First it was the ‘B’ word, now it is the dreaded ‘C’ word. The widespread impact of COVID-19 on supply chains is impacting us all, both in the business world and at home. Whether it be the lack of shipments from Asia following China’s month-long lockdown, the temporary closure of UK workplaces to slow-down the spread of coronavirus through social distancing, or perhaps the lack of household essentials on the shelves of our local supermarkets, the disruption to our everyday supply chains is unprecedented.
A quick look at the stock markets shows that the business effects of this pandemic are truly global, unlike anything we have seen before, and it is inevitable that all businesses in the UK will therefore feel some knock-on effects to their supply chain. Whether it’s an inability to deliver goods to a customer on time, or a failure of a supplier to deliver required quantities to you, it is important that businesses look at their contracts now to ensure they are prepared if they need to look at terminating arrangements, or implementing variations to your existing supply contracts.
When looking at your contracts, the following points should be considered when deciding what your best course of action is and how to avoid (as far as possible) problems in the supply chain. For further consideration about whether your contracts are generally disaster proof you can also read the following article.
Does your contract include a force majeure clause and how might it help your business?
Force Majeure clauses are inserted into contracts to allow a contract to be suspended, varied or terminated without the party suffering the effects of the force majeure event being in breach of contract. There is no legally accepted definition of a “force majeure event”, and so in every contract, the parties will need to have regard for how the clause has been drafted. Usually, this is defined by reference to either a definitive or an illustrative list of events which are outside of the reasonable control of one or both of the parties. The ability to seek comfort from a force majeure clause will depend on if you have such a clause in your contract – it doesn’t appear as of right and the clause will not necessarily be headed ‘force majeure’ so you need to take note of wording to the effect of ‘events beyond a party’s reasonable control’, or references to the effects of, for example, government action, strikes, or importantly, in today’s climate, pandemics.
In the event your contract does include a force majeure clause, you will only be protected if the breach of contract is caused by the force majeure event as drafted. If it is only more difficult, time consuming or expensive to carry on supplying goods because of the force majeure event, then the force majeure clause is unlikely to be effective. It will also need to be the only reason you were unable to perform your obligations. You therefore have to ask yourself… ‘if it were not for the coronavirus would I have been otherwise able to carry out my obligations’… if the answer is yes, then the force majeure clause will come into effect.
Usually, if you have the benefit of a force majeure clause, the contract will often provide that you are not otherwise in breach of the contract if you fail to perform your obligations on time. Both parties should be conscious that the ability to terminate the contract could be tied to the force majeure clause, whereas in some contracts, the force majeure clause might only allow for a delay to each party’s performance obligations – you must consider the terms of each clause on its own merits.
You will also need to consider if there are ways both parties can mitigate losses and if, for example, you are able to perform some of your obligations, but not all, usually you will be obliged to do what you can in the circumstances. Just because you are financially disadvantaged because of a potential breach of contract from someone in the supply chain due to the effects of COVID-19, this does not necessarily mean that you have an automatic right of recovery for all such losses against someone in your supply chain. Generally, under contractual law principles in England and Wales, parties are expected to try and mitigate their loss as far as possible, to minimise the damages exposure that is recoverable. Reviewing your contracts therefore is vital.
If your supply contract does not include a force majeure clause and your termination clause does not otherwise allow you to terminate, you will have to look at other options, as set out below.
What is frustration and will your business be able to rely on it?
Never heard of the common law doctrine of frustration? No? Most people haven’t! This doctrine could be important in providing an alternative option, particularly if your contract is silent as to the effects of force majeure events. In those circumstances, you may be available to rely on frustration if the contract becomes impossible or illegal to perform, or otherwise radically different from that contemplated by the parties at the time of entering into the contract because of an unexpected, serious event that is beyond the control of the parties.
So, if your supply chain is completely frozen, your contract becomes impossible to perform in the timescales contemplated by the contract and there is unlikely to be an imminent ‘fix’, it might be necessary for the parties involved to be able to terminate the contract. Frustration allows a contract to be terminated, without restoring the parties to their pre-contractual position. In such circumstances, some obligations in the contract will remain (i.e. payment for goods already received), but future performance obligations would ordinarily be disregarded. However, it is worth noting that courts have tended to narrowly interpret the doctrine of frustration and as such, there is a high threshold to overcome before you can be sure you are covered by the doctrine. If it simply costs more to perform the contract, or it is more inconvenient to perform your obligations that is normally not sufficient to invoke the doctrine – you are looking for that element of “impossibility” to perform. Nevertheless, it is still something you should consider and discuss with your legal advisors if you envisage that your supply chain will be completely disrupted.
