Disaster in Japan: Legal Issues Your Company Could Face During Japan’s Recovery

March 31, 2011 Authors: Joshua P. Agrons, Glen Banks, Cindy Kang Ansbach, Layne E. Kruse, Stephen M. McNabb, William R. Pakalka, Stephen P. Pate, Lana K. Varney, William D. Wood

Fulbright & Jaworski L.L.P. extends its deepest sympathies to those with families, friends, and colleagues affected by the massive earthquake and resulting tsunami in Japan. The earthquake, tsunami, and subsequent earthquakes have caused catastrophic damage and loss of life, and it is heartrending to see the effects of this natural disaster on the people of Japan. As the consequences of this event continue to unfold, Fulbright remains committed to assisting those individuals and companies affected by this extraordinary circumstance. This white paper identifies many of the legal issues raised by the earthquake and resulting tsunami, as well as the concerns faced by many companies as business operations resume in Japan. Topics include contract issues, debt obligations and financing agreements, international trade concerns, insurance coverage, securities reporting, cloud computing and information management, and employer/employee relations.

Anchor Contract Issues

The events in Japan will impact not only Japanese companies, but also those companies relying on goods, parts, or ingredients that are made in or shipped from impacted areas. A company’s supply of parts or ingredients could be delayed or prevented entirely, which will affect the manufacture of products that depend on supplies from Japan. This disruption of the supply chain can result in the inability of a company to timely perform its contractual obligations, such as the delivery of its products to customers. The issues set forth below should be considered as relevant to a company’s rights and exposures in situations where contractual obligations have been disrupted.

If a company believes that its relationship with a supplier or customer will be impacted by the natural disaster, it should examine the relevant contractual provisions and clauses. For example:

  • Does the contract contain a force majeure clause that may excuse a performance that has become impossible or impractical because of an act of nature? If not, a party may not be able to contend its timely performance has been excused by a force majeure event. The specific language of the force majeure clause is the key. Where the contract does contemplate force majeure events, however, the following issues should be considered:
    • The force majeure clause may require the claiming party to give notice of the force majeure event, provide reasonable particulars, and take steps to minimize its impact.
    • The force majeure clause may justify only a delay in performance and not excuse performance entirely.
    • A party may not be able to take advantage of a force majeure clause if it fails to make reasonable efforts to perform its contractual duties despite the force majeure event.
    • If suspension of performance materially affects the value of the contract, the other party may have grounds to terminate.
    • In the case of supply contracts, a supplier affected by force majeure may have to allocate remaining or available supplies among its customers.
    • Finally, the contract may also contain a clause to specifically exclude force majeure as an excuse for, or defense to, non-performance.
  • Is there a “hell or high water” clause? This type of clause imposes the risk of a catastrophic event interrupting performance upon the performing party. In spite of the catastrophic event, such a party must either perform or pay damages.
  • Does the contract have a material adverse change (“MAC”) or material market change clause that impacts the obligation to perform after a catastrophic event? See Debt Obligations and Financing Agreements, discussed below.
  • Contracts may contain a provision that shifts the risk of loss from seller to buyer upon delivery of the goods to a designated port for shipment. If risk shifted at a port in Japan, the buyer could have liability for goods it will never receive.
    • If there is a loss for which the buyer could be responsible, the buyer should give notice under any applicable insurance policy. See Insurance Coverage, discussed below.

Once it has become apparent that performance will be impacted, a company should investigate the possible steps for addressing breach of contract claims and the resulting damages.

  • Are there notice provisions that should be observed? A party owing performance may be required to give notice when the performance will be delayed or prevented. Alternatively, the party receiving performance may be required to give notice when default occurs.
  • Does the contract set forth a “meet and confer” obligation whereby the parties must try to address the circumstances impacting the performance of the contract?
  • Are there any conditions precedent to asserting a claim for a breach of the agreement?
  • Does the contract contain any clauses addressing damages? Liquidated damage clauses set the amount payable upon breach, while limitation on liability clauses can limit the amount of damages for breach and/or exclude specific types of damages (e.g., consequential damages).
  • If the contract contains an indemnification clause, what are the company’s rights and exposure under that clause?
  • If a company needs to set up a new source of supply, it should consider whether there are government sanctions or restrictions that would impact getting goods from the new supplier or providing information to the new supplier. See International Trade Concerns, discussed below.

