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ASCM Insights

Force Majeure: Has Your Company Reached the Breaking Point?

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Editor’s note: David Steven Jacoby is CEO of Boston Strategies International, a supply chain and operations management consultancy. He is an expert in force majeure, a clause in contracts that essentially frees both parties from liability or obligation in the event of an extraordinary circumstance, such as COVID-19. Jacoby recently spoke with ASCM’s Tim Piotrowski about when and how to review customer and supplier contracts and what anticipatory actions can help mitigate risk.

Piotrowski: What is a force majeure clause, and what does it cover?

Jacoby: I would generally describe it as a “get out of jail free card” in a contract. It specifies certain circumstances under which the obligations in the contract are no longer enforceable. To that extent, it exonerates either party — it could be the customer, or it could be the supplier, depending on the wording — of its responsibilities under the contract. These clauses can be anywhere from a few lines to a few pages depending on the nature and scope of the agreement and the size of the deal involved.

If you're talking about a large long-term contract where force majeure can be anticipated to be a possible remedy, those clauses typically include various types of conditions that might qualify for exoneration of contract responsibilities. Some of those are social-related, like social unrest and worker unrest of various kinds. Some are weather-related, like fire, flood, heat, storms. Some are war-related.

If there's a war, basically, all bets are off. I've worked a lot in war zones and in conflict areas where these are discrete and real possibilities. Some of the clauses are economic force majeure, which involve supply chain breakdowns and price volatility, the extent to which it could have been anticipated at the signing of a contract. Then, there’s this thing called act of God, which is often ill-defined, but the classic example is a lightning strike.

Piotrowski: Based on what you are seeing with the current COVID-19 crisis, how have people and organizations been using force majeure?

Jacoby: Viruses and health epidemics are often not explicitly called out in force majeure clauses. This can be the distinction between the short clause that I mentioned earlier and the long clause. Here’s a case where, if you’ve had really good legal advice, and if you put effort into the contract, it would spell out and make explicit the potential for a health crisis like COVID-19 to be part of that force majeure clause. But most contracts did not anticipate this.

Piotrowski: If a supply chain organization’s current agreement doesn’t include a force majeure clause, what does that mean for me today?

Jacoby: There are a few things that you might be able to do. One is you could claim force majeure anyway. Force majeure is so well-known, it could hold up in court even if it’s not explicitly part of the contract. In that case, you’re going to need a lawyer, you might need to litigate, and it still might not hold up, depending on many, many factors.

The second thing you could do is attempt to use other clauses that may get you to the same place as if you had a force majeure clause. If you have anything in the contract related to work stoppages or conditions under which delivery could be curtailed, delayed or re-evaluated, those types of conditions might allow you to renegotiate the contract or even potentially get out of obligations while not specifically invoking force majeure.

Piotrowski: Do you always advise securing a force majeure clause when putting together a contract?

Jacoby: Any well-drafted contract should have a force majeure clause. I’ve dealt with many contracts, helped companies negotiate these contracts and helped them operate within the boundaries of these contracts. Honestly, all contracts of any scope and significance should have a force majeure clause. … If you have a contract, and it’s not in there, you should amend or even terminate and renegotiate the contract. Make sure it specifically calls out epidemics and pandemics.

Piotrowski: What are some ways supply chain organizations can protect themselves in a crisis besides invoking a force majeure?

Jacoby:  One of them is to delay or defer purchases. If you don’t have the ability, or don’t want, to declare force majeure, you might be able to simply extend, delay or defer purchases. Look at some of the mandates coming from the government regarding mortgages and credit card debt and other types of financial liabilities. Basically, what a lot of them are doing is allowing a deferment of the payment. That’s become almost a commonly accepted accommodation for the problems caused by the coronavirus.

Some products are unavailable, but others are, so substituting product is another option. While it might not satisfy everybody’s needs, it might get you over the contract hump. You could also look for price-adjustment opportunities. If the contract in any way allows for indexation, or if you have a volume purchase agreement with breakpoints based on volume and price, they might come into play.

If none of those options gets you where you need to go, you could terminate the contract. In that case, see if you have a termination for convenience clause. If it’s not for convenience, you might still be able to terminate it.

Finally, I know this is kind of a Hail Mary, but you could declare bankruptcy if you need to protect from a very large liability that is an existential threat to your company.

Piotrowski: Is there any current data on how many supply chain organizations are using or will use force majeure and what that means for the industry?

Jacoby: I would say that May is going to be very busy for force majeure. It’s the fall after the reporting period. Most of the Q1 financial results were reported in April. Some will still drag out into May or even June. During that whole period, all these companies will be trying to endure the financial stress. We’re getting close to the point where companies will need to renegotiate or even break some very big contracts.

 

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