A Fresh Look at Force Majeure for Supply Chain Fallout

It seems as though supply chain issues have been never-ending these last few years. Although supply congestion has ebbed and flowed, it remains unpredictable. "One positive thing about our current supply chain situation is that the NY Fed Global Supply Chain Pressure Index fell for the third straight month in July 2022, reaching its lowest point since January 2021," Evan Blum, managing director in corporate finance at Hilco Corporate Finance, said during an NACM webinar, Protect Your Company Through the Ongoing Supply Chain Crisis.

Spending also has shifted from goods to services in recent months—giving the supply chain a much-needed break, he added. "Everybody wants to go on vacation. People have stopped buying stuff and started doing more stuff." Most retailers are expected to reduce purchases, and those who overbought have pulled back considerably, according to Blum.

Still, as we have learned before, the supply chain is unpredictable and backlogs can quickly pile up. Production is still slow in China due to continued COVID-19 lockdowns, and the Russia-Ukraine war is continuing to disrupt global trade routes. As we enter the holiday season, it is important for creditors to protect themselves, Blum explained.

"If you see a bad Christmas, know that it's because people are concerned about their economic interests and it's going to have a negative impact on consumers or goods companies," he said. "An impact particularly for those that are over-inventoried. In 2023, we might be facing liquidation."

Jason Torf, partner at Tucker Ellis, LLP (Chicago, IL) suggests that companies should focus on contract drafting to protect themselves against the negative effects of supply chain issues. "The first and most important thing to do is establish a very clear and mutual understanding with your customer. A lot of this has to do with making sure that all parties are on the same page and maintaining a positive relationship going forward."

Contract provisions, or stipulations within a contract, will help your company during tough, unexpected situations. One of the best provisions to use is called the force majeure clause, where an unforeseeable circumstance prevents someone from fulfilling their side of the contract. "Force majeure is a provision in a contract that gives you an out, to suspend or excuse yourself from performance when a circumstance outside of the control of either party that precludes you from being able to fulfill your obligations under the contract," Torf said. "Unforeseeable events" include epidemics and pandemics, floods, earthquakes, strikes or labor stoppages, acts of terrorism, acts of God and war.

Force majeure clauses should specify whether it is a broad or narrow provision, with much more specific triggering events listed. "For example, if you don't perform because of labor shortages and your customer sues you for damages, a broad force majeure provision can be used as a defense in that lawsuit," Torf said. "Three years ago, there wasn't a need to include global pandemics and it might've been covered back then under a broad provision but now it can't since it has happened."

As long as there is a specific event beyond the party's control, it doesn't matter whether it was foreseeable and there must be no fault or negligence, he added. "We all can anticipate a pandemic happening because it's already happened and a broad force majeure cannot protect you. But a narrow provision will because it does not take into account if an event is foreseeable or not, if the event is listed, it counts."

Doctrines can serve to protect your company from supply chain fallout. One is called impracticability, essentially performance excused where impracticable. "This occurs where a supervening event changes the inherent nature of the performance to be more difficult, complex or challenging to the point that it contravenes a basic assumption of the parties' agreement," Torf said. For example, a severe shortage of raw materials or supplies due to war, embargo, local crop failure or an unforeseen shutdown of major sources of supply affects a company's performance.

-Jamilex Gotay, editorial associate

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Sunday, 04 June 2023

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