If you planned to purchase Christmas presents on-line this year, then you might have been warned that you should have done so already, lest those presents do not make it under the tree in time. Supply chain disruptions are being faced currently, the causes of which are varied and complex. Many ships carrying goods are currently stuck due to port closures caused by COVID-19 outbreaks, resulting in port congestion at other ports. This port congestion problem has been compounded by a strained trucking industry (in the US particularly), acute labour shortages, ultra-high consumer demand, limited inventories, increased shipping and freight costs and even adverse weather conditions. The supply chain issues are not simply impacting imports from Asia, but also shipments within the United States.
Unexpected disruptions to supply chains are not uncommon but unfortunately, global disruptions in the supply chain are expected to continue well into next year. As a buyer or supplier, is there anything you could do to limit the potential adverse financial impact of an unexpected delay?
The plain answer to this question is yes – a long-term commercial relationship may better withstand a calamity for both contracting parties, if the risks and costs are plainly allocated and regulated in the contract.
One way to do this would be to include an indemnification or indemnity clause. An indemnification clause or indemnity clause is a provision in a contract that establishes when and to what extent one party will assume liability for the losses of another. These are typically losses associated with claims advanced by third parties and they may also include losses directly suffered by the party protected by the indemnity. In the delay scenario, a buyer himself may not suffer loss but a customer of his relying on those goods might and in turn, attempt to seek compensation from the buyer. A typical contract for sale of goods may include a clause excluding the supplier from liability from any third party claims. In this regard a buyer may well be advised therefore to consider including an express indemnity clause to protect him from such loss. The supplier, on the other hand, may want to include an express indemnity to cover costs and losses that the supplier incurs, for example, if the buyer becomes unable to take timely delivery of goods, particularly where goods are perishable or manufactured specifically for that particular buyer and cannot be sold easily elsewhere.
Liquidated Damages Clause
A liquidated damages clause is a common feature of a commercial contract and describes a certain type of breach, for example non-performance, delayed performance or inadequate performance. The sum payable by the party at fault, is fixed in advance and written into the contract. One key advantage of a liquidated damages clause is that the quantum of loss does not have to be proved.
However, it is important to note that these clauses may be deemed unenforceable by our Court if they seek solely to penalise the defaulting party rather than to compensate for legitimate losses. Therefore, the fixed sum has to be based on a reasonable estimate of the probable loss. If the sum is deemed to be unreasonable or excessive, then the liquidated damages clause will not be upheld as valid by the Court. Such a clause in a contract helps in reducing ambiguity as to what can be recovered if there is a breach specifically provided for, such as delay. However, these types of clauses should be drafted carefully as the assessment of a liquidated damages clause turns on the precise wording.
Force Majeure and Frustration
One key contract term, is a “force majeure” clause which provides that if a supervening event beyond the control of the parties occurs which may affect parties’ ability to perform a contract, in this instance, the timely supply of goods, the affected party will then be relieved, for the duration of the event from its performance obligations. This is provided that the failure to perform is caused by the supervening event.
In most cases though, force majeure clauses are interpreted strictly by the Courts. In this regard, it is good advice to review the wording and potential interpretation of this clause to ensure it protects as the party relying on it might have intended. Furthermore, if there is no force majeure clause and the contract is silent, it will not arise.
Where there is no force majeure clause or where it is insufficient, the doctrine of frustration may apply to end a contract. However, frustration only applies in very restricted circumstances where performance has become practically or legally impossible.
Mere financial hardship caused by an unforeseen or unexpected event will not suffice to exempt a party under a standard force majeure provision or under the principles of frustration. Further, if frustration applies, the contract is at an end. Many force majeure clauses also provide for a right to end the contractual relationship if this clause is applied. This, however, may not be in the parties’ interest.
Parties to a contract may also want to pay attention to the termination clauses in a contract. Often, this is the last called upon remedy, as terminating the contract ends the commercial relationship between the parties, which is an outcome neither party may actually desire. Despite this, it is advisable for long-term supply agreements to set out express termination provisions that give a right to terminate (and seek damages) for breach of contract. Unless specifically provided for, delayed delivery may not sufficient, however, as a contractual breach to enable the buyer to terminate the contract. Rather only material or persistent breaches entitle the aggrieved party to terminate a contract.
There may be other remedies to counter delay or non-performance caused by unexpected events, including insurance or a right to adjust prices in particular circumstances. Ultimately though, there may be no quick-fix solutions to the supply disruptions and gridlock being faced worldwide. However, if you are a supplier or buyer in a commercial relationship, understanding what contract terms can best protect you in such a circumstance is paramount to weathering such disruption.