What's the issue?
Supply chains continue to feel the impact of COVID-19 with many key manufacturing hubs being hit the hardest. Those companies heavily reliant on China for products, raw materials or component parts are experiencing unprecedented disruption. The issue is not limited to China and supply chains across the world are vulnerable, experiencing similar issues all at the same time. Supply chain risk management is being tested to the limit with businesses having to act quickly to mitigate risks.
Disruption is resulting in long lead times, delivery delays, increased logistics costs and the need for businesses to consider alternative sourcing arrangements. As cash flows inevitably tighten, non-payment of goods will also be an issue. A number of high profile retailers have frozen supplier payments where stock is exceeding demand.
Consumers are also affected. Empty supermarket shelves, shortages of essential goods and purchase restrictions are only some of the visible challenges presented to consumers by the pandemic.
What's the development?
China has now begun to re-open some of its factories, but the disruption persists globally as manufacturing levels are likely to recover gradually. Many retailers are already in a position that puts obligations in consumer contracts at risk of not being met.
While governments and international institutions are being urged to maintain the resilience of the supply of essential services, many services depend on fast and efficient supply chains and the COVID-19 outbreak is proving to be unprecedented in its scale and severity.
Each sector and each business will be facing different supply chain issues but key issues are likely to include:
Supply shortages and delays
Challenges include port and production plant closures, new export/import restrictions and depleting inventory levels. As a result, it is becoming increasingly important for businesses to create transparency, evaluate supply chain designs and assess realistic final-customer demand. Manufacturers should engage in constructive dialogue with suppliers in order to monitor lead teams and optimise production capacity. See here for detail on considering alternative suppliers.
With restricted travel and prolonged quarantine periods, businesses are facing significant labour shortages. This is leading to inefficiency in delivering customer services and disruption in other key business areas, for example, product safety, product monitoring/tracing and engineering – all of which are vital in ensuring safe and quality products are made available to consumers.
As with data protection and competition law, consumer protection laws continue to apply. A key risk for businesses is not being able to adequately meet consumer demand – we have all heard stories about bulk buying toilet roll and excessive prices for hand sanitiser. Businesses with a strong online presence are proving more resilient and online sales are moderating some of the damage. However, they also present an increased cancellation risk if delivery becomes subject to significant delays. See here for more on consumer issues.
What does this mean for you?
Supply chain risk management systems are being tested to identify issues and you should take early action to mitigate risk and plan resolution.
Review your existing contracts
The legal analysis of supplier contracts should be mapped against commercial drivers for the business, looking at which contracts are most commercially important. The exact position will vary depending on the contract and relevant governing law, but you may wish to consider the following:
- Payment terms - There are a number of payment options to consider. If there is a risk a supplier may not complete its contractual obligations, this can be reduced by retaining a percentage of fees until the obligation is carried out - check for the availability of any existing retention of payment and/or deferred payment terms. Is there a clause that places the supplier under an obligation to offer you as favourable a price as the supplier grants to any other customers - a 'most favoured customer' clause? Would your supplier be willing to give a discount for cash payment?
- Variation - Can you agree appropriate variations to existing contractual commitments in order to mitigate the risk of any breach of contract arguments? For example, agreeing to make smaller, less frequent orders and adding flexibility to contract terms can improve outcomes for both suppliers and customers. Be sure to follow the correct process under the contract for recording a formal variation.
- Serve force majeure notices - Consider whether COVID-19 is a 'force majeure' event for the purposes of your supplier contracts - the application of force majeure is context specific and you should always obtain specialist legal advice. See here for our more detail on force majeure and COVID-19.
- Frustration - If a contract becomes impossible to perform as a consequence of the COVID-19 outbreak, it may be possible for a party to claim that it has been frustrated. The applicability of the English contract law doctrine of frustration is complex, will depend on the particular circumstances and, as with force majeure, legal advice should always be sought. See here for our quick read on frustration and COVID-19.
- Consider termination - Termination of supplier contracts may only be available if the contract terms permit and it may be affected by other factors, such as the waiver of a breach. Termination, often seen as a last resort, despite the ongoing disruption and uncertainty, should also not be triggered without legal advice.
- Re-source supply (wholly or partially) - For risks that could stop or fundamentally slow production lines or increase operation costs, businesses should consider identifying alternative suppliers. Should you broaden your supplier choices or consider near-shore sourcing? The former supply chain design often lowers risk levels, but leads to higher administrative, quality monitoring and unit costs. The latter option generally results in increased capital costs, although transportation costs are likely to be significantly lower.
Appointing new suppliers on an urgent basis requires extra care - existing exclusivity arrangements, tracing all suppliers in the chain, and product quality and safety are only some of the risks which shouldn't be neglected when due diligence may be limited.
Also consider taking the following practical steps:
- Identify insurance coverage: you should generally consider your insurance position and liaise with your insurers at an early stage - your coverage will depend on the precise policy wording and any exclusions.
- Protect your people: create a crisis communications plan and take actions to minimise disruption to your workforce. Consider moving employees around your organisation to relieve overworked departments - ensure that any steps taken are compliant with employment law and the latest guidance and advice from public authorities.
- Contact customers: maintain an ongoing dialogue with your customers about any actual or likely delivery delays - keep the dialogue open and fair. Also consider updating your customer service procedures to comply with consumer rights.
- Monitor marketing messages: check your current and new advertising and marketing statements to ensure they are fair, compliant with applicable consumer law (and the UK advertising codes) and are also clear about stock availability and/or delivery times.
- Maintain records: facts will be important to establish or defend any claim so you should keep appropriate records of discussions with suppliers. It is also important to document any steps taken to mitigate the impact of COVID-19, your decision-making process and justifications in respect of any actions not taken.
- Supply chain risk management: review existing or implement new supply chain risk management systems based on lessons learnt, addressing contingency planning particularly around alternative supply arrangements.
- Seek legal advice: there is value in seeking advice at an early stage, particularly to avoid common pitfalls in commercial negotiations such as a waiver of rights, unlawful termination or inadvertent contract variation. Key supply terms such as warranties, indemnities, liquidated damages, force majeure and termination should all be carefully considered.
Impact on future global supply chains
It is clear that the pandemic will force corporate decision-makers to rethink future global supply chain designs. Going forward, there will be an increased need for a diversified supplier base in order to hedge against disruptions to a particular geographic region or producer, for example. This is while maintaining transparency and an understanding of where goods come from especially below tier-1 suppliers which is often complex. It is likely that traditional factors such as cost, delivery and quality will be considered in supply chain management alongside new metrics such as responsiveness and resilience, as well as changes in consumer behaviours when there are extreme pressures on supply and demand.
There is also likely to be an increasing number of businesses that set up a supply chain risk management function to assess risk and develop remediation planning strategies to deal with economic, environmental, health or political crises.