17 March, 2020
The coronavirus outbreak has the potential to disrupt supply chains in terms of parts, labour and government restrictions.
Many products and services in the UK depend on fast, efficient supply chains, which are highly integrated and often operate cross-border. Any supply chain is only as good as its weakest link. Companies should act promptly to assess the risk that the coronavirus, officially Covid-19, poses to their supply chains and their ability to meet obligations under customer contracts.
The coronavirus is particularly likely to impact on:
- labour – with travel limited, extended holidays, prolonged periods of quarantine or difficulties in obtaining work visas, UK businesses may face labour shortages and the challenge of operating with significant disruption to labour;
- movement of goods – it is likely that there will be significant disruption to the movement of goods. This could stem from lack of labour to physically move materials, but also as a potential consequence of government action such as port restrictions affecting unloading goods;
- provision of services – for businesses providing services, the lack of ability for labour to move in and out of affected regions could be a significant barrier to service provision.
Dealing with customers and suppliers
Businesses risk not being able to meet contractual commitments to their customers, whether that is because the business itself is affected by the coronavirus or its supply chain is.
A clear understanding of contractual terms will enable businesses to plan and prioritise their response.
Clare Francis, Partner
All businesses should review:
- how they will address any lack of supply or claims for relief from their suppliers; and
- the steps they will take to ensure that they continue to meet their contractual obligations or can seek relief from their obligations.
The exact position will vary depending on the contract and the relevant governing law. However, there are some practical steps that businesses can take in order to manage and mitigate risk during the outbreak.
Review contract terms
Quickly identify the position under contracts with customers and suppliers. Contractual terms with logistics providers should also be considered, as they will be critical to keeping goods moving. A clear understanding of contractual terms will enable businesses to plan and prioritise their response. For example, which customer contracts have severe penalties for late delivery? What are the governing law provisions? What do relief and force majeure provisions provide? Which contracts can be terminated on short notice?
The legal analysis should then be mapped against the commercial drivers for the business, looking at which contracts are commercially important. This will enable the business to prioritise its resources and effort in order to minimise the overall potential impact on the business in both the short term and the long term.
Consider force majeure and relief provisions
Businesses may wish to consider force majeure and relief provisions in their contracts in order to reduce or eliminate liabilities. The position will depend on the specific wording of the clause and the governing law of the contract.
In China, and other jurisdictions governed by civil law, force majeure principles are implied into contracts. Obtaining relief from obligations tends to require that the event or circumstance is beyond the party's control and:
- was not reasonably foreseeable at the time of entry into the contract;
- the effects cannot be avoided by appropriate measures; and
- prevents performance.
The World Health Organisation (WHO) declared the outbreak a pandemic on 11 March. The term is used to describe a disease that is spreading in multiple countries at the same time. More importantly, it is also a term that is used in commercial contracts as a trigger event for the purposes of a force majeure clause.
It is worth noting that in the aftermath of the 2003 severe acute respiratory syndrome (SARS) outbreak, courts in China held that the outbreak was in the category of an epidemic for the purposes of force majeure. Given the governmental measures being put in palace, and the declaration by the WHO, the coronavirus will almost certainly be classed as a qualifying event. Businesses should consider any specific actions taken with customers or suppliers in response to SARS as this could inform their response to the present outbreak.
