Distressed supply chains – how can suppliers protect their position?
Published on 7th Jul 2022
Clear drafting on liability and force majeure can assist suppliers under strain
There is currently no shortage of global events imposing pressures on businesses' supply chains. The war in Ukraine has significantly impacted the performance of some contractual obligations by, for example, creating supply shortages and catalysing rising energy prices. The Covid-19 pandemic continues to cause supply chain issues, including in relation to the movement of labour. Separately, businesses and consumers alike are increasingly climate-conscious, and are demanding greater sustainability of the goods and services they consume. When suppliers seek to adapt to these changing demands this can also place increased pressure on strained supply chains.
There are various steps that suppliers can take to protect their position in order to avoid contractual remedies kicking in, and seek to prevent contract termination. These actions include analysing the protections a force majeure clause might provide, considering the application of the doctrine of frustration, and including a clear liability regime within supply chain contracts focusing on liability caps, exclusions of liability, and drafting narrowly drawn indemnities and protective liquidated damages regimes.
As we explored previously in relation to both Brexit and the effects of the Covid-19 pandemic, in order to rely on a right to suspend or delay performance as a result of an event beyond your reasonable control, you will need an express force majeure clause in your contract (or wording to the same effect) giving you these rights. Force majeure is an entirely contractual construct and the concept will not be implied into a contract.
If the contract does contain such a clause, then the drafting of the clause must be carefully analysed, looking at the words the parties have used, rather than considering the parties' general intentions: has the supplier genuinely been prevented or delayed from performing its obligations by reason of the event? The fact that the event has made a contractual obligation commercially unacceptable, impracticable, uneconomic or even unprofitable for a supplier (for example, as a result of rising energy prices or increased raw material costs) is unlikely to be sufficient.
The doctrine of frustration means that a contract may be automatically discharged (or frustrated) if something occurs after the formation of the contract:
- which renders it physically or commercially impossible to fulfil the contract; or
- which transforms the obligation to perform into a radically different obligation from that agreed on entering into the contract.
But the doctrine operates within very narrow confines, partly due to the fact that the courts do not want to permit parties to use frustration as a way of escaping a bad bargain. Broadly speaking, it seems unlikely that a contract will be frustrated as a result of the current pressures on supply chains: impracticability is not normally a ground for frustration. And suppliers are likely to be required to consider how else or where else they could obtain similar or substitute products before they could consider frustration.
It is also worth noting that wrongfully claiming that a contract has been frustrated could itself constitute a repudiatory breach of contract. Arguing frustration can therefore be a risky option for suppliers.
Drafting unambiguous contracts
Parties should always aim to trade on clear and unambiguous terms, and this applies more so now than ever.
The recent case of Pharmapac (UK) Ltd v HBS Healthcare Ltd (2022) demonstrates how issues can arise to bite suppliers where contractual requirements related to delivery and timing are not sufficiently tied down. In this case, a contract for the supply of face masks was finalised in an email which stated: "1st 500K shipment will be available for inspection and collection on Monday 16th March. Followed by 9 further weekly shipments". The language identifies the delivery time, but does not state that that delivery schedule is essential, nor of the essence.
Neither does the email state that the delivery time-frames are estimates only. And the High Court found that time was of the essence in relation to delivery because the "point was not just to get the masks as soon as possible, but to be able to cancel the contract if they had not arrived in time". Consequently, when the supplier failed to deliver the shipments "by, or before, the end of each weekly period", the customer was entitled to terminate the contract.
Although it is likely that this case is specific to its facts, based on the volatility of the face masks market and the "scramble for supply", suppliers should be aware that ambiguous delivery times may be interpreted against them – and seek to ensure clarity with estimated delivery times where possible.
Caps and exclusions on liability
Another key consideration for suppliers is ensuring that the liability they accept under a supply contract is as tightly drawn as possible. Suppliers should look to manage their liability by excluding certain heads of loss where possible, avoiding giving indemnities or including drafting safeguards and a conduct of claims clause where an indemnity is given, and including an express financial cap on all liabilities that are accepted.
As the recent case of CIS General Insurance v IBM (2022) demonstrates, it is important to ensure that the supply contract is clear as to whether any liability caps that are agreed are cumulative, or mutually exclusive.
In this case, there were a number of liability caps within the liability clause. One capped the supplier's liability "for the Implementation Services" and a later one, in the same clause, capped liability "arising otherwise under and/or in connection with this Agreement" (our emphasis). The supplier argued that because the primary claim fell under the first cap, there was no scope for any other claim, on the basis that liability could not arise under one cap and also arise "otherwise" under another; that the two were mutually exclusive.
The Court of Appeal rejected this argument and held that the two caps were cumulative. The court stated that this was the only sensible interpretation given the introductory wording to the clause which referred to the supplier's "aggregate" liability; as well as later wording which stated that each provision would operate as separate and additional liability limitations to all other limitations of liability. Suppliers that seek to have an overall cap on their liability would therefore be well advised to make this clear in the drafting of their supply contracts.
Providing a remedy
And although suppliers may wish to exclude all liability for failure to perform, if possible, it is worth bearing in mind that customers should still be left with a meaningful remedy.
In Acerus Pharmaceuticals Corporation v Recipharm Ltd (2021), the liability clause excluded liability for "any loss of profit, business or contracts, revenues or anticipated savings". The court found that this wording was "plain" and "general" but stated that the clause must be considered in its context in the rest of the clause which, the court said, was all about third-party claims that have consequences for the parties as between each other. The court consequently held that to interpret this wording as excluding the current claim for loss of profits and costs caused by the supplier's alleged failure to perform contractual obligations would be a "remarkable outcome" in commercial terms, and that this could not be the meaning that was, objectively, the intention of the parties.
It seems, subjectively, that it may well have been the intention of the supplier, but this case is a good reminder that if, as a supplier, you exclude all likely forms of liability in your supply contracts, the court may take the view that this goes against business common sense and interpret the liability clause so as to provide a meaningful remedy for your customer.
Service credit regimes
Parties may also consider including a service credit regime in supply contracts, which apply if the supplier fails to meet the agreed performance levels set out in the agreement. These can provide some comfort to suppliers, if the service credit regime is an exclusive remedy, by ensuring certainty as to the remedy available in the event of particular failures by the supplier.
Suppliers should take note of any service credits that they are required to pay, and take this as an early warning that performance standards may be slipping. Investigation of the underlying causes of the failure and ensuring the customer is kept advised of the status of any remedial actions being undertaken will be vital and will help to ensure that the issues can be resolved. This should avoid the need for escalation, and the customer seeking to use additional or alternative contractual remedies which may be available to it.