Continuous disclosure vs COVID-19: material contracts – what to disclose and when!

By James Morvell and Vanessa Murphy 

The drastic measures implemented to curb the COVID-19 pandemic and the resultant economic disruption are impacting a wide range of contractual arrangements. Many listed entities are facing issues far outside those they ordinarily grapple with, whether due to the direct impact of the pandemic or government restrictions on their own operations, the indirect flow-on effects of those they transact with, or market conditions generally.

This is, in turn, triggers various contractual issues, and it is more important than ever for listed entities to keep the market informed of changes or developments relating to their ‘material contracts’ in accordance with their continuous disclosure obligations. In part four of our four-part series, 'Continuous disclosure vs COVID-19', we provide an overview of these obligations.

Assessing the ‘materiality’ of any matter can be difficult at the best of times, and this is no different when considering whether a contract is ‘material’. Sometimes the answer will be clear, such as where the contract is with one of the business’ main suppliers or customers, is a lease that generates a significant portion of rental income or is a senior facility agreement that provides debt funding necessary for a business to operate. However, this is not always the case, which means that continuous disclosure obligations in this area can present two threshold issues:

1. Is the contract itself ‘material’/‘market sensitive’?
2. Does the relevant matter or circumstance (such as a change to that contract) require disclosure in accordance with the continuous disclosure test?

Given the current economic volatility in response to the COVID-19 pandemic, there are a number of circumstances in which listed entities are currently grappling with what key contractual events they might need to disclose to the market, and when. Also, as government subsidies are progressively removed over the coming months, it’s likely that various contractors to a business may simply no longer be in a position to perform their contractual obligations.

Financial covenants

Bank covenants are particularly sensitive to breaches in the current climate. Small drops in earnings or asset valuations, for example, may result in the breach of a covenant and event of default under a debt facility.

Loan to value ratio (LvR) covenants are particularly susceptible to any economic downturn affecting property or other asset values. Similarly, interest coverage ratio (ICR) covenants may be breached where entities experience a drop in earnings. While lenders are typically permitted to treat any breach of an LvR or ICR covenant as a default by the borrower under the facility, financiers may instead opt to use covenant breaches as an opportunity to renegotiate more favourable terms. Where an entity has entered into arrangements with more than one financier, the breach of one agreement also has the potential to trigger a cascade of cross-defaults.

ASX expects the occurrence of an event of default under a material financing facility to be disclosed to the market immediately, given the severity of the potential consequences. Similarly, notice of a standstill from a bank is also regarded as information that meets the requirements of the continuous disclosure test in Listing Rule 3.1.

Where events of default are anticipated, or parties are negotiating with financiers for waivers or revised facility terms, listed entities should be cautious to refrain from premature disclosure that could lead to a false market. In such circumstances, the exemptions from the continuous disclosure requirement set out in Listing Rule 3.1A should be carefully considered and regularly monitored.

Ultimately, entities should closely monitor covenant compliance, engage with financiers early and update the market where any price-sensitive matters arise in relation to the facilities.

Termination of contracts

The Listing Rules expressly provide that the termination of a material contract may be market sensitive, and so subject to a continuous disclosure obligation.

The current circumstances are giving rise to contractual termination rights that could not ordinarily be relied upon (and would not generally be paid much attention!). These termination events include the occurrence of a’ material adverse change’, the triggering of a ‘market out’ clause, or reliance on a ‘force majeure’ provision where non-performance is attributable to circumstances outside the parties’ control.

At the same time as dealing with the commercial issues that these purported or actual contractual terminations raise, listed entities should be cognisant of the potential need to disclosure a termination or notice of such.

The termination of a material customer or supplier contract or the loss of a material licence may also necessitate updated earnings guidance (or simply the withdrawal of previous guidance).

In these circumstances, as discussed in our earlier article in the series, ‘Continuous disclosure vs COVID-19: has the ability to rely on information being ‘insufficiently definite’ become ‘insufficiently uncertain’?’, entities should announce whatever information is in its possession about the event immediately, but signal that it will make a further announcement when it has had the opportunity to prepare an updated earnings guidance in light of the event.

