Posted In: Business Transactions & Corporate Counseling
By Elizabeth Schultz-Horbus on February 26, 2020
With the coronavirus running rampant through China’s industrial and manufacturing hubs, many cities within the country are on quarantine and have enforced mandatory plant closures. The threat of the virus has caused many U.S.-based companies to shift their normal supply chain activities from China to suppliers located in other parts of the world.
So what does this mean for your company?
Force majeure clauses are common contractual provisions excusing performance in the event of an act of God (e. g. flood, fire, tornado, lightning, drought, earthquake) or unanticipated man-made events (e.g. war, riot, sabotage, changes in government regulation, labor strikes/lockout) that were unforeseen or unforeseeable when the contract was written and that would make performance impossible or excessively expensive or burdensome. The concept is related to similar common law doctrines of excuse. Their counterpart in M&A and purchase/sale contracts are “material adverse change” clauses. Each allows parties to allocate risks in the case of an extraordinary event.
Under the terms of most such agreements, and under the common law of contracts, an event does not excuse performance unless it is impossible or impracticable for the party to perform. Events that make it merely unprofitable or inconvenient to perform are insufficient. This is supported by the common law of contracts. Section 261 of the Restatement 2d of Contracts provides:
Where, after a contract is made, a party’s performance is made impracticable without his fault by the occurrence of an event the non-occurrence of which was a basic assumption on which the contract was made, his duty to render that performance is discharged, unless the language or the circumstances indicate the contrary.
Comment d to this section states that “[a] severe shortage of raw materials or of supplies due to war, embargo, local crop failure, unforeseen shutdown of major sources of supply, or the like, which either causes a marked increase in cost or prevents performance altogether may bring the case within the rule stated in this Section.” On the other hand, Comment d further provides that “mere change in the degree of difficulty or expense due to such causes as increased wages, prices of raw materials, or costs of construction, unless well beyond the normal range, does not amount to impracticability since it is this sort of risk that a fixed-price contract is intended to cover.” Section 225 of 18 O. Jur. 3d. Contracts explains that a court will not excuse a party’s performance under a contract merely because the contract has become hard and unprofitable, as these risks are assumed when the contract is made.
Whereas illness has not typically been deemed a force majeure event in the past, the overwhelming impact, mass plant shutdowns, and large-scale quarantines strengthen the argument that performance impacted by the coronavirus may, in fact, render a party’s performance impossible or impractical.
If your company has been impacted by the virus, here are some steps to take to determine your rights in dealing with supply chain disruptions:
- Read through your contract to determine whether it includes force majeure provisions.
- If it includes force majeure provisions, consult an attorney to determine whether the language was drafted in a manner sufficient to include the coronavirus as a triggering event.
- Determine what steps are required under the force majeure clause to invoke its protection. Some clauses have a time period in which the event must continue before the part is afforded remedies. Others require notice be provided to the party impacted by the event, or in the alternative, notice to the party invoking the force majeure remedy.
- Ask the supplier whether it has facilities located in areas outside of China that could source products in the interim.
- Investigate whether an alternative supplier exists to provide back-up coverage until the event resolves.
- Decide whether to invoke your right to terminate the agreement if in fact that right is provided within the force majeure language.
Regardless of whether your company is the purchaser or the supplier impacted by the recent coronavirus outbreak, it is a good idea to review your supply contracts and consult your attorney for guidance in allocating risk and minimizing the impact on your bottom line. The attorneys at Brouse McDowell are skilled in this area and are happy to assist you in managing disruptions in your supply chain.
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