The world is in a different place today. Global supply chains have been under an unprecedented strain since the start of the pandemic in early 2020, and delays, interruptions and escalated costs continue to be the norm. This means companies are continuously navigating an unpredictable environment as they go through shortages while grappling with continuous and cascading bottlenecks. In 2022, the wider geopolitical implications of Russia-Ukraine war and renewed COVID-19 lockdowns in China contributed in compounding an already bleak global supply chain situation. Existing restrictions imposed on Russia coupled with the potential for further restrictions continue to impact the wider crisis. Organizations have had to adapt their operations and all the stakeholders in the entire chain are learning ways and means to modify business practices. Despite the mammoth impact on the supply chain, surprisingly, litigation has not erupted and companies have adopted a pragmatic business approach. Of course, it goes without saying that such an approach is best even while contracts are renegotiated so that relationships don’t go south and are preserved. It would be safe to state that the available legal remedies remain pretty much the same and contracting parties in the supply chain need to collaborate even more closely to find solutions.
This newsletter focuses on issues arising out of supply chain disruptions and steps businesses can undertake to minimize the consequential impact.
2. Contracting Considerations
The contract is the key driver of a supply chain, be it the process of selling, buying, manufacturing or movement of the goods. Supply chain contracts are quite varied and complex, given the network of entities involved who bring a product from its conception all the way through its design, manufacture, sale and delivery to the end user. The primary parties are manufacturers, distributors and raw material providers. The kind of contracts include sale of goods, distribution and manufacturing agreements. While all are crafted to fit the circumstances, industry and parties’ requirements but certain key provisions are common to all. If the ripple effect of interruptions continues for an undefined period, it will be essential to reassess contracts, loopholes, rights and possible defenses while preparing for a potential litigation. Apart from carefully examining express terms, parties should consider the historical course of performance and respective conduct while evaluating actions. While an entire contract review will be essential, but certain crucial provisions are outlined below and they are not in any particular sequential order of significance.
Firstly, potentially, disruptions may lead to an outcome where some are unable to perform their contractual obligations. Before legal action becomes imperative, a party repudiating the contract must ensure it has made its inability to perform clear through words or actions, amounting to anticipatory repudiation. By declaring an anticipatory breach of contract, the non-repudiating party can initiate legal action as soon as the repudiating party demonstrates its intention to break rather than waiting for the actual breach to occur. Prior to declaring an anticipatory breach, a party should carefully re-examine its existing contract(s) to see if it contains relevant force majeure provisions and determine its terms. Those wishing to invoke it must necessarily ensure compliance with notice, timelines or other specific requirements (if any) and record all relevant evidence as the situation evolves. Of course, reliance on such a clause to excuse performance is always going to be based on specific facts and the actual language. Where force majeure does not apply, the evaluation should be based on the doctrine of frustration of contract which could aid in termination.
Secondly, usually contracts require delivery of goods by a certain time. Where time is of essence in the contract, strict compliance is required and failure to do so constitutes a breach. But where partial or delayed shipments are permitted in the course of performance then a breach of contract action may not be viable.
Thirdly, in view of the current ability to predict delays or interruptions the notice provisions have assumed greater importance. The non-performing party needs to carefully evaluate the right time to give notice. The turmoil is on how soon one has to give that in order to avoid disruptions and ensuing potential claims. Hopefully, contracts will contain defined periods for when notice is imperative and must be given. If not, a reasonable period has to be considered else conflicts will only increase.
Fourthly, mitigation cannot be over-emphasized. In common law jurisdictions contract law imposes a duty to act in good faith and attempt to mitigate losses. A party that claims breach should make every effort to mitigate damages which will include possibly finding third parties to perform the repudiating party’s contractual obligations. Effectively, a claim for damages will require a party to clearly demonstrate documented efforts to secure replacements, which will also aid in determination of actual damages. But buyers may confront situations where they are unable to find an additional supply line and, in that case too their efforts to look for alternatives will go a long way to showcase mitigation in a dispute.
