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Proactive Management of Incentives Deals

In light of the COVID-19 pandemic, companies need to determine if they are at risk of breach of incentives contracts and communicate with the incentive-granting authorities.

Q3 2020
If you or your clients have incentives contracts, now is the time to examine your incentive agreements to understand the potential risks if your company is unable to perform key obligations.

The first step in any crisis is to determine exactly what the problem is. Review your incentive agreements to confirm with specificity your obligations. Second, closely review the language of your agreements to determine if any of your obligations can be delayed due to a “force majeure” provision, a “market conditions” provision, or a similar provision. Third, as soon as the crisis begins to abate, and perhaps sooner in certain situations, contact your incentive counterparty to discuss potential options.

Assess Your Situation
Your incentive agreements may have ongoing requirements, such as minimum payroll and full-time equivalent employee benchmarks. Some incentive agreements, though, require that performance meet minimum levels only through an evaluation date, and thereafter the company’s performance impacts the value of the incentive but not whether it is in breach. In either case, it is important to understand the agreement, whether you are at risk of being in breach due to the pandemic, and what consequences there are, if any, for a breach.

Identify Key Contract Provisions
After you have identified whether there is a potential breach of the agreement, review your agreements to see if they have a “force majeure” provision or a similar “market conditions” provision. In some agreements, this section addresses what happens if performance under an agreement becomes delayed or impossible through outside forces. For example, government orders, such as the shutdown orders issued in most states in the last three months, could directly or indirectly prohibit business operations or restrict timely access to needed items to complete your project, such as governmental permits or inspection approvals.

Some agreements provide force majeure provisions that temporarily relieve a party from its performance obligations. This is a common contractual provision, tolling or delaying obligations due to unforeseen events beyond the party’s control. Those unforeseen events, often listed as acts of god or war or terrorism, may include acts of governments such as a mandated shutdown of private and/or public services, prohibitions against gathering, or the other restrictions that practically cease interstate commerce. To preserve the protections of force majeure under a contract, you may be required to provide notice to the other party of the delaying event (e.g., a specific government action), or take other steps to mitigate the situation. Failing to timely comply with any notice required under the provision could waive your contract rights.

There may be other contract provisions to consider as well, such as provisions allowing deadline extensions upon request, or alternative performance metrics. It is also important to understand the amendment provision and what an amendment requires. For some public bodies and economic development organizations, an amendment can be handled administratively. For others, an amendment requires public notice and approval at a public meeting, which may need to happen before an actual event of default. In that case, it is important to understand the process, which could be both time-sensitive and subject to a long-scheduled meeting calendar.

Providing a solution that demonstrates a net benefit to the public entity, while extricating the company from an anticipated future breach, can be a win-win. Communicate
Upon review of your incentive agreements and assessment of your risk of breach, you may need to contact your counterparty. For instance, if you have a loan with a payment coming due that you cannot make, you will want to contact the lender to discuss a forbearance. Given the broad shutdown being ordered by the government, our experience suggests that economic development entities will want to work with you to minimize defaults or provide a reasonable accommodation. If the potential breach is not until later in the year (for a payroll or jobs default measured annually), you should still plan to contact your economic development counterparty now or as soon as the crisis abates. Also contact your counsel or other advisor to assist you in developing a game plan and a proposal to address the potential breach.

Public bodies and economic development organizations are reacting to COVID-19 in several different ways. Some are waiting for legislative action, or for more clarity about the political implications of any action. For some incentives and some programs, the incentives providers are simply waiting for their phones to ring. For job creation and other programs measured annually, the timing of the crisis is such that last year’s annual reports were filed, and next year’s reports are still far into the future. Generally, economic development entities, both public and private, have been amenable to reasonable extension requests. For loan and other programs with monthly obligations, there have been blanket extensions of six months or more, with the ability to opt-out (rather than having to opt-in).

Beware, though, that automatic and blanket extensions may not be in your best interests. For example, if you are still able to meet your commitments, extending your commitment dates one or two years, and correspondingly extending your compliance and reporting obligations, may be harmful. Monitor your correspondence from your counterparty and be sure you fully weigh whether any blanket extension offered is actually beneficial.

What Happens If Compliance Is Not Feasible?
The pandemic may cause long-term shifts in how certain businesses can or choose to operate. If you are no longer going to be able to meet your metric commitments, and you have communicated with your counterparty, consider steps to mitigate damage and risk. For example, you may be able to negotiate an early termination of the incentive, forgoing future benefits in return for waiving repayment. Public bodies do not want to have to clawback funds. Providing a solution that demonstrates a net benefit to the public entity, while extricating the company from an anticipated future breach, can be a win-win. Alternatively, if some repayment is required, it is best and most effective to negotiate the amount and process to avoid an action before a public body or in court that puts the company’s performance into the public eye and could impact the company’s reputation and its ability to get incentives in the future.

Lessons Learned
Crisis creates learning opportunities. In your future incentive agreements, carefully review and negotiate the force majeure provisions, which often do not include specific “epidemic” or “pandemic” language. Also, consider negotiating a termination provision that allows the recipient to terminate the agreement. The public body may require a full or partial repayment, but by initially negotiating a termination right, the incentive recipient can mitigate the public and reputational risk of damage. Rather than being in breach of an agreement with a public body into the future, or having to negotiate a settlement without any leverage, a termination provision may allow the company to save money and save its reputation by not violating its agreement, but rather following the contract terms. In addition, such a provision may mitigate future reporting of the company’s performance under the agreement, since the company was never in default.

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