The hotel industry: responding and adapting to unprecedented times

• 30 April 2020
• News

The coronavirus pandemic has, without a doubt, reshaped our personal and professional lives. All industries and sectors have been affected in one way or another and are responding in different ways. Some areas of the hotel industry have taken steps which no-one could have foreseen just a few months ago. So, how is the hotel industry responding to the crisis, what measures and arrangements are being put in place and what are the longer term considerations for it?

Examples of how the hotel industry has responded to the pandemic

Current government guidance in the UK states that, as part of the measures to prevent the spread of the coronavirus, certain venues, including hotels, must close (although there are a number of exceptions, including the provision of accommodation to key workers and vulnerable people), whilst in some other jurisdictions, government bodies are looking to hotel owners to ease the strain placed on the healthcare industry with some hotels being transformed into temporary quarantine facilities.

Key workers and the homeless

Hotel businesses are teaming up with the government and local authorities in order to provide rooms to key workers and the homeless. According to the Ministry of Housing, Communities and Local Government, 90 per cent. of the homeless have been invited to stay in hotels, in order to protect rough sleepers during this time, with the rooms being paid for by the government.
The details of such arrangements have not been made public but it is understood that they are offered at substantially discounted rates.

If hotel businesses have not already done so, and they have appropriate properties for the proposed use, they may wish to reach out to the government and local authorities to explore the ways in which their vacant hotels may be able to assist during the current crisis by providing accommodation to key workers and/or the homeless. Demonstrating a positive and practical example of coming together as a country in this way may help cement stronger relationships with customers and suppliers into the future.

Hotel or hospital?

As the infection took hold in the UK, the need for hospital beds became an urgent priority and there was much discussion concerning the possibility of converting hotels into hospitals. At the time of writing, the evidence suggests that the social-distancing measures are having a positive impact on the number of hospital admissions. However, given the rapidly evolving nature of the pandemic, such strategies may well be considered again in the future. Whether this is a suitable interim strategy for a business will need to be considered in the context of the specific hotel property, the works required in order to convert the hotel into a hospital and whether, given the speed at which they will be required, it is feasible.

That said, hotel businesses, particularly those located within close proximity to hospitals, may wish to open up dialogue with healthcare providers to consider whether they might be able to form an alliance in the coming months.

Quarantine facilities

In other jurisdictions, such as Dubai, hotels have collaborated with the healthcare sector to transform empty hotels into quarantine facilities for patients who are either asymptomatic or suffering from only mild coronavirus symptoms. Such partnerships aim to free up much needed hospital beds, whilst at the same time, providing an effective isolation environment away from the individual’s family unit, for those who know that they are infected but are not yet completely free of the virus. The information available suggests that under such arrangements, the healthcare provider manages the hotel through an agreement with the government.

The transformed quarantine facility hotels are manned entirely by medical staff and not the hotel’s employees. Each patient has a private room and is provided with food, free wifi and access to laundry services. Nurses and doctors monitor the vital signs of the patients on a regular basis throughout the day.

The French hotel group, Accor, has also said that it intends to open a number of its hotels in France as quarantine centres, along the lines of those in Dubai. However, this model may not be something that is possible in the UK until testing becomes more widely available.

Interim considerations for hotel businesses

Maintain communication with landlords

With regard to leases, hotel businesses would be well advised to maintain regular contact with their landlords. Some landlords have indicated a willingness to offer short rent waiver periods during the current crisis, whilst others may be willing to defer rent payments (in whole or in part) in the short term.

Review hotel management agreements

Hotel owners and operators should carefully review the terms of their management agreements and other documentation to ensure that any interim measures are properly agreed and documented between the parties, having considered the terms currently in place. For example, the interim measures which focus on healthcare may see operators providing very limited operating services with certain options requiring a wholesale handover of the hotel and operations to healthcare providers.

Further, whilst legal rights (such as asserting force majeure or frustration or termination of a contract due to circumstances beyond the parties’ control) may be available under the terms of such agreements, such action may prove detrimental to business operations and relations in the longer term.

Review financials

Hotel operators should ensure that they keep detailed operating accounts during the current period of uncertainty. For businesses that were performing well prior to the onset of the crisis, such accounts and records will reveal a clear distinction between the pre- and post-coronavirus condition of the business and could serve as a valuable tool in any discussions with stakeholders.