Do you have insurance and will it cover COVID-19 effects?
Most businesses will have some form of insurance covering their activities, which can have, as an optional extra, some form of business interruption cover. The specifics of the cover each business has will depend on what was agreed between you and your broker at the time of renewal of your policies and it is therefore worth reviewing your policies or speaking to your broker to see if you have cover for COVID-19 effects.
However, what many businesses have found out of the last few weeks is that many policies will have exclusions for pandemics, and many insurance companies are restricting the payouts available because of this. It is important you understand the position your business is in and assess the risks and how to manage/mitigate those.
As well as business interruption insurance, you should also look at whether you have credit insurance in place, particularly if someone in your supply chain suffers an insolvency event. A full assessment of the insurance position is vitally important and should be one of your first ports of call.
Can you seek alternative suppliers?
At this stage, it is worth trying to be prepared and plan ahead. You should now be talking to your suppliers and your customers if you have concerns about disruption to the supply chain. It might be that you can work out alterative terms in the current climate, or you may be able to find alternative suppliers – however, ensure that by doing so, you don’t breach any restrictions in your supply contracts if you have, for example, agreed exclusivity arrangements to source certain goods from certain suppliers.
Is there capacity for dual- or multi-source products? Do your contracts with your customers have clauses to protect you in the event of default of your supplier? Be mindful that any alternative suppliers will still need to be managed by a supply agreement, but considering this early will enable you to put contingency plans in place and ensure any new contractual arrangements are potentially more flexible.
Can price increases be passed onto customers?
Whilst the Government has been clear that bodies like the Competitions and Markets Authority will be quick to act against companies who deliberately increase prices in order to profit from COVID-19, with suppliers going out of business and a reduced supply of labour and/or materials, the likelihood is that part or all of the supply chain will inevitably want to increase costs. As to whether these end costs can be passed onto customers and/or end users is a matter of construction in the contract:
- Sometimes, price variation clauses allow increases to be passed on to a customer in the chain where factors outside of a parties control means additional expenditure might need to be incurred by one of the parties. If that is possible and/or was foreseen in the drafting, is there a requirement for proof of such price increases to be shared and agreed before a price increase can take effect?;
- If the contract is silent, that does not mean the parties cannot look to try to agree a price variation – depending on the relationship between parties in the supply chain, it may be possible to try and renegotiate terms. A price increase might be easier to bear than a complete lack of supply at all if part of the supply chain is affected by insolvency.
What are the implications if a party in a supply chain suffers an insolvency event?
It is inevitable that over the coming weeks and months, with the increased pressure from COVID-19 and the closing down of certain parts of the business world, we are likely to see an increase in administrations and/or liquidations of businesses. If one of those businesses is directly, or even indirectly, affecting your supply chain, our team of insolvency specialists are on hand to assist.
Ultimately however, reviewing your contractual terms is vitally important at this difficult time. Insolvency events are often included into contracts as termination events, but as to what happens to outstanding invoices, stock or tooling that might be with an insolvent customer or supplier, or your wider supply chain, such events are not uniform across the board in all contracts. It will be important to understand when title and risk to products passes to customers, particularly if a customer has extended credit terms – is this at the time of delivery of goods or at the time of payment? If title to such goods has not passed yet, some contracts might allow the innocent party the right to seek recovery of such goods, but it does depend on a number of other caveats – are the goods you supplied sufficiently identifiable as yours in your customer’s premises; have the goods been integrated with the goods of someone else; have they already been sold on as part of the supply chain? The practical reality is as important as the contractual position.
If the supplier goes bust, does the contract make it clear who owns the tooling and do you have a right to be able to claim possession of it? Have you got invoices or contracts to show that the tooling belongs to you and is it feasible to be able to seek recovery of it whilst some businesses go into lock-down? All of the above is necessary in case a replacement supplier can be found to ensure delays in your supply chain are minimised as much as possible.
In such uncertain times, the only “known” is that the impact of COVID-19 will not disappear overnight. The wide-reaching funding packages being announced by the Government will certainly help some businesses who are facing huge uphill challenges, but this won’t negate the need for you to review your existing contractual arrangements. If you are in doubt about the interpretation of any of your contracts, whether as part of a wider supply chain or otherwise, please do not hesitate to contact our commercial team as soon as possible.
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