The recent events in Japan could also excuse performance under a contract. Grounds for excuse include:

  • Impossibility. Impossibility will provide grounds for excuse when an act of nature has made it impossible for performance to occur. The defense is available, however, only if there is no way that any company could have performed the contract at issue. For example, this defense may not be applicable when equivalent parts could be obtained from China, even though the parts were impossible to obtain from Japan.
  • Impracticability. Unless the language or circumstances of a contract indicate otherwise, performance may be excused by an event that alters the essential nature of the parties’ agreement.
  • Frustration of Purpose. This seldom-applicable doctrine provides that the obligation to perform is discharged because an unforeseen event has destroyed the underlying reason for performing the contract.

The United Nations Convention on Contracts for the International Sale of Goods (“CISG”) may be applicable to the affected contract. The CISG governs agreements between parties from different signatory countries unless the parties have chosen that their relationship be governed by another law. The CISG directs that its interpretation be informed by its international character and the need to promote uniformity in its application and the observance of good faith in international trade. Under the CISG, a seller can be held liable if it fails to timely deliver the quantity of goods called for by the contract that conform to the description or sample provided. The CISG provides, however, that a party is not liable for a failure to perform if the party proves that the failure was due to an impediment (1) beyond its control that could not have been reasonably expected at the time of contracting and that could not have been avoided and (2) the impediment or its consequences cannot be overcome. Japan and the United States are signatories to the CISG.

If a party obligated to provide a product has some product available but, because of the events in Japan, does not have enough product to fill all of its obligations, it might wish to consider allocating the products among all its customers. In this way, the party will be able to partly perform all of its contractual obligations, as opposed to fully satisfying obligations to some customers while completely failing to satisfy others. Some contracts may even have provisions requiring allocation of product by a force majeure impacted supplier.

After considering the provisions outlined above, a company may need to decide what action to take in response to the failure of a party to perform under the contract. Possible actions might include termination of the contract and suits for breach of contract; thus, it will be important to account for the following:

  • The contract may have provisions concerning the manner in which it may be terminated, as well as the acceptable reasons for termination. A termination that does not comply with such provisions might be viewed as a repudiation and breach of the contract.
  • A material breach goes to the root of the agreement and is so substantial that it defeats the purpose of the parties in entering into the contract. If the breach is material, does the affected company terminate the agreement and sue for breach?
    • Failure to terminate and sue for breach may constitute an election to continue with the contract and a waiver of the right to terminate for that particular breach.
    • Moreover, a company may lose its right to recover damages for the breach if it continues with the contract without giving the other party notice of the breach with a reservation of rights to assert a claim for damages.
    • If a company decides to pursue a claim for breach of contract, it must take reasonable action to mitigate its damages. In addition, any damages for breach of contract must be directly and proximately caused by the breach and not due to intervening causes.
  • While the breach persists, the affected company may suspend whatever performance it owes to the breaching party.
  • If the contract cannot be performed, the parties may wish to negotiate a mutually agreed termination or rescission. These negotiations might contemplate whether certain provisions of the contract should survive termination (e.g., non-disclosure or indemnification provisions).

Hopefully, parties to contracts affected by the catastrophic events in Japan will be able to work together to reach a mutually agreeable understanding that will address any interruptions in business operations. However, in situations where contract performance issues will be addressed in court or before an arbitrator, both parties should bear in mind:

  • Any actions taken may later be scrutinized with the benefit of hindsight, focusing on whether the parties acted in good faith and in a commercially reasonable manner.
  • Any communications that are preserved via pen and paper, voice mail, or electronically (e.g., e-mails, texts, videos, or social media postings) could be used in that adversarial proceeding.

 Debt Obligations and Financing Agreements

Various types of financing agreements often have provisions in them that are triggered by the occurrence of a material adverse change (a “MAC”) in the business, financial condition, results of operations, or prospects of the debtor. These provisions may be found in bank credit agreements with great frequency, but they may also be found in hedging documentation (International Swaps and Derivatives Association (“ISDA”) documents). MAC provisions of some kind are customarily found in sub-investment grade credit agreements as a condition to funding under a revolving credit facility and occur with somewhat lesser frequency as the borrower moves up the ratings scale above investment grade. MAC provisions may also be found in the notice provisions of sub-investment grade credit agreements. Occasionally a MAC provision is an event of default in the credit agreement of a poorly rated borrower. Analogous MAC-related provisions may be found in ISDA documents in various forms, including notice provisions, cross default provisions, and requirements for the posting of additional collateral where the counterparty has a reasonable basis to deem itself insecure. Companies should also consider and review other debt agreements, such as note purchase agreements for private placements of notes, overdraft facilities, uncommitted credit lines, and bond indentures to determine whether a MAC necessitates action under such documents.

