The impact of coronavirus on supply chain contracts

As cases of the coronavirus (COVID-19) increase around the world, industry continues to experience the effects. In particular, Chinese manufacturers in some areas have stopped operations due to factory shutdowns which in turn is starting to affect supply chains. As lead times catch up with supply constraints we expect this to become problematic in the weeks to come.

While industry works to reduce the impact of the coronavirus, from cancelling travel, to working from home, some impact on operations will be unavoidable.  Accordingly, it is also crucial for companies to consider the impact this supply chain disruption may have on their respective contractual arrangements.

Force Majeure

Most, but not all contracts contain a “force majeure” clause. A force majeure clause allows an affected party to be (temporarily) relieved of its obligations under the contract in the case of certain emergencies.

Some Chinese parties are already relying on force majeure clauses in their contracts and the China Council for the Promotion of International Trade is offering force majeure certificates to help Chinese companies avoid being in breach of their contractual obligations. These certificates are not a get-out-of-jail-free card, and each contract requires to be considered individually in order to consider whether the event complained of is a force majeure event in terms of that particular contract.

What is a force majeure event will usually be provided for in the contract, or the contract may have wider wording to allow it to be an event beyond the control of the parties.

Oil and Gas contracts

LOGIC contracts commonly used in the Oil and Gas industry, or provisions based on or derived from LOGIC, contain a standard form force majeure clause. It lists various emergencies which allow the use of the force majeure clause to avoid claims of contractual breach, from “Riot, war” and “radioactivity from nuclear fuel” to  “earthquake”, “strikes” and  “maritime… disasters”. However, the LOGIC style force majeure clause does not contain wording which specifically covers a pandemic, or other illness-related occurrences (although it is possible for parties to depart from the standard LOGIC wording).

So, are there any other provisions that parties may look to if a pandemic is not covered in the force majeure clause? The LOGIC force majeure clause also catches certain changes in the law (including local laws); in other words if there are changes in the law that stop performance, parties may be able to rely on this as a force majeure event. Taking the Chinese situation as an example again, changes in the local law in China ordering a particular factory to close may mean that your supplier is able to claim force majeure to avoid being in breach. Whilst it may be possible to rely on this local law change, leading to the lack of supply of goods, as being a force majeure if, in turn, you cannot perform due to that same change in law. This approach is yet to be tested in court. It is always important to bear in mind that whether an event is force majeure or not, will depend on the circumstances, including the terms of your contract.

Difficult situations

You should not expect the words force majeure to allow you to automatically exit a difficult situation, and parties have learned this the hard way in cases before the courts. A party needs to show that it is the force majeure event and not some other event that has stopped the performance of the contract.

In the recent English High Court the case of Seadrill Ghana Operations Ltd v Tullow Ghana Ltd, Tullow claimed performance was impossible due to a moratorium imposed by the Ghanaian government which prevented Tullow from drilling, which Tullow claimed made it impossible to provide a drilling programme. The Ghanaian government had also refused to approve the plan for the wider oil field for other reasons. It was decided that Tullow was not entitled to rely on the force majeure provision to terminate the contract because, although the moratorium was a force majeure event, there were other reason for non performance that were not force majeure events.

This case demonstrates that force majeure must be the cause of the temporary non performance and that (unless the contract says otherwise) parties must use reasonable endeavours to avoid the effects of force majeure. It is not enough to identify that there is force majeure clause and stop considering other performance aspects of your contract.

In another recent case, it was decided that a party could not be relieved from its contractual obligations on the grounds of force majeure merely because the contract had become more expensive, or less profitable, to perform.

So what should my business do?

Given the widespread effects of the current situation, many of your customers will be in a similar situation and early identification of anticipated operational problems will help establish whether alternative methods of performance can be deployed.

Check your contracts, and in particular, whether time is of the essence, if liquidated damages apply if you are late and what the force majeure clause cover. If the problem is with your supplier, do the same for that contract.

Then engage with both customers and suppliers to try and find a solution. If no solution is possible – speak to your in-house legal team or external lawyers to establish where you stand legally.

If you would like advice or assistance in relation to your contracts please do not hesitate to get in touch.