Coronavirus - Is Your Supply Chain Infected?

Created by Dr. Christian Engelhardt |

Statutory and contractual regulations in the event of non-performance or supply disruptions

In the current situation, many companies are severely affected by the coronavirus (SARS-CoV-2) and either find themselves unable to meet contractual obligations or, conversely, are exposed to supply disruptions. In both cases, they are also faced with liability risks and the threat of losing sales. Both statutory and contractual regulations may considerably limit these risks and effects.

The coronavirus is spreading across countries and continents and the development of a vaccine will still take considerable time. The virus is highly contagious and the mortality rate far exceeds that of ordinary influenza. In response, many countries have established quarantine zones, in many cases over entire cities, and other measures to contain the disease. These measures are right and proper to save lives and any rapid response to the virus is welcome.

Economic impact of the pandemic

The quarantine of entire cities has led to the temporary closure of factories, loss of manpower and other serious disruptions in the increasingly international supply chains of today's global economy. The effects are dramatic. Markets have suffered historic losses within days and weeks, shortages of certain products are predicted or have already occurred.

From an operational and economic perspective, one of the main problems associated with the impact of the SARS CoV-2 pandemic is this disruption of supply chains. Raw materials and preliminary products are not delivered or not delivered on schedule and contractual obligations are not fulfilled. This can lead to significant losses both for companies that depend on timely deliveries and for suppliers that are unable to meet their obligations. The consequences can range from short-term financial losses to losses of sales and business that threaten the existence of the company.

Therapy - Limiting economic impact

There is no vaccine that can prevent a company from getting such an "infection". However, every affected company should take a look at the law and, above all, contractual agreements, as the "therapy" for the effects is already included in them. 

So-called force majeure or hardship clauses - and in some cases statutory regulations - can, depending on their content and the specific situation, limit the disruptive effects of coronavirus and ensure that affected companies find their way back to healthy business and do not become victims of the pandemic.

Statutory regulations
Many jurisdictions have legal provisions that govern situations such as the current one. They concern the lack of possibility of a party to fulfil its contractual obligations.

It is hardly possible to provide comprehensive information on all jurisdictions here, but we would like to mention a few examples and strongly recommend that affected companies seek legal advice on this.

In German law, a party is released from its primary obligation to perform if the performance is objectively (for everyone) impossible (Section 275 para. 1 BGB – German Civil Code). If it is completely unreasonable to expect a party to fulfil its obligation to perform, a performance obligation may also be waived (Section 275 para. 2, 3 BGB). In principle, this does not affect the (secondary) obligation to pay damages for non-performance, but since in a case such as SARS-CoV-2 this is not the fault of the debtor, Section 280 para. 1 BGB also excludes a claim for damages. Conversely, the other party is released from its obligation to provide consideration (Section 326 para. 1 BGB), meaning e.g. the supplier is released from its obligation to deliver and the customer from its obligation to pay.

The concept of "frustration of contract" codified in Section 313 BGB can also be used here if necessary and offers great flexibility in the adjustment of contracts - even if this instrument is not generally intended to mitigate deviations from fundamental "great" expectations of the parties, such as the overall economic trend.

Similarly, Art. 79 para. 1 of the UN Convention on Contracts for the International Sale of Goods (CISG) exempts a party from liability for non-performance if the performance is the consequence of an unforeseeable impediment beyond the control of the party. Insofar as the CISG is applicable to a contract - it is often expressly excluded under a choice of law clause - it should also apply to the present situation.

English and US-American law generally do not recognize any claim for specific performance, so that force majeure issues regularly arise in connection with liability for damages. Both legal systems know concepts that deal with this, the "frustration" in the UK and the "doctrine of excuse" in the US. In most cases, contracts in these jurisdictions contain clauses specific to force majeure.

Contractual regulations

Many contracts contain so-called force majeure clauses. These are used to regulate situations that are beyond the control of the parties but which may affect the fulfilment of contractual obligations under the same contract - i.e. exactly such a situation as a global (or even just regional) pandemic. The parties typically define what is to be considered a "force majeure" incident and what the consequences are. In practice, the definitions of what constitutes a force majeure incident are quite similar, but the consequences may well differ.

Whether a force majeure clause is applicable in the current crisis depends first of all on its wording. Does the clause apply to a pandemic like SARS-CoV-2? Numerous force majeure clauses contain comparatively vague definitions of "force majeure". They may list some specific events, such as earthquakes or floods, but they may also contain terms such as "act of God" that are difficult to define. Many clauses also refer to unspecific "market disturbances" outside the control of one party. This latter type of definition of a force majeure event should cover the outbreak of a disease such as COVID-19 in any case. Nevertheless, it is necessary to evaluate each individual clause.

The agreed consequences may include, for example 

  • that termination rights for non-performance are suspended, 
  • that performance obligations as such are suspended,
  • that contractual penalties are not incurred,
  • that exclusivity agreements or restrictions of competition are suspended in order to allow the purchase from a second source, which would otherwise be prohibited by the relevant clauses.

Typically, the parties limit these consequences to the duration of the force majeure incident. Furthermore, such clauses often allow one or both parties to terminate the contract if the force majeure incident exceeds a certain duration.

So-called "Hardship Clauses" are similar to Force Majeure Clauses, as they also address the situation where one party is hindered in the provision of services through no fault of its own. However, the issue here is not the impossibility of performance, but the economic reasonableness. The consequences in hardship clauses are often similar to those in force majeure clauses, but may be less severe, e.g. obligations to perform may not be completely suspended, but only limited.

There are of course contractual regulations - under whatever name - which are a hybrid. In practice, this will not necessarily matter; the decisive factor is what the parties have specifically agreed on in such a clause.

Diagnosis, prognosis and therapy

We recommend that affected companies, together with legal advisors, immediately inspect and evaluate their contractual agreements, and determine

  • which law is applicable and whether it contains any provisions that may help,
  • whether contractual clauses are included which are applicable to the current situation and what legal consequences they have,
  • how best to communicate with contractual partners and
  • what medium and long-term strategy is appropriate for mitigating the business impact of the SARS CoV-2 pandemic.

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