COVID-19 Phase 2 and Force Majeure and Impracticability Implications for Manufacturers

Friday, July 17, 2020

COVID-19 continues to create unprecedented challenges for businesses throughout the world.  Manufacturers—particularly those in the automotive supply chain—are no exception.  Due to continuing governmental directives and social distancing guidelines, many manufacturers, along with their suppliers and customers, find themselves unable to meet some or all of their volume demands due to capacity or output constraints.    

As manufacturers continue to encounter operational obstacles and possible supply disruptions, they must grapple with at least two key questions:  First, to what extent will force majeure or impracticability defenses excuse (or not excuse) performance?  Second, how can manufacturers best avoid or minimize liability for future output or supply disruptions?

Force Majeure and Impracticability, Generally

Most manufacturing contracts, including automotive supply-chain contracts, incorporate a force majeure provision or similar clause, which temporarily excuses a party’s performance upon the occurrence of an event that is outside of its control.  While most force majeure provisions do not specifically mention “pandemic” among those events, most do mention governmental regulations or actions that render performance unlawful or impossible.  Additionally, to the extent that the contract itself does not solely control the issue of excused performance, Section 2-615 of the Uniform Commercial Code may excuse a seller’s performance on grounds of “commercial impracticability.” 

The commercial impracticability defense, however, will only excuse a seller’s performance if (among other things) (a) the parties’ contract, or their conduct under the contract, does not preclude the seller from invoking the defense under the circumstances (e.g., by expressly requiring continued performance), and (b) the non-occurrence of the event partially or completely preventing the seller’s performance was a basic assumption on which the contract was made, or the seller’s inability to perform is due to compliance with an applicable law or governmental requirement.  In that light, the impracticability analysis under UCC 2-615(a) is similar to the contractual force majeure analysis.

In either scenario, sellers impacted by shelter-at-home governmental mandates due to the COVID pandemic can argue that the mandates either constitute a “force majeure” event excusing performance or render performance impracticable.  While the strength of any force majeure/impracticability argument depends upon the circumstances and contract at issue, such arguments may have enhanced validity in today’s COVID environment.

The Future of Force Majeure and Impracticability as to COVID

Absent governmental mandates that preclude performance, the question of whether a force majeure or a UCC 2-615 qualifying event still exists must be analyzed in a different light.  Assuming (but not concluding in all cases) that COVID-related disruptions at least initially qualified as force majeure events or rendered performance impracticable at the inception of the pandemic, future disruptions may not be a basis for establishing force majeure or impracticability (at least outside of the governmental mandate context).  Simply put, as businesses continue to adapt to the “new normal,” might it be the case that COVID-related disruptions, like supply or labor shortages generally, are arguably now within the contemplation of the parties and no longer uncontrollable disruptions the non-occurrence of which was a basic assumption of the contract (particularly new contracts entered into after the COVID outbreak)?  For instance, while many manufacturers now face labor shortages due to absenteeism by fearful or sick workers, should manufacturers now assume these problems will persist?  Might they also have a duty to engage in contingency planning by hiring a temporary workforce to step in when needed?  The answers to these questions will necessarily be case- and context-specific.

Action Items to Minimize the Legal Risks Arising From COVID-Caused Supply-Chain Disruptions

How can manufacturers and sellers of goods protect themselves?  For starters, they can adhere to the following strategies:

(1) Review and Understand Your Existing Contracts and Terms:  The task of identifying and understanding the underlying contract is often more involved than many may assume.  It is critical to identify the events that excuse performance and to know the nature and extent of any accompanying notice and mitigation requirements.  

(2) Review and Update Standard Terms and Conditions.  Many companies, particularly automotive suppliers, rely heavily on standard terms and conditions to govern the substance of their agreements.  Many of these terms and conditions were drafted years ago.  Accordingly, while existing terms and conditions may generally or implicitly address COVID-related disruptions, they may not adequately address the events that have unfolded over the past several months.  To that end, manufacturers should ensure that at least their own standard terms of purchase and, if applicable, their terms of sale, properly deal with COVID-related disruptions and risks, and they should consider whether updated terms are warranted. 

(3)  Mitigation and Contingency Planning.  While many manufacturers understandably found themselves unprepared for COVID-related disruptions, manufacturers should expect to encounter additional bumps in the road, be they supply or material shortages, labor constraints, or perhaps reinstituted shelter-in-place requirements.  From a commercial standpoint, customers will increasingly expect their suppliers to have plans in place to minimize the impact of these events, and indeed, the law may be unforgiving to suppliers who fail to make the necessary arrangements to protect the continued flow of goods.  Simply put, force majeure and impracticability arguments will not be viable in all contexts, let alone indefinitely.

(4) Timely Communicate and Document Your Position.  Even where a manufacturer may otherwise have strong force majeure or impracticability arguments, a party can nonetheless find itself unprotected by failing to communicate and document its position properly.  Indeed, most force majeure provisions, as well as UCC 2-615, require sellers to provide prompt notice to their customers (often within a period stated in the contract) in the event of a likely or foreseeable disruption.  The purpose of such notice is to afford the parties, and particularly the customer, an opportunity to pursue contingency and loss-mitigation measures.  Sellers must ensure that they understand the nature and degree of disruption risks that require notice, particularly while COVID cases continue to spike and the risk of future operational disruptions remains real.  Parties likewise must ensure that their required notice is both timely and substantively sufficient, such that it contains at least the information required by the contract (e.g., the nature and cause of the potential disruption, the anticipated duration, and the nature of the impacted party’s efforts to mitigate the impact) or UCC 2-615 (e.g., in cases of partial deliveries and allocation among customers, the quota being made available to the customer).  Equally imperative is that each such communication be as clear and consistent with the seller’s other communications as possible.  Indeed, supply disruptions frequently become the subject of disputes and litigation, and parties must consider that each communication they send may become an exhibit to a subsequent court filing.

In summary, parties must remain prudent to ensure that they are continuing to safeguard their positions, both by understanding their existing contract terms, establishing mitigation and contingency plans if needed in the future, and timely and properly documenting their positions in the event of a potential supply disruption.  No single strategy will be sufficient alone, and it is imperative for manufacturers to pursue their legal and commercial strategies in tandem.

David J. DeVine
313.225.7088
devine@butzel.com

Cynthia J. Haffey
313.983.7434
haffey@butzel.com

Donald V. Orlandoni
313.225.5314
orlandoni@butzel.com

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