Parties to affected supply contracts are considering their contractual relationships, where they sit in the international pecking order, and their options to cancel or delay shipments in order to shift costs to other parts of the supply chain.
For goods already shipped or to be shipped, the first step is to understand at what point risk for the goods passes between the parties. Generally this is well understood through the adoption of Incoterms into international purchases.
This will in turn influence the decision as to whether parties can rely upon various general contractual rights such as force majeure, frustration and restraint of princes, and who is best placed to do so.
The quick examples below demonstrate the importance of getting this right.
Goods purchased EXW or FCA – let the buyer beware
Where Ex Works (EXW) or Free Carrier (FCA) Incoterms are used, delivery of the goods occurs at a point nominated by the seller and does not include any shipping costs. The buyer is then on risk from this point.
If the buyer is needing to ship those goods to another country to use but is unable to do so because of COVID-19, the buyer is unlikely to be able to rely upon remedies such as force majeure or frustration as COVID-19 is not preventing the parties from fulfilling their obligations to each other.
Goods purchased DDP – sellers’ risk
On the other end of the risk spectrum, if Delivered Duty Paid (DDP) Incoterms are used the seller is responsible for delivery of the goods, including payment of shipping, insurance and duty, to the nominated place of delivery.
In this situation, the risk for not being able to deliver goods due to COVID-19 restrictions will sit with the seller. As this will directly impact the ability of the seller to perform their contractual obligations, force majeure or frustration can come into play. In this situation, the seller is more likely to seek to rely upon a force majeure clause or argue that the contract is terminated by frustration as they bear the risk of non-delivery.
In these circumstances a buyer should carefully consider whether they are better off pursuing a claim for breach of contract or accept that a force majeure event has occurred or the termination of the contract due to frustration. Each party’s rights and obligations can vary significantly depending upon the path chosen.
Goods purchased CPT, CIP, CFR or CIF – things are getting complicated
Whereas the above examples clearly have risk sitting with either the buyer or seller, where CPT, CIP, CFR or CIF Incoterms are used, risk passes and costs are transferred at different places.
For example, with CPT, the seller delivers the goods to the carrier at an agreed place and the seller must contract for and pay the costs of carriage necessary to bring the goods to the named place of destination. Importantly, the seller fulfils its obligations once it hands the goods over to the carrier and not when they reach the place of destination.
What happens then if the destination country imposes restrictions on a vessel arriving from the country of origin? The seller has passed on the risk from delivery onto the carrier vessel. As with DDP, there may be little or no contractual remedy available to the buyer as the seller has performed their obligations. Similarly, CIP essentially mirrors CPT, but with the addition of the seller having to obtain insurance on the goods against the buyer’s risk of loss or damage to the goods during carriage. This only has to be on minimum cover. Whether this covers COVID-19 will depend on the precise terms of the insurance policy obtained.
What you should do now
Whether you are a supplier or a receiver of goods, where you sit in the contractual pecking order will determine the impact COVID-19 has on your business in the next four weeks.
Due to the uncertainty of the long-term effects of COVID-19 on cross-border supply chains across different commodities, it is important to review your supply contracts to properly consider your position in mitigating commercial risks and losses.
Understanding any Incoterms incorporated into your contract is the first step in deciding how to deal with any supply contracts. As the examples of just some of the Incoterms above show, different Incoterms can have very different impacts upon your options where delivery is interrupted.
The issues are morphing almost daily and the information that we are receiving from our mainland China office gives us particular insight on the current state of play.