The effects of the coronavirus (COVID-19) on the world economy and global supply chains are rapidly unfolding, and are likely to have wide-ranging impacts to Australian companies. Companies without adequate supply chain diversification and short inventory may now be facing significant business disruption and loss.
Key manufacturing zones such as Wuhan and South Korea have been heavily affected by wide-spread quarantines, factory closures, and logistics disruptions. Many companies have been attracted to these manufacturing centres in an effort to reduce supply chain costs. At the same time, the adoption of a ‘just-in-time’ delivery and logistics methodology has led many companies to keep minimal inventory stock.
Short term impacts
In the short term, companies will need to take urgent steps to mitigate the effects on their business. This may include:
- finding alternative sources of supply;
- extending lead times for customer deliveries;
- suspending or limiting new customer orders; and
- renegotiating customer contracts.
Many companies will be looking to implement disaster recovery plans, however such plans may be of little use unless they contain geographically diverse sources of manufacture and logistics.
Long term impacts
In the long term, the COVID-19 outbreak will influence thinking around supply chain design and risk planning. It will likely encourage companies to seek greater geographical diversification in their supply chain, onshore critical functions, invest and use automation technology such as robotics to reduce the risks of epidemics to production and transport, and adopt more conservative approaches to ‘lean’ supply chains and ‘just-in-time’ inventory management.
Next steps for companies
A company’s approach to the relevant legal considerations will be different depending on whether it is reviewing its position in the context of being a customer or a supplier. In many instances, companies will be both (eg. a retailer) and will need to consider both perspectives.
A company considering its position from a customer perspective should:
- proactively contract manage its suppliers, including by engaging with them on their ability to meet delivery commitments, and their supply forecasts and disaster recovery plans. Customers should make assessments on whether supplier forecasts and disaster recovery plans are realistic and likely to overcome supply issues. For instance, do disaster recovery plans propose alternative facilities or suppliers in unaffected areas, and will the supplier contractually commit to their supply forecasts? In having such discussions, customers will need to be careful not to compromise their contractual position, such as by waiving rights or remedies, or making representations or concessions that could serve as grounds for estoppel;
- check for exclusivity commitments that could prevent it changing suppliers. If exclusivity obligations apply, does delay or non-performance release the customer from its exclusivity obligations? Where exclusivity prevents a customer from seeking alternative supply arrangements, termination may be an option (as considered below);
- assess whether its suppliers are likely to be relieved from performance on the basis of force majeure. A typical force majeure clause will relieve a party from any delay or non-performance that is directly caused by unforeseen events outside of that party’s control, and it is not uncommon for contracts to identify epidemics or pandemics as examples of a force majeure event. However, relief under such terms is often conditioned on the non-performing party having taken reasonable steps to mitigate or overcome the effects of the force majeure event (for example, by maintaining and implementing a disaster recovery plan). Although the effects of COVID-19 itself is a development outside of any contracting party’s control, whether or not the effects of COVID-19 provide relief to a non-performing party will depend on the wording of the force majeure clause, the connection between the non-performance and COVID-19's effects, and often, what steps the non-performing party takes to mitigate or avoid the non-performance. Customers should be actively requesting their suppliers to provide evidence of the steps they are taking to mitigate or avoid disruptions caused by COVID-19. For more on force majeure, please see our recent article;
- review supply contracts for supplier obligations to not discriminate and raise any concerns with relevant suppliers. Suppliers may be tempted to triage their supply to most favoured customers, or to satisfy contract obligations that carry greater liability for breach. Customers should also be wary of suppliers seeking to rely on termination rights (eg. for force majeure) to avoid liability for non-supply in such circumstances. Enforcement of ‘no discrimination’ provisions will often be difficult due to a lack transparency into supplier arrangements with its other customers, however audit or dispute resolution mechanisms may assist customers in such circumstances; and
- consider its termination rights, and in particular, whether any force majeure claim, or supplier breach or anticipated breach, will give rise to a right to terminate. As always, where customers consider exercising termination rights, it is critical to obtain legal advice and be confident that the relevant termination right has arisen to avoid potential exposure for wrongful termination. Customers should also consider whether terminating supply contracts is likely to help overcome supply problems – due diligence should be conducted to assess whether there are viable alternative suppliers that are not equally affected by COVID-19.
A company considering its position from a supplier perspective should:
- make an assessment of its ability to discharge existing contractual obligations, including delivery dates and lead times, service levels, and maintenance and replacement obligations;
- if there is a risk of breaching supply obligations, consider whether it has contractual rights to renegotiate, or seek relief from, such obligations. For instance, it may be open to a supplier to seek relief for force majeure (as considered above). Alternatively, a supplier may be able to require a change to the contract, including under any ‘change in law’ provision. In the latter case, it may be necessary to consider whether change in law terms apply to changes to foreign laws, or laws that apply to upstream suppliers but not the contracting party directly. Whether or not there is a contractual right to relief or renegotiation, suppliers should engage with their customers to discuss supply disruption and to seek to negotiate any required relief or relaxation of contractual commitments;
- in cases where the Australian Consumer Law applies, ensure compliance with statutory obligations to customers. For example, suppliers may need to allow customers to cancel orders where goods or services cannot be provided within a reasonable or promised timeframe;
- be careful to ensure that it does not engage in misleading or deceptive conduct in providing information to customers. It may be necessary for suppliers to take steps to amend terms or representations in its standard documentation and published materials, including in respect of delivery times and its ability to fulfil orders or satisfy maintenance or replacement obligations;
- consider its business interruption insurance policy, and whether it is likely to cover any losses that are suffered as a result of COVID-19 related disruptions. In many cases policies may not cover business interruption caused by effects of COVID-19. As Karl Sullivan, the head of risk and operations at the Insurance Council of Australia, recently stated, “the majority of business policies are likely to contain some exclusions relating to losses caused by infectious diseases or similar”. Nevertheless, policies and potential claims should be considered on a case-by-case basis; and
- carefully balance its obligations to perform under its existing contracts, with its duty of care to employees.
Most of these issues are operational in nature, however it is important that companies seek legal advice in navigating the legal and broader risk management issues at play as they take steps to respond to COVID-19.