Corona Virus – Is your supply chain affected?

It will not have escaped the attention of most readers that the world’s largest manufacturing territory is currently undergoing an outbreak of a virulent and deadly virus. At the time of writing, significant parts of China are on lockdown, with the Chinese government extending the Lunar New Year holiday, quarantine measures being put in place in at least twelve major cities, and many businesses temporarily shutting down operations (and, in the case of international businesses, evacuating employees). The impact on the global economy is starting to be felt, with slumps in the NASDAQ and FTSE100, as well as in the value of shares of technology businesses such as Apple, which are heavily reliant on China as a manufacturing centre.

The likelihood is that businesses throughout the world will see some disruption to supply chains as a result of the coronavirus and the measures being put in place to attempt to contain its spread. So how can businesses leverage their contracts in order to minimise the impact on their business and the risks that may arise as a result?

The main contractual mechanism that is available to businesses in relation to events outside of their control is the force majeure clause. This provides a business with protection in the event that it is unable to perform its contractual obligations as a result of an event outside of its control. A supplier will therefore want to be able to rely on the force majeure clause if they are unable to supply products due to a problem further up their supply chain. A customer, on the other hand, will want to ensure that the force majeure clause is sufficiently narrow that a supplier will not be able to rely on it to avoid liability for problems in the supply chain.

However, the scope of a force majeure clause will depend very much on the exact wording of the clause; there is no standard definition of the words “force majeure”. Businesses should, accordingly, be looking carefully at the wording of their force majeure provisions to see exactly how much protection they provide. Below is a short summary of the key elements of a force majeure clause that can determine their usefulness in this type of situation:

Triggering events

A clause should define what a “force majeure” event actually is. This might be an exhaustive list, so that only those events specifically listed will count for the purposes of force majeure. Whether the coronavirus outbreak falls into such a list will depend on whether it is covered by any of the items in the list. For instance, some force majeure clauses include “epidemic or pandemic” or something similar. Of course, it may be a matter for debate as to whether the coronavirus outbreak has at this stage reached the level of an epidemic.

Alternatively, a “force majeure” event may be defined by referring to “causes outside the control of a party, including” followed by a list, in which case the list is only illustrative, and other events may also be included in the definition if they are outside the control of a party. The coronavirus outbreak would almost certainly be considered to be outside the control of a party and therefore constitute a force majeure event, on a definition in these terms.

Causing the contract breach

However, even if the coronavirus outbreak is a force majeure event, in order to rely on a force majeure clause, the event must not only cause the contractual breach, but it must be the only cause of the contractual breach. The 2019 case Classic Maritime Inc v Limbungan Makmur SDN BHD considered the situation where Limbungan was contractually obliged to supply Classic Maritime with iron ore cargo, but was unable to do so. Limbungan claimed that this was due to the shutdown of the supplying mine due to a burst dam, but the court found that, in the circumstances, Limbungan would not have been able to provide the cargo anyway, and so the burst dam did not in reality cause their breach. It must be clear that, if the force majeure event had not happened, the contract would not have been breached. How this applies to a specific contract will depend very much on the words used in the force majeure clause.

Effect

The effect of a force majeure clause also depends on what remedies have been set out in the clause. A force majeure clause will almost always suspend the affected party’s obligations and remove their liability for any breach caused by the force majeure event. However, the parties may also agree to include the right for the non-affected party to terminate the agreement if the force majeure event continues for a certain period of time, giving that party the ability to move to an alternative supplier. Finally, the parties may agree a specific obligation for the affected party to take all possible steps to mitigate the effect of the force majeure event; although the court may imply this anyway, so it is safest to assume that this applies in any event.

Businesses that are experiencing, or anticipate, disruption within their supply chain as a result of the coronavirus outbreak should be looking at their contracts now, in order to identify whether they can benefit from a force majeure clause, or indeed whether they are at risk from their suppliers attempting to rely on such a clause. If you need advice on your specific circumstances or would like an expert eye cast over your own contracts, contact our Commercial team for assistance.