually bear the loss it incurs. For this reason, the law provides that the party affected by force majeure shall promptly notify the other party so as to mitigate the loss sustained by the latter.

In this transaction, after Company B’s force majeure notice is given to the target company and Company A, the target company has to promptly see to its rights, obligations and due dates under the repayment arrangements it has made with its many creditors so as to avoid or mitigate loss. As any loss sustained by the target company or in its value after the acquisition would eventually be reflected in the interests of its shareholders, Company A and Company B, it is advisable that Company B should do its best to assist the target company in mitigating loss after giving the force majeure notice. For the protection of Company B, an agreement can be added that Company A will compensate Company B for any loss in the target company’s value beyond a certain amount during the interim period. Such agreement would serve to prevent the original team from slacking.

3. Expanded analysis of the impact of the COVID-19 pandemic on investment and M&A transactions.

3.1 Scenarios in which founders of target companies lose the capacity for civil conduct due to COVID-19.

If the founder of a target company has passed away or lost the capacity for civil conduct due to COVID-19, this would give rise to a host of issues such as succession and shareholder qualifications. If the successor takes on the shares, the valuation adjustment mechanism for an existing investment transaction may be affected as the successor may not be capable of performing the valuation adjustment obligation.

For instance, as mentioned in the case study entitled The Death of a Party to a Contract Constitutes Force Majeure published on the website shfy.chinacourt.gov.cn on 18 July 2013, in the 2003 trial of a dispute under the real estate presale contract between Shanghai Yuanzhong Jing’an Real Estate Co., Ltd. and Yan Dingyi, Shanghai Jing’an People’s Court held that although the creditor’s rights and debts of the deceased party under the contract could be transferred to its successor, it would not be fair or reasonable to simply assume that the performance of the contract could be carried on. For one thing, the successor might not necessarily be aware of the existence of the contract, while the other party might not necessarily be able to get hold of the successor. With such lack of communication, it is impracticable to avoid the obstacles to the performance of the contract caused by the death of a party. For another, the successor would not be aware of the existence of the presale contract as the deceased’s death was sudden.

For more examples we can refer to the civil judgments (2018) Y No. 1802 MC No. 1370 and (2018) Y No. 18 MZ No. 2466. In the case related to these judgments, the plaintiff went into a coma with a sudden disease after paying a deposit, and the defendant requested to terminate their contract and keep the deposit. The judgment of the second instance stated as follows: “The plaintiff became a person without the capacity for civil conduct from a person with full capacity for civil conduct due to a sudden disease, which was beyond the control of his will. The impossibility of performance which led to the termination of the contract was thus caused by an event not attributable to either party.” The judge of the second instance further held that in compliance with the Contract Law, performance of the unfulfilled part of the contract should be ceased after the termination of the contract; as regards the part that had already been fulfilled, each party should be obliged to return any amount owed to the other party.

For the above reasons, the court applied the force majeure principle and released both parties from liability for breach and ordered them to return any amount owed to each other in relation to the part of the contract that had already been performed. In a similar situation concerning investment transactions, it would be appropriate for other core members of the founding team of the target company to continue to run the company. If the value of the target company relies on the founder alone (such as the founder’s core technology and research results), the death of the founder would make it impossible to achieve the contract purpose. In these circumstances, the successor would not be obliged to ensure the valuation adjustment performance, and the investor would be entitled to terminate the contract and withdraw the investment fund.

3.2 Scenarios in which M&A transactions involve tourism, catering, offline teaching and other industries that are heavily affected by the COVID-19 pandemic.

If the target company of an M&A transaction is in tourism, catering, offline teaching or other industries that are heavily affected by the COVID-19 pandemic, its evaluation may need to be adjusted in the light of the pandemic. If evaluation adjustment mechanism is also involved, it may be advisable to consider adjusting the evaluation adjustment performance.

Now we will look at situations in which the target company is in the tourist industry. Although the Tourism Law provides that loss caused by the termination of travel contracts shall be shared between travel agencies and travelers (instead of being borne by travel agencies alone), in practice many travel agencies would refund travelers fully as a commercial means to engage customers and increase their market appeal. Consequently, during the pandemic, the financial statements of travel agencies may be significantly different. In making valuation adjustments during this period, it is not advisable to calculate the target company’s depreciation rigidly accordingly to applicable legal provisions. Instead, it would be better to take its marketing plans into account.

3.3 Points for attention in cross-border M&A transactions.

As regards the COVID-19 pandemic, if a cross-border transaction contract is governed by the law of Mainland China, force majeure is a statutory circumstance under which liability can be exempted. Even if the contract does not include a force majeure clause, applicable legal provisions can be referred to in determining whether the party unable to perform the contract can be exempted from liability by claiming force majeure.

In common law countries and regions, force majeure is interpreted based on contractual provisions and legal precedents. For this reason, as regards the “slumbering” provision of force majeure, it has become increasingly important in cross-border transactions to extensively list force majeure events and logically specify feasible solutions following the occurrence of such events. A typical list of force majeure events might include war, strike, government action, natural disaster (such as typhoon), and terrorist attack. In light of the COVID-19 pandemic, “serious communicable disease”, “public health emergency”, and “control measures taken by the government” may be added to the list.

3.4 Points for attention in M&A and restructuring of publicly listed companies

Article 3 of the Provisions on Issues Concerning Regulating the Material Asset Reorganizations of Publicly Listed Companies provides that “if, after the decision passed at the first directors’ meeting on purchasing assets by issuing shares is published, the board of directors have not within 6 months given notice about convening a general meeting of shareholders, the publicly listed company shall reconvene a directors’ meeting to discuss matters concerning the purchase of assets by issuing shares, and the date when the decision passed at this meeting is published shall be deemed as the base day for pricing of the shares to be issued.” The COVID-19 pandemic may hinder agencies from conducting due diligence and issuing audit reports, evaluation reports, opinions and other documents. If the delay so caused is too long, all previous efforts might be wasted.

Accordingly, the Notice of Further Strengthening Financial Support for the Prevention and Control of the COVID-19 Pandemic (YF [2020] No. 29), issued by People's Bank of China, Ministry of Finance, China Banking and Insurance Regulatory Commission, China Securities Regulatory Commission, and State Administration of Foreign Exchange, provides that “…to extend appropriately the time limits for procedures in relation to the capital market, the validity periods of financial documents required for obtaining administrative licenses for M&A and restructuring of publicly listed companies, as well as the time limits for giving notice on convening a general meeting of shareholders following the disclosure of restructuring preschemes. A company unable to update financial documents or give notice about a general meeting of shareholders in time due to the impact of the COVID-19 pandemic may, after fully disclosing the specific impact of the pandemic on the restructuring, apply for one month’s extension of the validity period of the financial documents or the time limit for giving notice about a general meeting of shareholders; up to 3 applications may be submitted for such extension. During the pandemic, the time limits for share issuers to respond to feedback and notification letters, as well as the validity periods of their financial reports and approved refinancing permits, shall be suspended as of the date this notice is published. As regards bonds not issued within the validity periods of the licenses obtained for their issuance, applications may be made to China Securities Regulatory Commission for extending the time limits for the issuance.”

[Special thanks are given to Wen Congjun, director of M&A and Restructuring Business Research Committee of Shanghai Bar Association, and Chu Xiaoqing, deputy director, for their guidance and assistance with amendment throughout the writing of this series of articles.]

Wang Xiaoli

Senior partner of Shanghai Yingdong Law Firm

Leader of Investment and M&A Team

Ni Chenliu

Lawyer of Shanghai Yingdong Law Firm