Brexit, the Covid-19 pandemic, severe weather conditions, Suez canal congestion, political instabilities … unexpected disruptive events affecting supply chains around the world are manifold and if general scientific and geo-political forecasts are accurate, these events are likely to increase in frequency and severity.
Unexpected disruptions to supply chains are nothing new but, if they occur, suppliers and customers often discover that the terms of their supply contract do not protect their position in the way that they thought they would.
The Problem
The supply of goods between businesses are frequently based on loosely agreed supply terms, often simply incorporating a party’s standard terms of sale, or ill thought-out reliance on Incoterms or other industry-standard provisions, which are not necessarily suitable for particular supply arrangements, particularly those which are concluded long-term, if delays occur.
This article highlights some issues that the parties to a supply of goods contract would be well advised to consider in order to limit the potential financial impact caused by unforeseen delay.
Force Majeure and Frustration
If supply and delivery of goods becomes delayed or impossible to perform due to an unexpected event, there are only very limited remedies available to parties to a contract under English common law.
Firstly, the parties will therefore look whether the contract contains a “Force Majeure” provision on which they can rely to limit or entirely avoid their liability for the delay in or entire non-performance. Force Majeure clauses are provisions which, generally speaking, anticipate that some sort of supervening event (factual or legal) beyond the control of the parties occurs (e.g. blockage of the Suez Canal, restrictions imposed during a pandemic) which may affect the ability of a party to perform the contract (here e.g. the (timely) supply of goods). Provided, the failure to perform is caused by the supervening event, the affected party will then be relieved (for the duration of the event) from its performance obligations.
Whilst most terms of sale commonly contain Force Majeure clauses, these clauses are liability limitation clauses and as such are interpreted restrictively by the courts. They need to be carefully reviewed because whether they apply to exempt a party from its performance obligations will depend on the way that they are written. The application of and therefore the protection offered by Force Majeure clauses is often very limited. Unlike some jurisdictions, under English law the concept of Force Majeure is entirely contractual, meaning that if the contract is silent, Force Majeure relief will not arise.
The common law doctrine of frustration may apply to end a contract where a force majeure clause is insuffient or non-existent. However, frustration only applies in very restricted circumstances where performance has become practically or legally impossible. It offers limited relief and remedies to the parties.
The dilemma with both Force Majeure and frustration is obvious: Are vessels able to deviate around the Cape of Good Hope if the Suez Canal is blocked? Could a supply of goods have been maintained with appropriate protections (e.g. social distancing measures) for workers being implemented? The above measures may cause delay and additional costs to the parties, but performance (e.g. delivery/ supply of goods) might still be possible and hence the supplier might find that it is not released through force majeure or frustration from delivering the goods.
It seems generally established, that 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 principals of frustration – e.g. “Tandrin Aviation Holdings Ltd v Aero Toy Store LLC and another [2010] EWHC 40”; and “Davis Contractors Ltd v Fareham UDC [1956] AC 696).”
Also if frustration applies, the contract is at an end and many force majeure clauses also provide for a right to end the contractual relationship. This, however, may not be in the parties’ interest.
Allocation of risk and remedies for delay
The parties to a supply of goods contract are therefore well advised to consider to include provisions that allows them to clearly allocate and to control the risk of loss caused by a delay.
1. Contractual Indemnities: A buyer of goods, should include express contractual indemnities to cover its potential losses associated with delayed delivery or even non-delivery of goods. Whilst a buyer may not itself suffer loss, its customers might (e.g. construction works have to be halted due to unavailability of the delayed goods), and they will then seek compensation for their loss from the buyer. Under standard terms of sale for goods, the supplier’s liability for such “third party claims” suffered by the buyer will commonly be excluded and not be recoverable by the buyer from the supplier. This is unsatisfactory, as the supplier is at fault here (by delivering late) whilst the loss is suffered by the buyer (who has not done anything wrong). An express indemnity to cover the buyer against such loss is therefore advisable.
The supplier, on the other hand, may want to insert an express indemnity to cover it against costs and loss that the supplier incurs, if the buyer becomes unable to take timely delivery of goods, particularly, where goods are perishable or bespoke and cannot easily be sold elsewhere.
