Contractual safeguards during the supply chain crisis

Contractual safeguards during the supply chain crisis

Delays and disruption to supply chains are set to continue and with no clear end in sight, it’s likely that disputes will increase, as businesses seek to mitigate or recoup their losses. But what should businesses be looking out for in their contracts?

Suppliers, unable to fulfil orders, may wish to know where liability lies and whether delivery times can be extended. Purchasers and downstream suppliers, who face delays and are unable to meet the demands of their customers, may look to terminate contracts and understand their legal rights against their suppliers and their obligations to their customers. 

Last year ‘force majeure’ was widely discussed. Used to cover a situation where an unforeseen or unavoidable event prevents or delays a party from performing its contractual obligations, force majeure provisions have been front and centre of contract disputes with suppliers looking to excuse performance. These clauses vary widely and so it’s important to review their specific wording to consider the scope of the triggering event. However, it’s likely that for new agreements the coronavirus pandemic will no longer be viewed as an unforeseeable event and thus the effectiveness of force majeure clauses in these circumstances is likely to be limited.

Where force majeure doesn’t apply, the common law doctrine of frustration may assist to effectively terminate a contract where an event that wasn’t foreseen by the parties, and which doesn’t arise as a result of a breach of contract by either of them, makes performance of the contract impossible. Whist there are examples of frustration being successfully argued, the English courts have consistently affirmed that the threshold for proving frustration remains high. 

Now, that we are two years into the coronavirus pandemic, it’ll be difficult for parties to argue that its continuation is an unforeseen event and as a result it’ll be difficult to rely on force majeure clauses or the doctrine of frustration to avoid being bound by contractual performance obligations. Also, these principles will generally only apply where an unforeseen event makes contractual performance impossible rather than making it more difficult or economically less viable.

Force majeure and frustration claims are not contractual cures which will solve all supply problems caused by the coronavirus pandemic. Instead, businesses should be seeking to identify supply chain vulnerabilities to enable these to be better addressed. It’s often the case that businesses are unaware of their full supply chain (from original manufacturer through to direct supplier), and only know the identity of their direct suppliers. This can cause problems in detecting supply chain weaknesses as businesses are unable to identify the ultimate source of their products and whether those manufacturers are all based in one relatively small geographic area.

Customers and suppliers should also renegotiate existing contracts to cover more eventualities and to apportion risk between the parties appropriately. There are several factors that should be considered – the first is to ensure that the contract provides for a clear allocation of responsibility and risk between the parties in case of unexpected events. It’s also important to factor in both the predictable elements of change, such as changes to volumes and prices, and more unpredictable and unexpected elements such as a global fuel shortage, a major cyber-attack or global internet outage. Additionally, if the customer’s purpose of the contract or the obligations undertaken by the supplier rest on a key factor, then ensure this is specified in the contract. 

Secondly, insurance policies should be reviewed to ascertain whether those policies might cover additional expenses and other losses incurred as a result of a disruption to supply chains. 

Thirdly, businesses should consider whether there are any other available sources of supply, or alternative ways of doing business, which could help mitigate the impact of disrupted supply chains. 

Lastly, suppliers must review existing indemnity and liability clauses to ensure they’ve fully considered the ‘risk profile’ and scope of the damages for which they may be held liable.

Businesses who take a proactive approach to reviewing their contracts will ensure they’re better protected in the event of any potential dispute arising due to the supply chain crisis. If a dispute does arise, it’s vital to take legal advice early to help negotiate the best possible outcome.

Kathryn Rogers
Kathryn Rogers

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