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Contracts, COVID-19, and “Material Adverse Change” Clauses: Protecting your business agreements during a global pandemic

As someone with extensive experience advising public and emerging growth companies and their investors, along with parties in M&A transactions, I am often asked to advise companies on how they can prevent interruptions to their business priorities, particularly interruptions to customer and supplier relationships. With the advent of COVID-19 and the declaration of a “global pandemic” by the World Health Organization, companies are more concerned than ever about protecting the business contracts they have in place. I am now being asked if companies are able to trigger a “material adverse change” clause that would allow them to terminate a contract they are bound to and how companies can ensure the contracts they have in place are protected.

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What constitutes a “material adverse change”?

A “material adverse change” clause, or MAC clause in short, is a clause outlined in a business agreement that allows a counterparty to exit the agreement if there is a major degradation affecting the fundamentals of the deal between when it is signed and closed. MAC clauses have been prevalent in commercial and investment contracts and are often interpreted in the context of merger agreements with the buyer being able to walk away from the deal.

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When determining if a MAC clause has been breached, there are several things a court needs to assess. The adverse change must be “material” to the deal in whole and occur over a significant period of time. A circumstance that is only temporary and occurs over a short period of time is not enough to necessitate a MAC. Additionally, the MAC must have actually taken place; the threat of a forthcoming MAC will not trigger a MAC. For a MAC to be triggered, the party wanting to trigger the MAC needs to demonstrate the adverse change in terms of time and quantity while being specific to how and why the MAC occurred. If the consequence was foreseeable when the contract was established, but was not spelled out, the courts would be less likely to see the event as a MAC. A MAC clause will be carrying more weight when leveled against an unknown or unforeseeable event.

Triggering a MAC should not be taken lightly, as the party seeking to trigger the MAC must provide evidentiary support to prove that a MAC has actually occurred. A famous example of a MAC was between a buyer and seller of a sugar refinery in Cuba in which the subject refinery became nationalized under Fidel Castro following the Cuban revolution. Legal standards for a MAC do not differ across the states, though Delaware and New York are most persuasive (as to variations across national boundaries, that is another question entirely). Furthermore, there are no specific guidelines that must be followed, so courts interpreting a potential MAC must look at each circumstance individually with all facts presented.

COVID-19 and your contracts: Can this global pandemic trigger a MAC?

As stated above, the party wishing to trigger a MAC clause must provide immense evidentiary support for the clause to be granted. Terminating a contract poses consequences to the viability of commerce and the financial economy as a whole, and the courts will seek to preserve the economic basis of contracts in light of the consequences that may arise.

Questions to consider:

  • Was the circumstance, in this case COVID-19, already a known factor or had it been contemplated when the contract was established?
  •  Has the declaration of COVID-19 as a global pandemic resulted in an adverse change so severe as to render the agreement economically unfeasible?
  • How long is the circumstance occurring for in relation to the length of the contract? Will the COVID-19 outbreak occupy a significant time during the performance period of the contract?
  • If a MAC clause is not granted, will economic consequences to the other party be so great that they must cease operations in their current capacity?
  • Are pandemics specifically called out in the contract?
  • If more time passes and the COVID-19 outbreak subsides, will both parties be able to fulfill the terms of the contract?

How can your company protect its contracts now?

As the current COVID-19 situation stands, business should review their most important contracts. To determine:

  • whether the contract provides for suspension or termination of performance;
  • whether any representations, warranties, covenants, delay rights, termination rights, conditions or force majeure provisions are triggered by COVID-19 and determine next steps;
  • look for any notice requirements that have been or may be triggered;
  • the extent to which COVID-19 prevented a party asserting an inability to perform;
  • consider what, if any, other means exist to deliver or perform on contractual obligations
  • are there proactive steps that can be taken now in case the crisis continues for longer than currently anticipated?
  • is there any ability to mitigate effects to better perform?
  • try and quantify the potential consequences of a breach and/or default;
  • communicate, communicate and communicate, and consistently; and
  • to check for any governmental or regulatory statements that could impact performance or non-performance.
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Risks and opportunities should be assessed on an individual case-by-case basis.

