Material Adverse Change Provisions in the Legal and Judicial Practice of Azerbaijan
Comment on ‘Plenary decision of the Constitutional Court on The Interpretation of Article 422 of the Civil Code, 2018’
Table of Contents
Introduction: Usage of MAC clauses in Legal and Judicial Practice of Azerbaijan.
Currency Devaluation as a MAC Event: Decision and its Analysis.
Conclusion: The Lost Opportunity.
Introduction: Usage of MAC clauses in the Legal and Judicial Practice of Azerbaijan
Material adverse change clause shortly defined as MAC has lately gained the fame of a controversial issue about the interpretation of which opposite views and approaches exist in the legal and judicial practice of Azerbaijan. More likely, this is due to the fact that financial markets and economy have experienced various events which have made the execution of contracts difficult for contractual parties. This article will analyse the nature of such clauses in national legislation and analyse the Plenary Decision of the Constitutional Court of Azerbaijan dated 07 September 2018 regarding this issue.
Considering the possibility of the occurrence of any unanticipated event, in order to mitigate potential risks and exit costless, it is recommended to include a carefully crafted MAC clause in the contract. The Civil Code of the Republic of Azerbaijan (hereinafter “CC” or “Code” interchangeably) allows parties to change or terminate the contract under certain circumstances including in cases of a MAC event. The Code defines the term as a change which if the parties had been able to reasonably predict, they would have not entered into the contract or the contract would have been made under significantly different terms.[1]
Why is it of significant importance to negotiate the MAC provisions effectively? Actually, the negotiation of MACs historically was not the object of bargaining concern[2]. However, lately, the occurrence of some unforeseen events made people realise the significance of adding such clauses to the contracts and drafting them in the best possible way. Nowadays, MACs are the underlying cause of 69% of acquisition terminations and 80% of renegotiations[3]. The inclusion of this clause is important particularly in economically significant agreements dealing with great amounts of money and other high risks.
Civil legislation of Azerbaijan allows contractual parties to freely negotiate and agree on the definition of MAC and change or terminate the contract in case an event compatible with the given definition occurs. The national legislation allows parties to freely define the course of actions to be taken in case a MAC occurs. Such actions change from terminating a contract to changing it in countless ways.
According to the CC, if parties fail to dissolve their dispute by negotiations, the interested party can apply to the relevant court.[4] In general, MAC clauses have kept a very low profile in national courts, and judgments related to this concept are contradicting. Although MAC clauses can be a very powerful tool protecting parties from events and circumstances that may alter the prospects of their deal, it is particularly difficult to interpret it and its effects are particularly difficult to grasp and anticipate.[5] This was demonstrated by the conflicting decisions of the Azerbaijani courts when the currency sharply devaluated twice in 2015. One of the most significant court decisions regarding the MAC clause is the plenary decision of the Constitutional Court of Azerbaijan (hereinafter “the Court”) dated 7 September 2018[6] which was intended to put an end to those contradictory judgments.
The value of Azerbaijani manat experienced a dramatic decline and depreciated by 50 % in 2015. Debtors who took credits from banks in foreign currency suffered an irreparable amount of damage and applied to courts for the termination or change of the contract. It should be noted that none of those contracts included a MAC provision leaving that to courts to decide whether it can be applicable in such cases. As the court decisions varied about their approach, and this posed an obstacle on the way of formation of judicial practice for such cases, the Baku Appellate Court applied to the Constitutional Court for the interpretation of the Article 422 of the CC. On 7 September 2018, the Constitutional Court adopted a decision (hereinafter “Decision”) regarding the interpretation of Article 422 which concluded that devaluation of the national currency cannot be considered a MAC.
Currency Devaluation as a MAC Event: Decision and its Analysis
Article 422 of the CC being interpreted in this case ambiguously defines conditions for the change or termination of the contract by the courts. Article 422.2 defines the following requirements for the termination of the contract:
Unforeseeability. At the time of signing the contract, parties have relied on the assumption that circumstances will not change significantly.
Not dependant on any party. The change of circumstances was caused by reasons which the interested party is not able to eliminate after their emergence with the extent of care and caution required by the nature of the contract and terms of the turnover;
Violating property interests of parties. The performance of the contract without changing its terms would violate the property interests of parties and damage the interested party in a degree, that such party would be significantly deprived of what he was entitled to when entering into the contract;
Explicit obligation to bear the risks. The business traditions and nature of the contract do not provide for the interested party to bear the risk of changing circumstances.
