Client Alert

The Impact of the COVID-19 Outbreak on PE Investors and their Portfolio Companies in Asia – Part I

The COVID-19 outbreak disrupts business but also creates opportunities for PE players.

20 Feb 2020

The COVID-19 (the official name of the 2019 novel coronavirus) outbreak is likely to have an effect on the PE landscape in Asia and on anyone with interests in Asia. In this three-part article, we examine how PE buyers, sellers, and their portfolio companies should evaluate their existing contract terms to mitigate the impact of the outbreak, and how this may change the approach they take with respect to their future contracts and investments. At the same time, we look beyond the current crisis and share our views on which sectors will likely emerge from the COVID-19 outbreak stronger.

After almost a month of operational suspensions and the imposition of a broad quarantine, China sought to partially resume business in less affected areas, such as Shanghai, in the week starting February 10, 2020. However, many large companies in these areas have nevertheless instructed their employees to continue working from home until February 21, 2020. Other countries in Asia that have reported a significant number of infections also have implemented enhanced measures in an effort to contain the spread of COVID-19 in local communities. The impact of the suspended production and deal activity in China and some other parts of Asia has been felt worldwide. In this three-part article, we will consider:

  • Part I: How readily lenders, PE investors, their counterparties, or portfolio companies may invoke contractual provisions governing material adverse change (MAC) and force majeure (FM) in order to relieve themselves of existing contractual obligations as a result of the COVID-19 outbreak;
  • Part II:
    • How PE investors should work with their existing portfolio companies to respond to the immediate and long-term impact of the COVID-19 outbreak; and
    • How the lessons learned from this outbreak may change the manner in which PE investment and M&A deals are concluded and executed in China and elsewhere in Asia; and
  • Part III: Which sectors are likely to weather this crisis better than others and be increasingly attractive to investors.

Part I – Invoking Material Adverse Change and Force Majeure Clauses As A Result Of the Covid-19 Outbreak

The World Health Organization (WHO) declared the COVID-19 outbreak to be a “Public Health Emergency of International Concern” in late January 2020. The Chinese government imposed quarantine measures in severely affected Chinese cities and travel to and from China has been severely curtailed, both of which have impacted the ability to conduct site visits, on-site due diligence, and in-person negotiations on transactions with a China focus. Certain government functions have been closed or are understaffed, hindering the ability to obtain regulatory approvals. Some PE funds that have signed (but not yet closed) transactions prior to the outbreak of COVID-19 are considering whether the outbreak is a valid ground for triggering the MAC clauses in the transaction documents; at the same time, sellers and targets may be concerned that the situation presents buyers and investors with the chance to easily invoke the MAC clauses to walk away from what they may now consider to be a “bad deal.”

Additionally, PE portfolio companies that operate in or rely on production or supply chains, or brick & mortar food and beverage or retail sectors in the severely affected sectors in China and portions of Southeast Asia may have to report losses, trigger events of default under their loan documents, or breach the terms of their operational agreements if they do not manage to obtain subsidies from their governments, rent forbearance or rebates from their landlords or waivers from their lenders, or if they cannot get deadlines extended by invoking the FM and/or MAC clauses in the relevant agreements.

