Force majeure and MAC/MAE clauses during the period of Covid-19 in Hungary

author: dr. Balázs József FERENCZY

What force majeure means?

Force majeure (in the Hungarian legal language: “vis maior”) is a legal institution dating back to Roman law, and “means a force or event that human weakness cannot resist.”[1] The legal literature includes both overwhelming natural forces, such as earthquakes, floods, shipwrecks, other natural disasters, and certain human/social movements, such as wars, revolutions, or other extraordinary social events of extreme force. According to Roman law, “no one is generally liable for force majeure”[2], unless (i) it has been undertaken by someone in a contract (such as in the case of ancient “insurances”, like the pecunia traiectitia or the lex Rhodia de iactu mercium), or, for example, (ii) if the person was liable for (i.e. it was attributable to him) that the asset has been affected by force majeure.

Force majeure – although it has classical roots and a fairly widespread contractual practice – does not have a normative basis in the current Hungarian legal system. This legal institution can be deduced indirectly from certain provisions of the Civil Code and their explanations (cf. the system of exemption from contractual liability according to § 6: 142 of the Civil Code),[3] and in practice, the exact meaning and content thereof are set forth by the parties in their contractual clauses and in the judgments developed by case law.

Can the current epidemiological situation be considered as force majeure and can we invoke it in our contractual relations?

In our contractual relations force majeure may be invoked mainly in cases where the parties have made the vis major cases, and among them the epidemiological situation, part of their contractual agreement. These clauses are most often included in medium- and long-term contractual schemes (e.g. construction and installation contracts, credit line contracts), but it is important to note that the contract must be examined each time (i) to find out if it contains any additional force majeure clause, on the one hand, and if this exist (ii) what is the exact content thereof, on the other hand. These provisions usually provide a clear indication of the contractual obligations the parties are liable to meet in the event of force majeure (e.g. the obligation to notify in writing on the occurrence of force majeure event and the nature thereof), the duration of such a situation (the parties generally allow the application of force majeure event for a transitional period) and what should and/or can be done after this transitional period (withdrawal or termination if the force majeure situation does not cease during the transitional period or resumption of contractual obligations).

The provisions on the payment moratorium set forth in the Government Decree Nr. 47/2020 (III. 18.) on the immediate measures necessary to mitigate the impact of the coronavirus pandemic on the national economy, as well as in the Government Decree Nr. 62/2020. (III. 24.) on the execution of the former one (hereinafter collectively referred to as the “Government Decree”) in Hungary, for example, contain an exemption from the fulfilment of contractual obligations for the debtors of credit, loan and financial leasing contracts disbursed on a commercial basis, which, in fact, prevented the risk of mass insolvency resulting from the epidemiological situation and, therefore, the risk of mass litigation procedures, which was likely to place a heavy burden on the economy as a whole and on the judicial sector, too.

Force majeure may also be applied even without a contractual clause, for example, if the party relying on it can properly prove that he was unable to meet a contractual obligation specifically due to the epidemiological situation or for a reason directly attributable to the epidemiological situation, he did not foresee the occurrence of this event, neither could he be expected to assess/foresee it in advance. In this respect, for example, an important and decisive issue may be the date of conclusion of the contract as well as to what extent and in what manner the given business was affected by the possible shutdown of foreign suppliers around this date, for example.

In which cases could difficulties arise in relation to force majeure event?

Despite the above, there are many systems of contractual relations where reference to force majeure event is likely to cause difficulties, such as, for example, lease contracts for retail units and shops. As our colleague, Mátyás Rada explained in his previous article “since force majeure in lease contracts usually means events beyond the control of the parties that damage or destroy the building or part of it rendering the leased property unavailable or unusable (such as fire, flood, or even war events), a new interpretation of ‘un-usability (unavailability)’ may emerge in the context of a coronavirus pandemic.”

Is there causing of damage in case of force majeure?

If the defaulting party properly alleges and proves that he was unable to meet his obligation due to force majeure event, therefore his conduct or his omission resulted from a cause beyond his control, he can be relieved of his liability for breach of contract and thus for causing damages.

