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Coronavirus Causing Disruptions Along Global Supply Chains

March 12, 2020

Since first making headlines in late 2019, the coronavirus (causing COVID-19) has expanded beyond its origin in Wuhan, China to over 167,000 confirmed cases, over 6,000 fatalities in over 100 countries worldwide at the time of publication. The numbers seem to be changing by the hour and experts agree the true number of cases is likely much higher. In addition to the troubling individual and public health concerns, the rapid spread of COVID-19 across the world is leaving its mark on global commerce, extensively disrupting the manufacturing supply chain. In addition to the practical difficulties of operating a business, many manufacturers have expressed their concerns about breached contracts (and their options) in light of the circumstances.

China, “the world’s factory,” is a critical global trade market and its struggle to timely contain and eradicate the outbreak at its origin sent major ripples up and down international supply chains. The worldwide impacts of COVID-19 range from quarantined residences, shuttered factories, closed national borders, transportation delays, lost sales, postponed events/trade shows, cancelled flights, forgone deposits, delayed transactions/closings, workplace injuries, damaged perishable goods, volatile stock prices and dwindling inventories. Several factories worldwide are closed indefinitely. Those that are open are facing challenges with manpower, production and shipping. Many U.S. companies have already felt the initial brunt of the supply chain impact and have started dipping into their existing inventory, which will eventually be depleted absent replenishment from existing or new suppliers. Much of the “pain” is expected after the existing inventories have been drawn down.

China’s medical situation and commercial sectors seem to be stabilizing, exports from China have remained strained due to complications in the freight/transport sector in the rest of the world that is just now starting to experience rapid spreading of COVID-19. In the United States, stocks of many publicly traded companies have dipped drastically and some companies have started including anticipated or actual risks associated with COVID-19 into their SEC annual reports and adjusting financial reserves as prudent. Smaller companies, with leaner reserves and cash flow flexibility, are struggling to deliver products and weighing the decision to close facilities in the interest of workforce health.

Besides simply “weathering the storm,” many companies are evaluating their own contractual requirements, liabilities, protections and remedies. The outbreak has resulted in companies worldwide being unable to fulfill their contractual obligations, the impacts of which will vary among jurisdictions. To mitigate the legal consequences for Chinese companies, China’s Council for the Promotion of International Trade has issued thousands of “force majeure” certificates across dozens of industry sectors. A force majeure provision is a risk allocation mechanism in a contract that excuses or suspends a party’s performance of its obligations if specified events occur that are beyond such party’s control and render performance of its contractual obligations impracticable or impossible. Depending on the force majeure provision of a given contract, companies presenting such certificates (or other claims) to their counterparties will attempt to avoid contractual breaches and corresponding penalties for failure to fulfill their performance obligations due to circumstances outside of their control.

As a preventative measure, U.S. manufacturers should undertake a legal review of potentially affected contracts to assess contractual risks and opportunities arising from the COVID-19 outbreak and the anticipated effects on their businesses. The review should include an evaluation of the force majeure provision itself and alternative ways to satisfy or cure contractual obligations, including procedural requirements and the anticipated challenges/responses from a counterparty. In parallel, it would be prudent for companies to determine the availability and adequacy of insurance coverage (e.g., business interruption, workers compensation). In summary, companies should considering taking proactive steps to amend current contracts and to ensure new contacts adequately account for and protect themselves against the uncertainty of COVID-19 and other business disruptions from infectious disease/pandemics on this scale.

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