According to Article 422.4 of the CC, the contract amendment due to significantly changed circumstances shall be allowed under a court’s decision in exclusive cases, when the dissolution would contradict with public interests or lead to a loss for parties, significantly extending expenses, required for the performance of the contract under changed terms, established by the court.[7]
In order to better understand the importance and the applicability of the MAC clause, the Decision will be analysed based on the abovementioned requirements.
A. The Court concluded that the contract cannot be terminated by courts since the devaluation is not a MAC and it fails to meet the requirements of Article 422.2 of the CC.
Is Devaluation foreseeable?
The Court rightly holds the opinion that change in circumstances should be material. It links the materiality to unforeseeability concept contending that circumstances should change to an extent that if parties had been able to reasonably predict them, they would have not entered into the contract or the contract would have been made under significantly different terms. The Court considers that debtors should have been aware of the possibility of devaluation as Central Bank regularly determines and announces the rate of national currency in respect to foreign currencies.[8]
Approaching the issue from a different perspective, on 15 August 2016, the Civil Collegium of the Baku Appellate Court in a case related to this issue[9] concluded that the majority of debtors could not foresee the occurrence of devaluation because the rate of the Azerbaijani manat to USA dollars was stabilised for a long period. For this reason, Baku Appellate Court considered the devaluation of the currency as a MAC event.
Agreeing with the approach of the Baku Appellate Court, I would like to note that the Constitutional Court should have considered the degree of change and the gravity of its consequences when approaching the concept of unforeseeability. I agree that a mere change in the currency is not a material adverse change; however, when the change is dramatic, the gravity of the situation and its potential consequences should be taken into consideration. Double devaluation led the currency to lose its value by 50 %. Moreover, such deterioration is not the result of gradual weakening but a sudden decision. Even if debtors would foresee a change in the currency rate, they would not predict the change of conditions in such a dramatic degree. If they would foresee such change, they would reasonably include several risk-eliminating provisions in the contract or would not enter into it in the first place. Moreover, according to some foreign doctrines, the unforeseeability requirement, which was considered by the Court important in this case, is highly controversial. Unforeseeability requirement would come close to reading the MAC clause out of existence because, in the cosmic sense, everything is foreseeable, and if an acquirer foresees a particular risk, the natural protective measure would be to include it in the MAC clause.[10]
Currency devaluation by 50 % is an unforeseeable change that parties, especially debtor, could not foresee when entering into the contract. Therefore, it complies with the first requirement.
Can parties eliminate reasons giving rise to the evaluation?
Since the Court considered that the change of currency rate is foreseeable, it did not analyse the second requirement. However, we should note that the given situation meets the second requirement as parties are not able to eliminate reasons giving rise to the devaluation.
Does the performance of the contract violate the property interests of parties?
Furthering its justification, the Court added that it is a risk that the debtor takes when he borrows money in a foreign currency. Change in the value of the currency is a factor establishing financial risk which is taken by the debtor when entering into the contract.[11] In my opinion, even if a debtor was aware of the risk that the currency can change, reasonably no one would guess a 50 % value loss. In our case, the performance of the contract clearly violates the property interests of debtors leaving them in a large amount of debt. Its performance is incredibly unfavourable to the interested party as the debtor is obliged to pay twice the amount he took as a credit. On the other hand, I agree with the opinion that changing the contract in the interest of the debtor is not the solution since it would be hugely detrimental to lenders and would lead to their insolvency. To establish a win-win situation, the Court should have come up with a mechanism to protect the interests of both parties.
Who shall bear the risk of changed circumstances?
The Court again refers to the financial risk notion to explain why the interested party shall bear the consequences. However, neither the contract nor the business traditions explicitly provide a basis for the interested party to bear the risk of changed circumstances.
B. The Court concluded that the contract cannot be changed since the devaluation is not a MAC and it fails to meet the requirements of Article 422.4 of the CC.
Although a dramatic change in the currency value can be evaluated as a MAC for the mentioned reasons, terminating the contract would not be a solution to the problem. It would result in the irreparable loss to parties and violate their public interests. The best approach for the Court could be changing terms and dividing damages incurred or other risks between lenders and borrowers.
The Court sets forth the possibility of applying Article 422.4 of the CC and states that it is possible to change terms of loan agreements in the interest of debtors depending on the financial ability of banks.[12] However, this provision is recommendatory and does not put any binding obligation on banks.