Owners and operators should maintain an open dialogue to ensure that both parties can assess the liabilities of the hotel and how they impact upon each of them, bearing in mind that hotels may also face significant re-opening costs when restrictions are lifted. As ever, liabilities should be reduced where possible and there may be a strong incentive for owners to engage in discussions with operators regarding terms once the market show signs of recovery.

It is likely that any KPIs/performance tests contained in contracts will not be met during the current period of uncertainty. Owners are likely to ask managers to provide amended budgets and forecasts to see how hotel operators intend to weather the current storm, paying close attention to matters such as operating costs, cash flow, liquidity, asset maintenance costs and projections for the remainder of this year and in to 2021.

Review under-performing third party contracts

It is also worth mentioning that should a business have any contracts that were not performing in the way in which they had hoped prior to the onset of the crisis, now may be the time to examine the terms of such contracts and consider whether there is any scope to renegotiate, or even terminate, those contracts.

The future

Owners and operators will also be looking to the future as much as possible and considering how the current pandemic may affect their business and guest behaviour going forward:

• It may be that additional measures are added to a hotel’s health and safety procedures, which could include staff wearing masks, testing being conducted on admittance to the hotel, and the adoption of further measures to allow people to continue practising social-distancing, such as increased room service offerings and minimising interaction between staff and guests, where possible. Extra training for staff will also be required in connection with such measures and procedures.
• Guest behaviour may see a shift in the market towards aparthotels and serviced apartments to enable them to maintain social-distancing more easily.
• In terms of operational measures, hotels should consider engaging with their health and safety advisers and cleaning contractors on a more frequent basis, as regular, deep cleaning will be required.
• Occupancy levels are likely to be affected in the short to medium term, as rooms may not be available for consecutive occupation if hotel businesses adopt measures such as leaving rooms vacant between guests for at least 72-hours to allow any viable traces of the virus to reduce, in accordance with government guidance.

Conclusion

Guided by history, it would be logical to conclude that the global markets and economies of the world will ultimately recover from the COVID-19 pandemic. Governments around the world will work to make the downturn as short and shallow as possible but, whatever the duration, it appears likely that the current economic uncertainty will continue for some time.

For now, the focus for the hotel industry is cash conservation and immediate liquidity needs and an open dialogue between owners, operators and landlords to ensure that any temporary measures are clearly documented between the parties. As the pandemic evolves, business owners must be ready to adapt to an ever-changing market.

How the market will evolve will largely depend on how long social-distancing measures are required and the ability of the industry to rebound once the quarantine measures are lifted. Experts are predicting that once markets recover and social-distancing measures are relaxed, the rebound in the hotel sector will be strong and quick. When it happens, hotel owners and operators must be ready to make the most of the opportunities that arise in the reshaped market, whatever that reshaped market looks like.

Disclaimer

The current global crisis is evolving rapidly, and the rules and guidance for individuals, companies and other entities to manage its implications are similarly fast moving. Notes such as this may be out of date almost as soon as they are published. If you have any questions prompted by this article or on any other matter relevant to you, please get in touch with your usual contact at Forsters.

Art in the time of Coronavirus: Disputes in the Art World

• 24 April 2020
• News

With one third of the global population living under lockdown, we are witnessing the dawn of a new, and hopefully temporary, normal. We are all having to adapt to significant changes to our daily lives, social interaction and the operation of our businesses.

As the virus has spread, so has the closure of galleries and museums, the cancellation of art fairs and auctions and the shutting of borders, thwarting the movement of art works and the completion of international sales. Like most (if not all) other industries, the art world is feeling the effects of the pandemic.

There are specific legal issues arising from the UK government measures designed to combat the pandemic that affect clients operating in the art world. These include matters relating to tax, employment, financing, tenancy obligations and charities, which are discussed in our articles on these topics.

In the same way, there will be (and already are) disputes that arise as a direct result of the pandemic (for example, because parties are defaulting on their contractual obligations or due to copyright issues concerning virtual exhibitions and online viewing rooms). As litigators specialising in this area, we also need to consider how pre-existing or traditional art disputes may be managed and resolved in these unusual circumstances.