In England and other common law jurisdictions, the specific terms of the force majeure clause must be carefully considered. There is no one-size fits all approach. Terms to watch include:
- trigger event – plague, epidemic or pandemic: the WHO declared coronavirus formally as a pandemic on 11 March. Therefore, from this date, coronavirus will be a trigger event where the clause refers to epidemic or pandemic;
- trigger event – acts of government, shortage of raw materials, shortage of labour – many contracts provide specific circumstances. This will be fact specific and need to be reviewed on a contract by contract basis. However, in the current circumstances, government actions such as quarantines and extended holidays may provide opportunities to rely on these provisions;
- trigger event – beyond the reasonable control of the party – some contracts will provide for an exhaustive list of triggers. However, others are more general and include situations "beyond the affected party's reasonable control" which may provide more flexibility and allow for reliance on the force majeure clause;
- notification requirements and timelines – it will be important to consider notice requirements and follow these carefully to ensure that the right to rely on the force majeure or relief event is not lost by not following the correct processes;
- 'hindered', 'prevented', 'delayed' and 'disrupted' – the distinction between these terms is important: must the affected party be prevented from performing in order to claim or is it merely enough that they are hindered or disrupted? To be prevented, it would need to be physically or legally impossible to perform;
- mitigation – it will be important to take steps to mitigate any impact. Customers should be pressing their suppliers to take steps in mitigation. However, in the context of the coronavirus, careful thought will need to be given to what steps can be taken practically given the wide application;
- ultimate termination right – many contracts contain a backstop termination right if the services are suspended for a specified period of time or longer. These should be noted and diarised to ensure that relevant action can be taken closer to the deadline to reassess the situation and either make use of this right or take steps to prevent it from being exercised by a counterparty.
Monitor for early warning signs
Businesses should ensure they have processes and procedures in place to spot difficulties early on and act on them. Some of the largest supply chain failures in history came about because early warning signs were not aggregated through an official business process and therefore no action was taken.
Businesses should be particularly vigilant about:
- service of force majeure or release notices – make sure the business knows to look out for these and to escalate them promptly so that they can be validated and the wider business implications assessed;
- requests for changes to payment terms – requests for accelerated payment, deposits, up-front pre-payments or reduced retentions can indicate cash flow problems. The reasons behind any requests should be explored fully and quickly;
- non-delivery – supply chain members not delivering in accordance with agreed schedules or contract terms can be an indication of a more endemic problem. Investigate this early and ensure that lenience is only applied where appropriate so that performance of suppliers does not slide;
- lack of communication – silence, particularly after persistent enquiry, can indicate that the supplier is avoiding contact and busy focussed on other things;
- market intelligence – rumour and gossip must be treated with caution and are best supported by information received from more authoritative sources. However, market intelligence may give a real time indication of events occurring at your supplier. This may come from sources as diverse as contacts at the supplier, other customers or even the media and the internet.
Any of these signs may indicate potential difficulties and should act as a trigger point for further investigations and potential action.
Consider strategy and steps to take
It is one thing to have internal systems in place to pick up relevant information on your suppliers, but it is another to use them effectively. Being proactive and ahead of your customers can make all the difference in these situations.
In England and other common law jurisdictions, the specific terms of the force majeure clause must be carefully considered. There is no one-size fits all approach.
Some specific actions businesses can take include:
- serving force majeure and relief notices – consider serving these on customers where appropriate and in accordance with contractual provisions. These will need to be served in a timely manner in order to avoid losing the ability to rely on these provisions;
- collate evidence – ensure records are kept of the evidence of force majeure and the impact. It will be particularly important to document any steps taken to mitigate the impact, and the decision-making process and justifications in respect of any actions not taken;
- re-source supply wholly or partially – risks can be reduced or removed if you have a viable alternative which can be implemented quickly. Consideration should be given to the lead times for re-supply and how these fit with existing inventory. Be careful as re-sourcing may be in breach of existing supply contracts;
- terminate contracts – this may only be available if the terms of the contract permit it. Careful consideration and advice should be taken about whether termination is possible and the best strategy;
- recover assets – you may have supplied tools to your supplier or they may be using certain assets under licence. Equally, they may have stock or other materials on site which belong to you. The terms of any applicable contract will strongly influence your ability to recover these items.
Specific, appropriate advice should be sought before taking action in relation to any of these options.
This article was published in Out-law here.
For further information, please contact:
Clare Francis, Partner, Pinsent Masons
clare.francis@pinsentmasons.com
