The coronavirus crisis has disrupted trading relationships worldwide – and as a consequence we are seeing negotiation and renegotiation of contracts on a massive scale. This would be difficult to manage in the best of times, but right now, with home working the norm for many employees, it presents a monumental challenge.
In the time to come, it is expected compliance pros to do things differently, to take force majeure more seriously. This could become a negotiating point when striking new agreements, and those who are unprepared could encounter delays or even lose deals.
Force Majeure
Countless supply contracts are being disrupted by factory shutdowns in the areas most affected by COVID-19. In recent weeks, European agencies and chambers of commerce have issued millions of force majeure certificates to European companies. However, coronavirus crisis will not give rise to a valid force majeure defense under every contract and in every circumstance, as different contracts and governing laws stipulate different requirements for different situations. Companies are therefore well advised to proactively manage the related legal risk and carefully assess which party must ultimately bear the financial losses caused by COVID-19.
How extensive is the disruption?
The answer to that varies quite significantly by industry and size of a company.
By mid-March, around 60% of businesses were reporting moderate to severe impact on their contracts – both with suppliers and to customers. The crisis has had a rolling effect as it spread around the world, steadily resulting in mass shut-downs and distancing.
The nature of that disruption differs between industries. For some, customer demand is increasing and generating a need for both new and revised contracts – for example, food and drink, consumer packaged goods, health, transport and logistics. For others, the story is almost entirely negative – airlines, hotels, travel and entertainment. Almost everywhere, this has resulted in a strong focus on force majeure, rights of increase or reduction, revisions to scope, deferral or delay. And that is not to mention the need for extensive reporting as management seeks rapid information on risks and rights within existing agreement portfolios.
Here are some practical pointers to help you prepare for the challenges we are facing now and in the future:
1. Identify the exact nature of the supply problems.
Reliable and up-to-date information of the facts is crucial for proper management decisions and your ability to prove those facts may determine your success in any subsequent legal proceedings.
If your company is directly affected, make certain you understand the reasons why you are unable to supply. Is it due to government-ordered factory shutdowns or quarantines, staff illness, staff staying home out of fear or other reasons?
Identifying the exact nature of the problem is critically important and you should secure evidence proving the cause of your specific problem.
If your supplier cannot supply you, do not accept an unspecific force majeure declaration, but ask for details about how exactly your supplier is affected. Do not take a position on the force majeure declaration before knowing the relevant facts.
2. Analyze the risk allocation under your contract and the governing law.
Not every contract and governing law provides for a force majeure defense based on unforeseeable events outside the parties’ control. The scope and requirements of force majeure (and similar legal defenses) vary from contract to contract. A careful legal analysis of your specific situation is therefore indispensable and will depend on the exact nature of the supply problems, the specific terms of your contract, and the governing law. If you find yourself facing a force majeure defense by your supplier and, as a result, cannot supply your own customers, you need to assess the risk allocation under each contract separately to develop the best risk management strategy.
3. Use your Force Majeure right.
Specific contract terms or the governing law may require you to give prompt notice of a force majeure event, failing which this defense will be barred. If there is such a requirement, you may need to issue a force majeure declaration before you have had the opportunity to complete your assessment of the first two points above. If you receive a force majeure declaration from a supplier, carefully frame your response to protect your legal position and, if you must then issue a force majeure declaration to your own customers, avoid any language that could prejudice your position in a future dispute with your supplier.
4. Make efforts to overcome the supply problems.
Many contracts and governing laws exclude a force majeure defense if you can overcome the consequences of the force majeure event. Often, you cannot rely on a force majeure defense to avoid significantly higher costs of supplying alternative goods, unless you are entitled to invoke hardship (which is rare under most governing laws). If you receive a force majeure declaration that you consider invalid, you are obligated to take steps to mitigate your damages. Document all your efforts to overcome the supply problems, particularly if they are unsuccessful.
5. Think before you allocate existing supplies. Prioritize!
If your reduced production output allows you to supply only some of your customers, allocating the available supplies is tricky. Carefully check your contract and the governing law as to whether they contain any restrictions or guidance. Supplying your priority customers and declaring force majeure vis-à-vis all other customers may be problematic. If you receive a force majeure declaration, find out how your supplier allocates remaining stock.
6. Manage contract disputes proactively. Resolve them efficiently.
There will be many lawsuits over who must bear the losses caused by COVID-19-related supply chain problems. Managing contract disputes proactively will increase your chances of resolving them efficiently and successfully. Engage with your suppliers and customers in a cooperative and reasonable manner – this will go a long way toward avoiding or resolving disputes. At the same time, take all necessary steps to protect your legal and evidentiary position in the event a dispute escalates, and check your contract’s dispute resolution clause to identify what court or tribunal would decide a dispute and how that adjudicator would likely assess the situation.
7. Putting an end to force majeure.
Typically, force majeure serves as a temporary defense, which must be lifted as soon as it can be overcome and supplies can be resumed. Until that time, many contracts require that you provide regular updates. When necessary, you should assess whether your contract and the governing law only excuse temporary non-performance or also entitle you to modify the contract terms or terminate the contract altogether.
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