Disputes arising directly as a result of the pandemic

Defaulting on contractual obligations

The cancellation of auctions, exhibitions and fairs, together with the interruption to cross-border travel and shipping, has made it very difficult, and in some circumstances impossible, for clients (and / or their contracting counterparties) to comply with contractual obligations. This is a breeding ground for disputes since people and companies will want to look to defaulting parties to recover their losses.

We do not yet have any certainty as to when lockdown in the UK is likely to end, and indeed what the “end” of lockdown will look like (and this will differ from country to country). Accordingly, clients find themselves having to balance the risk of crystallising, but hopefully reducing, their losses by terminating contracts now (if the contract in question allows them to do so), or holding off in the hope that the restrictions will be lifted or the other party will be the one to default.

Further, in circumstances where only “key workers” are encouraged (or in some countries permitted) to go to work, we are seeing the security capabilities of storage facilities, museums and galleries being heavily (and worryingly) reduced. Notwithstanding the admirable displays of altruism that are arising in response to the crisis, unfortunately, public spiritedness does not appear to be all-encompassing. On the first day after the French “self-confinement” measures came into force, thieves took advantage of the halt in the restoration of Notre-Dame and took stones from the cathedral to sell on the black market. In Holland, a Van Gogh was stolen from a museum closed because of the virus.

Theft is first and foremost a matter for the police and the criminal courts. However, where for example art is stolen from warehouses where security has been reduced as a by-product of lockdown measures, victims may want to seek recourse from the party who had agreed to store their works safely. Whether this is feasible will depend on the provisions of the contracts in place.

Under English law, the absolute nature of contractual obligations that require ongoing performance means that parties are still required to carry out those obligations regardless of the effects of the pandemic and are liable to their contractual counterparty for any failure to do so. There are, however, two exceptions to this rule: force majeure clauses in contracts and the common law doctrine of frustration.

Force Majeure Clauses

These clauses provide that where events outside the control of the contracting parties prevent the performance of contractual obligation(s), the relevant party will not be liable for its failure to comply with relevant contractual obligation(s).

The wording of the particular clause will determine whether it is applicable to Covid-19; some provisions set out the events to be covered (e.g. war or natural disasters) and particularly where these are non-exhaustive, careful scrutiny of the drafting, taking into account the governing law and the relevant circumstances (including industry and trade practices), will be required. It is worth noting that some force majeure clauses expressly exclude government measures taken in response to an event, in which case parties will need to analyse whether performance of the contractual obligations was thwarted by the virus itself or the restrictions put in place to prevent its spread.

Usually, these clauses are only triggered where performance of an obligation has been rendered impossible (not merely difficult) and the burden of showing that the clause is applicable is on the party seeking to rely on it. Practically speaking, parties will also need to consider whether and what duties of mitigation and notification apply.

Frustration

In the absence of a force majeure clause, in some circumstances, parties may be able to rely on the common law doctrine of frustration.

Parties seeking to invoke frustration will need to demonstrate that a change in circumstances has made it physically or commercially impossible to perform the contract, or that performance of the contract would be radically different under the changed circumstances.

If frustration is successfully invoked, the defaulting party will be discharged from their contractual obligations. However, case law demonstrates that the circumstances in which this doctrine will apply are extremely limited.

Given the severity of the restrictions in place and the significant and in some cases devastating impact that these are having on businesses, it appears highly likely that the UK Courts will soon be examining the applicability of both force majeure clauses and common law frustration. The individual circumstances will come into sharp focus and the outcome of such cases will therefore turn on the specific facts. Further, in view of the potential volume of such claims, the Courts may also need to bear in mind relevant policy considerations.

The counterparties against whom a force majeure clause or common law frustration is successfully invoked will no doubt want to seek compensation from their insurers. However, it may be that typical business interruption policy wording does not cover losses arising from Covid-19 on the basis that loss of income does not stem directly from physical damage. However, this will obviously depend on the precise terms of the policy. Nevertheless, looking at the aftermath of 9/11, even where policy wording provides good arguments for non-payment, in reality, it may be a political necessity for insurers to pay such claims. Indeed, recent tweets from the US President, as well as comments from the Financial Conduct Authority in the UK, indicate that the insurance sector may be under significant pressure to pay out on business interruption policies.