2. Liquidated damages: In the case of delayed delivery, the buyer may in theory have a claim for breach of contract against the supplier, but as in practice it is often very difficult and time consuming to establish the actual loss caused by the delay, the buyer will only rarely pursue such claim. A solution for the buyer could here be a provision for “liquidated damages”.
A liquidated damages clause describes a certain type of breach (e.g. delayed delivery) and provides that a fixed sum is to be paid upon a breach (e.g. a fixed rate for each day of the delay). The advantage of a liquidated damages clause is that the claimant does not have to prove that it has suffered loss when making the claim, nor will the claim depend on the interpretation of clauses capping liability and typically also excluding certain heads of liability such as lost profits, business or opportunity.
There is a catch, however: The fixed sum has to be based on a reasonable estimate of the probable loss. If not, and the sum is unreasonable or excessive, then the liquidated damages clause may not be valid. Also, as a liquidated damages clause describes a certain type of breach, it is therefore usually the only available remedy, even if the claimant suffers greater loss. In order to be effective, a clause for liquidated damages must be carefully drafted.
Liquidated damages clauses are usually not suitable for major breaches but are an adequate way to deal with minor breaches (such as delay in delivery) in supply contracts. As the level of compensation is an agreed remedy, such clauses usually enable the parties to preserve the commercial relationship even if there has been a poor performance by one party.
3. Termination: Termination of the supply agreement is often the remedy of last resort, the nuclear option, as it ends the commercial relationship. Standard terms of sale are usually drafted for one-off sales and hence do not set out adequate termination provisions. Long-term supply agreements therefore should set out express termination provisions that give a right to terminate for breach of contract or insolvency of a party.
The question often arises, as to whether a delayed delivery will be sufficient as a contractual breach to enable the buyer to terminate the contract. Commonly, only “material” or “persistent” breaches entitle the aggrieved party to terminate a contract.
If the timing is important and a buyer wants to be entitled to terminate the contract if faced with a delay, then time of delivery should be expressly stated to be “of the essence” of the agreement. There is some authority to suggest that in the case of perishable goods, time of delivery is of the essence by implication. However, this is not settled law and should not be relied on by the buyer. If time of delivery is expressed to be “of the essence” and delay occurs, then late delivery should entitle the buyer to terminate the agreement and pursue a claim for damages (including loss of contract) against the supplier
The supplier will usually try to resist such a provision in the contract and more sophisticated supply agreements therefore often expressly state that time of delivery shall not be of the essence.
If the contract is silent on this issue, and delay occurs, then the buyer should still be able to make time of the essence of the contract by notifying the supplier (in writing) that it must deliver the goods within a reasonable deadline failing which the buyer will be entitled to terminate the agreement. By giving such notice, the buyer can make time of delivery of the essence of the contract and can subsequently invoke the stated remedies (e.g. termination of the contract and claim for damages). This can be a useful tool to put pressure on the supplier. It is, however, also a very harsh remedy which is likely to bring the commercial relationship to an end.
4. Minimum purchase obligations – remedies and forecasting: Long-term supply contracts usually determine minimum supply / purchase quantities. Specific remedies to deal with shortfalls on either side should be incorporated: The supplier will usually insert a right to claim the purchase price for any shortfall in the quantities purchased by the buyer. Alternatively, the supplier may agree that any shortfall will be taken into account in the price adjustment for the subsequent contract year. On the other hand, where the supplier fails to deliver the minimum quantities, then the buyer will often have to purchase similar goods from third parties at much higher prices. In such event, the buyer will insist to include an express right to claim the additional costs from the supplier and also that quantities purchased from third parties shall count against the buyer’s annual purchase obligations under the supply agreement.
Often overlooked in this context is the importance of adequate forecasting provisions. Even if these are expressed not to be binding, regular and frequent forecasts provide an early warning system, if the supplier’s and/or the buyer’s ability to supply and/or receive the goods is impaired by an unexpected event. This often enables the parties to enter into a dialogue to resolve the problems or to adjust the contract by agreement.
Other remedies to deal with delay or non-performance caused by unexpected events, can include insurance, a right to adjust the prices for the goods (credits for good performance, OTIF (on-time in-full), and price reductions for delay) and to obtain performance guarantees from other group companies. A long-term commercial relationship is more likely to survive a crisis if the risks and costs are clearly allocated and regulated in the contract.