  • Whether MAC clauses are triggered will depend heavily on the specific wording of the MAC clause and the particular circumstances of the business at issue.
    • MAC clauses in transaction documents come in all shapes and sizes (please refer to the Glossary at the end of this article for further details on MAC clauses). Whether a party can rely on the impact caused by the COVID-19 outbreak to trigger the MAC clause under a particular agreement will depend heavily on (1) how the clause is drafted, (2) how the clause will be construed under the agreement’s governing law, and (3) the actual impact on the business at issue.
    • If a MAC clause does not specifically define the circumstances that constitute a MAC, courts will require the party seeking to invoke the MAC clause to show an unforeseen adverse change that is material under prevailing precedent. That typically will require such party to show that the event has a significant long-term adverse effect on the business at issue. This is a very high bar and requires something more than a short-term downturn in business or business prospects. For example, under Delaware law, courts apply a test (which has been referenced in UK decisions) requiring a fact-specific demonstration that the event “substantially threatens” the earnings potential of the entire business “in a durationally significant manner.” While a fact-specific determination, this has proven to be a very high hurdle in practice.
    • In the present circumstances, the full effect of the COVID-19 outbreak is not yet clear, and it may be too early to determine conclusively whether a MAC clause has been triggered. Any subsidies, etc., provided by the governments will likely be taken into account in determining whether MAC could be argued.
    • For that reason, parties should closely monitor and maintain documentary records showing the impact of the COVID-19 outbreak on the business at issue in order to evaluate whether the situation threatens a MAC. In the meantime, PE investors and their portfolio companies should continue to approach contract performance in good faith and maintain thoughtful and commercially reasonable communications with their counterparties. Courts are sensitive to motive and are unlikely to favor a buyer’s position if it is apparent that the buyer simply is suffering “buyer’s remorse,” for example.
  • Specific and appropriate FM clauses, together with official orders and guidance in China, may help to provide relief from existing contractual obligations.
    • Whether the COVID-19 outbreak qualifies as an FM event under a contract governed by Hong Kong law will depend on the construction of the clause in question. PE investors or their counterparties may find it easier to use such clause if the clause specifically identifies “disease,” “epidemic,” or “quarantine” as FM events or, at least, more general events such as “acts of God,” “acts of government,” “strikes,” or “circumstances beyond the parties’ control.”
    • Where a contract is governed by Chinese law, the party seeking to invoke FM clauses to postpone the performance of, or be relieved from, any existing material obligation must prove that circumstances of the outbreak rendered it unable to properly perform the contract. In 2003, following the Severe Acute Respiratory Syndrome (SARS) outbreak, the Supreme People’s Court issued a notice to confirm that FM would apply where the SARS outbreak or government measures adopted to combat it rendered a contract unable to be performed. Subject to how an FM clause is drafted, unless the target’s long‑term business and/or earnings prospects over a sustained period is expected to be seriously threatened, a buyer would find it challenging to rely on FM to get out of “bad deals” concluded in an investment agreement or sale and purchase agreement. For underlying operational agreements already entered into by a PE portfolio company of a nature that are severely impacted by the outbreak, unless official orders are issued by the Chinese government to suspend operation for an extended period necessary to perform such contracts and the Chinese courts confirm their view on the applicability of FM, the relevant portfolio company may find it difficult to legally invoke the FM clauses in those contracts to seek relief.
    • In Singapore, construction firms in Singapore, which are heavily dependent on foreign labor, are reportedly seeking advice as to whether they can invoke FM clauses in building contracts, with one of the considerations being that the Singapore government has denied the entry of Chinese workers or required them to be quarantined as part of the nation’s efforts to contain COVID-19. We expect to see an increased interest in the FM analysis across the affected countries. For more information and analysis, please also refer to our briefing on how “force majeure” clauses would be considered under Chinese and Hong Kong laws.
  • Potential breach of covenants and MAC under facility agreements. Facility agreements entered into by PE SPV borrowers and portfolio companies typically contain standard MAC clauses as one of the events of default.  In reality, the use of such a MAC provision as a ground to accelerate loans has generally been viewed as a last resort. As the financials of the borrower deteriorate, other events of defaults, in particular the typical financial covenants breaches, are likely to be the first trigger entitling lenders to demand early repayment of loans. After SARS was brought under control, many affected businesses managed to bounce back – with that experience, lenders will likely evaluate the risks on a case-by-case basis before deciding whether to accelerate their loans.

PE investors may wish to consider preparing for any potential triggering of MAC and/or FM clauses by working with counsel to examine their rights under such clauses as the COVID-19 situation evolves, and closely monitoring any policies and guidance that may be issued by the Chinese government and any developments in case law. In any ongoing negotiation, in relation to acquisition of potential portfolio companies or disposal of existing portfolio investment that may suffer from the impact of the COVID-19 outbreak, PE investors should assess to what extent other epidemics and pandemics should be specified as, or carved out, from MAC.


1. Material adverse change (MAC)

  • A typical MAC clause might define MAC as “any event, circumstance, fact, change, development, condition, or effect that, either individually or in the aggregate, has had or could reasonably be expected to have a material adverse effect on the business, financial condition, results of operations, or other aspects of the business of the target and its subsidiaries, taken as a whole.”  Generally the parties would negotiate for several carve-outs from this broad definition of a MAC. These carve-outs are usually the focus of MAC negotiations as sellers wish to narrow what the buyer can argue constitutes a MAC. In particular, industry-specific or larger economy/geography impacts are very often carved out from the definition of MAC.
  • MAC is a means of allocating risks between signing and closing and can be used in different parts of agreement: (i) in representations and warranties on a standalone basis regarding nonoccurrence of a MAC since a given date; and/or (ii) in “back door” closing condition, “bringing down” the accuracy of the seller’s representations and warranties given at a previous date, which prevents the seller from making further disclosure, and enables the buyer to terminate the agreement if the condition is not met.

2. Force majeure (FM)

An FM clause is a common clause in contracts that frees both parties from liability in the event of an extraordinary circumstance beyond the control of both parties preventing one of both of them from fulfilling their obligations under the contract.

As further explained in the Terms / Notices linked below, the information provided herein does not constitute legal advice. Any information concerning the People’s Republic of China (“PRC”) is not intended and shall not be deemed to constitute an opinion, determination on, or certification in respect of the application of PRC law. We are not licensed to practice PRC law.



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