Shift to the virtual realm

Thanks to technological advancements combined with a new generation of buyers who grew up in the internet age, the development of an online art market was already underway. Indeed, in March 2019 the Gagosian gallery sold a painting for a record-breaking $6 million through an online viewing gallery after just three hours of its display and without the purchaser having seen the painting in person.

That said, the headline grabbing nature of this sale exemplifies that the art market’s shift to the virtual realm has thus far been limited. However, the current crisis appears to have accelerated development in this regard; as people are gradually adapting to the new normal, online sales appear to be gathering momentum. A recent online sale of 25 prints by Banksy totalled $1.38 million (i.e. approximately $70,000 over the high estimate) and Sotheby’s online sale on 3 April (which was originally planned to be a live auction at their NYC headquarters) reached a total of $3 million, with several works out-performing their estimates.

This increase in online sales will likely shape, or at least impact, the types of art-related disputes that arise in a post Covid-19 world, not least because in the UK different statutory provisions govern the terms and conditions of such sales. Therefore, we are likely to see an increase in disputes arising under the different applicable provisions and it is important that both vendors and purchasers are aware of the discrepancies. From a UK perspective, several of the rules applicable to the international art market are subject to change following the end of the Brexit transition period.

Advantages of the move online

Without downplaying the potentially devastating effect of the pandemic on some aspects of the art market (for example, several museums and galleries may find themselves unable to reopen after government restrictions are lifted), there is no doubt that the shift online could offer opportunities. For example, as we see people become more comfortable transacting in the virtual realm and the relevant technology develops further as a result, it may be that the post Covid-19 world gives rise to a more fluid and efficient art market.

Separately, it is anticipated that shifting the art market further online could eventually have a positive impact on issues concerning questions of provenance, which account for a significant portion of art-related disputes. To date, establishing a work’s provenance has required reliance on paper-based systems and the word of single authoritative bodies; transacting through online platforms (and specifically via blockchain) leaves permanent and accessible records of a work’s provenance from initial authenticity to present ownership. As such, if the art market’s transition to online sales and auctions continues to gain momentum, it may be that one of the legacies of this challenging period is a gradual change (and improvement) to how we record and establish provenance and therefore eventually to a reduction in disputes connected with authenticity.

Resolving disputes in the current climate

Enforcing liabilities and recovering losses

The restrictions put in place by the UK Government mean that the Courts are not operating normally. Alternative dispute resolution (including arbitration and mediation) has also been affected. Our commercial dispute resolution articles discussing these issues can be found here.

In relation to cases that have settled, it is worth noting that we are also likely to see an increase in defaults on contractual obligations under settlement agreements, with parties failing to comply with payment obligations as a result of cash flow difficulties resulting from the interruption or suspension of their business activities. Clients therefore need to consider how best to react, e.g. whether extensions can be agreed or security obtained.

Regulation

This global crisis is dominating the UK Government’s agenda (as well as those of Governments worldwide) and has therefore inevitably interrupted the oversight and enforcement of laws. Government bodies are therefore unlikely to be in a position to issue guidance in relation to legal and regulatory frameworks. For example, there is a backlog of queries concerning the new anti-money laundering rules that came into force in January this year following the implementation of the European Union’s fifth anti money laundering directive (“5AMLD”).

It is inevitable that the effect on the UK economy of the suspension of business activities will be significant. Governments worldwide are facing economic downturn and economists are projecting that mitigation will be a lengthy process. Following the crisis, Governments will be looking for ways to balance the requirement to service and repay debts that have arisen as a result of the crisis with that of protecting taxpayers from heavy taxation in order to encourage economic recovery. As such, among other targets, Governments may consider the scope to increase their revenue from the wealth lodged in the international art market.

The art world’s well-publicised lack of transparency has historically been regarded as a useful cloak for money launderers and tax evaders. Now that regulation is in place in the form of new compliance obligations imposed on art dealers under 5AMLD, the UK Government (and others, no doubt) are likely to focus their efforts on pursuing such avenues (whilst being careful to maintain the UK art market’s position globally).

Players in the art market must not mistake the Government’s current distraction as reflective of a lack of inclination to enforce the new rules. It is perhaps more important than ever for art dealers and others involved in the art market to review their activities and ensure that they are compliant with the new regime.