It is important to note that, on the basis of a regulation developed for this purpose[4], a so-called certification of force majeure can be required from the Hungarian Chamber of Commerce and Industry (HCCI) in respect of non-performance of an obligation (or obligations) specified in a particular contract, which is an institution rather foreign from the until now existing Hungarian legal practice. At the same time, HCCI underlines in its abovementioned regulations that “The concept of “force majeure” has not been defined neither by Hungarian law, nor by EU legislation and judicial practice. The purpose of the Chamber’s certification of force majeure is to avoid possible lawsuits, to promote civilized economic co-operation between enterprises, to simplify the proof in lawsuits that may still be initiated, and to reduce the duration of lawsuits.”

A major question of judicial practice following the coronavirus epidemic is the direction in which the case-law related to force majeure will be further developed, based on a simultaneous examination of the above elements, in a forward-looking manner.

What does MAC/MAE clause mean?

If the contract cannot be terminated due to force majeure, the contracting partner may have to seek other clause(s)/legal grounds for terminating the contract.

As impact of the Anglo-Saxon legal system and international model contracts, the use of the so-called MAC/MAE (that is to say: Material Adverse Change/Material Adverse Effect) clauses is widespread also in Hungarian contractual practice, that can typically be found in credit and loan agreements and in the documentation of M&A transactions. The main source of the MAC clauses – similarly to force majeure – are the provisions mutually agreed upon by the parties in the contract. The legal background for this legal institution does not currently exist in the Hungarian legal system.

For example, in a loan agreement standardized by the LMA, any fact, event, or circumstance, or a series thereof, shall be considered as material adverse effect that has occurred to the borrower which, according to the creditor’s reasonable opinion, have or may have a material adverse effect on

(a) the economic (financial or other) situation of the borrower;

(b) the management and business of the borrower;

(c) the ability of the borrower to meet any obligation under the financing agreement or the collateral contract securing thereof; or

(d) the legality, binding force, validity, enforceability, ranking of any transaction document to which the borrower is a party.

A MAC/MAE’s

lack (as expected by the creditor) may, for example, serve as a precondition for the financing party to meet its financing obligation under the credit facility agreement; or
occurrence (unauthorized by the creditor) may, for example, result in the breach of the borrower’s obligation undertaken in respect to the lack of MAC/MAE, which may lead to an event for breach of contract; or
occurrence/existence (not permitted by the creditor) may also result directly (sui generis) in an event for breach of contract.

When can we speak about the occurrence of a “material adverse effect” under the MAC clause?

In this matter – in lack of Hungarian judicial practice and legal provisions – it is worth relying on the results of Anglo-Saxon legal development. According to them, a material adverse effect, for example,[5]:

must continue existing for long-term: the change cannot be only temporary, it must be for long-term and permanent in terms of the company’s ability to generate revenue (“over a commercially reasonable period, measured not in months but years.”);[6]
must be quantitatively significant: a waiver based on the MAC clause could be successfully invoked, for example, in the case of a 50% reduction of two consecutive quarterly revenues,^[7], in another case the court considered a reduction of 64% of the quarterly revenue to be a close case,^[8] while a decrease of 86% of EBITDA was considered as an undoubtedly significant and substantive change („short-term hiccup should not suffice”);[9]
externalities affecting the whole industry concerned, given that they affect all participants of that industry, do not normally fall within the scope of the MAC clauses. If a material adverse effect affects the given contracting party only, regardless of the industry concerned, the termination on the basis of the MAC clause may provide an appropriate basis thereof; however, if the effects affect the whole industry in the same way, the contract cannot normally be withdrawn under a MAC clause.

