Commercial Update 76: Protecting the Chain…Issues for Supply Contracts

Whether via the war in Ukraine, the continued effects of the Covid-19 pandemic (and don’t even mention the ‘B’ word), supply shortages, and rampant price uplift for some materials seems to be with us all for the moment.

In addition to this, the demands (rightly in my view) from consumers for sustainability in goods and services provided add further pressure on strained supply chains.

So, what can suppliers do?

Some actions to take when looking at supply chain contracts that keep coming up within our team and clients are:

  1. Considering the protections, a force majeure clause might provide;

The starting point here is that in order to rely on a right to suspend or delay performance as a result of an event beyond your reasonable control, you will need an express force majeure clause in your contract (or wording to the same effect) giving you these rights. The key starting question then (as a lot will depend on the wording of the clause) is ‘whether the supplier has genuinely been prevented or delayed from performing its obligations by reason of the event in question?’. Please note that even if any such event has then made a contractual obligation commercially unacceptable, impracticable, uneconomic or even unprofitable for a supplier (for example, as a result of rising energy prices or increased raw material costs) is unlikely to be enough for the force majeure clause to kick in.

2. Understanding the application of the doctrine of frustration;

This means that a contract may be automatically discharged (or frustrated) if something occurs after the formation of the contract that either:

  • makes it physically or commercially impossible to fulfil the contract; or
  • which transforms the obligation to perform into a radically different obligation from that agreed when the contract was entered into.

This is a narrow channel in which to run – it seems from the caselaw here that the courts do not want to permit parties to use frustration as a way of escaping a bad bargain.

On this basis and even given the current pressures on supply chains, any impracticability around supply will not normally be a ground for frustration, suppliers will undoubtedly be required to consider how else or where else they could obtain similar or substitute products before they can consider frustration.

If you argue for frustration as a supplier and get it wrong, this could constitute a repudiatory breach of contract – this option does therefore carry risk.

3. Looking at a clear liability regime within your supply chain contracts with a particular focus on:

a. Liability caps and exclusions of liability;

This mainly means anyone (or ideally all of) excluding certain heads of loss where possible and including an express financial cap on all liabilities that are accepted. Bear in mind though that although all suppliers may wish to exclude all liability for failure to perform, if possible, it is worth bearing in mind that customers should still be left with a meaningful remedy. Recent case law has shown that if a supplier seeks to exclude all likely forms of liability, the court may take the view that this goes against business common sense and interpret the liability clause so as to provide a meaningful remedy for the customer.

b. Material Adverse Change clauses

These started off life in non-trading agreements (such as in lending transactions to allow the lender to end the arrangement if there is an adverse change in the borrower’s position or circumstances or in corporate acquisition agreements to allow a buyer to walk away from the deal if events occur that are detrimental to the target company) but became popular after Brexit. They tend to come in 2 flavours:

Type of clause 
 A specific event occurs (for example, currency exchange rates fluctuate) and then an agreed consequence follows (for example, the price of the products or services is adjusted).
 A trigger occurs (for example the imposition of tariffs, a change in regulatory requirements, a party’s costs increasing) and the affected party may request renegotiation of the contract on the basis that if no deal can be reached, the affected party can terminate.

Both of these could allow flexibility in different ways to a supply contract and need considering.

c. Narrowly drawn indemnities;

The best indemnity is the one you don’t give! Outside of avoiding giving indemnities for supply though, it is essential to look at drafting safeguards if possible, and also having what is called a conduct of claims clause where an indemnity is given.

d. Protective liquidated damages regimes.

These are a fixed or determined sum agreed by the parties to a contract to be payable on breach by one of the parties. The starting point here is that a contractual clause that is designed to deter a breach rather than provide genuine compensation will be considered a penalty. The consequence of a clause being categorized as a penalty is that it will be deemed unenforceable. Any contractual clause seeking to provide a determined sum has to be a genuine pre-estimate of loss.

Assuming that test is met, this could include for example, an exclusive service credit regime (which would provide certainty as to the remedy available in the event of particular failures by the supplier), applying if a supplier fails to meet the agreed performance levels set out in the agreement.

Final thoughts on this are there are myriad of other potential and actual causes of disruption that will continue to impact the supply chain in the future, long after the impacts of Covid-19 and the other factors referred to above have faded, such as ongoing issues with shortages of workers, transport delays and the availability and cost of materials plus political decisions and trade policies.

It cannot be a better time now to review supply contracts to ensure that suppliers are suitably protected plus looking at whether it is possible to build flexibility and redundancy into supply chains, so that when disruption does arise, they have a greater range of options to help mitigate the disruption and avoid breaching obligations.

Regards to all,