Conclusion

The impact of this unprecedented global crisis is and will be significant, with every aspect of people’s lives and businesses affected.

Nonetheless, the art market remains active (albeit in different forms), and careful attention should be paid to the new challenges and opportunities that are arising.

As the situation develops and the restrictions are modified, clients operating in the art world should ensure that they are aware of any relevant changes and take legal advice where necessary.

If you require any advice in relation to contentious, or potentially contentious, art-related issues that you or your business are facing, whether arising from the COVID-19 crisis or otherwise, please contact Rebecca Welman.

Disclaimer

The current global crisis is evolving rapidly, and the rules and guidance for individuals, companies and other entities to manage its implications are similarly fast moving. Notes such as this may be out of date almost as soon as they are published. If you have any questions prompted by this article or on any other matter relevant to you, please get in touch with your usual contact at Forsters.

A practical guide for landlords on the impact of a tenant entering liquidation

• 20 April 2020
• News

Despite stimulus packages from the Government, it unfortunately seems inevitable that a large number of businesses will enter liquidation in the short and medium term as the economic impact of the COVID-19 pandemic is felt in nearly every sector.

Below is a practical guide to the mechanics of a typical liquidation, and the rights of a landlord if their tenant is liquidated. Landlords will also need to consider the impact of specific Covid-19 related legislation on their rights and remedies when considering an appropriate course of action.

What is liquidation?

If an insolvent business cannot be sold as a going concern, liquidation acts as a vehicle for selling the company’s assets and winding it up.
There are 3 different types of liquidation:

• Compulsory liquidation takes place where a company is wound up by a court order;
• Creditor’s voluntary liquidation- this is where the company’s members pass a resolution to wind up the company; and
• Members’ voluntary liquidation- here, the directors of a company make a statutory declaration of solvency and then wind the company up following a members’ resolution to do so. This is sometimes referred to as a “solvent liquidation”.

For compulsory liquidation, a statutory moratorium is put in place which prevents proceedings being commenced against the company in liquidation. There is no such moratorium for voluntary forms of liquidation, which will allow a landlord to take forfeiture action or pursue CRAR (taking control of the tenant’s goods in order to satisfy the arrears) if they desire.

Will rent be paid?

Rent will remain payable unless the lease is disclaimed (cancelled) by the liquidator.

The liquidator’s role is to wind up the company. If there are funds available, the liquidator will distribute them in the order of priority outlined below:

• Secured creditors
• Expenses of the insolvency process
• Preferential debts (mainly employee claims up to the statutory prescribed amounts)
• Ordinary unsecured creditors
• Interest on preferential and ordinary unsecured debts
• Postponed creditors, for example shareholders

If the lease is not disclaimed, rent will be treated as an unsecured debt. However, if the premises are used for the purposes of administering the liquidation, rent can then be claimed as an expense of the liquidation and will accrue at a daily rate for as long as the premises is used for these purposes. This is beneficial for a landlord, as liquidation expenses are second in the list of priority.

In relation to rent arrears and other sums due under the lease which accrued prior to the liquidation, landlords without security will again rank as unsecured creditors. The landlord will be asked to submit a proof of debt form, and if there are funds available following the liquidation of the company’s assets they will receive a dividend alongside the other unsecured creditors. Unliquidated sums, such as dilapidations claims, can also be added to the proof of debt form. Unsecured creditors are unlikely to receive the full sum they are owed.

Can the lease be terminated?

The liquidator is free to choose whether to disclaim the lease, which has the effect of ending the tenant’s rights, obligations and interests under the lease.

If landlords require certainty as to whether the lease will be disclaimed, they can to serve a “notice to elect” on the liquidator, which will give the liquidator 28 days to decide whether to disclaim the lease. If they do not elect to do so in this time, the liquidator will lose their right to disclaim the lease.

If the lease is subject to a guarantee, the disclaimer will not impact the landlord’s rights against the guarantor. Depending on the wording of the guarantee, the landlord may be able to compel the guarantor to take a new lease of the premises or step in and fulfil the obligations of the tenant under the existing lease. The landlord will need to ensure that they do not take any steps which could be construed as releasing the guarantor from its obligations (for example, by re-entering the property in a manner which terminates the lease).

