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Supply Chain Disruptions: A Wake-up Call to Re-evaluate Supplier Contracts

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Businesses today are increasingly dependent on global manufacturing, cross-border transportation and widespread, highly sophisticated supply chain networks. 

With major developments such as the COVID-19 pandemic, the Russian invasion of Ukraine, and raw material and labor shortages, businesses find themselves facing a wide range of economic and legal challenges, resulting in the inability of suppliers and buyers to meet contractual obligations.

Usually, contracts require the delivery of products or services by a certain date. With an uncertain outlook for improvement, companies are exploring their options to comply with contractual obligations for projects. Even with the best of efforts, such compliance might be difficult to achieve if a company is unable to provide products or perform services due to unexpected disruptions in its supply chain.

These disruptions have an impact not only on a company’s direct customer, but also on other parties within the supply chain. A classic example is the inability to perform of a lower-tier supplier in the automotive industry, resulting in production line stoppages at the original equipment manufacturer with often catastrophic economic outcomes for all parties involved.

These new challenges have revealed an already existing issue pertaining to the structure of contracts. Disputes between parties often show that the underlying contracts contain either ambiguous provisions or are even silent on certain terms that are crucial to preventing a major breach or substantial damages. As a result of insufficient stipulations, many businesses find themselves in a weak negotiating position, limiting their options to modify their contractual obligations amid economic reality.

While many of these challenges may seem purely detrimental, they can also present an opportunity for long-term success and cost savings by reassessing existing contractual obligations. To assess such opportunities in business transactions, it’s important to examine the most essential aspects that are particularly in need of clear and detailed stipulations, to minimize potential liability risks in the event of supply chain disruption.

Force majeure. Force majeure is a legal concept usually intended as temporary relief from contractual obligations due to an unexpected event. It has been frequently sought to address supply chain issues.

A force majeure clause allocates the risk of loss if performance is hindered, delayed or prevented because of an event that the parties could not have anticipated or controlled. Contrary to popular belief, however, in the event of force majeure, the entire contract is not voided. Instead, the affected party can release itself from its specific obligation to perform, usually for a certain period, while the contract remains enforceable.

Because of a lack of statutory standards, force majeure rights largely depend on terms agreed-upon between parties. If these terms are ambiguous — such as unclear covered events, exceptions, or mitigation responsibilities — asserted force majeure rights can be meaningless. To address force majeure scenarios and similar risks, poorly crafted contractual arrangements should be reassessed, avoiding unintended confusion as well as lengthy and costly disruptions for future projects.

Further, defining remedies is often as critical as covering force majeure events. As an example, a party might not be able to terminate an arrangement or unilaterally change terms, such as an extension of delivery times or increase in prices, unless covered in an agreement.

In addition, parties are usually required to mitigate the effects of a force majeure event. While statutory requirements for such mitigation do not exist, outlining this process — such as taking reasonable actions to locate alternative means of performance, or coordinating cost-sharing for increased prices — is of paramount importance. Stipulating such matters during contract negotiations may reduce the risk of disputes upon the occurrence of a force majeure event.

There are arguments on both sides about whether a breach of contract caused by COVID-19–related issues, such as increased prices, supply chain delays or poor workforce performance, triggers the force majeure clause in a contract. The determination of whether such events do trigger the clause generally hinges on foreseeability and the language within the agreement.

The non-breaching party will often argue the world has been dealing with COVID-19 for nearly three years, and businesses must anticipate supply chain issues, price fluctuations and workforce shortages when contracting for goods and services. Arguing that COVID-19 is an “act of God” is often not enough. Instead, the breaching party must establish that it provided adequate notice and explored alternative methods of performance where feasible.

Timely notice of force majeure events is sometimes required to be given in writing, with a receipt acknowledged by the opposing party. Alternative methods of performance can include manufacturing similar conforming goods and, if services are the subject of the agreement, hiring a subcontractor that can perform the contractual obligations on the breaching party’s behalf.

In sum, when negotiating an agreement, parties should leverage the opportunity to carefully craft (a) the scope of force majeure events, (b) corresponding remedies and (c) mitigation obligations.

Pricing structures. Traditionally, prices are fixed and may only be adjusted periodically, but due to frequent changes in raw material prices and availability, parties may account for such challenges by creating concrete parameters for events affecting prices and threshold amounts allowing future adjustments, such as a certain percentage price increase for raw steel over a specific period.

Limitation of liability and potential capping of damages. Even though “limitation of liability” provisions are frequently found in contracts, parties often neglect to appreciate or don’t fully comprehend the impact of such provisions. Rather than using standard language, companies ought to focus on likely scenarios, such as line stoppages and severe damages from late deliveries. In turn, detailed drafting of liability language can provide certainty and allow parties to prepare for potential disruptions.

Other key areas. International contractual relations require choice of law and venue provisions to facilitate predictable outcomes with respect to disputes. Furthermore, an alternative dispute resolution clause instead of a standard venue provision can mitigate the risk of conflicting decisions arising from parallel disputes across the supply chain.

Suppliers should consider adopting delivery obligations with some flexibility and should especially avoid “time is of the essence” language. In addition, it’s advisable to include regulations regarding liability caps, waivers and liability for consequential damages of downstream suppliers.

Despite ongoing supply chain risks, companies need to be aware of their opportunities to position and adjust for long-term success and cost savings, by reconsidering existing contractual obligations and general terms and conditions with suppliers.

Sebastian Meis is a shareholder and member of the Global Business Team at the law firm Baker DonelsonLee Smith is a shareholder and leader of Baker Donelson’s International Trade and National Security practice.

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  • Source: https://www.supplychainbrain.com/blogs/1-think-tank/post/35581-supply-chain-disruptions-a-wake-up-call-to-reevaluate-supplier-contracts

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