COVID-19 – affecting your supply chain
With approximately 80,000 cases of COVID-19 confirmed globally, concerns raised over its impact on economic growth and a number of multi-national companies having issued profit warnings due to COVID-19's impact on commerce, the novel COVID-19 outbreak has had far-reaching implications, not only on human health, but also in impacting on the global economy.
With quarantine restrictions in place as well as the closure of numerous ports and production facilities, manufacturing and shipment of goods are facing dire disruption and free movement of workers in and out of China has been heavily impacted. Some businesses are having to shut down operations temporarily while they await greater clarity on the status and containment of the epidemic.
Supply chains are taking a hit across the globe, with the automotive, industrial, electronic, luxury goods, commodities and food & beverage sectors being a handful of examples of those particularly affected. With China's status as the world's largest crude oil importer and one of the largest consumers of metals, liquefied natural gas (LNG), copper and other commodity prices have suffered since the start of the outbreak.
It has been widely reported that, among other things:
- The World Health Organization declared a global health emergency on 30 January 2020;
- China National Offshore Oil Corp., China's biggest buyer of LNG, has refused to take delivery of LNG cargoes, claiming that COVID-19 is constraining its ability to import fuel;
- Sinopec Corp., Asia's largest oil refiner, is cutting throughput in February 2020 by approximately 12% (the biggest cut in over a decade) as a result of the outbreak's effect on demand, and will likely reduce the amount of crude oil delivery from Saudi Arabia in March 2020;
- Major Chinese copper buyers have asked Chilean and Somalian suppliers to delay shipments, cancelled preliminary contracts and stopped placing new orders;
- Fiat Chrysler Automobiles NV has reported that it is temporarily halting production at a car factory in Serbia because of its difficulty in sourcing car parts from China;
- In recognition of associated transportation difficulties, Samsung has resorted to flying in electronic parts from China to its factories in Vietnam for its electronic devices;
- JCB, one of Britain's largest manufacturers, is reported to have curbed production at its factories and cut back staffing hours due to supply shortages triggered by the COVID-19 outbreak, with a number of Chinese suppliers having halted operations; and
- China's Council for Promotion of International Trade announced on 30 January 2020 that it will provide 'force majeure' certificates to local companies struggling to fulfil their international contractual obligations.
Businesses will continue to face challenges in seeking to handle their commercial arrangements sensitively and as effectively as possible as things develop, and in this bulletin we provide an overview of some of the issues which in house counsel in various sectors are likely to need to consider. Naturally the potential impact of COVID-19 across many industries will be varied, and so in this bulletin we have focused on some of the areas which market participants have raised with us.
Performance of contractual obligations
Force majeure – overview
Where parties are facing challenges in complying with their contractual obligations because of COVID-19, they may look to force majeure clauses in contracts which, in broad terms, seek to relieve parties from their contractual obligations under certain extreme circumstances. Derived from the literal French translation for 'superior force', force majeure clauses are found in many commercial English (and other) law contracts, but the term 'force majeure' does not have an exact recognised meaning under English law. It is commonly defined in contracts by reference to circumstances not within, or circumstances outside of, a party's reasonable control. A non-exhaustive list of examples of such circumstances is normally included in the drafting, and some of these examples include acts of God, war or government or regulatory intervention.
Depending on how the force majeure clause is drafted, a contracting party which successfully relies on its force majeure clause may either rely on the right to suspend its contractual obligations or terminate the contract, with potential exclusion from liabilities for associated delay or non-performance. A supplier facing difficulty with sourcing its materials during this period may well wish to rely on such a clause where it prevents it being able to perform its delivery (or other) obligations under a contract, but the customer, on the other hand, may seek to argue a narrow construction of the force majeure clause to prevent a supplier's full exclusion of duty / liability. As ever, it will come down to the drafting of the clause.
Force majeure – steps to be taken
Understandably, in this time of uncertainty, businesses are striving to maintain business continuity. As a first step, prevention is always better than cure, and so where business reviews indicate a likely interruption to supply then early conversations with related stakeholders (including suppliers, customers, financiers and others), to seek to mitigate risks, is prudent. Where supply contracts are concerned, companies may wish to:
- Consider any methods to mitigate the effects of the inability to perform contractual obligations (e.g. sourcing materials from another supplier or sourcing workers from elsewhere). The entitlement to benefit from a force majeure clause is typically subject to the affected party mitigating the impact of the supervening event;
- Review their contracts to assess whether they may be able to rely on the force majeure clause if required;
- Check for any notice requirements and time limitations in invoking force majeure;
- Review contracts to assess whether their clauses cater for any increase in prices of materials which may be driven upwards due to shortage, and if this is not the case, suppliers may wish to negotiate and agree on such terms with counterparties; and
- For listed companies, ensure regulatory compliance in respect of material disclosures to the market such as disclosure of profit warnings.
In summary, invoking force majeure clauses under a contract should be a port of last call where it has become impossible for parties to perform their obligations under a contract, as opposed to circumstances which lead to it being significantly more difficult, but not impossible, for parties to perform their obligations. Before seeking to rely on force majeure clauses, businesses, particularly those with supply chains, should first consider identifying key stakeholders, suppliers, customers and service providers and beginning a discussion with them on potential contingency plans and alternative arrangements as COVID-19 continues to spread.
