Rebuilding resilient supply chains through contract management

In moving to rebuild a resilient supply chain, businesses will need to consider a number of strategies as part of their business planning. No 'silver bullet' clause exists to fully protect any one party from the consequences of something as unexpected and with such far-reaching impact as Covid-19, and the best approaches will depend on the shape of the supply chain.

Organisations that learn from the current crisis and adjust contracts and processes as needed ahead of time will get a competitive advantage in the new world post Covid-19.

This is part of a series, find out more about creating a resilient supply chain regime.

Future of force majeure clauses

Force majeure clauses have been tested by the Covid-19 pandemic like never before. Parties seeking relief from contractual obligations have been required to scrutinise and rely on these clauses, with the exact wording critical to defining the basis, scope and conditions for relief.

The drafting of force majeure clauses will be impacted by the experience of dealing with the effect of Covid-19 on supply chains. Currently, we are seeing significant focus on force majeure or excusable delay clauses in new contracts. These clauses are being drafted with the specific situation today in mind, and often provide for specific consequences relevant as the contract is entered into together with the specific relief that the parties intend.

Given the inherent uncertainty, these clauses are typically linked to re-negotiation or termination rights if the situation pans out in a different way to that currently envisaged by the parties. The clauses deal specifically with Covid-19 rather than with future potential disruption more broadly.

In the medium term, as companies update their precedent documentation, we will start to see more material changes to force majeure clauses which consider both the lessons learned from the pandemic but also potential future disruption more broadly. Among the elements we expect businesses to review are:

• trigger events – force majeure clauses will include a catch-all for "anything outside the party's reasonable control" and specifically include references to issues such as disease, epidemic, pandemic, government intervention, labour shortages and supply chain failures;
• payment obligations – currently, the drafting of force majeure clauses does not usually deal specifically with the corresponding payment obligations. Setting out the specific relief will be particularly important, even more so if the contract is fixed price or there are fixed price overheads associated with delivery which are not relieved by the force majeure event;
• period of relief – typically, clauses referred to 30 days before a termination right accrued. While this is a reasonable period for many force majeure events, we have seen much longer periods of disruption in the context of Covid-19. Careful consideration will need to be given to the length of disruption and whether this should vary dependent on the event giving rise to force majeure;
• exit from force majeure clauses - whilst clauses provide specific steps to be taken to claim force majeure, they often have little detail on how the force majeure event is exercised. We are likely to start seeing more detail around this, more akin to clauses such as step-in clauses which have a detailed process for exiting the event and returning the contract to its steady state.

In the longer term, change will ultimately be driven by case law as and when it emerges. It will important to see how these cases develop in light of the other provisions in the contract, such as liability; and the relief that is granted.

Additional contract and business planning mechanisms

The evolution of force majeure clauses will be just part of the picture as businesses emerge from the pandemic and seek to rebuild resilient and robust supply chains. The issues remain varied, and the complexity of supply chains makes it challenging to impose a one-size fits all approach.

Mechanisms to consider include:

• governance – Covid-19 has shown us that businesses did not automatically reach for the contract to litigate and enforce terms on their suppliers immediately. It was generally recognised that the pandemic was not the 'fault' of either party. Good governance clauses - and, where relevant - audit rights - have given parties a strong and robust framework to discuss and resolve their issues. This has also helped to ensure that the relationship between the parties is there for the long term after the disruptive period;
• business continuity – many companies have found that business continuity plans and even their Brexit planning process has provided them with the solutions for how to combat some of the disruption caused by Covid-19. The interaction within contracts between the business continuity plan and force majeure clauses should be closely reviewed to ensure that the two work in tandem and do not contradict each other;
• financial distress – as we potentially move to a period of economic uncertainty post Covid-19, businesses should consider including relevant contractual terms which provide for early warning signs if a supply chain member is in potential financial difficulty. This can include practical steps such as the supplier providing regular management accounts or notifying the customer if there is a downgrade in its credit rating. Requiring a supplier to produce a financial distress continuity plan in these situations can help ensure that the customer has oversight of any supply chain issues, and can be proactive with any actions it might take in response;
• exclusivity – where a member of the supply chain is affected, it is important to consider where exclusive rights are provided and to ensure that these do not inhibit you from approaching an alternative supplier or considering other options in order to obtain continued supply of critical parts and avoid a production line stoppage;
• forecasting – as well as focusing on lines of defence, the contract should also provide for more proactive measures to support the supply chain and ensure that it can ramp up and down to meet changes in customer demand. Well-drafted and effective forecasting provisions can enable collaboration with the supply chain to ensure that supplies remain on track and with an appropriate buffer for short-term disruption;
• step-in and emergency manufacturing rights – as a backstop position for appropriate supply chain partners. These would allow for the use of the supplier's premises, equipment and IP as required in order to continue manufacturing where there is a supplier failure. These clauses can be a fast and effective way of mitigating the exposure for the benefit of both parties that is practical in nature.

Thinking the unthinkable

Of course, no one can be sure whether these changes to the force majeure clause and other elements of the contract will be effective against the next pandemic or similarly disruptive event. Although the contract drafting changes may help insulate a business in some instances, clearly there are wider lessons to be learned from this pandemic. Therefore, although the contract may be the first line of defence, supply chain planning and business continuity arrangements will surface as top priorities.

The challenge for businesses is to think the unthinkable. Imagine how your business would deal with a global fuel shortage, major cyber attack on global banks or prolonged global internet outage. If you are tempted to discount these as unrealistic, think of the wide-reaching impact of Covid-19.

For businesses building resilient supply chains, this is important context. A resilient supply chain needs to factor in both the predictable elements of change - such as changes to volumes - and the unpredictable elements. A truly resilient supply chain will continue to meet customer need and expectations, notwithstanding any potential disruption along the way.