Supply Chain Mess Leads to Contract Changes

Pandemic-driven strains in supply chains are triggering changes in contract terms between suppliers and their manufacturing customers as companies address the risks and added costs brought on by disruptions.

Procurement experts say that when drafting new contracts and renewing existing ones, companies increasingly are seeking to add provisions that cover the impact of pandemics or epidemics and accelerating inflation.

The moves come as commodity costs and shipping prices have soared far faster during the past two years than considered in traditional contract terms. A fourfold increase in container shipping rates has made ocean freight for some shippers more expensive than the products they are shipping.

“These are costs that were not contemplated by the parties at the time they entered into the contract,” said Vanessa Miller, a partner at Foley & Lardner LLP. “So the question is, which party should now bear the risk of these increased costs?”

International supply-chain contracts generally carry broad parameters on delivery and cost terms, and many include standard language developed by the International Chamber of Commerce known as Incoterms, short for international commercial terms. The Chamber describes Incoterms as “the world’s essential terms of trade for the sale of goods.”

The aggregate logistics prices index, a combination of inventory, warehousing and transportation costs, reached an all-time high in September. While the fourth quarter is generally crunch time in logistics, readings from January to September this year are the highest costs over any nine months in the history of the index.

Experts say these changes have overwhelmed the guideposts in many contracts. That has led to conflicts between suppliers and buyers over how to account for rising costs and delivery shortfalls.

Some of the new contracting focus is on language related to force majeure, the legal provision that allows suppliers to be excused from contract terms due to unforeseen circumstances. Buyers want definitions that go beyond boilerplate escape clauses that explain what suppliers can and must do when disruptions hit.

“Customers today are saying, ‘That doesn’t help me at all. I don’t want a supplier who’s excused. I want a supplier who’s ready and is able to perform despite the force majeure event,’” said Brad Peterson, a partner in Mayer Brown LLP. “Meanwhile, the suppliers are seeing COVID-19 and the supply chain shocks as nowhere near over.”

Before the pandemic, force majeure provisions were treated as “cut-and-paste” contracting language, Miller said. “It was just in the miscellaneous provisions at the very end. No one really paid much attention to it. Now there’s a lot more focus.”

Globally, force majeure declarations tripled in 2020 from 2019 levels, according to Everstream Analytics, a supply-chain risk management company.

Some suppliers also want to include what the contracting experts call dynamic pricing, or the ability to adjust prices if costs shift outside a certain range during the time covered by a contract. That might mean using an index as a base for the prices of raw materials or services such as shipping.

“In my entire lifetime, we’ve been out of practice for using inflation clauses, and now we’re getting back to it,” said Sarah Rathke, a 45-year-old partner at Squire Patton Boggs.

Source: Wall Street Journal