Member Article

Introduction

The supply chain effects from the global spread of the novel coronavirus have been building for nearly two months, and are expected to reach a peak in the near future (if not necessarily then to recede).[1] The effects have centered on China to date, but the epidemic has spread to other centers of production and the duration of its threat to public health and of the governmental and social measures taken to address its spread remains unknown. Supply chain participants thus face the risk of widespread and compounding supply pinches, disputes and even breakdowns.

The event and its supply chain effects necessarily raise issues of force majeure, or contractual frustration and impracticability. While going under different names, the basic law governing these issues is fairly uniform worldwide. However, the determination of these disputes is usually highly fact-specific, depending on the characteristics of an intervening event—including its scope, severity, and duration—and of the relationship in question and the market. The law also provides for a range of remedies, including allocation of available production, suspension of obligations, and damages, from which parties may choose to fashion a resolution. The utility of these measures, too, will depend on the facts of the specific situation, even with the broader ambit of an event such as the present pathogenic outbreak. Finally, the characteristics of this particular event have certain implications for the force majeure issues that are arising as the event progresses, and to which supply chain participants should attend.

The Governing Law

The law governing interruptions of contract performance due to intervening events goes by different names in different systems. In the United States, it is governed primarily by the doctrine of impracticability set out in Section 2-615 of the Uniform Commercial Code. Fundamentally, the doctrine excuses performance made impracticable by an event whose non-occurrence was a basic assumption of the contract; requires sellers to allocate any available supply to its contract buyers in a reasonable fashion; and requires seasonable notice of the event, and any resulting delay or allocation, to contract buyers. Upon receipt of notice of such an event, the buyer may then accept the delay or allocation, or if the event substantially impairs the value of the whole contract, may terminate the contract. Increased costs of performance that are due to unforeseeable contingencies normally qualify as events excusing performance.

These same basic principles prevail under the English doctrine of frustration, albeit subject to greater judicial scrutiny as to the parties’ intent and the circumstances, in the absence of a contractual clause. The same principles also underlie the French doctrine of force majeure, and the German doctrine of fundamental change in circumstances, or Wegfall der Geschäftsgrundlage, although the continental doctrines leave questions of allocation to be addressed under the rules on specific performance and restitution. Chinese law also provides for excuse or partial excuse of performance in the case of unforeseeable, unavoidable and irresistible intervening events, and for notification and allocation as a matter of mitigation. International commercial law, including the Convention on the International Sale of Goods and the UNIDROIT Principles, are in accord with regard to the requirements of an event of force majeure, although they also leave matters of allocation of supply to be addressed by the doctrines of specific performance and restitution. Finally, of course, most supply transaction agreements will include a force majeure clause that will govern such events; while these clauses vary widely, most will invoke these same basic principles of national and international commercial law on the subject.[2]

These national and international laws, and many force majeure clauses in use, also address an issue of particular importance with regard to the present epidemic event: The issue of chains of force majeure events, in which an immediate supplier’s inability to perform might arise from the unavailability of an input, which in turn arises from a force majeure event affecting an upstream supplier. Under the governing laws that specifically address this question, it is fairly well-settled that an immediate supplier may claim force majeure excusing its performance only if it can establish that the upstream supplier’s performance should also be excused as a result of force majeure. Thus, generally speaking, an ultimate buyer may be able to require an immediate supplier to bear the entire risk of such an event, unless a force majeure event has affected both the immediate supplier and its upstream supplier.

The Coronavirus Epidemic at Present and Force Majeure Law

The application of the foregoing provisions is usually highly fact-specific, depending on the scope and nature of an event; the severity of the event with regard to its effects on a party’s ability to perform; its duration or expected duration; and its relation to the assumptions and purposes of the contract. The coronavirus epidemic presents certain parameters that appear likely to pertain to many force majeure cases and assessments, and that have implications for the likely course of negotiations and disputes.

First, as to suppliers (and buyers) in China, the epidemic appears highly likely to qualify as an event of force majeure in the bulk of cases. Chinese courts established a record of determining claims of force majeure on an appropriately case-by-case basis in the wake of the SARS epidemic in 2002-03. But that event was more geographically limited even within China, and the governmental and social measures taken to address that epidemic were much less invasive than the measures taken in response to the coronavirus. In this instance, most of the effects on Chinese supply chain participants have resulted at least in significant part from state edicts requiring complete or partial shutdowns of production. The Shanghai Superior Court, the highest court in Shanghai, has recently issued informal guidance providing that, if a contract cannot be performed due to government action taken to prevent or control the spread of the COVID-19 virus, then those circumstances may constitute a force majeure event. Chinese governmental authorities have certified thousands of events of force majeure upon request by Chinese suppliers. At the same time, at least at present, Chinese supply chain participants appear to be slowly regaining capacity, albeit with considerable difficulty. Assessments of supply chain issues arising out of the last two months’ events in China, and of positioning with regard to remedies available under force majeure clauses and law, thus should focus less on whether such an event has occurred than on the options available for allocations of supply and workarounds for delays in deliveries.

As the epidemic spreads further, however—with economically-significant outbreaks and countermeasures now having occurred elsewhere in east Asia and southern Europe—suppliers in different jurisdictions will face different conditions, presenting different scenarios for assertions of force majeure. Additionally, the risk of chains of force majeure events, involving both immediate and upstream suppliers, likely will grow. This same result will likely prevail if there is a resurgence of coronavirus cases, and responsive public health measures, in China. By their nature, issues and disputes arising out of differently-affected jurisdictions, and out of asserted chains of force majeure events, will require deeper attention to the specific circumstances faced by individual suppliers. Because such chains of supply chain interruptions will also likely be more persistent than “classic” force majeure events affecting a single supplier or a single geographic area, they will also be more likely to cycle through allocation and remediation efforts and result in severe delays and breakdowns of supply, and termination and substitution of some supply relationships. Each of these, in turn, will be more likely to develop into contested disputes. 

Accordingly, as supply chain effects are felt, and particularly with regard to apparent or asserted chains of force majeure supply disruptions, practitioners should conduct attentive assessments of the conditions affecting each involved supplier, as they pertain to the likely severity and duration of the effect on that supplier. These will include such considerations as the countermeasures taken by the supplier’s jurisdiction and the supply of available labor, and will indicate the likely merits of a notice of force majeure by the supplier as well as its prospects for a timely recovery. In each instance—of immediate suppliers and upstream suppliers—practitioners also should consider the range of remedies realistically available, including possible allocations of supply, and available substitute supply allowing for termination of suppliers who are failing to recover. These assessments can inform negotiations as well as contingency planning, and should be monitored and updated regularly and as information is received. In instances where a supplier appears unlikely to recover timely and to an extent that still serves the fundamental purpose of the contract, practitioners should then consider both the prospects for substitute supply and the dispute resolution options—including tailored, expedited procedures for escalated negotiations and binding arbitration, including arbitration on written submissions—available for use in the event of a necessary but contested termination.

For more information about any of the information in this alert, please contact Timothy McCarthy (214-698-7857 or [email protected]) or your Dykema relationship attorney.