The foregoing points support that the currency devaluation by 50 % triggers the MAC clause and meets the criteria for relevant contracts being terminated or changed by courts. This point is also supported by the special opinion of one of the judges to the proceeding. Justice Isa Najafov points to the intention of the legislator while drafting the MAC provision in the CC. As normative legal acts shall be based on law and justice (equal interests and equal relations)[13], he correctly states that the legislator has relied on this provision when including a MAC provision to the CC with the consideration of the high risk of the currency devaluation.
I agree with his opinion which relies on the statistical information regarding the analogical cases in local courts explaining the ramifications of the dramatic currency devaluation. With the consideration of the high number of similar cases in the courts, closure of 12 banks due to bankruptcy and unprecedented job losses, we can rightly conclude that the devaluation of the national currency is a material adverse change event. [14]
Conclusion: The Lost Opportunity
Judging from existing legal provisions and the judicial practice, we can conclude that MAC provisions are not a common practice in the Republic of Azerbaijan. However, due to recent occurrences, when dealing with a significant amount of money, parties should be more willing to include such provisions in the contract rather than leaving it to courts to decide if a certain event can be interpreted as a MAC or not.
Decisions made by the Constitutional Court are final and binding in Azerbaijan. Therefore, the Court should have made sure that used principles and justifications were sound and in line with the intention of the legislator. The Court has seemingly tried to eliminate any risk of making an unjust decision with regards to the lenders since they are also subject to detrimental effects. Deciding in the interest of debtors would lead to an economic downturn causing insolvency of banks, on the other side protecting the interest of lenders led to devastating results for small entrepreneurs. Having analysed the judgment, I can conclude that even if dramatic currency devaluation meets requirements for being considered as a MAC event, terminating the contract would violate public interests and propel even more banks to the insolvency. Changing the contracts to mitigate risks of both parties defining more favourable terms would be the perfect way in such cases. This approach would achieve greater justice.
[1] Article 422.1, Civil Code of the Republic of Azerbaijan (hereinafter “Civil Code”)
[2] Gilson, Ronald J. and Schwartz, Alan, Understanding Macs: Moral Hazard in Acquisitions (February 2004). Columbia Law and Economics Working Paper No. 245; Stanford Law and Economics Olin Working Paper No. 278; Yale Law & Economics Research Paper No. 292. Available at SSRN: https://ssrn.com/abstract=515105
[3] Denis, David J. and Macias, Antonio J., Material Adverse Change Clauses and Acquisition Dynamics (November 21, 2011). Journal of Financial and Quantitative Analysis (JFQA), Forthcoming. Available at SSRN: https://ssrn.com/abstract=1609765
[4] Article 422.2, Civil Code
[5] Locke Lord LLP – Theodore H. Cominos Jr., Arzum Gunalcin and Cristina Proca, Material adverse change – focus on Turkey. Available at https://www.lexology.com/library/detail.aspx?g=5ec3b57d-b2b2-4ea3-83be-3fc49ee33173
[6] The plenary decision of the Constitutional Court of the Azerbaijan Republic Regarding the Interpretation of Article 422 of the Civil Code, 07 September 2018. Available at (http://www.constcourt.gov.az/decision/1164)
[7] Article 422.4, Civil Code
[8] Article 5.0.3, the Law on Central Bank of the Republic of Azerbaijan
[9] The decision of Civil Collegium of Baku Appeal Court dated 15 August 2016. 2(103)-6486/2016. Available at http://bakuappealcourt.gov.az/uploads/images/document/%E2%84%96_2(103)-6486-2016_f3d20b8e6bcad27b23c2083bafed0b72.pdf
[10] Daniel P. Dain and Robert L. Brennan, Negligent Security in the Commonwealth of Massachusetts in the Post-September 11 Era, 38 NEW ENG. L. REV. 73, 84 (2003); See also Saul Litvinoff, Force Majeure, Failure of Cause and Theorie De L’Imprevision: Louisiana Law and Beyond, 46 LA. L. REV. 1, 26 (1985).
[11] The plenary decision of the Constitutional Court of the Azerbaijan Republic Regarding the Interpretation of Article 422 of the Civil Code, 07 September 2018. Available at (http://www.constcourt.gov.az/decision/1164)
[12] ibid.
[13] Article 149, The Constitutional Law of the Republic of Azerbaijan on Normative Legal Acts.
[14] Special Opinion of Justice Isa Najafov to the Plenary Decision of the Constitutional Court on the interpretation of Article 422 of the Civil Code. Available at http://www.constcourt.gov.az/decision/1164
Published on SSRN on 30 July 2019. Available at https://ssrn.com/abstract=3426975
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