Up Again UK: Suppliers and Contractors

Restructuring

1. Navigating the supply chain in a distressed market:

a. My company supplies goods and I am concerned about the solvency of my customers. Are there any steps I can take to mitigate risk/my exposure?

Some solutions that may improve a supplier's resilience:

  • retain title to goods supplied until all payments due from the customer are made
  • periodic monitoring – for example, are customer’s accounts filed on time? Are any CCJs/winding up proceedings commenced? Conduct an audit of stock segregation conditions at customer premises if holding goods supplied that are not yet paid for
  • is credit insurance available?
  • monitor and review level of credit exposure
  • procure payment on account

New provisions in the Corporate Insolvency and Governance Act 2020 , prohibit the enforcement of insolvency based termination clauses in contracts for the supply of all goods and services, except for some financial products and services contracts, and, temporarily, supplies made by small businesses. An affected supplier is, however, entitled to apply to court for permission to terminate by showing it is suffering hardship.

b. My company relies upon the supply of goods/services and I am concerned about the solvency of my supplier? Are there any steps I can take to mitigate risk?

Some solutions which may improve a customer's resilience:

  • identify key suppliers
  • consider whether there are any alternative suppliers and what the timeframe would be for them to replace one of your existing suppliers
  • monitor potential knock-on impact on your ability to deliver an onward supply contract
  • in the event of supplier distress, would that provide an opportunity to acquire assets/bring part of the production in-house?

Litigation and Regulation

2. How will legal disputes that have arisen as a result of COVID-19 or its effects (for instance, in relation to force majeure) be affected by restrictions being lifted and resuming business operations in whole or in part?

Business operations are likely to resume when lockdown restrictions and other significant disruptions to commerce caused by COVID-19 and the government’s response end. In all likelihood, that will also herald the end of COVID-19-related force majeure events, allowing claimants in such proceedings to crystallise their losses and quantify their claims.

Where parties are subject to escalation clauses in their contracts (requiring them to negotiate, mediate or take other steps before commencing proceedings), those provisions are unaffected by the lockdown and must be strictly complied with. Accordingly, if the negotiation, mediation or other procedural stages have been impossible to carry out during the lockdown period, the parties will need to take those steps once lockdown is lifted before (if necessary) commencing proceedings.

At this stage, it is unclear when the courts will reopen. Though, as noted in our Virtual hearings report, a significant number of hearings have gone ahead virtually during the lockdown period, the volume of cases going through the courts is still far lower than pre-lockdown, claimants have also deferred filing (or in Scotland raising) new cases. The courts may therefore need to deal with a backlog of cases when they reopen, slowing down the litigation process for participants.

3. How should you manage those disputes once COVID-19 restrictions are lifted?

The resumption of commerce will allow businesses in dispute to take stock. If their dispute has arisen from the extreme circumstances of COVID-19 and the associated restrictions, it may be in both parties’ interests to reach an amicable settlement, allowing their commercial relationship to resume, rather than engaging in lengthy and costly litigation proceedings.

Where that is not possible, prospective claimants should consider whether they need to commence proceedings, whether because:

  • negotiations have broken down;
  • there are limitation issues at play (under English law, claimants are generally required to start proceedings based on breach of contract or tort within six years of the date on which the cause of action accrued; in Scotland it is five years); and/or
  • if no action is taken, they might be accused of having waived the relevant breach of contract.

Parties who have suffered losses will also need to take all available steps to mitigate them.

Businesses resuming operations after a period of inactivity may also wish to consider the availability of third-party funding, where a funder will finance a claimant’s legal fees in exchange for a share of any recovered damages. DLA Piper has excellent relationships with all the major litigation funders and can take you through this process.

Parties should note the Cabinet Office guidance for England on responsible contractual behaviour in the performance and enforcement of contracts impacted by the COVID-19 emergency, in which the government recommends that parties act “responsibly and fairly, support the response to COVID-19 and protect jobs and the economy.” Though this guidance does not override or deprive a party of its legal rights under a contract or otherwise, parties should bear in mind any reputational issues that might arise if a party chooses not to follow the government recommendations. The Guidance applies to England only. The devolved administrations of Scotland, Wales and Northern Ireland may issue their own guidance.

4. What should you do when restrictions are lifted if you have suffered loss under a contract as a result of COVID-19 or the restrictions, but have not yet taken legal action in relation to that loss?

As noted in the answer above, you should preserve your position regarding any potential claims. If you have not taken any steps to review your contracts, particularly your rights and obligations under the contracts, you should do so immediately, as understanding the strength of your legal position is crucial to identifying the best strategy.

