Supply chain disruption as a result of war and conflict – Is your business protected?
By Katherine East, Irwin Mitchell
Four years ago, global supply chains and their potential fragility were thrust into mainstream media as Covid-19 changed the world as we knew it. Less than two years later, supply chains were rocked once again when Russia invaded Ukraine.
Before the invasion, both Russia and Ukraine were major exporters of gas and other natural resources, including a significant proportion of the world’s wheat, barley and sunflower oil, in addition to fertilizers and minerals. As the conflict deepened, so did the world’s involvement, with financial sanctions and trade restrictions being placed on Russia which have caused commodity prices to soar.
Just 18 months later, Hamas launched an attack on Israel, which has resulted in a fierce war between the two in Gaza. The situation escalated in November and December 2023 when Houthis rebels from Yemen, allegedly in retaliation against Israel’s bombardment of Gaza, began a series of attacks on vessels passing through the Suez Canal, which is one of the largest shipping corridors linking eastern and western trade, having handled approximately 12% to 15% of global trade in 20231.
This has caused a number of shipping companies to divert ships to take the significantly longer route around the African continent, leading to delivery delays of a number of weeks, increased costs and a reduction in available vessel capacity around the world. As an idea of the magnitude of the impact, when the Suez Canal was blocked for six days in March 2021 by a container ship that run aground in the Canal, over 350 ships were delayed as a result of the blockage. It has now been 3 months since Houthi disruption in the Suez Canal began and the United Nations estimates that weekly container ship transits through the Suez Canal have dropped by nearly 70%.*
Global conflict causes threat and disruption not only to life and physical infrastructure, but also to transportation networks, the flow of goods, product availability and the availability of food, resulting in increased costs as well as regulatory and legal challenges.
What is clear is that organisations can no longer treat supply chain disruption as a one-off event and it is imperative for organisations now to have in place more resilient supply chains and crisis management plans for when disruptions occurs.
So what should organisations consider when looking at their supply chains?
Stress test your supply chains
The first task organisations should undertake is to gain visibility into and risk assess their supply chains. It is vital that businesses are aware of not only their own supply chains, but all extended supplier networks.
Once businesses have visibility over their entire supply process, from raw materials all the way to delivery, they can assess where pressure points on key commodities might then affect the supply of goods. Organisations can use technology to assist with this process, including with obtaining real-time alerts in respect of potential threats to their supplier networks.
Diversify supply chains
If there is any risk of interruption in supply, organisations should look at multi-sourcing supplier relationships to allow for secondary suppliers and the ability to look elsewhere if there is a chance of a supply chain interruption. In the face of global concerns, it is also worth considering local supply opportunities, and the potential increase in costs as against the cost of non-delivery.
Strategic stocking
There was a time when having low or zero stock and therefore low or zero overheads made financial sense. Now businesses are looking at strategic stocking to allow for contingencies. For many businesses this would be a wholescale change in approach, and cost increases and the impact of inflation need to be considered as against profitability before committing to any storage facilities.
Supply chain acquisitions
If viable, organisations could consider an acquisition, merger, joint venture or other similar model with key parties within their supply chain if doing so would ensure best price and surety of supply.
Contractual considerations
Businesses should review all key supply, distribution or logistics contracts as performance of those contracts may become difficult due to the knock-on effect of supply shortages or delays. Any problems need to be anticipated and planned for in advance by both contracting parties working together, if at all possible.
In this context, the following is a list of contractual provisions which businesses should review and, if possible, negotiated or re-negotiated if they are no longer fit for purpose.
· Exclusivity clauses
If there is an exclusivity clause in the contract, it might prevent businesses from diversifying their supply chains. Anything which suggests that a business might be restricted in who it obtains products from, or supplies them to, might result in unhelpful restrictions in times of crisis. Parties should review these clauses and include any caveats or exceptions they require in order to continue without disruption in times of crisis.
· Time clauses
Does the contract state a timeframe for delivery and, if so, does it make it a key or essential term of the contract? Such clauses often include the phrase “time is of the essence”. This has a specific meaning in English law, being that timing is material to the performance of the contract, and any failure to deliver on time means that the defaulting party is in breach of the contract and allows the other party to immediately terminate the contract and claim damages. The inclusion of such a clause should therefore be carefully considered.
