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Covid-19: supply chain disruption rips up contractual rulebook

Neil HodgeThursday 28 October 2021

The impact of the Covid-19 pandemic on supply chains has led to a re-evaluation of how companies write and enforce contracts with third parties around the world.

Months of lockdown, travel restrictions and supply chain disruption have both demonstrated how resilient companies must be in a crisis, and how ineffectual some business contracts are when high impact – but low likelihood – events occur.

Martin Hauser, Co-Chair of the IBA Mediation Committee and a certified and experienced commercial mediator in Munich, says ‘trade players are aware that supply chain disruptions caused by the Covid pandemic have their origin in the general change in the balance of contracts due to a change in circumstances which could not have been foreseen at the time of their formation. A priori, no party is at fault.’

As a result, Hauser adds, ‘contractual adaptations are necessary according to the doctrine of frustration of purpose. The parties themselves know best their true interests and needs. Increasingly, they will take the initiative to renegotiate their contract, either in direct contact, or in a mediation with the support of a neutral third-party, the mediator.’

Hauser says that parties are aware that, if there’s no agreement, a judge or arbitrator may review the case for them. This is a situation companies want to avoid because of the frustration a ‘win/lose’ decision, instead of a jointly negotiated solution, would cause.

Christopher Blake, Co-Chair of the IBA International Commerce and Distribution Committee and co-chair of Hahn Loeser’s International Practice Group and Corporate Transactions Group in Cleveland, says that there are several areas where contractual disputes have arisen.

Force majeure clauses, normally used to cover a situation where an unforeseen or unavoidable event prevents or delays a party from performing its contractual obligations, were commonly invoked when the pandemic broke and the world went into lockdown.

However, the pandemic has not guaranteed that such clauses are justified. According to Blake, ‘Covid-19 might only justify non-performance of the contract to the extent that it has all the characteristics that the contracting parties have agreed to attribute to the event of force majeure, it being necessary, however, to prove that the pandemic is characterised by the peculiarities summarized in the formula “externality, unforeseeability and unavoidability.”’

‘The proof that Covid-19 is an event beyond the control of the person invoking it and unforeseeable by him at the time of the conclusion of the contract does not seem to face any particular obstacles,’ he adds.

On the other hand, says Blake, proving that the pandemic precluded the performance of the contract by explaining effects that could not reasonably have been avoided or overcome may not be as easy. This is because there needs to be proof of the connection between Covid-19 and the impossibility of performing the contract. Meanwhile, the pandemic may not be considered as an event capable of precluding performance because the parties may need to consider the specific circumstances related to Covid-19 and its effects, including the adoption by governments of measures to contain the virus’ spread. These measures may also have prevented the terms of the contract being carried out.

The fact that force majeure clauses may be interpreted differently from one jurisdiction to another also doesn’t provide the assurance that some companies would want from their contracts, Blake adds.​​​​​​​

Even more interesting, he says, are cases where the contract has opted for the application of the Convention on the International Sale of Goods (CISG). This provides that a party is not liable for non-performance if it proves that the non-performance is due to an impediment beyond its control, which could not reasonably have been foreseen at the time of the contract’s conclusion and the consequences of which could not be removed or overcome.

Cash is king in pandemic time, so companies have used their bargaining power paying cash to assure timely delivery of goods that are essential

Javier Canosa
Co-Chair, IBA International Commerce and Distribution Committee

Other clauses companies looked to rely on may have offered only limited – if any –protection, says Javier Canosa, Co-Chair of the IBA International Commerce and Distribution Committee and a partner at Canosa Abogado in Buenos Aires. For example, material adverse change (MAC) and material adverse effect (MAE) clauses, which allow companies to terminate contracts if they can no longer deliver goods or services due to circumstances that prevent their operations or make them prohibitive, may not always apply because epidemics might not be among the events which the parties expressly intended to exclude, or be classed as a ‘material’ event.

‘Some courts have favoured a restrictive interpretation of the materiality requirement, such that Covid 19 might not in and of itself be considered sufficient to constitute a MAC or MAE because its effects might not be of lasting nature and not exhaustible in a limited period of time,’ says Blake.

Hardship clauses are negotiated provisions to be applied when events occur that substantially alter the balance of the contract, either because of an increase in the cost of performance of one party or because of a decrease in the value of the counter-performance. These clauses may prove useful, provided they were included in contracts finalised pre-pandemic and that the parties have not provided for specific exclusions.

Ultimately, says Canosa, the test as to whether a legal provision in a contract provides a company with the protection it wants if the pandemic makes it too onerous or impossible to fulfil depends on the jurisdiction in which it’s signed or applies.

Given the lack of legal certainty, companies are relying on their main strengths – how big a client or supplier they are, and the money at their disposal to throw at the problem. ‘Cash is king in pandemic time, so companies have used their bargaining power paying cash to assure timely delivery of goods that are essential,’ says Canosa.

Image:  Golden Sikorka​​​​​​​/ Shutterstock.com

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