With the coronavirus sweeping through major manufacturing hubs in China, the government has mandated shutdowns in many cities. The mandatory evacuation and closure of many businesses and schools in the area has shut down a number of manufacturing facilities and distributors located in China. In addition, many companies based in the United States and elsewhere are suspending or limiting their operations in China.
The outbreak and resulting measures imposed by the government are impacting companies with manufacturing facilities, or suppliers, located in China. With no end to the outbreak in sight, the impact on the supply chain is likely to increase in the short term. Companies should review their supply chain and manufacturing footprint to assess whether they are at risk of having their operations disrupted. Companies also should consider their potential risk if the outbreak spreads to other major manufacturing hubs in Asia, such as Japan or Taiwan.
Affected, or potentially affected, companies should take proactive steps to mitigate their risk and prepare for how they will address any interruption to their operations or those of a critical supplier. One of the most important steps companies should take is to review their contracts to determine what “force majeure” rights and requirements may apply. Force majeure refers to a legal doctrine under which a party may be relieved from liability for non-performance if circumstances beyond the party’s control prevent the party from fulfilling its obligations under a contract.
Force majeure provisions can vary greatly depending on how they were drafted by the parties, but they usually cover several categories of events that could impact suppliers and customers across the supply chain. Many of these provisions include a list of specific events that may be considered a force majeure event under the contract. While most force majeure provisions are unlikely to list disease, epidemics, or quarantine specifically, many include general provisions covering such things as natural disasters, “acts of God,” acts of government, or “other circumstances beyond the parties’ control.” The coronavirus outbreak presents a somewhat unique situation in that it includes both a naturally occurring component (the virus itself) and a government action component (including the quarantines and other measures put in place in response to the outbreak). Parties should carefully review the force majeure provisions in their contracts to determine whether they apply.
Any party seeking to invoke the force majeure provisions in its contract usually must show that there are no alternative means for performing under the contract. Increased costs alone will not be sufficient to prevail on a claim of force majeure. For example, if a company is able to ship parts from a different manufacturing facility, even if that requires running extra shifts, paying employees overtime and/or expedited freight, then it will be very difficult to show that it was unable to perform under the contract.
While every situation is different, there are a number of best practices that most companies can follow when they invoke the force majeure provisions of a contract or when they receive a force majeure notice from a supplier:
- Review the applicable force majeure provisions to determine what the provision allows and whether the current situation is covered.
- Confirm that the notice requirements under the contract have been met. Note that some force majeure provisions have time limitations on reporting the force majeure event after it occurs, so this step should be completed as soon as possible.
- Provide or obtain as much information about the specific force majeure claim as possible, including the timing, the number of impacted parts/facilities, and when the force majeure event is expected to conclude. If complete information is not available, the declaring party should supplement its notice as additional information becomes available.
- The parties should work together to assess inventory on hand, whether there is a bank of parts that can be accessed, whether there are other manufacturing lines available at different locations, and the affected supplier’s allocation plan (note: a “fair and reasonable” allocation across customers is required under UCC § 2-615(b)).
- Consider whether and when an alternate supplier can be ramped up.
- Be aware of the other party’s rights if force majeure is invoked, which may include the right to terminate and source from an alternate supplier or to terminate after a certain period of time.
- Look across the company’s supply chain to determine whether its suppliers have facilities that might be impacted by the coronavirus and begin considering contingency plans.
- If the company has received a force majeure notice from one of its suppliers, evaluate whether that notice triggers a force majeure event for the company, requiring that notice be provided to its customers.