Insights

Supply Chains and Covid-19

24/03/2020

The Covid-19 pandemic is having immediate and serious implications for businesses and their supply chains.  Delays and other failures to perform contracts are occurring.  Some contracts are becoming impossible to perform, or more onerous than ever anticipated by a party.  

This is being caused by a number of factors, including labour restrictions, manufacturing closures, transportation restrictions - for example a sharp reduction in air freight volumes, quarantine measures and government imposed restrictions on trading.

What rights will a seller and a buyer respectively have in these circumstances?  Do recent events excuse performance by the other party, or are they using the situation to attempt to exit an unprofitable contact?  We address some of the key issues for supply chains below.

Force majeure.  Your contracts may contain a term, known as a "force majeure" clause, by which one or both of the parties is entitled to cancel the contract, in whole or in part, or is entitled to suspend performance or to claim an extension of time for performance, upon the happening of a specified event or events beyond their control.  Look out for wording covering an epidemic, pandemic, contagious disease, actions by government agencies, or work stoppages. 

Sellers may need to obtain goods of the contract description from an alternative supplier, if available, if their intended supplier is unable to supply them.  This is particularly the case if the force majeure clause provides that the party relying on it must have been "prevented" from performing the contract.

Allocation of limited supplies of goods to contracts needs careful consideration.  A supplier may have insufficient goods to meet all of their existing contracts, but be able to fulfil some of them.  A force majeure clause may assist by excusing non-performance of those unfulfilled.

A seller can allocate their available goods in a manner considered proper and reasonable in the trade, for example on a pro rata basis, or in date order.  Conversely, prioritising new customers, who are prepared to pay a higher price, is not likely to be reasonable.

A government embargo prohibiting the intended method of performance of a contract may well trigger a force majeure clause.

International supply chains.  Be aware of the law governing the contractual obligations of the parties if your supply chain is international.  Foreign law may apply.  The contract will likely stipulate whether or not English law applies. 

Under some civil law systems for example, force majeure type relief may be available under statute, regardless of whether there is such a clause in the contract.

Frustration.  Even if your contract contains no force majeure clause, it may be brought to an end by frustration.  Frustration is where something occurs after the formation of the contract which renders it physically or commercially impossible to fulfil, or transforms the obligation to perform into a radically different obligation.  It is however narrow in scope.

Changes in the law and delays are potential frustrating events.  Covid-19 related problems may well be (as, separately, may Brexit).

The perishing of goods in transit, or before risk passes, where there is no fault on the part of the seller or the buyer is a frustrating event ending the contract, as set out in statute. 

Importantly, an agreement to sell goods will not be frustrated simply because performance of the contract by a party will be commercially unprofitable, assuming it is still physically and legally possible to perform.

If it has become impossible to import goods from a particular country, where this was the basis of the contract, this may be a frustrating event.

The necessity for a longer and more expensive mode of transport of goods, or deviation and quarantine of goods, might amount to a frustrating event.

Material adverse change.  Contracts may also contain a material adverse change (MAC) clause which parties can utilise to their benefit.  Contracts may contain a hardship clause, a clause dealing with changes in the law, or a price fluctuation clause.  The wording of the particular clause is critical and will determine the parties rights and obligations.

Contractual notices.  Contracts should be scrutinised for notices that parties may need to serve to rely on the clause in question.  Strict compliance with the requirements for notices is necessary for their validity.

Insurance.  Policies should be reviewed to determine what coverage is available as a consequence of the Covid-19 pandemic. 

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