The COVID-19 pandemic has caused tremendous displacement in the world’s economy. The international supply chain, particularly from China, but now including other parts of the world, has experienced significant impacts. Many companies have been unable to receive component parts or goods due to factory shutdowns or have had shipments delayed. Some buyers rely on timely shipments to fulfill time-sensitive customer orders that impose penalties for late delivery. Other companies simply need shipped products to maintain profitability.
When there are economic losses due to lack of shipment or delayed shipment does the buyer/importer or the seller/exporter bear the loss? Many international supply chain contracts have a force majeure clause that excuses or extends performance upon the occurrence of certain unforeseen contingencies. Typical contingencies include acts of God, natural disasters, governmental orders, fire or floods. Some clauses include labor shortages or energy crises. It is uncommon for a force majeure clause to cover epidemics. If the coronavirus crisis is covered by a force majeure clause, then the economic loss is allocated contractually, in most cases to the buyer/importer. Typically, it will excuse performance or delay performance for the period of the contingency, in this case the delay caused by the epidemic. Otherwise, the exporter could assume the economic loss for failure to perform or for breach.
If the force majeure clause does not expressly provide for epidemics, a seller may still have the ability to shift the economic loss. For example, when many of China’s manufacturers were closed in February and factory workers were not allowed to work, a seller might be able to rely on the labor shortage contingency. Similarly, if a government orders closure, as was done in China’s case, then the seller can rely on the government order contingency. However, the contingencies in force majeure clause may not fit neatly into a particular contingency category. This could result in litigation or arbitration.
If a contract does not have a force majeure clause, the exporter may find some comfort in the doctrine of commercial impracticality codified in some laws. The first question is which law applies. While domestic transactions in the United States are governed by the Uniform Commercial Code, which is in effect in all fifty states, many international contracts are not governed by the law of a U.S. state. The United Nations Convention on Contracts for the International Sale of Goods (CISG) governs supply agreements and international sales contracts between countries that have adopted the U.N. Convention (which most major countries have) unless another governing law is expressly stated in the contract and the CISG is expressly excluded. The U.S., China and most European countries are parties to the U.N. Convention. If a contract is governed by the laws of a state of the United States and does not explicitly disclaim application of the CISG, the CISG is deemed to supplant that state’s laws, since the CISG is a federal treaty that overrides state law. If, on the other hand, the contract is governed by the law of another country, one must look to the laws of that country.
The Uniform Commercial Code provides that a failure or delay in delivery is not a breach of performance if the contract’s performance has been made commercially impractical because the contingency was not foreseeable and contemplated at the time the contract was made. The determination of whether a contingency is foreseeable and comes within this provision has been the matter of much case law. For example, cases have held in some circumstances that a shortage or failure of supply, non-performance of a third party contractor the seller relied upon to fulfill the contract and crop failure did not excuse performance. Another case held that the failure of an oil company to provide aviation fuel due to the Arab Oil Embargo in the 1970s did not excuse performance. However, under other factual circumstances, some of these same contingencies have been held to be unforeseeable.
There is a similar but different provision under the CISG. That provision exempts a supplier from liability for failure to perform if it was due to an impediment beyond the supplier’s control and the supplier cannot reasonably be expected to have taken the impediment into account at the time of the conclusion of the contract or to have avoided or overcome it.
The remedies under the Uniform Commercial Code and the CISG also differ. The CISG excuses a party from damages for failure to perform and provides that once the impediment no longer exists, compliance is required. The Uniform Commercial Code has a myriad of remedies based on the circumstances.
Given the fact-sensitive analysis under these laws, reliance on governing law in the absence of a force majeure clause can often lead to litigation or arbitration.
A properly drafted force majeure clause has the potential to minimize a dispute. The parties can agree on the contingencies that will excuse performance. If the contingency is clearly listed, the party bearing the economic loss is less likely to bring legal action. A force majeure clause is often considered boilerplate. The COVID-19 pandemic has demonstrated that this provision must be carefully considered and drafted.
Unfortunately, there will be litigation or arbitration over existing force majeure clauses and failures to perform due to the coronavirus. For those who are entering into or amending international supply agreements, they should view their force majeure clauses carefully to make sure they cover epidemics. The international and litigation/arbitration lawyers at Fox Rothschild stand ready to assist our clients in determining the impact of this terrible virus on their international sales contracts.
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