Virtual Symposium Part III: Stephen Wilks on Supply-Chain Contracts

Is Covid19 a Force Majeure Event Within Our Supply Chains?Stephen Wilks

Most of us who teach contracts or sales are familiar with the role force majeure clauses serve as risk allocation devices. The current pandemic has reinforced the importance of these provisions, given the widespread impact on carrying out enforceable obligations. COVID-19 has dramatically upended our lives, reconfiguring behavioral patterns and forcing us into various forms of isolation pending the development of a vaccine. Public health imperatives – such as lockdowns, wearing masks in public, and  “social distancing” requirements – have also reached into business operations across most sectors, with some industries closing entirely.  The resulting commercial impacts warrant revisiting contract law norms that operate where a mix of governmental and market forces frustrate performance.

COVID-19’s impact on contract performance has become most apparent in supply chains – the infrastructure that sources and transforms raw materials into intermediate or end products for sale in commercial or consumer markets. Now the subject of training and research across a wide variety of institutional settings, supply chains are complex, highly dynamic, and carefully coordinated to account for the range of potential disruptions that complicate domestic and international production, discussed here, here, and here—or so we thought.

In the wake of COVID-19’s arrival, some supply chain disruptions reflect changes in our consumptive patterns, such as declines in dine-in restaurant traffic due to state-imposed lockdowns. Inflexible food supply systems cannot easily redirect restaurant-bound goods to grocery stores. By contrast, other disruptions have originated from more intrusive expressions of state power. In May of 2020, for example, President Trump invoked provisions under the Defense Production Act, which forced The 3M Company (“3M”) to divert goods bound for its clients to the U.S.  This decision was especially controversial because it entailed using power to control a private actor’s supply chain in ways that transcend merely prioritizing government orders over all others and mandated interfering with contractual obligations owed to third parties. 3M was also forbidden from exporting masks made in its American factories. The contract breaches resulting from such events will undoubtedly trigger disputes as to whether barriers to performance should relieve parties of their contractual obligations.

Do these dramatic upheavals relieve parties of otherwise enforceable obligations? The short answer is, “it depends.” Contracting parties who turn their minds to this question during negotiations will determine what constitutes a force majeure event – commonly understood as an occurrence beyond a party’s reasonable control and which prevents performance of an obligation. Force majeure events must be beyond the affected party’s reasonable control; must prevent, impede or otherwise hinder the affected party’s performance; and must have occurred despite the affected party’s reasonable efforts to mitigate or ovoid its occurrence. Covid19’s effects do not change the fundamental legal doctrines limiting excuse from otherwise enforceable contract terms. But they demonstrate how parties may be exposed to losses as a result of inadequate business planning or shortsighted drafting since force majeure language will therefore determine whether a non-performance constitutes a breach or triggers relief.

Force majeure clauses will often distinguish political events (such as civil unrest, armed insurrection, or the nationalization of assets) from non-political or natural events (such as extreme weather, earthquakes, wildfires or accidents). Depending on the parties’ wishes as expressed in any resulting agreement, these distinctions can trigger different options for claimants seeking relief – ranging from extended deadlines and changes in contract price to other deviations from original performance terms and relief from performance. Additionally, the sweeping language in “catch-all” provisions will typically address “Acts of God” or “government action” which might capture the kinds of scenarios claims left unaddressed elsewhere in the agreement.

In the supply chain context, government’s role in shaping COVID-19’s business impact will combine with affected parties’ mitigation efforts to figure prominently in the resolution of COVID-related contract disputes. This calculation will turn on a mix of context, market conditions and industry norms. For example, dairy distributors who normally provision now-shuttered restaurants or college dormitories may repudiate supply agreements with farmers who dump their milk instead of seeking entry into other distribution networks that service grocery stores. Absent some effort to mitigate or explain why mitigation is futile, force majeure arguments relying on governmental action alone may not suffice.

Domestic and global business communities must also anticipate globalized scrutiny of foreseeability as they pertain to fore majeure claims. Prior to the pandemic, for example, there were several western firms operating in Wuhan—the Chinese city widely thought to be the site of the first major Covid-19 outbreak and a major manufacturing hub. The city of 11 million boasts factories producing goods for General Motors, Nissan, Honda, IBM, HSBC, Siemens, Walmart, Ericsson, and other well-known companies. In an interesting parallel to labor patterns in segments of the U.S. economy, migrant workers travel into Wuhan from inland provinces like Hubei, Shaanxi, Anhui, Hunan, and elsewhere to work in factories, where they live in cramped dormitories for much of the year until returning home to celebrate the Lunar New Year.

According to media reports, the U.S. military’s National Center for Medical Intelligence (NCMI) issued an internal report warning that an unknown virus was sweeping through the Wuhan region. The report’s precise date of authorship is unclear, but its release came sometime between November of 2019 and January of 2020. The result of covert surveillance, the NCMI report described wholesale changes to life patterns and business activity in the Wuhan region.  The notion that western firms operating in Wuhan during this period were unaware of these wholesale “life quakes” occurring the city towards the end of 2019 warrants scrutiny, given the effects on local workforces toiling in their factories. How much did executive leadership at these firms know about the outbreak’s early phases in Wuhan? To the extent such knowledge can be discerned, what kinds of mitigation should management have undertaken, given the risks to international production?

The foregoing examples demonstrate two of the many ways force majeure disputes will test the duty to mitigate in domestic and international contexts. They also raise questions about how lawyers might draft force majeure clauses in the future. Will phrases like “government acts” form part of “catch all” language or will they be narrowly tailored in the wake of current events? As COVID-related performance issues continue rippling through domestic and international production, the cascading series of contract breaches will incentivize parties to re-evaluate the role of contract terms in allocating risk.