Rental defaults

The Mandatory Code of Conduct for SME Commercial Leasing Principles during COVID19 released on 7 April 2020 (Code of Conduct) provides that during the COVID-19 pandemic, landlords of certain commercial, retail and industrial premises must not terminate leases (or draw on security) where a tenant fails to pay rent. In these circumstances, landlords must reduce rent proportionately to the reduction in the tenant’s turnover, through waivers or deferrals of rent, and there will be a freeze on rent increases.^[1]

Listed entities, such as REITs, that hold property portfolios may need to disclose information about the extent of any tenant assistance provided pursuant to the Code of Conduct. For example, disclosure may be required where relief is provided:

• to number of tenants, who together make up a material portion of the portfolio;
• in circumstances where it is anticipated to impact earnings; or
• where a single or a few significant tenants are provided with relief.

Where forecasts or guidance is provided in circumstances where rental relief could have an impact on an entity’s performance, the assumptions on that guidance that are disclosed to the market may need to specifically address the issue of rental relief going forward.

New material contracts

Many listed entities are entering into new material contracts in response to COVID-19. Some common examples are supply agreements for in-demand products related to COVID-19, contracts connected with capital raising activity, or the acquisition of assets that may be ‘pandemic-proof’ or available at extraordinary value.

Wherever possible, an announcement of entry into a new material contract should contain sufficient detail for investors or their professional advisers to understand its ramifications and to assess its impact on the price or value of the entity’s securities. ASX has recognised that this will often include commercially sensitive information, as well as the potential application of the ‘trade secret’ continuous disclosure exemption in Listing Rule 3.1A to such circumstances.

ASX generally expects disclosure of the name of a counterparty or customer with whom an entity has entered into a market-sensitive contract, as it allows the market to assess the standing and creditworthiness of the counterparty-generated revenue. In limited circumstances, where ASX is satisfied of legitimate reasons for withholding a counterparty’s name (as may occur with some government agencies or entities in the defence or security industries), ASX may accept a description that is sufficiently detailed to allow the same assessment.

Listed entities must also keep in mind that continuous disclosure obligations will prevail over any confidentiality or non-disclosure agreement that might otherwise require it to keep information confidential. While most non-disclosure agreements will contain a carve-out for disclosure ‘required by law’ (which captures continuous disclosure), the expectations of counterparties who may have regarded this as a ‘boilerplate’ exemption should be managed.

When circumstances are changing daily in the current environment, it is also important that listed entities do not prematurely announce new contract ‘wins’. ASX has warned against disclosing information that is not yet ‘ripe for disclosure’ as there is a risk that it could mislead the market. Recent ASIC regulatory action and class actions alleging continuous disclosure breaches have also been founded on the basis of disclosure relating to purported revenue-generating contracts that were in fact found to be non-binding, preliminary arrangements.

A call for caution

Listed entities are encouraged to err on the side of caution when it comes to disclosing matters relating to material contracts, given that overly positive messaging in relation to material contracts has sparked regulatory attention to date. Contractual issues and developments are inherently dependant on not only the listed entity itself, but the conduct and performance of the counterparty, who is likely facing the challenges of the COVID-19 pandemic as well.

Given this, it is important that the market sensitivity of any issues that arise is regularly assessed, and – to the extent possible– listed entities should map out what could occur under the terms of their existing key contracts, to be in the best position possible to respond.

[1] There are criteria that apply to this. For example, must be eligible for Federal Government’s JobKeeper program and have a turnover of $50 million or less.

In case you missed any of our previous articles in this series you can read them here:
Continuous disclosure vs COVID-19 –
Part 1: The welcome introduction of a due diligence defence
Part 2: Has the ability to rely on information being ‘insufficiently definite’ become ‘insufficiently uncertain’?
Part 3: Continuous disclosure vs COVID-19: correcting false market consensus and engaging with analysts