Managing Supply Chain Legal Risks

Nick Lees


October 26, 2021

A laptop keyboard with a glass globe on it, surrounded by a circle of shipping boxes.

Recent threats to supply chains include internationally disruptive events that were either presumed highly unlikely or came entirely out of the blue, such as the Brexit vote and Donald Trump’s presidency, with their attendant tariffs, barriers and trade disputes; the Suez Canal blockage; as well as sudden flare ups in long-simmering conflicts; an increasingly unpredictable and dangerous climate; and devastating earthquakes and volcanic eruptions around the globe.

The biggest disruption of our time is COVID-19, which has transformed social, economic and cultural landscapes, creating massive problems for national and international supply chains. With a global vaccination program still developing and new variants blooming across the planet, the highly infectious virus is set to continue to cause delays and uncertainty along transport lines and at ports and other hubs. This means that administrative and commercial difficulties for businesses are likely to continue for some time.

Business Responses

There are several ways that businesses can mitigate unexpected interruptions to their distribution and logistics arrangements. They should produce and implement crisis plans to cover both their day-to-day operations and immediate “fire-fighting” responses. Then they must consider how best to deal with commercial counter-parties and (potentially) financial creditors, particularly where an event has caused contractual and/or financial breaches or default. In addition, they should address stabilizing the organization for the future, including building in resilience.

Commercially, this can involve considering the maintenance of liquidity; shoring up inventory (not operating a just-in-time supply chain), which may impact logistical arrangements and storage capability; reducing or removing over-reliance on any one source or country of origin for vital supplies; and considering on-shoring or near-shoring supply chain components where possible.

Finally, businesses should regularly review both their interruption insurance arrangements and legal protections in case of an event that is significant enough to disrupt or stop supply and distribution.  

The Costs of Inaction

Supply chains are driven by contracting—the process of buying, manufacturing, selling and transporting goods is all ultimately underpinned by legal contractual relationships. When supply chain activity is running smoothly and business is good, commercial parties can focus all their energies on day-to-day business operations. However, when problems arise and it becomes necessary to look at the legal levers available in a stressed supply chain situation, it pays dividends to have planned in advance so that parties can work with their legal advisors efficiently and effectively, knowing which contracts and legal mechanisms to examine, depending on the specific situation.

If nobody has thought through the legal arrangements underpinning trading relationships, there can be nasty surprises where a business finds itself exposed by not having suitable up to date documentation (or any documentation) to work with and apply in legal stress situations.

Ultimately, this can make the difference between having some legal levers to help achieve a good commercial outcome or not having a remedy at all. Being left with a naked commercial position not shored up by a legal position can weaken a company's ability to achieve a satisfactory outcome in a contentious situation.  

Legal and Practical Considerations

As part of a business' assessment of the impact of a major disruption on its commercial arrangements and financial viability, whether contracts or common law remedies allow the flexibility to renegotiate or the ability to terminate, commitments and the ability to avoid or mitigate disputes will be key.

Undertake a review of all key contracts to determine where contracts and commercial relationships might allow for flexibility and negotiation, and where pressure points or breaking points emerge. Where pressure points exist, businesses should seek specialist advice on the options available, whether related to termination or suspension of contracts; re-structuring or re-financing; or claiming pursuant to any trade credit or credit risk insurance policy.

As part of the contract review, ascertain the existence and terms of any force majeure provisions, which may excuse one or more parties from contractual performance. Any business wishing to invoke force majeure—or to ascertain the validity of any force majeure claim made against it—should ensure compliance with any notification, timescales or other requirements the contract specifies, and should keep records of all relevant factual and economic evidence as the crisis unfolds.

Where force majeure does not apply, businesses should take specialist advice on whether the common law doctrine of frustration may assist to effectively terminate a contract. Parties should check their various insurance contracts because, in some cases, invoking or receiving a force majeure or a frustration claim can impact insurance policies. Particularly, parties should ascertain any notification requirements.

Businesses should also establish the existence and implications of any other contractual provisions that may provide flexibility and/or commercial assistance. These might include (non-exhaustively) break clauses to terminate contracts or leases early, forfeiture clauses, insolvency provisions, price adjustment clauses, variation/no-oral modification clauses and material adverse change clauses.

Commercial disruption, uncertainty, financial hardship, and contractual default can all prompt disputes. Businesses should therefore review contractual arrangements to ensure that they understand the extent of their (and their key counter-parties’) obligations and liabilities. Key clauses in this context include any guarantees, indemnities or performance bonds, limitation/exclusion of liability clauses and any endeavors obligations.

Where possible and financially feasible, parties should consider alternative ways to perform affected contractual obligations and/or for mitigate any loss or damage. Again, they should keep clear records of all factual and financial evidence upon which they might rely in the event of any dispute. Where disputes arise, parties should check whether the relevant contract contains any mandatory dispute resolution provisions. An effective clause requires the parties to follow a pre-agreed route to resolution, which can prevent any potential secondary dispute about whether and how the primary issue should be resolved; minimize the scope for any tactical game-playing (thereby helping to preserve commercial relationships); and ensure that the time and costs of dealing with formal litigation are only incurred as a last resort.

Businesses should ensure that they keep open communication channels with staff, suppliers, customers and other key counter-parties. Dialogue can minimize disruption within a business and can often help avoid or effectively resolve disputes, saving both commercial relationships and cash.

Parties Turn to Litigation

Generally, commercial parties tend to be amenable to resolving differences consensually. However, where one side has made repeated concessions over a long period, they may become less inclined to continue a downward slope of giving away value and turn to law instead. Litigation is used mainly to seek monetary compensation for breaches of commitments between parties. Parties may also resort to litigation to to compel one side to perform an activity they may be resisting, or, conversely, to prevent them from carrying out a particular action that may harm another.

These are matters that require input from a court, which has legal powers of compulsion not available to those whose relationship has broken down to the point where negotiated co-operation is no longer a viable option.

Getting Expert Advice

Businesses can anticipate some adverse, if unlikely, events and better prepare contingencies to deal with them. An experienced commercial dispute resolution team can support businesses in successfully navigating uncertain times and seemingly devastating incidents, whether it be from a risk management perspective and/or to help with resolving of a dispute. 

Nick Lees is partner at leading law firm Walker Morris, where he specializes in commercial litigation. His experience includes disputes concerning trading relationships, transactions, employees, banking and finance, professional negligence, and fraud.