With the coronavirus outbreak spreading at rapid pace not only throughout China but worldwide, most sectors of business are likely to be impacted to some degree. As the constraints on movement of goods and services begin to highlight the potential gaps in the supply chain, and companies start to see the negative impact on their share price, our partners, leading commercial law firm Muckle LLP, consider whether Coronavirus constitutes a force majeure event.
On 31 December 2019, the World Health Organisation (WHO) learned of several cases of severe pneumonia in the Chinese city of Wuhan. Although the ultimate consequences are unknown at this time, risk always exists, and it is vital to understand how supply chains can anticipate and be prepared for managing those risks. In terms of the legal implications, there could be risk of contractual breach and substantial financial loss that businesses need to consider.
Impacts on the supply chain
Companies, businesses and organisations may see impacts across their supply chain including:
- Consumers: Although perhaps not yet seen in the UK or the wider global market, consumers in China may be more cautious in their purchasing habits due to fears about being in public and potential exposure to the virus. Many may turn to online sales, which in turn may challenge logistics networks.
- Materials and goods: there could be supply shortages of materials, finished goods coming from or routed through Chinese logistics hubs in impacted areas.
- Workforce: quite simply, there may not be the resource to build/make the materials and goods due to quarantine/self-isolation requirements. This will directly lead to a gap in the supply chain.
- Transport of goods and materials: Travel may be restricted to certain areas limiting business and product advancements in certain regions. Hubs and supply networks that may already exist may be limited in capacity and availability leading to unpredictability and meaning that businesses may need to source alternative routes and means of transport.
Force Majeure clauses
The main contractual mechanism that a business should consider if it anticipates that it will have problems fulfilling its contractual obligations as a result of the coronavirus outbreak is the force majeure clause. This provides protection in the event that a business is unable to perform its contractual obligations as a result of an event outside of its control. A supplier will need to consider whether it can rely on the clause if it is unable to supply products due to a problem with its supply chain. A customer will want to ensure that the force majeure cause is sufficiently narrow that a supplier cannot rely on it to avoid liability for problems in the supply chain. Whether or not a force majeure clause can be relied upon will depend on the exact wording of the clause.
It’s the wording that counts
The clause may expressly define which events are covered. Although unusual, this may be an exhaustive list, so that only those specific events will be a force majeure event. It is unlikely that coronavirus is expressly stated as such an event currently, but the force majeure clause may have reference to epidemics and pandemic. Again, the definition of epidemics and pandemics is open to interpretation unless expressly defined. Presently, a pandemic has not been declared which may make relying on a force majeure clause more difficult.
It may be that the clause has a wider interpretation, for example “causes outside the control of a party, including” followed by an illustrative list and other events can be included in the definition if they are seen to be outside the control of a party. Coronavirus would most likely be considered outside of the control of a party in the current circumstances.
Was it the only breach?
Even if coronavirus does qualify as a force majeure event, in order to rely on the clause, the event must cause the contractual breach, but also it must be the only cause of the contractual breach.
The 2019 case of Classic Maritime Inc v Limbungan Makmur SDN BHD considered the situation where Limbungan was contractually obliged to supply Classic Maritime with iron ore cargo, but was unable to do so. Limbungan claimed that this was due to the shutdown of the supplying mine due to a burst dam, but the court found that, in the circumstances, Limbungan would not have been able to provide the cargo anyway, and so the burst dam did not in reality cause their breach. It must be clear that, if the force majeure event had not happened, the contract would not have been breached.
The effect of a force majeure clause also depends on what remedies have been set out within the contract. A clause will normally suspend the affected party’s obligations for a specified period of time and will remove liability for any breach caused by the event during that period. After that period of time, there may also be a right for the innocent party to terminate the agreement if the force majeure event continues.
Mitigation of loss
Should your business start to feel the impact, it is vital that appropriate steps are taken to limit and therefore mitigate any loss that you are likely to incur. It may be that your business needs to consider getting goods or materials from another supplier, even if this more expensive. Purchasing an alternative product may mean that you maintain the sales and therefore limit the impact on your end profit. If in time, the coronavirus is classed as a force majeure (depending of the definition of each individual contract) then there are additional hurdles to navigate and the duty to mitigate loss is a vital consideration at every stage.
Actions to take now
The full implications of the virus on the supply chain may not become apparent for some businesses for some time yet. However, businesses should assess the situation now and review their supply chains and legal positions. In particular:
- ensure all inventory is within reach and outside an impacted area (although this may be difficult to anticipate currently);
- check with your insurance provider if your business has interruption cover and if the current circumstances are covered;
- supply chain mapping- establishing the journey that the goods or materials undertake before they arrive with you is vital. Your goods or materials may come from Europe, however the supplier may rely on Chinese suppliers. Knowledge of your complete supply chain will aid you in preparing for the variety of impacts your business may face; and
- work with legal teams to understand any financial implications of not being able to deliver goods to customers or other businesses.
Actions for the future
In the longer term, it is unfortunately clear that outbreaks such as SARS and coronavirus are going to happen, and businesses need to have clear plans in place to deal with the potential supply and legal consequences. This may include conducting a scenario planning exercise and developing action plans for future outbreaks. On the legal front, providing express provision for viruses like coronavirus within the force majeure clause. If businesses aren’t sure of the current implications of these clauses, a legal advisor should review the terms.
This would also be a good time to consider alternative sources for good and materials in the marketplace. It is better to be more prepared than your direct competition, which might even open new opportunities when the next disruption comes around, alongside a force majeure clause that works to your advantage.