If the premises are left empty while the landlord negotiates with the guarantor, it is possible for the landlord to secure the premises by changing the locks without it amounting to termination of the lease if clear notice is given to the interested parties of the landlord’s intention to do so.

Can you force the lease to an end?

The answer to this question depends on the type of liquidation being undertaken.

• Voluntary forms of liquidation- Where a tenant is in voluntary liquidation the landlord is initially free to exercise any right to forfeit they may have, whether by peaceable re- entry or through Court proceedings. If forfeiture proceedings are underway in Court, the liquidator or another creditor may apply to stay the application.
• Compulsory liquidation- The landlord may not commence forfeiture proceedings when a winding up order has been made except with the permission of the court, and subject to the conditions imposed by the court. If the landlord wants to bring the lease to an end without applying to the Court, they may be able to convince the liquidator to disclaim the lease, which would have the same effect.

Practically speaking, any landlord seeking to terminate a lease, whether or not their tenant is in liquidation, will need to consider the practical ramifications of forfeiture, paying particular consideration to government stimulus packages for distressed landlords and tenants and the likelihood of finding another tenant in the current economic climate.

Jack is an Associate in our Property Litigation team.

Disclaimer

The current global crisis is evolving rapidly, and the rules and guidance for individuals, companies and other entities to manage its implications are similarly fast moving. Notes such as this may be out of date almost as soon as they are published. If you have any questions prompted by this article or on any other matter relevant to you, please get in touch with your usual contact at Forsters.

Think carefully before putting pen to paper (or, in this case, fingers to keypad…)

• 17 April 2020
• News

In the recent case of Athena Brands Ltd v Superdrug Stores Plc [2019] EWHC 3503 (Comm) the courts held that a binding contract was made by a simple exchange of emails between parties.

Case

The case highlights the importance of businesses following internal policies when discussing and negotiating purchase agreements and being very careful when negotiating and discussing potential orders by email. As social distancing rules and regulations are implemented and individuals are required to resort more and more to electronic means of communication, particular attention must be paid to the exact words used in emails between counterparties.

Facts

The emails were between a Brand Manager at Athena and a Buyer for Superdrug in relation to the establishment of a new brand of cosmetic products that Athena would supply to Superdrug.

In the course of the email exchange, the Brand Manager asked the Buyer to confirm that he was placing orders and committing to the specified yearly quantity over a 12-month period. The Buyer emailed back saying to go ahead.

The Brand Manager’s email dated 23 May 2017 stated,

“Just to confirm, you are placing orders and committing to the yearly quantity against all lines detailed below based on the ROS you have provided. We have agreed that you will call off stock, in exactly the same way as [another product] on an ad hoc basis within a 12 month period.

[Table of products, quantities and prices]

If you could drop me a note to confirm all the above ASAP that would be great, I shall then be in a position to push the button at this end…”

The Buyer replied by email on 25 May 2017 as follows:

“Please go ahead with the below, happy on [product name]…”

The cosmetic products sold much more slowly than anticipated and on 7 February 2018, Superdrug emailed to say that orders going forward would be unlikely. No further orders were made. Athena brought a breach of contract claim against Superdrug.

Legal background

The key elements for an enforceable contract are as follows: an offer, acceptance of the offer, consideration (for example, a promise or undertaking; in the current case, a payment in return for the supply of the products), intention to create legal relations and certainty of terms.

Where an employee seeks to contract with a third party on behalf of its employer, an additional element is required: Such employee must have the employer’s authority to do so.
Authority can be actual or ostensible (i.e. it appears to a third party that an employee has due authority to act on behalf of its employer and the employer conducts itself in such a way that demonstrates that it has approved the employee’s actions). If the employee acts within the scope of this wider authority, the employer is then bound by the employee’s actions vis-a-vis third parties. The third party’s belief in the ostensible authority of the employee must be reasonable.

The parties’ positions

Athena asserted that a contract was made by the exchange of emails, which committed Superdrug to purchase specified minimum quantities of various cosmetic products and that the emails clearly showed an agreement between the two parties. Athena sought losses from the shortfall in the minimum quantities calculated at just under £980,000, plus interest and storage costs in relation to the unsold stock.