Companies that are experiencing or anticipating business disruptions due to the tragedy in Japan should first evaluate the severity and impact of those disruptions on their business. If the company concludes, with the advice of counsel, that the earthquake and resulting tsunami would have caused, or would reasonably be expected to cause, a MAC on the company, then the company should review its credit facilities and any outstanding swap documents to determine what action is required, including whether notice is required, whether credit facilities are impaired (due to inability to satisfy conditions precedent to funding), any related liquidity impacts, and whether or not the company may be subject to calls for additional collateral under swap documents. Affected companies should take appropriate action. Publicly held companies may have additional obligations, including disclosure obligations. See Securities Reporting, discussed below.

 AnchorInternational Trade Concerns

Many companies are now faced with the challenge of suddenly reconfiguring aspects of their international trade operations, such as their supply chain, due to the natural disaster in Japan. U.S. companies and any company dealing in U.S. goods, technology, and services must comply with all applicable U.S. laws and regulations, including the following trade controls:

Furthermore, U.S. companies, citizens, residents, companies listed on U.S. stock exchanges, certain non-U.S. persons, and all of their officers, directors, employees, or agents must comply with the bribery provisions and all issuers must comply with the accounting provisions of the U.S. Foreign Corrupt Practices Act (15 U.S.C. §§ 78dd-1, et seq.) (the “FCPA”).

Companies must also ensure that their transaction partners (e.g., suppliers, distributors, agents, and joint ventures) understand and comply with U.S. trade controls regarding any business done on their behalf.

The following list provides some best practices and compliance steps that companies can consider to minimize their exposure to violations of U.S. trade controls.

  • Understand which U.S. trade controls apply to your business and comply with all applicable licensing and authorization requirements under these controls.
  • Train appropriate personnel, transaction partners, and family companies on their obligations under U.S. trade controls. Offer periodic follow-up training to refresh understanding of and address any changes in the law.
  • Where necessary, conduct due diligence on prospective transaction partners and customers.
  • Include protective language in all relevant agreements, such as sales contracts and transaction partner agreements.
  • Develop and implement policies and procedures for U.S. trade controls compliance. These policies should address extenuating circumstances scenarios, including natural disaster events.

In addition to ensuring continued compliance with U.S. trade controls, companies should carefully monitor any developments related to imports from and exports to Japan.

  • Companies attempting to export items to Japan to help with the relief efforts should be aware that they may still require a license to export to Japan.
  • Companies that typically export either directly or indirectly to the affected regions in Japan should be aware that any diversion of those exports to other countries, whether by the company itself or its distributor, could require a license.
  • Although the business operations of end customers in Japan may no longer exist as a result of the natural disaster, any license that was obtained for these particular customers in Japan cannot be automatically transferred to other end customers or destinations.
  • Further restrictions on Japanese imports could be forthcoming, particularly following the discovery of radioactive materials in the food and water supply.
  • In addition, companies covered by the FCPA desiring to assist the Japanese government (including any department, agency, or instrumentality thereof) or any other country’s government in relief efforts in Japan should take precautions to ensure that they provide the assistance in good faith and that it cannot be misconstrued as an illicit offering to the government to obtain or retain business or secure an improper business advantage in that country or elsewhere under the FCPA. Companies should carefully document their relief efforts in that regard.

Anchor Insurance Coverage

Companies will need to examine both their business interruption and contingent business interruption coverage. Business interruption coverage will restore any profits lost as a result of an insured loss, placing an insured in the same financial situation as if the loss had not occurred. This type of coverage usually requires direct physical damage to a plant, and coverage may be less certain in instances where there was a work stoppage due to fear of radioactivity from a nuclear disaster or fear of a tsunami, rather than direct damage. Contingent business interruption (“CBI”) coverage will restore any losses incurred due to stoppage of a business that is not owned, operated, or controlled by the policy holder but is a key supplier of the policy holder’s business. Many CBI clauses are complex and depend on several factors, such as physical loss to the supplier, before coverage will apply.

 Securities Reporting

A public company that is subject to the rules and regulations of the Securities Exchange Act of 1934 and that is required to file periodic reports with the United States Securities and Exchange Commission should consider whether to publicly disclose the effects or potential effects of the recent events in Japan on its business, financial position, and results of operations. Companies with facilities in Japan and companies in the nuclear power industry are particularly likely to be affected by these events, but the general economic fallout from the events, as well as the impact on many Japanese manufacturers, suppliers, and customers could have a more widespread effect on other public companies. A company should assess, with the assistance of its counsel, the materiality of such effects and whether public disclosure is required or advisable.