Fifthly, pay heed to fine print to see the risk allocation. This must be clearly allocated in an equitable manner. These provisions include indemnification, limitation of liability, warranties, termination clauses and post-termination obligations. It is also important to establish when ownership of products passes hands, determining who carries the risk at what point in the transfer of goods.
Generally, differences can be resolved with consensual give and take. It goes without saying contracting parties should work together to find reasonable commercial solutions to address disruptions leading to contractual breaches. Often this principle is reflected in the contract. However, sometimes, despite intent and business reasons to avoid litigation, it is possible parties may inevitably confront irreconcilable conflict, more so when past concessions by one do not help. In such instances, litigation is used mainly to seek monetary compensation for breach or to compel specific performance or to prevent particular action of one that may harm the other. In today’s environment both claims and defenses are likely to be viewed through the application of business efficacy principle and whether a party’s actions and conduct were commercially reasonable in view of the circumstances.
3. Business Matters
Businesses have several ways to attempt to mitigate interruptions to their distribution and logistics arrangements. A starting point will be the ability and flexibility to renegotiate or terminate and avoid disputes. This means
- Conduct a contract review to determine where such flexibility exists and, in the process, identify breaking points including, amongst others, material adverse change clauses
- Assess the payment and pricing provisions and not simply the amount of payment method and timing. Many conflicts arising from supply chain contracts involve payment, so these provisions require a careful review
- Evaluate the available options related to termination or suspension of contracts including price adjustments and need to refinance. At the same time, understand the extent of parties’ obligations and liabilities and, at the cost of repetition, do a deep dive of indemnities or performance bonds, limitation of liability plus exclusions, if any, to determine who bears the risk
- Where disputes arise, parties should check mandatory dispute resolution provisions. It is common to see clauses which require the parties to follow a pre-agreed route to resolution, with an aim to find a resolve and, in the process, ensure litigation is the last resort.
A key imperative would be to manage and address business continuity and resilience for the future. This means implementing some or all of the following
- Commercially, it would be essential to spread the sourcing and eliminate over-reliance on any one source or country and taking concrete steps for near-shoring supply chain components, to the extent feasible
- Warehouse space is limited to keep up with the demand and long-term solutions to manage higher volumes will require infrastructural changes. Consider collaborating also with those who provide on demand warehousing, if and when necessary
- Review insurance fine print regularly
- Optimize and employ current technologies. Explore or augment use of technologies that will enhance supply chain visibility (through programs to track fulfilment of contracted obligations) and automate through increased use of artificial intelligence. For example, AI can be used to automate processes by using algorithms based on data from previous processes, identify patterns which can be leveraged to forecast demand and manage inventory
- Increased supply chain visibility will aid in identifying problems or concerns that may be corrected ahead of an actual disruption. Enter blockchain technology where all components of the supply chain can be integrated into a single platform which can be used to notify customers of the product. The same system can be used for invoicing and payments which should streamline the hiccups and enable organizations to identify issues before they occur.
Companies that maintain global supply chains tapped into the world’s best resources and talent. But, now, the struggle is real all around the globe. Perhaps now more than any other time, global conglomerates are compelled to navigate a wide variety of challenges that threaten either the continuous operation or viability of their supply chains. In an endeavor to be transparent, it is all the more important to engage in concise communication with relevant stakeholders to minimize disruption. Keeping in touch is always a great idea, especially during troubled times when somebody going silent usually means bad news. The planning, coordination, and related challenges of complex supply chains that depend on inputs from around the world, and often operate under just-in-time principles, occupy top executives now in a way like never before.
Supply chains are the lifeblood of most, if not all, businesses today. Keeping their components running as smoothly as possible ensures that a business can provide on-time delivery of products and services, especially with changing consumer demands and disruptions brought about by the pandemic and the events of 2022. Owners are beginning to demand strict adherence to existing contracts. Going forward, all parties must be more mindful when executing new contracts given the full understanding of what pandemic and other global events have meant and will mean for supply chain management. In other words, the world we live in has changed radically and there is a dire need for contracting parties to determine the contours of their agreements, work together to find innovative solutions to problems effecting both parties, unchain the problems and employ technologies to insulate themselves from future disruptions. We would do well to remember that many of the best opportunities are born out of necessity.