With the COVID-19 outbreak being categorized as a global pandemic, businesses now have a standard for handling such a situation in the future. In the current state of affairs, businesses should take this as a chance to thoroughly review their standard terms and conditions regarding business activities, including any agreements in place between customers, suppliers, or vendors. These contracts can then be tailored going forward according to experiences and expectations during a global health crisis, including if situations degrade before they get better.

Entrepreneurs and those in management should take a long-term view of relationships and avoid over-reacting to the current COVID-19 pandemic, which could, and most likely will, have only a temporary, albeit large, impact on their business. It is advisable to uphold any commitments that have been made to the fullest extent feasible, while continuing to look for business opportunities that foster trust, confidence, and continued growth in the future.

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9 Considerations for an Effective Board Meeting

As your company grows and has completed its first venture capital fundraising round, it is customary to include one or more outside investors on your board of directors. As your company enters this stage, board meetings will become formalized events engaged and effective dialogue between the company’s executives and its board of directors.

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The following are 9 considerations for structuring and promoting a productive board meeting.

  1. Determine how often your board of directors should meet. You want to strike the fine balance between keeping the board engaged throughout the meeting without the time commitment for preparation and attendance becoming unreasonable or inconsiderate of board members’ busy schedules. Meeting quarterly, at the minimum, is advisable.
  1. Prepare your board deck to serve as a meeting outline.Your board deck should provide an overview of the areas of focus for your company and what will be covered in the board meeting. You want to include an financial report covering current capital, capital projections for the upcoming period, and a calculated future capital prediction. In addition to financials, the board deck may highlight concerns regarding operations, development, competition, legal matters, or additional matters of business that require the board’s approval or feedback.
  1. Provide sufficient time for the board to review the board deck. The board deck should be circulated a minimum of one full business day ahead of the scheduled meeting to ensure board members have time to look through the material that will be covered. Delivering the board deck immediately before the meeting not only prevents the meeting from running as efficiently, but also reflects poorly on the company for a lack of organization.
  1. Schedule regular updates with the board so there are no unexpected surprises. When unexpected developments occur, it is important to inform the board prior to these concerns being brought up in the board meeting. Being candid in regards to unforeseen challenges or concerns facing the company allows the board generate feedback and prepare strategies that can help the company overcome the challenges. The board is there to guide and assist when challenges arise, don’t be afraid to utilize this.
  1. Spend more time focused on one or two areas where the company excels or struggles. The board deck serves as a meeting outline, however, rather than skimming over every area of focus of the company during the meeting, it may be more effective to give the majority of the meeting’s time to acutely address one or two areas where the company has excelled or struggled since the previous board meeting.
  1. Don’t waste your board members’ time. Your board members have busy schedules. Board meetings should be no longer than 3 hours, to ensure the meeting stays focused, efficient, and respectful of everyone’s time.
  1. Include your company’s leadership team, not just the top two executives. While the CEO and CFO should be present at all board meetings, the board meeting is an excellent platform to introduce the entire management team to your board. If a board meeting will be more focused on matters dealing with sales, for example, having the executive in this area present their concerns will allow the board to view the company from a more organizational standpoint and see what areas of the leadership team need to be developed.
  1. Make a note of questions, suggestions, and advice brought up by the board. When your board members are engaged in the meeting, they will be asking questions, giving task suggestions, and providing advice. It is important to show your board that you value their input by providing a follow-up on their recommendations at the next board meeting.
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  1. Showcase your company culture to build and maintain your relationship with the board. Activities beyond the board meeting can help build a meaningful and lasting relationship with board members. The board of directors is a great asset to a company’s growth and ensuring this relationship is built on trust and transparency can help when the company faces greater challenges.
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Early-Stage Financing Rounds

When it comes to financing a startup, many entrepreneurs think of venture capital. While a venture capital fundraising round is critical to securing funds for an emerging company, there are other options to consider when a company is still in the early stages of its life cycle. This article will cover the friends and family round and the angel investment round of early-stage financing.

