UNDERSTANDING FORCE MAJEURE CLAUSES IN LIGHT OF THE COVID-19 CRISIS
Corona virus (COVID-19) is the major topic for most new stations today. In addition to having a tragic effect on the health of the world’s population, the virus, and the safety measures implemented in response to the virus, are having a negative effect on international businesses. Globally manufacturers and suppliers are scrambling to identify contractual relief as COVID-19 causes supply chains to crumble. The reason behind this disruption ranges from worker shortages and closures of manufacturing plants, to transportation bans and mandatory quarantines.
CONSEQUENCES OF COVID-19 ON YOUR COMPANY
How COVID-19 will affect your company may differ from how it affects the next company. Understanding your obligations and the related provisions within your contracts is essential when it comes to navigating supply chain disruptions and mitigating related losses. This is where the often-overlooked force majeure clause become important. These clauses identify those circumstances or events beyond the parties’ control, the occurrence of which makes performance under the contract impossible or impracticable. Typically, force majeure clauses either operate to excuse performance or extend the time to perform under a contract when an unforeseeable event, or one that is outside the contractor’s control causes project delays.
While majeure event provisions are not standardized in the United States, such provisions often use the phrases “acts of God” or “acts of Governmental Entities”, in addition to listing other possible delaying events such as war, riots, famine, strikes. It is not often that these provisions explicitly refer to epidemics and/or quarantine.
DETERMINE IF A COVID-19 FORCE MAJEURE EVENT HAS OCCURRED
To determine if a force majeure event has occurred, one must analysis the event using the terms of the contract. To start, you must first determine what events constitute a force majeure event under the contract. These events will either be generally or specifically identified in the contract, as shown above.
Should you determine that a qualifying event has occurred, you must then determine whether the provision completely relieves a party (you or the other side) of their obligation to perform or does the provision merely delay or suspend performance until the force majeure event has been resolved or is concluded. It is important to note that most force majeure clauses do not address adjustments in contract price should a force majeure event occur, instead they focus only on extensions of time to perform.
MITIGATION OF RISKS RELATED TO COVID-19
The next step requires you to determine if you are the only one required to take steps to mitigate the risk of any potential losses as a result of the force majeure event or if the other party under the contract is required to take steps to mitigate the potential losses as well.
NOTIFICATION TO INVOLVED PARTIES
The last part of the analysis, related to notice, is often overlooked and can cause major issues when over-looked. It is extremely important to determine the type of notice required to be given under the contract and when such notice is required. Certain provisions even require that regular updates be given. Failure to give the require notice can cause the protections granted by the provision to terminate.
TIPS ON HOW TO HANDLE COVID-19 FORCE MAJEURE EVENTS
In the event that your company is impacted by COVID-19, the following tips will help you manage the situation.
1) Identify the issues and document them. Accurate information is essential for making proper management decisions. In addition, your ability to identify the facts on which you based your decisions may be crucial for subsequent legal proceedings. It is essential that you fully identify the issues and the underlying facts and then properly document such.
If your company is a manufacturer or service provider, make sure that you understand and document the reasons why you are unable to supply/perform. Is it due to government-ordered factory shutdowns, quarantines (voluntary or required), staff illness, or other reasons? It is important that you identify the exact nature of the problem and that you secure evidence of the problem (or the cause of it).
If your supplier cannot supply you, make sure that you require your supplier to provide you with specific details as to how they are affected and why they cannot supply you. Do not accept an unspecific force majeure declaration from a supplier and do not take a position on a force majeure declaration until you have all the relevant facts.
2) Review your contracts and governing law to see how risk is allocated. Not every contract, and not all states, provides for a force majeure defense based on unforeseeable events outside a parties control and fewer specifically refer to epidemics or forced quarantines. As stated above, force majeure provisions differ from contract to contract, and from state to state, so each contract must be analyzed separately. Often a careful legal analysis of your specific situation is required and will depend on the exact supply problem, the specific terms of your contract and the applicable law.
3) Keep everyone properly informed. Often a force majeure clause, or governing law, will require that you give prompt notice of a force majeure event; if you fail to do so, you will not be able to use it as defense. If there is a notice requirement, you may need to give notice before you have had the chance to complete the assessments identified in Steps 1 and 2 above. Whether you are drafting your force majeure notice or drafting a responding to a force majeure declaration from a supplier, it is important to avoid using any language that could prejudice you in the future should a dispute arise.
4) Try to overcome the supply problems. Many contracts, and several states, exclude a force majeure event if you can overcome the force majeure event. You must consider other potential sourcing options and/or transportation means which would allow you to satisfy your obligations under the contract. As stated above, most force majeure clauses do not address adjustments in contract price; if an event has not made performance under the agreement impossible, but instead, has made it more expensive, a force majeure defense may not be valid.
5) Be careful how you allocate existing supplies. If your reduced output allows you to supply only some of your customers, carefully check all your contracts and any applicable laws to see if they provide any guidance or impose any restrictions. Problems can arise if you choose to supply your priority customers and then give the rest force majeure declarations. If you receive a force majeure declaration, make sure to find out how your supplier allocated their remaining stock.
6) Manage disputes proactively. There is no doubt that the current COVID-19 outbreak will result in numerous lawsuits being filed related to the supply chain problems. Managing disputes proactively will increase the likelihood of such being resolving quickly and successfully. It is important to communicate with your customers and suppliers in a cooperative and reasonable manner; doing so will help to avoid escalating disputes and may resolves matter quicker.
In order to lessen the severity of events like this in the future, we recommend taking the following three steps:
1. Have a Plan B (and a Plan C and Plan D). Those company that currently rely upon a single supplier are especially vulnerable to supply chain disruptions caused by events such as COVID-19. Good supply chain practice recommends having several suppliers in different countries and geographies.
2. Update your force majeure clauses. You should update your template force majeure clause for future contracts or renegotiated your current contracts to make certain it covers common problems in the event of a global pandemic or similar disruptive phenomena.
3. Update your dispute resolution and choice of law clauses. These clauses determine how and where you can enforce your rights. Certain courts, especially international courts, may not be the best forum for resolving disputes and pursing claims for damages.
FOR ADDITIONAL INFORMATION REGARDING COVID-19
To keep informed, and avoid misinformation, business owners should visit the official Center for Disease Control (CDC) and World Health Organization websites at CDC Coronavirus Website and WHO Coronavirus Website.