Components such as microchips are in short supply (pic:Sahand Babal)
Supply chain disruptions should be part of any company’s contract agreements, write LOUISE HAMILTON and ALLAN REID
The pandemic may be passing, but supply chain issues persist. Port disruptions, component shortages, on-going quarantine restrictions, record freight rates… the list goes on. And just as Covid-19 may have eased, there is a war in Ukraine, tensions over Taiwan (maker of two thirds of the world’s semiconductors) and, according to Intel’s CEO, semiconductor shortages will continue into 2024.
New cars continue to be in short supply, as manufacturers have been forced to temporarily shut down production because of supply chain issues. Even the world’s largest companies such as Tesla and Apple are not immune from supply chain problems.
More recently, as the effects of Covid-19 have abated (at least in terms of economic activity), we have seen Covid-19 clauses feature less often in contracts. But whether you’re a buyer or seller, supply chain problems will continue for the foreseeable future and ought to be part of your thinking for contractual relationships.
Until 2020 it would have been very difficult to get clients interested in a discussion about force majeure wording, but events in the last two and a half years have shown its worth as more than ‘legalese’ for the back of a contract.
Under both Scots and English law, force majeure does not exist as a concept in common law. Therefore, to get relief from fulfilling obligations this must be clearly stipulated in your contract.
In the past, force majeure cases have been few and far between but there has been a flurry of them recently around Covid-19. Whether force majeure applies will depend on what the contract says, and the courts will interpret provisions in accordance with the words used and not implying any further meaning.
It is better to be clear up front that Covid-19 – or supply chain issues more generally – is a force majeure event rather than relying on a standard contractual boilerplate provision which may or may not apply depending on the circumstances.
So, if you’re a seller and can’t guarantee the incoming supply of goods you need in order to make your products and supply them to your customer, be clear about this in your sale contract. And if you’re a buyer, you may have to accept that your seller can’t guarantee its supply chain will hold up.
Between the two positions, it is possible to agree in the contract the efforts the seller needs to make – e.g. to try to get a supply from another source – or to specify that it needs to be an industry-wide shortage.
A related issue is hardship, sometimes called ‘material adverse change’. This is where performance of the contract is possible but at a much higher cost.
A buyer will want the same prices to apply, but for a seller performance of the contract may no longer be economically viable. This will be generally more relevant to longer term contracts, particularly if there is fixed pricing. A clause dealing with hardship should be included if the parties intend obligations to be set aside or renegotiated if financial or other circumstances change for the worse.
If force majeure doesn’t apply or there is no force majeure clause in your contract, is there anything else you can do? It may be possible to rely on the doctrine of frustration of contract. This would be a risky choice as the courts will always try to apply the contract that has been agreed so the bar for establishing frustration is set very high.
There must be an unforeseen event, outside the parties’ control, which has made it impossible or illegal for them to perform their obligations under the contract. Alternatively, circumstances must have changed to such an extent that it is so far removed from the parties’ original intentions as to be unfair for the contract to remain in place.
As with hardship, it is not enough that performance has been made more costly or difficult. It is also unlikely, in 2022, that a pandemic would be regarded as an unforeseeable event. One final point to consider on this is that even if the parties wanted some obligations under the contract to remain, the effect of frustration is to end the contract in its entirety.
Although it is possible to include a clause allowing for unilateral variation of the contract by a party these more commonly appear in standard terms and conditions rather than negotiated contracts and there can be legal issues around their application.
As recent history shows, it is worth paying attention to risks associated with the delivery of a contract and to consider how those should be allocated and that remains the case because these constraints are showing no sign of abating anytime soon.
Louise Hamilton is a Legal Director, and Allan Reid a Senior Legal Director within the Legal Counsel Service team at Vialex
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