Superdrug contended that:

1. it was not committed to purchase any products unless it issued a specific purchase order and was not bound to issue purchase orders for the alleged minimum or any other quantity;
2. the parties did not intend to create legal relations; and
3. the Buyer for Superdrug did not have actual or ostensible authority to commit to any contract – the Buyer’s authority was limited to identifying suitable products to purchase and negotiating those terms with the prospective supplier.

Decision

Looking at the words used in the emails, the court found that:

• there was a clear offer, followed by an acceptance of the proposals to commit to a minimum number of the goods in question. A contract had been made by the exchange of emails between the parties, which bound Superdrug to purchase the specified minimum quantities of the various cosmetic products even though no purchase order for the products had been completed by Superdrug;
• the Superdrug Buyer had been held out as a buyer authorised to negotiate terms of trade, with no relevant restriction identified to Athena and there was no basis to assert that such terms could not include a minimum quantity commitment, if the Buyer on behalf of Superdrug, considered it commercially appropriate in the circumstances; and
• there was no evidence that anyone had told Athena that the Buyer lacked the authority to agree a minimum quantity commitment, and even if he might, at some point during the negotiations, have stated that he did not intend to agree to such a commitment, he must have changed his position as he plainly had so agreed at the end of the negotiations.

Even though Superdrug asserted that according to established industry practices, well known to buyers and suppliers alike, retailers such as Superdrug do not buy large quantities of products on an upfront basis, the court rejected this argument and found that there was no such sufficiently definable industry.

There was nothing in the history of the negotiations between the parties capable of showing that Athena or an objective observer would have understood that the Superdrug Buyer’s apparent agreement to a minimum quantity was not, or could not be taken as being, what it seemed, or that in making it he did not intend to bind Superdrug. There was no doubt that Athena had relied on the Buyer’s confirmation as binding Superdrug, and nothing in the evidence was capable of showing that Athena had acted unreasonably in doing so. Judgment was granted in favour of Athena.

Discussion

This case highlights that courts are willing to find the existence of a contract even in casual, informal emails.

It should be borne in mind that the courts will assess each set of facts objectively. This case highlights that short, informal email chains can have heavy consequences for businesses and can create legally binding obligations even though this may not be the intention of the parties to the emails.

As social distancing rules and regulations are implemented and individuals are required to resort more and more to electronic means of communication, particular attention must be paid to the exact words used in emails between counterparties.

Whilst it is understood in commercial terms that businesses do not always follow their systems (including purchasing systems) to the letter, now, arguably more than ever before, is the time to adhere to such systems as far as is practicable. Businesses should also consider whether their purchasing systems and procedures, and the training of employees in relation to the same, need review in light of the current circumstances.

Businesses and employees should be mindful that seemingly innocuous words such as, “Please go ahead with the below…” could inadvertently commit businesses to incurring significant costs or liabilities.

Also of note is the importance of clarifying the extent of an employee’s authority to enter into contracts when acting on behalf of its employer – even if an employer’s representative does not have authority to enter into binding commitments on the employer’s behalf, the courts may find that the employee has nevertheless bound the business if an objective observer would have come to the same conclusion and believed that the relevant employee had such authority. It may also be worth considering whether it is appropriate to specify in such contracts the category of persons who have authority to bind the employer. For example, the employer could specify that only a person who holds the title of ‘director’ has authority to enter into a binding contract on its behalf.

It is interesting that part of Superdrug’s defence was that there was no ‘intention to create legal relations’. The Buyer for Superdrug asserted in his evidence that it was not his job to raise a purchase order and he did not know how it was done. Even though that may well have been the case, under English law, the courts will look at the objective conduct of the parties and will disregard the subjective thoughts of each of the parties involved.

Leila is a Senior Associate in our Corporate team.

Buyer Beware: Counterparties and Covenant Strength

• 17 April 2020
• News

In times of growing economic uncertainty business owners will face numerous commercial and strategic challenges. Ultimately, this may result in corporate restructuring or asset and business sales in order to manage liquidity or in more serious cases, protect parties from insolvency.

This may provide investment opportunities for buyers with excess cash reserves, recession-proof revenues or healthy balance sheets to alleviate financial pressure on distressed sellers.

Below, we reflect on how we advised a client to best mitigate the risks associated with transacting with a seller in financial distress with limited covenant strength, a scenario which parties may be dealing with increasingly in the current climate.

