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INSIGHT: Coronavirus Contract Considerations Beyond ‘Act of God’ Issues

March 13, 2020, 8:00 AM

Researchers predict the novel coronavirus is just the latest viral outbreak and the world will likely experience additional and more widespread outbreaks in the future.

Each outbreak presents different challenges to the performance of existing contractual relationships, and coronavirus creates the opportunity to consider—or reconsider—some key strategies for mitigating the risks associated with these ever-increasing global outbreaks in pending contract negotiations.

Force majeure clauses, which free a contract’s parties from obligations in the event of an “act of God,” are top of mind in light of Covid-19. However, looking at issues of impossibility and impracticability is also relevant, as well as a host of other contract clauses that could have bearing on parties’ rights and obligations in the midst of the current outbreak.

The effect of viruses like Covid-19 on overall business continuity and performance should be a priority in assessing operational, reputational, and contract risks and their potential consequences and liabilities.

Not Just a ‘Force Majeure’ Issue

If performance of the contract is prevented, hindered or delayed due to events outside the reasonable control of a party, a force majeure provision in the agreement may be relevant to the assessment of a party’s right to suspend or, in the event of prolonged force majeure, terminate the agreement.

In common law jurisdictions, force majeure is not a doctrine applied by the courts absent a provision in the applicable agreement. Hence, to understand the proper scope of rights and remedies, particular focus should be placed on the contractual language of the force majeure provision and the applicable choice of law.

In the absence of an express contractual force majeure provision, there are other avenues of relief to consider that could potentially offer a narrower form of protection. The doctrine of impracticability could be asserted under U.S. common law, which may provide relief where superseding events occur, the non-occurrence of which was a basic assumption on which the contract was made and it would be unreasonable or commercially senseless to require performance in light of such events. See also, Uniform Commercial Code 2-615 (Excuse by Failure of Presupposed Conditions).

A much more difficult doctrine to establish, but one that be worth consideration in light of the government actions around the Covid-19 outbreak, is impossibility, which requires a party to establish that performance was rendered objectively impossible for any similarly situated party.

Finally, Article 79(1) of the UN Convention on Contracts for the International Sale of Goods contains similar protections afforded by force majeure provisions and may be applicable to international contracts if the UN Convention is not otherwise expressly excluded by the parties in the agreement.

Other Key Contractual Terms

Several other contractual terms that typically appear in commercial, supply chain, outsourcing, and other service agreements also may be worthwhile for the parties to assess or consider in pending negotiations while the Covid-19 outbreak continues.

Ordering Process

The ordering process specified in an agreement may provide a key to navigating obligations in the event of supply constraints. Common terms such as lead times, forecasted quantities, the ability to reject orders, such as due to either (i) capacity constraints (eg, because of unavailability of personnel due to illness or quarantine) or (ii) upstream supply issues (eg, due to interruptions in service or inability to obtain raw materials or component parts), may all come under increased scrutiny.

Timely Delivery, Notice, and Mitigation

Many agreements also provide remedies to buyers in the event of supply chain or other disruptions. For example, is the supplier required to notify the buyer in the event an anticipated shortage or delay, and does the buyer have any additional rights to require mitigation in such event as expedited shipment?

Is timely delivery of product or services (ie, a “time of the essence” clause) required? Is the supplier able to make partial shipments, or can the buyer reject incomplete or untimely shipments and seek legal remedies? What visibility does the buyer have to the bill of materials and vendors lists (eg, is the supplier required to provide up-to-date product allocation reports?) and what process can be put into place to ensure continuity of supply for components and materials, especially for sole source and long lead time components?

Does the agreement include any favored customer provisions that require the supplier to provide priority allocation in the event of capacity constraint over that of any other customer of supplier, or that at least ensures that the buyer receives a fair (or preferred) allocation based on its proportionate share of volume ordered or some other metric.

Wind-Down and Termination Assistance Services

If there is a risk the agreement may be terminated, the buyer should review the agreement to determine if it is entitled to termination assistance services or other wind-down protections that allow it to obtain assistance from the supplier in moving to an alternative provider or supplier.

Disaster Recovery and Business Continuity

Some agreements may—and likely should—require a supplier to implement and comply with business continuity and/or disaster recovery plans (BC/DR plans) that are acceptable to the buyer. The BC/DR plans should address how goods and services may be provided to the buyer in the case of a force majeure event. For example:

  • Are backup or alternate facilities are required for manufacturing, procurement, assembly, test, storage and warehousing activities.
  • Can workload be shifted from one facility to another?
  • Is the supplier required to provide alternate transportation methods; offsite storage of records and data, including design and manufacturing documentation; emergency component and raw materials acquisition; and/or replacement of tooling and equipment required for the manufacture of product?
  • Is there a risk of a release event being triggered under a software escrow agreement?
  • Do the BC/DR plans include specific recovery time objectives for when services must resume or it is considered a default or termination right under the agreement?

The agreement should clearly state the relationship between the obligations to implement BC/DR plans and the relief that may be provided under the force majeure provisions. Relief may not be provided in circumstances where the implementation of BC/DR plans can avoid the consequences of a force majeure event and the supplier failed to implement the BC/DR plan.

For parties that are in the midst of negotiating agreements that incorporate a BC/DR plan, there should be a review of the triggering events under the BC/DR plans and ensure that listed force majeure events are, in fact, covered under the BC/DR plans. If a viral outbreak, epidemic or pandemic is not listed, consider expanding the definition of the triggering events to include such events.

However, each situation should be carefully considered to evaluate whether a mere outbreak or epidemic, as opposed to pandemic, should be a triggering event, especially if alternative means of delivery are available for more limited outbreaks and epidemics.

Self-Help and Step-in Rights

Continuity of supply, whether goods, services or otherwise, is paramount to the success of any business operation. Intermediate remedies such as self-help and step-in rights should be factored into your negotiations to allow a party to continue business until the non-performing party can resume performance.

Parties should not rely upon the law to necessarily provide a self-help remedy and, instead, the contract should clearly define the basis for self-help and step-in, the permitted timeline, which party bears the costs and how the parties may resume performance or ultimately terminate the arrangement if performance cannot be resumed.

Self-help and step-in rights may afford both parties some relief during any waiting period that may be required before a termination right can be invoked due to a force majeure event and, therefore, the interplay between such rights and the force majeure provisions of the contract should be carefully considered.

Understanding the potential impact of Covid-19 on your rights and obligations under your commercial, supply, outsourcing and other services arrangements that exist today, as well as those in the course of being negotiated, is critical during this time of potential disruption.

Of course, the business realities will control whether—and if so, how—those rights are asserted, including (i) the benefits of any long-term business relationship, (ii) determining when operations might resume and (iii) whether an expansion or clarification of terms to include more explicit references to either Covid-19 or its anticipated impacts should be considered to mitigate the results and impact of the outbreak, and assessing reasonable alternatives to ensure business continuity.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Victoria Lee is a partner based in DLA Piper’s Silicon Valley office. She has been practicing in DLA Piper’s Technology and Sourcing group for more than 25 years.

Mark C. Lehberg is based in San Diego and a partner with DLA Piper. He focuses his practice in the area of business and legal counseling in connection with complex business and technology related transactions.

Vinny Sanchez is a DLA Piper partner splitting his time between Chicago and Los Angeles. He advises clients in complex technology, strategic sourcing/outsourcing and commercial transactions as well as with respect to governance, workouts and disputes relating to such transactions.

James M. Vickery is senior counsel with DLA Piper and based in Austin. He concentrates in technology licensing, strategic alliances, business contracts and intellectual property strategic planning and counseling.

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