If the effects of recent events in Japan are likely to be material to a public company, a company may want to consider disclosing these effects in a Form 8-K or a press release. For example, disclosure of the effects or potential effects of recent events in Japan in a Form 8-K or press release in compliance with Regulation FD could address potential “selective disclosure” concerns by allowing the company to discuss these effects with its stockholders, analysts, or other interested parties. In addition, such disclosure might remove any question as to whether the company should close its trading window to prevent insiders from trading in the company’s securities while in possession of material, nonpublic information relating to the company.

Depending on its business, a company may be required to disclose the effects or potential effects of the recent events in Japan in the management’s discussion and analysis section of its next Form 10-K or Form 10-Q. In addition, a company should consider whether its risk factors and forward-looking statement disclaimers should be updated with respect to recent events in Japan.

 AnchorCloud Computing and Information Management

The recent events in Japan have resulted in a heightened scrutiny of disaster recovery plans for computer systems, as many companies were forced to rely on these recovery programs during the natural disaster. Even now, rolling blackouts in Tokyo and other parts of Japan continue to affect the stability of primary computing systems in the region. If a company has placed any of its data in a “cloud” storage facility it should take immediate steps to minimize data loss and maximize its potential recovery from the cloud provider.

  • Data integrity should be immediately assessed, and any lapses addressed immediately.
  • If cloud storage was used but the remote storage facility was damaged or destroyed by the earthquake or tsunami, resulting in the loss of data, the company’s agreement(s) with the cloud storage facility need to be examined for possible recourse against the provider, deadlines for making claims, necessary documents or proof of loss, etc.
  • Any damages potentially owing to the company from the cloud storage provider will be contractual, and thus the company should take all available steps to mitigate its damages, to avoid having that affirmative defense invoked against it in any subsequent litigation or negotiation. Any steps taken should be well documented.
  • Business interruption insurance should be examined to determine if the loss of the company’s data from a cloud storage provider is a covered risk.
  • If the company is subject to U.S. laws, was any data lost that might be subject to a document retention requirement, whether imposed by regulation or by implication in a litigation? If the company is involved in litigation, was any data lost that was subject to a litigation hold for discovery purposes? If data was lost, companies should consider what disclosure might or must be made to appropriate authorities.
  • If you have lost the record copy of any of your data, consider whether versions or copies of that data may have been previously provided to a third party, such as law firms or other vendors, who may still hold that data.

Anchor Employer/Employee Relations

Employers should consider the possible issues faced by their employees with close connections to Japan. Some employees may wish to travel to Japan to be with their family members or to assist with the recovery. Others may seek to delay their return, unsure of the damage caused to their homes in Japan and unwilling to add to the already significant challenges faced by their government in providing for its citizens. To assist these individuals, Immigration and Customs Enforcement (ICE) has temporarily suspended the removal of Japanese nationals from the United States, and U.S. Citizenship and Immigration Services (USCIS) has provided temporary relief measures, including extensions and expedited processing of immigration applications, employment authorizations, parole requests, and visa applications.

Additionally, companies may employ individuals who were in Japan at the time of the earthquake and tsunami. The U.S. Embassy in Tokyo has indicated that its first priority at this time is to assist U.S. citizens who may be injured or missing. The embassy provides specific information related to tsunami warnings, travel restrictions, rolling blackouts affecting transportation services in various prefectures, airline service, and travel alerts. The embassy also details information about missing persons in Japan, other possible ways to inform family and friends of one’s situation, and the International Committee of the Red Cross. The most recent warden messages issued by the embassy are available at: http://japan.usembassy.gov/e/acs/tacs-earthquake-all.html.

Postscript

The massive earthquake and resulting tsunami in Japan have caused loss of life and catastrophic damage. This tragedy calls for a generous response from all of us. In that spirit, the Fulbright & Jaworski Foundation will be supporting the relief efforts of the following organizations with contributions from the Firm: American Red Cross International Response Fund (http://www.redcross.org/) and Project HOPE (http://projecthope.org). Fulbright has also established a program to match donations made by Fulbright employees to the relief effort in Japan. In this way, we can provide a small measure of help and hope to those who so desperately need it.

If you have questions about this white paper, please contact any of the following Fulbright attorneys: Josh Agrons, Glen Banks, Cindy Kang-Ansbach, Layne Kruse, Steve McNabb, Gozie OnyemaBill Pakalka, Steve Pate, Kevin Trautner, Lana Varney, or Willie Wood.