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How to read your customer and supplier contracts

David Reid, principal lawyer, and Mark Allen, senior associate, DWF
David Reid, principal lawyer, and Mark Allen, senior associate, DWF
09 April 2020 5 minute readShare
contract

The COVID-19 crisis is causing serious interruptions to a majority of businesses. Many firms from a wide range of industries are being faced with varying degrees of uncertainty over their commercial contracts and, specifically, whether they can continue to meet their supply/service obligations. In this article, David Reid and Mark Allen discuss two questions being asked often as a result of the current environment.

“I can foresee that I will not be able to meet all of my supply/service obligations. What can I do to protect against claims from my contracting parties?”

For any business facing such uncertainty, we recommend taking a three-step review of current contracts so that you have a clear understanding of your legal position, particularly whether you may be legally excused from performance.

Step 1: Review contracts, check for a ‘force majeure’ clause

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Firstly, businesses need to check their contracts for a “force majeure” clause. These are usually headed “force majeure” or “delays” and are sometimes placed within the general clauses at the rear of contracts.

Force majeure clauses often provide a legal and commercial lifeline in that they generally work to excuse performance in situations where it becomes impossible (or very difficult) to meet your obligations due to an external (and unforeseeable) event. 

 

Secondly, check the events which trigger the provision. Every contract is different and the force majeure clauses can differ in their approach; some are general and may include something like the following: “any circumstance outside of a party’s reasonable control that delays performance or prevents a party from performing”. Other clauses are specific and list the qualifying events like fire, flood, acts of God, threat or act of war, terrorism, riots, blockades and epidemics. A pandemic is an epidemic that has spread across multiple countries and the World Health Organisation formally declared COVID-19 as such on 11 March 2020.

If there is no direct reference to an epidemic in the force majeure clause, then it doesn’t mean the provision will not be triggered. The pandemic, coupled with the various state and Commonwealth governments’ responses, could well fit a general force majeure provision around “outside of a party’s reasonable control”. 

Thirdly, review whether your ability to meet your obligations has actually been prevented. It is not enough to show that a qualifying force majeure event has arisen; you must be able to show that it is preventing you from performing your obligations (in part or in whole).

Some factors to consider include:

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  • Price rises in your supply chain are not likely to be sufficient in themselves. If the goods you require are still available, but are now priced at a premium, you are unlikely to be able to claim that you cannot perform your obligations simply because those obligations are more costly to you.
  • Government closure of borders will be relevant. However, we note that governments around the world have gone to pains to reinforce that while the movement of people has been restricted, the movement of goods has not. If your supply chains are still functioning, then you are unlikely to be able to claim force majeure.
  • Delays in your supply chain caused by government shutdowns or border closures will be relevant. If goods are being delayed, either through manufacturing slow-downs, or by extended shipping time frames, it may be sufficient. However, you will need to assess alternative means of sourcing the required goods. If alternatives are still available, but, say, at a higher price, then you will unlikely be able to claim force majeure.
  • Restrictions on use of labour will be relevant. Where through a government-required shutdown your staff are not able to perform their normal work duties (say, they cannot attend a manufacturing plant), then this may be sufficient.

Whether force majeure is applicable will depend on the wording of a particular clause and the circumstances. If this is unclear in the contract, then you may wish to get in contact with a lawyer to know where you legally stand. 

If there is no force majeure clause in your contract, then the general law of “frustration” may apply and excuse your performance. At law, a party’s performance of an obligation will be excused (and the contract will be terminated going forward) where:

  • an event arises which was unforeseeable, and
  • the event makes it impossible to perform that obligation.

Given the severity of the effect of the law of frustration (termination of the contract), establishing that a contract is “frustrated” is generally more difficult to prove than relying on a force majeure clause.

Step 2: Consider the impact on your contracting parties

The pandemic is affecting all of Australia, and everyone will be feeling the impact on their daily lives in some way. In the interests of maintaining business relationships in times of hardship, you should consider what can be done to minimise losses to your suppliers or customers. Some force majeure clauses will legally require you to take steps to mitigate the loss to your contracting parties. 

In circumstances where you may not qualify for relief under a force majeure clause, you should look to minimise losses to your suppliers or customers so that any claim by them against you will be less. This could be through early notification of supply delays, allowing your customers to seek alternative supply. Your supplier or customer may also be open to an idea of suspending performance or other pragmatic ideas that help to alleviate the impact.

Step 3: Seek legal help if someone tries to hold you to your contract where you cannot perform

If a supplier or customer is insisting that you continue to perform when you can’t or when there is some significant impediment to you continuing to perform, then you may wish to seek legal advice prior to communicating with your supplier or customer. Anything you say may be later used against you, and there is a risk that you will unwittingly confirm your obligations or waive your rights to other remedies such as frustration with your words.

“I can foresee that my suppliers will not be able provide me with products. What can I do?”

Your first task should be to read and understand your contract. There may be provisions that can help.

Some provisions that may assist if they are in your contract include: 

  • Force majeure clauses and termination provisions (some of which may be tied). If a supplier claims force majeure, then some contracts will tie this to a termination right in the hands of the customer or supplier to either allow them to source supply from elsewhere or release the supplier from future obligations. There may also be termination rights which accrue on failure to meet supply time frames or that arise after delay notifications.
  • Preferential supply clauses which either require your supplier to prioritise you (or other customers) over others or require the supplier to pro-rata any limited supplies that are available among all customers.

As a note of caution (and perhaps reality, too), a contract is only as good as the financial backing of a party to that contract. That is, a contract can provide for any number of remedies, but if a party who is responsible for those remedies has no financial standing (i.e. they cannot pay), then you have no remedy.

If you are still unsure about your legal rights or obligations, it is better to get expert advice sooner rather than later so that you can make informed decisions across your operations. No one can be certain at this juncture how things might change down the line, but knowing what your options are under different circumstances will help you plan and survive.

How to read your customer and supplier contracts
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David Reid, principal lawyer, and Mark Allen, senior associate, DWF
David Reid, principal lawyer, and Mark Allen, senior associate, DWF

Maja Garaca Djurdjevic is the editor of My Business. 

Maja has a decade-long career in journalism across finance, business and politics. Now a well-versed reporter in the SME and accounting arena, prior to joining Momentum Media, Maja reported for several established news outlets in Southeast Europe, scrutinising key processes in post-conflict societies and enabling citizens to influence decision-making.

You can email Maja on [email protected] 

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