Supply chain disruption: are contractual disputes just an "ever given"?

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Whether it is queuing for hours to fill up cars with petrol, consumer fears over potential Christmas turkey shortages, or watching the Egyptian authorities attempt to free the Ever Given container ship blocking the Suez Canal, recent events have brought the fragile nature of local and global supply chains to the forefront of the public's mind. Staff shortages, shipping delays and problems procuring components and materials are all playing their part in preventing businesses from fulfilling their contractual obligations and causing knock-on impacts further down the supply chain.

Where delays and disruption to supply chains emerge, contractual disputes inevitably follow, as businesses seek to recoup the losses that result. There are a number of considerations that businesses should bear in mind when facing supply chain disputes.

Right to terminate

In assessing your legal rights and obligations, and considering how best to approach supply chain disruption, start with the contract. This may sound obvious, but we see many disputes where the trading arrangements that develop between the parties do not reflect the contractual position.

Considering the contract will help you to establish your position, understand whether obligations have been breached and identify what options are available to you. Delivery obligations may allow some flexibility, while force majeure clauses might suspend obligations entirely. Supply contracts often specify liability caps or include insurance requirements that could compensate potential losses.

Understanding the rights and obligations in the contract also allows you to consider whether the contract has been breached in a fundamental way, and consequently whether you, or the other party, may be entitled to terminate the contract.

When considering whether to exercise the right to terminate, be particularly careful to consider:

  • whether time is of the essence in the contract, in which case a delay could potentially be considered to be grounds to terminate the contract. Otherwise, late delivery may only give rise to a claim for damages. If you get it wrong and purport to terminate where you do not have the right to do so, this itself will be a breach of contract, leaving you open to a damages claim from the other party; and
  • the need to make a decision on termination relatively quickly. If the innocent party does not do so, it risks affirming the breach and losing the right to terminate. As businesses seek to preserve their working relationships and compromise with upstream and downstream parties to resolve delays, it is important to understand whether any actions may inadvertently legitimise the breach or vary the contract.

Consequential losses

Disruptions to one contract in the supply chain can often lead to disruption throughout the chain, as delays have knock-on impacts that can prevent other parties fulfilling their obligations. For complex supply chains, this can be even more pronounced. In the automotive industry, for example, where vehicle manufacturers rely on components from hundreds of suppliers, delays to a single component can hold up or shut down production entirely, such as with the shortage of semiconductor chips. While production is reduced, demand for upstream goods dries up, and downstream businesses do not receive their goods.

In such scenarios, you may need to consider whether you could be liable for the consequential losses of downstream suppliers flowing from a breach of contract. As with termination rights, the contract will often help to set the parties' positions in a dispute, by limiting liability to a cap or excluding certain types of damage. Beyond this, English law takes a fairly strict view on the recoverability of "indirect losses" (meaning losses that are not foreseeable as a natural consequence of the breach). A party will only be able to recover indirect losses if the other party was aware of the special circumstances that would give rise to those indirect losses when they entered into the contract.

The party suffering loss will also be expected to take reasonable steps to mitigate that loss. This is particularly relevant where supply chain issues are likely to impact on other suppliers in the chain. Clear communication with suppliers and customers at an early stage will allow parties to adapt to the situation as it develops. This in turn will help preserve the business relationships, as well as putting you in a stronger position should a dispute develop.

Supply chain disruption will continue

While initially expected to have a temporary impact on their industries, leading representatives of the food and drink and haulage industries warned the House of Commons Business, Energy and Industrial Strategy Committee in October 2021 that the current supply chain disruption is expected to continue into 2023 or 2024.

However, while a large part of the current disruption could be blamed on COVID-19, there are myriad other potential and actual causes of disruption that will continue to impact the supply chain in the future, long after the impacts of COVID-19 have faded. Ongoing issues with shortages of workers, transport delays and the availability and cost of materials, not all of which are due to COVID-19, will continue to have a compounding effect on each stage in the chain. Political decisions and trade policies can also have a demonstrable, often unintended, impact on supply chains – trade policy by the US and other countries is a major cause of the lack of availability of semiconductor chips. This in turn has major knock-on impacts on a range of industries, such as UK vehicle manufacturing.

While new contracts can adapt to some known disruption, it is important to regularly review your contracts to ensure that you are suitably protected in the event that disputes arise. It is also worth considering whether it is possible to build flexibility and redundancy into supply chains, so that when disruption does arise, you have a greater range of options to help mitigate the disruption and avoid breaching obligations.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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