· Force majeure clauses
A force majeure clause seeks to exclude the liability for one or more parties to a contract for events which are beyond their reasonable control and render the party’s (or parties’) obligations legally or physically impossible.
Often these become mere boilerplate clauses which lack focus and, as was seen during the Covid-19 pandemic, this approach can result in significant difficulties for a party which becomes unable to perform its obligations under the contract. This is because there is no recognised legal definition of “force majeure” and it is not a term which is implied into contracts by either statute or common law. As such, it must be an express term in the contract and its drafting will become critical to its interpretation. In addition, there must be a causal link between the force majeure event and the result, being that the party is unable to perform. It is simply not enough for performance to be too expensive or difficult.
For the purposes of global conflict, consider whether the force majeure clause refers to wars, conflict or armed conflict, human actions, border-closures, travel restrictions, sanctions or port closures. If not, would it be possible to negotiate and amend the clause for all contracts which have not yet been entered into?
The effect of triggering the force majeure clause is also a relevant consideration. Often this will result in the termination of all or part of the contract. Whilst none of the global conflicts mentioned above may be over as soon as we would hope, it may be that the effects on supply chains are short-lived in the grand scheme of a contract. It is therefore worth considering whether triggering the force majeure clause is a commercially sensible move.
· Notice clauses
If a party is unable to perform its obligations, the contract will usually have a clause which prescribes how notices under the contract are to be served. This is an important consideration for both the party who is unable to perform and wants to issue a notice of force majeure, and the other party who may wish to serve notice to terminate in order to procure performance from elsewhere. Ensuring a notice is served in accordance with the terms of the contract is essential for the notice to be enforceable.
· Waivers and variations
Parties who choose to accept non-performance during periods of disruption caused by conflict need to be careful that any acceptance does not amount to a waiver of their right to terminate should the non-performance continue. Similarly, parties need to be careful that any negotiations or agreements formed during the conflict do not amount to a formal variation to the contract in the long-term. Attention should be given to the relevant contractual terms in relation to waivers or variations of the contract to ensure this does not happen in advertently.
· Indemnities and liquidated damages clauses
Parties need to be cautious of any indemnities they have provided in their contracts and any obligation to pay liquidated damages for non-performance.
Sanctions
Sanctions, restrictions and embargoes should all be closely monitored by businesses to ensure that any business transactions do not fall foul of any government restrictions on trade.
Such restrictions can mean that it is no longer possible to perform a contract. In these situations, the contract itself (and most likely the force majeure clause) might allow a party to terminate the contract on the basis of illegality. If not, ‘frustration’ may apply.
‘Frustration’ is a doctrine of English law which applies to all contracts where an unforeseen event renders contractual obligations impossible, illegal, or radically different from that which had been agreed when the contract was entered into.
Where frustration occurs, it brings an immediate end to the contract. All sums paid prior to the unforeseen event are recoverable but any sums yet to be paid are no longer payable, subject to the court’s discretion to allow the recovery of already incurred expenses.
It is worthwhile noting that a contract becoming excessively expensive to perform does not mean that it cannot be performed. In this instance, frustration would not apply. Tariffs, therefore, would likely not result in frustration occurring, and any additional costs would need to be absorbed by businesses, ideally within their supply chains.
ESG and reputation management
ESG should be at the top of all organisations’ agendas.
In the midst of a global humanitarian crisis, businesses need to carefully consider how and from where they obtain the supply of goods and resources.
Similarly, a number of organisations have already suffered reputational damage as a result of providing false or misleading information about how ‘green’ their products are and such information should be reviewed if there is a change in an organisation’s supply chain. If your business claims, for example, that its products have a specific carbon footprint, which will be increased as a result of redirected ships or changes from sea to air freight, that business could face a green washing claim if it continues to use outdated information which is misleading. Additional concerns will apply if your business sells directly to consumers given the strict rules which apply in respect of business to consumer transactions and the accuracy of information provided.
Managing disputes
If any form of dispute does ensue, it is vital that businesses firstly maintain good records and audit trails, and secondly modify and substitute where possible and consider whether there are alternative sourcing opportunities so that they may mitigate any losses.
Ultimately, prevention is better than cure. If businesses have any concerns or are likely to face new challenges, please do contact us and we would be happy help.
*1 Red Sea, Black Sea and Panama Canal: UNCTAD raises alarm on global trade disruptions | UNCTAD
