As the COVID-19 pandemic unfolds, many businesses are experiencing challenges managing their contractual obligations with customers and suppliers. With unprecedented disruption to supply chains, businesses are being forced to assess risk exposure at all levels of their supply chains and to consider whether their suppliers, their customers, or they themselves, can comply with their current and future contractual obligations. For many businesses in Australia, this follows the strain that has already been felt in the wake of the recent bushfires and floods.
In this alert, we look at the steps you should take to assess your risk exposure and your options if you cannot fulfil your contractual obligations.
Reviewing your contractual obligations and assessing your risk exposure
With respect to each supplier/customer contract, you will need to review your contractual rights and remedies so that you know what protections you have and consider whether you are able to fulfil your contractual obligations under that contract.
You may need to prioritise which contracts you review first by focusing on the contracts which are most critical to your business and which you are most at risk of breaching.
Some of the contractual terms you will need to consider are:
It is important to understand exactly what your commitment is under the contract, whether there is a fixed ongoing minimum commitment, or whether your commitment is determined on an order-by-order basis. You should also consider whether there are any performance metrics and what the consequences are if you do not satisfy the performance metrics or are unable to fulfil the commitment.
Identify whether there are fixed timeframes or whether the contract sets out processes for dealing with delays, cancellations or for requesting extensions.
Disruption to your supply chain could result in increased costs. Consider whether there are mechanisms for reviewing, adjusting or varying prices and conversely whether your suppliers or customers have any similar rights.
Many businesses are already experiencing delays in payments and are renegotiating credit terms as a result of the current economic environment. You will need to be familiar with the payment terms in each of your contracts and the consequences for not paying an invoice on time, for example a contract may allow for interest to be charged on any unpaid amounts, or for a party to have a termination right in the event of late payment. You should also note whether any security has been given under the contract and when a party can exercise their rights over that security.
It is important to understand what will constitute a breach, whether there are different types of breaches, the process for notifying a party that a breach has occurred and whether the party in breach of the contract will have an opportunity to rectify the breach. You should also be aware of what rights the non-breaching party has in the event that a breach occurs, for example, they may have a right to terminate the contract.
You should know your liability position under each contract as this will be important in assessing your risk exposure. A contract may contain provisions that limit a party’s liability by excluding certain types of loss (such as consequential or indirect losses) or by capping a party’s aggregate liability under the contract.
What should you do if you cannot fulfil your contractual obligations?
If you are unable to fulfil your current or future contractual obligations then you will need to consider whether you are able to negotiate a commercial solution or whether you are able to vary, suspend or terminate the relevant contract.
Some of the options that might be available to you are:
Mitigating your loss
You should continually assess your loss mitigation strategies and put additional measures in place as necessary. This is particularly relevant during the COVID-19 pandemic as businesses may find that they need to show evidence of how they were affected by COVID-19 and how they mitigated against the loss that they suffered as a result of COVID-19.
Negotiating a commercial solution
Depending on the relationship you have with your suppliers/customers, you may be able to raise the issues you are experiencing with them for the purpose of negotiating a commercial solution. This may offer a quick and practical way of dealing with short term or immediate issues, but may not be appropriate for ongoing, long term commitments. If the parties agree to vary or change any terms of the contract, then that variation should be documented in a deed of variation or amendment signed by all parties.
Suspending or postponing performance
Depending on the terms of the contract, you may be able to suspend or postpone your performance of your contractual obligations where your business has been impacted by an unforeseen event or circumstances beyond your control. For instance, if you are prevented from fulfilling your obligations under a contract as a result of the COVID-19 pandemic and the contract contains a force majeure clause, you will need to check whether “pandemic” constitutes a force majeure event and whether you are required to provide any notices or take any specific steps in order to seek relief under that clause. You may still be required to mitigate your loss during a force majeure event. A contract may specify that it can be terminated where a force majeure event continues beyond a specified period of time.
The grounds on which a contract can be terminated will vary from contract to contract, and parties to the same contract may have different rights when it comes to their ability to terminate the contract. In some situations it may be possible for you to terminate only part of a contract (for example, you may no longer be able to supply your full range of products, but can still continue to supply a reduced offering) or a purchase order under a broader head purchase agreement. The consequences for terminating a contract may also vary depending on how the contract was terminated, which could impact your risk exposure.
Dispute resolution process
Most contracts set out the process that the parties are to follow in the event of a dispute. It is important that you are aware of this process as you may be required to provide or receive certain notices or take certain steps within specified timeframes. Dispute resolution processes generally require parties to negotiate or mediate a dispute before commencing proceedings in court. This gives the parties an opportunity to agree on a mutually acceptable solution before resorting to arbitration or litigation.
After reviewing your customer/supplier contracts you may find that they do not contain certain rights or remedies that would be beneficial for your business. Before entering into any new contracts you should check that they contain appropriate rights and remedies and you should also make sure that any template contracts used by your business are updated accordingly.
If you have any questions about managing the contractual obligations of your business or about the impact that COVID-19 is having, please contact a member of our national Corporate & Advisory team.
Nell Cantrill | Associate | +61 2 8248 3476 | firstname.lastname@example.org