The “friends and family” financing round

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Your company’s first source of capital is likely your personal savings or an investment from those in your close network. A company can expect to receive an investment anywhere from $10 000 to $150 000 in this round, with investors providing their own money due to their personal connection with the founder of the startup. Because this round comprises investments from those primarily in your close personal network, it is commonly referred to as the friends and family financing round. To prevent future conflicts and to maintain a lasting investment relationship with the investors of this round, you should ensure to retain some level of formality to the documentation process, much like you would for a corporate investment.

The angel financing round

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Angel investors are often wealthy individuals that have experience working with and investing in early-stage companies. Angel investors can also belong to angel investing groups, small firms created for investment purposes. Angel investors are interested in companies that are still considered early-stage, however they have a developed and deliverable product. An angel investment can range anywhere from $50 000 to $2 million, with angel investors focused on the return they will receive.

Key differences between these financing rounds

The investor:

The investor in the friends and family round is just that, a close personal connection of the entrepreneur. Their choice to invest in the company is based on their loyalty to and relationship with the founder. An angel investor typically does not know the entrepreneur and sees the investment in terms of the return and the opportunity to share their industry knowledge.

 

The size of the investment:

The capital raised from an angel round will typically be larger than that from a friends and family round. This is because angel investors or angel investor groups typically have greater personal wealth to invest in a startup. The average capital raised from a friends and family round is just over $20 000, whereas the average angel investment is more than three times that.

 

The valuation of the startup:

As friends and family round is one of the first sources of financing for a startup, the company often has a valuation no greater than $1 million. Angel investors typically invest in startups with a valuation between $1 and $3 million.

 

The time taken to secure the investment:

A friends and family investment is a quick solution to the immediate financial needs of the startup, as it usually takes no longer than two months to close the deal. An angel investment will take between three and six months to close, though if an angel group has a structured pitch and review process, it may take longer than six months to close the deal.

 

The chance of a repeat investment:

Investors in a friends and family round have a close relationship with the founder so they are more likely to support the idea of continuous or long-term support. An angel investor is concerned with their investment returns so they prefer diverse portfolios, making it unlikely for a company to receive repeated funding.

 

The cost of the round:

Being that the friends and family round is informal, without strict procedures in place, a company will save on transaction, documentation, and legal fees. The costs associated with an angel round will be greater, but this round also provides industry knowledge and advice from the experienced investors to the entrepreneur, making the fees worthwhile.

Companies should pursue these early-stage financing rounds to secure capital before they are ready to enter a formal round of venture capital fundraising.

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7 Reasons Talented and Hard-working Employees Leave

Choosing the right lawyer that fits your business is one of the most important steps you can take in today’s litigious world. Whether you are launching a new venture, pivoting to reposition your current business or have a “bet the company” challenge or opportunity, finding the lawyer that fits your unique situation is critical.

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How to build healthy relationships at work

Silicon Valley lawyer Louis Lehot shares 10 tips on how to build healthy relationships at work. It’s no surprise that many of the strongest relationships I have built over the past 20 years have revolved around my work.

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Looking for A Lawyer? Choose wisely, your business is at stake, says Louis Lehot from L2 Counsel

Choosing the right lawyer that fits your business is one of the most important steps you can take in today’s litigious world. Whether you are launching a new venture, pivoting to reposition your current business or have a “bet the company” challenge or opportunity, finding the lawyer that fits your unique situation is critical.

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Building the perfect pitch deck

I’m often asked by clients, in the initial fundraising process how to build a pitch deck. As a recent outside general counsel to well over a hundred emerging growth private companies in the technology, life sciences, medical device, and clean energy industries, in all stages of growth (from formation to liquidity), I am sharing my observations on what works.

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Running an effective board of directors By Louis Lehot of L2 Counsel P.C.

Companies usually run informally at the pre-seed and seed-stage, without formal meetings of the board of directors. However, once your business closes its first round of formal venture capital financing from a professional investment firm, and one or more venture capital partners have joined your board of directors, the meeting process becomes more formalized.

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