In considering contractual obligations in the current climate, it is not just force majeure provisions that will be relevant, but of course others linked to non-performance under a commercial contract, such as the impact of 'time is of the essence' clauses, termination rights, indemnities and liquidated damages provisions (to name a few).
Employee and third party liabilities, and corporate governance
In addition to considering contractual obligations to customers and suppliers, COVID-19 may also expose businesses to certain other considerations and liabilities which they should be cautious of, for example:
(i) negligence claims by customers or third parties alleging that a business failed to exercise reasonable care in protecting them from being exposed to the virus;
(ii) claims by shareholder(s) against director(s) on the basis that director(s) have failed to mitigate the adverse impact of COVID-19 on the business, to the extent that such failure could be seen to be caused by a breach of their applicable statutory or fiduciary duties; and
(iii) workers' compensation claims by employees who have been impacted by the outbreak.
A claim for negligence would ultimately turn on the facts of each case and whether or not a duty of care arose in the first instance. There is an inherent risk that such duty of care may arise in certain businesses by the nature of their services (such as those involved in the hospitality and travel sectors) but it may still be difficult for claimants to establish a causal link for isolated incidents. Nevertheless, many businesses have sought to mitigate the risk of such claims arising, for example with airlines and hotels responding to the outbreak by allowing customer cancellation or flexible rebooking policies. All businesses should look to ensure that they have complied with, and can continue to comply with, their existing duties of care to third parties.
The laws of a number of jurisdictions impose on employers an obligation to ensure the health and safety of employees. For example in Malaysia, the Occupational Safety and Health Act 1994 imposes a statutory duty upon employers to ensure, so far as practicable, the safety, health and welfare at work of all employees. At common law, employers can be similarly required to take reasonable steps to ensure the health and safety of their employees. In the event of any health and safety threat, such as COVID-19, businesses, in their capacity as employers, need to take reasonable measures to ensure that they continue to satisfy their obligations to their employees.
Requiring employees to continue to travel to affected areas could extend beyond legal and regulatory implications, to impact on reputation as a responsible employer and business.
As a starting point, businesses should monitor development of the outbreak and implement health and safety policies in the workplace in accordance with any guidelines issued by the World Health Organisation or the relevant governmental health authorities in its jurisdiction. Certain policies which may be implemented include:
(i) adopting a flexible work arrangement policy for employees and considering the implications of the policy to existing wages and benefits entitlements in the interim;
(ii) restricting or deferring non-essential business travel and considering other alternatives (e.g. video / conference calls);
(iii) implementing, and making employees aware of, health and hygiene policies in the workplace, and keeping employees abreast of the latest developments;
(iv) imposing a quarantine period on high risk employees who have travelled to affected areas or come into contact with other high risk individuals;
(v) ensuring contact details for employees (including emergency contacts) are up to date; and
(vi) adopting specific measures to screen and monitor employees' health, including communicating the position as to absences from work in the event of certain symptoms arising and the need to report to human resources teams.
The economic impact of COVID-19 has been felt globally and many businesses will inevitably suffer a downturn in business activities as a result of COVID-19. Certain employers may be thinking of staff restructuring in the most severely impacted circumstances, but employers need to approach this with caution as this may expose them to unfair dismissal claims, and relocation of staff could have tax consequences for individual staff members that need careful consideration. Due thought should be given to the laws of the relevant jurisdiction and appropriate legal advice should be sought. In a number of jurisdictions, including the UK and Malaysia, the burden of proof in proving that an employee was fairly dismissed would lie with the employer.
Key executives and leadership may also be absent as a result of the outbreak which can be disruptive to day-to-day business operations. Alternative plans for leadership and decision making need to be established. Where there are critical business functions, businesses should develop contingency plans to cover those business functions in the event they are disrupted by the spread of COVID-19. This may include training and establishing more than one team/committee, potentially across multiple jurisdictions, that is capable of covering similar business functions.
Given the number of viral outbreaks in recent years, businesses should take a proactive approach in managing the risk that comes with it. Various types of insurance policies may respond with coverage for viral outbreaks. For example, business interruption insurance can be taken up to protect businesses against income losses sustained as a result of disruption to their operations, although care needs to be taken to ensure that the policy adequately covers the potential circumstances and losses. Businesses should review their current insurance polices to determine whether they adequately cover against losses for business disruption, third party liability and workers' compensation, where required.
The impact of the potentially worsening COVID-19 situation could be severe, but implementing business continuity plans can help mitigate the effects on operations and ensure that businesses remain viable.
Clearly this bulletin only touches on a limited number of the potential implications that COVID-19 may have for business and the areas that need careful consideration, and there is more to be said on these themes. Much will vary depending on the relevant industry, for example this bulletin has not sought to address pressures other industries such as retail may face (e.g. the need to consider lease commitments) and those businesses which outsource IT arrangements which may be impacted by counterparty business closures.
Please get in touch with your usual contacts in the Trowers & Hamlins Kuala Lumpur office if it would be helpful to discuss these themes or others in the context of specific circumstances that you are facing.