The above only sets the framework for Anglo-Saxon case law (drawn with rather inaccurate lines) and does not mean that minor revenue losses cannot lead to a decision respecting MAC/MAE clauses (with special regard to the existence of other important circumstances), nor they mean that even in the case of a higher loss of revenue, the court could not decide against the application of the MAC/MAE clause. However, it can be stated in general, the courts interpret the MAC/MAE rather strictly and narrowly. They usually exclude the applicability of the MAC/MAE clauses in the event of, for example, war, natural disasters or force majeure, placing the systemic risks on buyers/creditors, essentially. As the pandemic became global, the Covid-19 epidemic also began to appear in MAC clauses as a specific circumstance being an explicit exemption from the causes of withdrawal[10] (a substantially similar trend was observed after the events of 11 September 2001, when the terrorist attack was included among the events of force majeure). However, it is important to underline that specific circumstances referred to in the MAC/MAE clause (including the Covid-19 epidemic, too) can only constitute an exemption if they affect the given industry or activity, including all market participants, in general. If the impact on a given company is (significantly) more severe than on the industry in average (“except to the extent that the target was disproportionality impacted compared to other industry participants”), the systemic risk thesis may be overturned and the application of the MAC/MAE clause against the target company/borrower may legally be founded, taking into account all the factors of the case.

Can the current epidemiological situation justify withdrawal from the contract or refusal to financing by reference to the MAC/MAE clause?

In each case, extensive and thorough contractual interpretation is needed in order to determine whether the epidemiological situation caused by the Covid-19 virus and the resulting economic and legal circumstances fall within the scope of the MAC/MAE clauses set out in the contracts. In our view and in the light of past experience, it can be said in general that the MAC/MAE clauses relate specifically to the individual financial, economic or legal situation of the debtor/contracting partner. The fact that both the world economy and the Hungarian economy have to face a global epidemiological situation as a result of the Covid-19 virus does not in itself provide a sufficient legal basis for the contracting party to exercise its right to terminate the contract under the MAC/MAE clause.[11] Nevertheless, special consideration in the risk analysis should be given to the possible disproportionate impact on a given company caused by the current situation referred to above.

Are there other contractual rules under which a credit institution may, for example, consider terminating a loan agreement?

As we explained in one of our previous articles, the payment moratorium (at least, concerning Hungary) only grants, temporarily and not permanently, exemptions from the rules of the loan agreements related to the repayment of capital and interest. This is a very important, but by no means a single set of borrower obligations. In addition to capital and interest repayment rules, loan agreements commonly used in the legal practice impose obligations on borrowers to comply with certain financial ratios (DSCR, LTV), to provide financial information on an ongoing basis, or to maintain collateral value (listing only the most important ones). Borrowers are obliged to fully comply with these obligations, even during the payment moratorium set out in the Government Decree and the existence of the force majeure situation. Should any of these obligations be breached, these may allow the credit institution to consider the termination of the relevant contract, which is not in the borrower’s interest during the moratorium period, either.

What is the solution?

In the current situation, both (legal) force majeure (Government Decree on the declaration of an emergency and its execution) and the MAC/MAE clauses can provide an appropriate basis for the contracting parties to negotiate and resolve disputed issues reassuringly and for long term. It is clear that in this way parties are primarily facilitating to relaunch the various sectors of the economy after the emergency will cease, which already seems to be a huge, but mutual task, trying and testing people and the market.

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[1] History and Institutions of Roman Law (András Földi and Gábor Hamza), Institute for Educational Research and Development, Budapest 2015. Brósz-Pólay: Roman Law, Textbook Publisher, 1974, p. 351 .: “cui humana infirmitas resistere non potest” – D.44.7 .1.4. – Gaius.

[2] D. 50.17.23. – Ulpianus, 1.

[3] Section 6:142. of the Hungarian Civil Code

[4] https://mkik.hu/vis-maior-igazolas-kiallitasa

[5] https://corpgov.law.harvard.edu/2020/04/04/covid-19-as-a-material-adverse-effect-mac-under-ma-and-financing-agreements/

[6] Akorn, Inc. v. Fresenius Kabi AG https://courts.delaware.gov/Opinions/Download.aspx?id=279250

[7] Raskin v. Birmingham Steel (Del. Ch. 1990)

[8] IBP Shareholders Litig. (Del. Ch. 2001)

[9] Akorn, Inc. v. Fresenius Kabi AG https://courts.delaware.gov/Opinions/Download.aspx?id=279250

[10] Morgan Stanley-E*TRADE merger agreement: https://news.bloomberglaw.com/bloomberg-law-analysis/analysis-morgan-stanley-e-trade-merger-excludes-coronavirus

[11] https://www.ashurst.com/en/news-and-insights/legal-updates/is-coronavirus-covid-19-a-material-adverse-change/