It is quite common in supply chain contracts for the buyer and the seller to have competing interests in negotiating key contractual provisions and protections. Before COVID-19, force majeure provisions were often just an afterthought in contract negotiations, with very little difference regardless of whether the manufacturing company was on the buy- or sell-side of the contract and without regard to the specifics in the supply relationship. Instead, manufacturers would copy the same, tired force majeure language across all of their contracts, which typically would be found buried at the bottom of the contract in the “Miscellaneous” section.
In the current COVID climate and given the lessons learned as force majeure disputes continue to ricochet through supply chains across nearly every industry, force majeure provisions and related risks have a renewed focus. Going forward, manufacturing companies and their counsel will focus on mapping their supply chains and the related risks. Risks will vary depending upon the volumes, timing of the program, the geographic location of the plant, suppliers and even sub-suppliers, whether the products are ordered on a JIT (Just-In-Time) basis, whether the parts are sole-sourced or there are alternate suppliers available, and whether safety stock or inventory banks are accessible. Manufacturing companies will then use future contract negotiations and form commercial documents to allocate the various risks accordingly.
Key categories of force majeure events include risks that prevent or delay contractual performance due to the following events and circumstances:
|Acts of God
||Acts of War
||Other Labor Issues
Although each supply contract is different, there are some high-level guidelines that manufacturers should consider when tailoring and negotiating force majeure provisions. These considerations will differ depending upon whether the manufacturer is the buyer or seller and the various ways that the supply chain could be disrupted.
Key Considerations for Buyers
- The buyer may want to narrowly limit force majeure events to matters that are truly outside of the seller’s control and buyer-friendly force majeure provisions may exclude strikes, labor issues or anything involving the seller’s workforce.
- The buyer will not want to include tariffs, government embargoes or acts of government among the enumerated events under a force majeure provision and may want to include an additional protection in the pricing provision that prices are inclusive of “all costs, including taxes, imports, duties and tariffs.”
- Although it has become standard practice for force majeure provisions to contain the broad, catch-all language at the end of a parade of horribles—“or any other circumstances beyond a party’s reasonable control which prevents performance”—this may allow the seller to claim that anything not explicitly listed that prevents performance is a force majeure event.
- The buyer will want to require prompt notice of any force majeure event so that it can immediately evaluate the impact to its supply chain and execute its contingency plan.
- The buyer should ensure that there is a clause that allows the buyer to exit the supply agreement if the seller is not able to resume performance within a certain period of time. The amount of time should align with the buyer’s contingency plan—whether it be a bank of parts or the ability to source from alternate suppliers. This is akin to a contractual “escape hatch.” Because the buyer will be required to turn to an alternate supplier if the original supplier is not able to resume performance, the buyer will be able to negotiate much more favorable terms by negotiating a new long-term agreement or higher volume PO with an alternate supplier than it would under a spot-buy scenario. This is particularly important if the buyer does not have the right to terminate for convenience under the contract.
Key Considerations for Sellers
- Force majeure provisions typically favor the seller as the party that has the obligation to deliver parts or services. Therefore, the seller will want to negotiate as broad a list of force majeure events as possible, taking into account specifics about the contract such as the regions, parts/services at issue, volumes and timeframe for delivery. The seller will want to include strikes and labor issues that may result in delays or inability to perform under the contract. Even broader protections would cover equipment breakdowns, power outages and raw material shortages.
- The seller also will want to list specific risks like epidemics, pandemics, quarantines, acts of government and government travel bans.
- The seller will seek to include the broad catch-all included for other circumstances whether foreseeable or unforeseeable beyond its reasonable control that prevent performance.
- The seller will want to be aware of the notice period and strictly adhere to it when it becomes aware of any disruption or potential disruption.
- Finally, the seller should consider what the buyer’s rights are when it exercises force majeure. Force majeure is a mechanism for suspending performance under the contract. It is not a mechanism for demanding a price increase and, in fact, the exercise of force majeure may trigger the right of the buyer to terminate the contract and source from an alternate supplier if performance does not resume after a certain amount of time.
As with all divergent interests in supply chain contracts, the competing positions of the buyer and seller should be addressed during contract negotiations. For example, the party that agrees to bear risk if there is a force majeure event may leverage this risk against pricing or termination rights.
In addition to the language of the force majeure provision, there are other contract provisions that manufacturers should strengthen and best practices to implement as a result of lessons learned from COVID-19. When the pandemic began and various executive orders required manufacturers to shutter, there were a flurry of issues that impacted manufacturers. Force majeure notices were sent, but parts already were in transit—who pays for the costs to return those parts when there was no one onsite to receive them? There were situations where a plant in one location had to be closed, but other manufacturing facilities had capacity—who pays for the costs to tool up and ramp up at an alternate location or for employee overtime? Throughout the pandemic and the reopening phase, there have been additional costs incurred in manufacturing lines, including employee overtime and freight expedites—who pays? These are just some examples of the types of responsibilities and risks that can be allocated in supply contracts going forward.