Recent events have disrupted business activities and supply chains around the world. The spread of the COVID-19 pandemic and the Ever Given getting stuck in the Suez Canal are examples of events that have caused unexpected delays in business operations as well as a backlog in ports. Businesses are not able to keep a consistent supply of goods flowing through the supply chain. As a result, contracts need to be evaluated to understand what happens if they cannot perform the way they say they will. 

What About Force Majeure?

Claims surrounding these events will consider force majeure, which excuses parties from obligations when unforeseen circumstances arise and cannot be controlled. The term includes acts of nature such as floods and hurricanes and acts that people do such as riots. While Force Majeure clauses provide for some remedies, they may not fully cover extended delays due to COVID-19 closures. Economic hardship or drop in demand do not constitute force majeure.

Improving Supply Contracts

Businesses will need to decide how to handle major disruptions in the future and how to improve on their supply contract.

1. Review the Contract. The current contract should be evaluated to see exactly what language is used regarding certain events. In determining what will be covered, what the contract states is critical. Force majeure clauses vary by contract.  Are events that affect supply issues sufficiently covered? Long-term contracts should be reviewed regularly.
2. Cost of Damages. Both buyers and sellers should pay close attention to the limitations on damages in the agreement. When a delay occurs, it is often difficult to determine the actual amount of loss that results from it. A liquidated damages clause in a contract provides that if a certain type of breach occurs, such as a delay, then a fixed amount is paid for each day that the delay occurs. This keeps the costs of the delay under control.
3. Compensation for Increased Prices. Long-term supply contracts often determine the minimum purchase quantities. The contract can include remedies for compensation for increased prices that the buyer has to pay to get comparable goods from another supplier.
4. Communicate Openly and Often. One of the challenges of supplier management is how to communicate and collaborate with suppliers.  An automated system that centralizes communications by compiling all suppliers in one place and gives all parties access to information. Therefore, when an incident does occur, the supply chain will be able to react quickly.
5. Review Warranties. Warranties dictate what the seller promises regarding goods being provided to the buyer.  Supply chain contracts usually include express warranties and implied warranties that will be part of the contract unless disclaimed.
6. Step-In Rights. The buyer may want to be able to ‘step in’ to agreements that the supplier has with sub-suppliers. However, it is often difficult to give the buyer such rights to its sub-suppliers, just as the sub-suppliers may be reluctant to accept the buyer.  In order for step-in rights to be beneficial, the buyer must ensure the supplier can supply access to its sub-suppliers and assist in agreement terms between the two.
7. Alternative Suppliers. In the case of an emergency, a contract should stipulate the right to find an alternative supplier if the contracted supplier is unable to meet their obligations in terms of delivery. Buyers should be able to obtain an alternative source of supply for as long as necessary and complete any ancillary supply arrangements before the supplier begins sending goods again.
8. Following forecasts is an important part of receiving regular shipments. If a supplier cannot ship goods, consulting a regular forecast gives an early warning that there may be a delay.
9. Recovery Plans. Suppliers should have a recovery plan in place that will kick in when an unexpected event does occur.  This should include what the buyer can do in order to still be able to conduct business. 
10. Termination should only be used if no resolution can be found and there is continued poor performance.  A strong supply contract will allow for dispute resolution that lays out how it should be handled and resolved. There should be several steps of involvement by both parties before termination is considered.

Manufacturers can mitigate risk by following best practices when drafting their supply chain contracts. Comprehensive and detailed supply chain agreements are also critical for risk management particularly when unexpected events occur.  The events affecting the logistics industry the last year should encourage buyers to review their supplier agreements regularly throughout the year.