Our client sought to acquire the entire issued share capital of a special purpose vehicle (SPV) holding a commercial property as its only asset. During the due diligence exercise, we identified from the accounts of the Seller, that it had been loss-making over the last two financial years. Furthermore, aside from the property being sold, it appeared to have a very limited asset base.

As the transaction documents included a large suite of general corporate and property warranties given by the Seller, which in reality, had very little substance due the Seller’s precarious financial position, it was necessary to consider which potential avenues could mitigate this risk and give our client comfort in proceeding with the transaction.

In doing so, we looked at the some of the following options to determine which best suited our client in the circumstances:

• obtaining warranty and indemnity insurance (W&I Insurance);
• seeking a guarantee;
• holding back some of the purchase price; or
• “taking a view”.

We briefly look at each of these options below:

W&I Insurance

W&I Insurance can be an effective tool in any transaction where the buyer is seeking some protection in respect of seller warranties and the seller is looking for a clean exit to utilise funds from the sale following completion. In this regard, a buy-side policy allows the buyer to claim directly against the insurer for a breach of warranty or claim in a share purchase agreement. The policy period can mirror or extend the time limits set out in the share purchase agreement but usually ranges from 18 – 36 months for general warranties and up to seven years for title, capacity and tax warranties. The insurance premium is linked to the policy limit and dependant on several factors including the amount and nature of the excess (deductible), limitations on the warranties, the jurisdiction and the nature and complexity of the transaction.

The cost of the premium for most corporate transactions generally ranges from 1% – 1.5% of the amount of coverage required. We note however, that during periods of economic uncertainty, some of the cover provided by insurers may be restricted or heavily caveated and pricing may vary based on the nature of the business or assets being sold.

Given the deadlines we were working towards to complete the transaction, obtaining a policy in the time available was not commercially feasible, as the process usually takes around two weeks to organise to give the underwriters sufficient time to diligence the transaction and familiarise themselves with the various transaction documents. This timing may also be impacted when the prevailing economic or social conditions mean that insurers are more cautious in their approach and require greater due diligence before insuring transactions.

Guarantees

Guarantees can protect the buyer in situations where the seller may not have the financial resources to cover warranty claims but a parent company or ultimate beneficial owner might. This enables a buyer to rely on the parent’s guarantee to cover the liabilities of the seller in the event of a warranty claim. For guarantees to be effective, the financial position of the guarantor needs to be thoroughly analysed in order to give comfort to those seeking to rely on the guarantee.

In our case, seeking a parental guarantee was not possible given the structure of the Seller.

Deferred consideration

Negotiating a deferral of part of the purchase price or holding back consideration can be a useful method to ensure that there is cash available to satisfy a successful warranty claim following completion of the transaction. Part of the purchase price can be paid into an escrow account or retained by the buyer and released on the satisfaction of conditions or certain time periods. In the circumstances of our transaction, the Seller was unwilling to accept deferred consideration given its need to be in funds following completion to satisfy obligations under various financing facilities. Furthermore, we were already holding back some of the purchase price to deal with certain remediation obligations in relation to the property.

“Taking a view”

Given the fact we had undertaken a thorough and detailed due diligence process in respect of the SPV and the property, in conjunction with a detailed disclosure process, our client formed the view that there was limited risk of any long tail liabilities associated with the transaction, notwithstanding the fact that some risks were identified during the course of our investigations coupled with the precarious financial position of the Seller.

Further mitigating this risk, our client had a history of dealing with the Seller and there was also the possibility of entering into some management arrangements in respect of the property going forward, incentivising the Seller to be professional and transparent in respect of its conduct, the warranties being provided and the associated disclosure regime.

Accordingly, our client was able to take comfort in the fact that despite the limited covenant strength of the Seller, the risks associated with the purchase of the SPV was low enough for them to enter into the transaction. This was ultimately down to the quality of diligence undertaken both from a legal and financial perspective and our client’s intimate understanding of the sector and underlying asset being purchased.

There is no one size fits all solution to structuring and negotiating a transaction where you may be dealing with a party with limited covenant strength or in a distressed sale scenario, however, it is important to consider what works best for you and how you will manage the risks associated with the transaction.

Please contact the Fosters Corporate team if you have any questions or would like any legal or transaction structuring advice.