Out-Law Guide 5 min. read
25 Aug 2011, 11:28 am
After the dust settles on a natural disaster in a particular country or region, the wider economic impact can be substantial. A tsunami or earthquake can have potentially dramatic effects on some global supply chains and in some situations it may take months before the extent of these effects is fully known.
There is currently no European-wide contract law to give certainty and consistency to the way contractual obligations are interpreted in the various countries that make up the EU. How obligations in a contract will be interpreted will depend on the law governing each contract. However, the United Nations Convention on Contracts for the International Sale of Goods (CISG) applies between parties to a contract which are based in different countries unless the parties have expressly agreed that the contract will be governed by the laws of a particular jurisdiction, or if the application of the CISG has been specifically excluded. The aim of the CISG is to promote uniformity and to encourage good faith in international trade.
If a contract between a buyer and a seller based in different countries has no express governing law clause, consideration will need to be given to whether CISG applies. Under CISG, the basic principle is that a seller can be held liable if it fails to deliver in full, on time and in accordance with specifications. However, CISG protects a seller from liability if its failures:
This guide summarises some of the contractual issues and provisions which are likely to be relevant to managing your supply chain if a natural disaster happens. These issues apply equally to both supplier and customer contracts. In the absence of a European-wide contract law, this is provided on the basis of contracts governed by English law.
Frustration is an English legal concept. A frustrating event is one which is not the fault of either party which so fundamentally changes the nature of the contract or renders performance impossible that the court will treat the contract as terminated. It is a seldom-used concept and the courts will only apply it when a contract has become impossible to perform. The fact that a contract has become more difficult or expensive to perform will not be sufficient for a court to hold that frustration applies.
Force majeure is the idea that, if an event outside the control of the parties occurs, the parties will not be in breach of their obligations under the contract if they fail to perform their obligations due to the occurrence of that event. There is no general concept of force majeure in English law. For the parties to be able to rely on force majeure, the contract needs to include express provisions to that effect and the event which has occurred needs to fall within the definition of force majeure used in the contract. In determining whether a force majeure clause applies, its wording is crucial. For example:
Bear in mind that a party may not be able to rely on a force majeure clause if it has failed to make reasonable efforts to perform its contractual duties despite the occurrence of the force majeure event.
If the suspension of a contract due to a valid force majeure event has a significant impact on its value, there may be grounds for the contract to be terminated. However, this is not a step that should be taken without legal advice - if the contract is wrongfully terminated, the party terminating could find itself in breach of contract and the subject of a damages claim.
Other relevant contractual issues
Termination: can the contract be terminated, either for convenience or for breach? It is likely that the contract will include termination notice time periods, material breach remedy periods and mechanisms for serving notices. It is important that these are complied with to avoid a claim that the terminating party is in breach of the contract, and therefore liable to pay damages.
Limitations of liability: to what extent is liability under the contract excluded or limited? If there are limitations or exclusions, will these be valid to cover the damages that may otherwise be claimable in the event of a failure to perform or another breach of the contract - for example, termination other than in accordance with the contract terms?
Risk: consider whether your contract deals with when risk passes from the seller to the buyer. Does the risk of loss shift from the seller to the buyer at a designated shipping point? If so, the buyer could have liability for products that it never receives. Similarly, if there is a loss that the buyer is responsible for which is covered by insurance make sure that the correct notifications are given to the insurer as soon as the position becomes apparent.
Exclusivity: has the buyer granted to the seller exclusivity of supply? Is the buyer committed to minimum purchase volumes? If so, simply switching sources of supply or obtaining alternative supplies from elsewhere could lead the buyer to be in breach of these obligations. Sourcing from elsewhere in these circumstances should be considered in light of the seller's ability to continue meeting demand and in light of other contractual provisions.
Pricing: is pricing fixed or is it capable of fluctuation, either generally or linked to the increase of price of components, raw materials or services such as transportation? Even if your direct supplier is unaffected by a natural disaster, consider whether that supplier itself relies on supplies from an affected area – in which case, it may be looking to invoke price escalation clauses.
Business continuity plans
Business continuity planning is a crucial element to supply chain management. It is also worth bearing in mind that all business are both suppliers and customers - having in place robust business continuity plans is therefore good practice for both suppliers and customers.
You should have at least two business continuity plans in respect of potential supply chain interruptions.
Internal plan: this should set out the processes and procedures to be followed in the event of supply interruptions. This should be backed up by significant amounts of information as to sources of supply and alternative sources, logistical arrangements and financial modelling. The plan should be kept under review, updated and tested on a regular basis.
Counterparty plan: this should set out the process the other party should follow in the event that its ability to continue supply on time in full is threatened. This should be incorporated into the business supply contracts and be legally binding. Again, this plan should be kept under review and regularly tested.
Hopefully, parties to contracts which are affected by catastrophic events will work together to achieve solutions to any supply chain challenges that ultimately lead to success for both parties. Offering positive support to each other through difficulties may result in much closer working relationships in the future.