Supply chain problems have been hitting the headlines in recent weeks with food chain Nando’s running out of chicken and McDonalds running out of milkshakes. This is not a new phenomenon though as global automotive production has been suffering from a lack of semi-conductor chips for a considerable time.
Supply chain disruption is being attributed to a number of factors: shortage of delivery drivers due to fewer drivers entering the UK post-Brexit, increased border controls and customs regulations causing longer wait times, the rise of the Covid “pingdemic” requiring drivers and production line staff to isolate and (in the case of the automotive sector), demand for semi-conductors outstripping supply, coupled with an increase in raw material prices.
For a manufacturer facing these challenges, it is important to remember what it has agreed to supply, and by when, by reviewing its customer contract. However, in times of adversity, is there any “wriggle room” regarding this manufacturing commitment? Earlier this year, in the much-publicised supply dispute involving the European Commission and Astra Zeneca, the European Court addressed this issue in deciding what was meant by “best reasonable endeavours” to supply Covid vaccines to the EU; and ultimately accepting Astra Zeneca’s arguments that its delivery commitments were somewhat flexible.
A manufacturer may want to see if any “force majeure” clause in its agreement may be of assistance. Such clauses allow a party to suspend or extinguish their obligations due to events out of their control, perhaps due to fire, flood, a natural disaster, war, a strike or, if specifically drafted, epidemic or pandemic.
A commercial approach to dealing with supply chain issues is encouraged and a manufacturer is often better-off being upfront with its customer as to likely supply issues. This may be through a contract “re-set”, or if this is not an option and there remains a tension between the parties, through the engagement of a third party (such as a mediator) to explore potential for a commercial solution.
A formal dispute process should be a last resort as it can irreparably damage business relationships not to mention be a costly exercise – financially and reputationally – whatever the outcome. The European Commission/Astra Zeneca dispute is an example of how a supply dispute can quickly escalate. Yet the decision of the European Court to order a staged vaccine delivery programme, with the “sting” of penalties if deadlines were missed, is helpful in showing how courts can adopt a commercial approach.
For suppliers able to meet their supply commitments but faced with customers who are experiencing cashflow problems, a supplier should be weary of favouring one customer over another. Whilst prioritising customers is ultimately a commercial decision, it will still be bound by manufacturing and delivery commitments in its other contracts.
From a customer’s perspective, business failure of a supplier can cause severe distress and risk them being left out of pocket for goods paid for upfront, or unable to meet orders for their own products.
Steps can be taken to try to avoid this scenario: customers should conduct due diligence on suppliers before exchanging contracts to determine their financial health; supply contracts can provide for ownership of goods to pass to customers upon manufacture rather than delivery, so that those goods can be ring-fenced if the supplier went into insolvency; or a customer may consider spreading risk across several suppliers, or take out insurance against supplier insolvency.
However, as the last year has illustrated, unforeseen events can turn any successful business into a struggling one without much warning.
If a supplier enters insolvency, some customers may want to cut ties and move on. Contracts typically entitle a customer to terminate upon the supplier’s insolvency. If a supplier enters administration, a statutory moratorium prevents customers from taking certain actions (including legal proceedings) against a distressed supplier without the administrator’s consent or court permission. A similar situation arises if a supplier seeks the benefit of a temporary moratorium as is now possible without entering administration. The moratorium should not prevent a customer from exercising its contractual rights, such as termination or retention of title rights (although it will fetter the customer’s ability physically to repossess the goods).
If the business continues trading whilst in administration, the buyer may want to fulfil any incomplete orders, and there may be scope for negotiation around future supplies. Where there are no other interested buyers or alternative suppliers, a customer may consider purchasing part of the supplier’s business itself to ensure continued supply.
If customers pay for goods in advance and the supplier enters insolvency, the goods are unlikely to be handed over unless title has already passed. The liquidator or administrator will only reimburse deposits if sufficient funds are available but in practice this rarely happens, as customers usually rank as unsecured creditors.
Undoubtedly these are challenging times. The combination of two seismic events such as a global pandemic following a major political upheaval will continue to send shockwaves through the manufacturing sector as businesses have to re-adjust and diversify into new ways of working.
This article was first published in UK Manufacturing, see here.
Tim Carter