Authors
On Monday, millions of people in China returned to work following an extended Lunar New Year Holiday – an extension imposed by Chinese authorities to prevent the spread of a new strain of coronavirus, COVID-19. Despite this, many factories in China remain closed or continue to operate only at a reduced capacity and many flights and other major transport links have been suspended.
The slowdown in China is having a significant impact on global supply chains, causing particular disruption to the motor and high-tech industries which widely rely on Chinese manufacturers to produce parts. Whilst some companies are able to call on inventory buffers to bridge the gap in supply, those that operate just-in-time delivery structures are beginning to feel increasingly exposed to the resultant hole in the supply chain.
How might your contract protect you?
The key clause to look for in your commercial contracts is a force majeure clause. This clause typically relieves one or both parties from performance of their contractual obligations following the occurrence of specified, unforeseeable events. These often include natural disaster, labour or trade disputes and terrorist attacks. Declaring a force majeure event may allow an affected party to avoid liability for non-performance of contractual obligations and/or grant the affected party extended time for performance, provided that they can show that they have tried to mitigate the effects of the event.
A coronavirus outbreak does not necessarily trigger force majeure provisions, and whether a supplier can rely on a force majeure clause will depend on how the clause is drafted. Some clauses may expressly list “epidemic or pandemic” as a force majeure event. COVID-19 has moved from the “epidemic” level to the “pandemic” level as the situation across the world has evolved, and would clearly fall into these categories if stated in a contract. Other force majeure clauses may include “acts of government”, which may be applicable given that some factory closures have been ordered by the Chinese authorities in an attempt to stem the spread of the virus.
The remedies available to a supplier seeking to rely on a force majeure clause will also be determined by the way the clause is drafted. Some contracts may simply provide for an extended timeframe for the supplier to meet its obligations, others may allow the customer to terminate the contract.
What happens if you have no force majeure clause?
When an unexpected event, outside of the parties’ control, occurs after a contract has been entered into and results in that contract becoming impossible (physically or legally) to perform, that contract is said to be “frustrated” and the parties are automatically discharged from their obligations. Frustration can have complicated consequences and is difficult to establish. The doctrine of frustration is limited and cannot be relied on where other provision has been made (for example, when you have agreed a force majeure clause); when performance is possible by an alternative method; when performance has become more expensive; or because a party’s suppliers are not performing.
What action should businesses take?
Whether your supply chain is currently under strain, or likely to be affected should the virus continue to spread, it is important to consider the following steps:
- Ensure you have a clear picture of your supply chain, including the locations of suppliers’ sub-contractors and their sub-contractors and so on, to enable you to build a risk profile and pre-empt likely issues.
- Review your contracts for force majeure or other relevant clauses and obtain advice as to whether you are likely to be able to rely on them based on their current wording. Consider whether there are any restrictions or conditions on your use of the clause (for example, time limits for notification of a qualifying event).
- Consider steps you or your supplier could take to mitigate losses – this will be vital if you choose to rely on a force majeure clause – such as actively searching for opportunities to temporarily cover the expected gap in supply.
- Check your insurance arrangements and look for wording in policies which relates to global health emergencies of this kind, particularly if shipping goods to or from a heavily affected country.
- Future-proof any contracts currently being negotiated by including provisions relevant to the outbreak and, if necessary, amend existing contracts where possible.
We recommend that you obtain professional advice prior to taking any action in relation to your supply contracts. For further information or advice on commercial arrangements or supply chain issues, please contact one of our Commercial team:
David Thompson, Partner
Philippa Collinson, Solicitor
Authors