Parties can inadvertently lose rights under a contract by delay, inconsistent words or actions, or through waiver, estoppel, election or affirmation (or the equivalent principles in Scotland). If in doubt, it can be worth clearly notifying the counterparty that you reserve all your rights regarding the loss, and that any measures you take when restrictions are lifted are without prejudice to those rights.  

You should also review and comply with any applicable deadlines for notice of a claim in the contract, and comply with any contractual dispute escalation provisions before bringing any legal action. As noted above, legal limitations tend to be measured in years, but this can be considerably shorter for certain types of claims. Claims for breach of EU procurement rules, for example, must be brought within 30 days of having the requisite knowledge needed to bring a claim. Similarly, contractual limitation periods may be significantly shorter than those under statute.

In the meantime, if you are considering potential future legal proceedings, you should retain and preserve documentary evidence of steps you or your counterparties have taken, the reasons for those steps, and of any steps taken to mitigate losses.

It is also worth considering with your legal team how communications with the counterparty should be handled (including press communications), to avoid both any waiver of rights and the generation of documents prejudicial to your interests that are not confidential or privileged.

5. Is there any risk of mass claims being brought against your business? If so, how would such claims be brought? Are third party funders able to fund such claims?

There is a real risk of mass claims being brought, which we expect to be initiated from the third quarter of 2020 onwards. Supply chains are being placed under enormous strain as they work against logistical and financial pressures, affecting the ability of businesses to fulfil their contractual obligations. The majority of contracts contain:

  • a force majeure clause that allows the parties to suspend their contractual obligations until a specific event has passed; and/or
  • a material adverse change (MAC) clause providing for rights of termination of a contract if particular circumstances arise.

Whether a force majeure/MAC clause can be activated depends on the precise wording of the clause and the circumstances in which the parties operate. We expect to see a number of claims arising from supply chain disputes between retailers and suppliers where orders have been manufactured but not delivered and/or sold.

How would such claims be brought?

In England and Wales, mass claims (or class actions) are brought by way of group litigation orders, representative actions or multiparty claims.

Group Litigation Orders

A group litigation order (GLO) concerns claims giving rise to common or related issues of fact or law. A GLO must be approved by the court. As a GLO operates on an opt-in basis (whereby individuals must take positive steps to join the claim), when a GLO has been approved, it must be publicised so that other relevant claims can join the GLO.

A GLO is not a singular action; it is a number of individual actions managed collectively, and the outcome of one case (i.e. a lead action or a test case) does not automatically determine the liability of the remaining claims. However, judgments/orders are binding on the parties to all other claims in the group, unless the court orders otherwise. If a group claim is lost, common costs (i.e. lead solicitor’s cost in administering the litigation) are split equally across the group.

Representative claims

A claim may also be brought by (or defended by) one or more individuals as representatives for others who have the “same interest” in the claim. Unlike a GLO, a representative action operates on an opt-out basis; potential parties need not even be identified. Similar to a GLO, a judgment or order in a representative action is binding on all those represented in the claim, but can be enforced only by or against a person not a party to the claim with the permission of the court.

The “same interest” requirement is strict and difficult to overcome. If members of the class seek different remedies or have different defences, it will not be possible to proceed under a representative claim. The recent high-profile case of Lloyd v Google [2019] EWCA Civ 1559 was a representative action. The victims had all suffered the same loss (control over their personal data) and, crucially, there was no reliance on the individual circumstances of the victims.

Mass multiparty claims

A claim may also be brought on a single claim form with multiple claimants listed, provided the claimants do not have conflicting interests. To bring such an action, the question is whether the claims can be “conveniently” disposed of in the same proceedings, which is a case-management issue. When deciding this issue, the court will consider whether disposing of the claims in the same proceedings would be just and could be done at a proportionate cost.

In Scotland, there is no special class action procedure and test cases are usually brought with related cases being paused. However, legislation has recently been passed by the Scottish Parliament that will enable a “group procedure” to be established. Further developments are awaited.

Are third-party funders able to fund such claims?

In the UK, mass claims are popular with litigation funders. Funders will invest in a claim only if it has at least a 50%-60% chance of success and it is economically viable to do so. But they will not limit themselves as to the type of dispute, and will fund cases across different industries. Funders are already setting up dedicated teams in respect of mass claims, and we expect them to be increasingly involved as such claims grow in popularity.

6. What should I do about recording contractually or otherwise any of the changes put in place during the COVID-19 lockdown period?

At all times, contracts should be kept up to date and reflect the ways in which the parties intend them to be performed. Any agreements by the parties to change a contract to reflect lockdown and/or any transition to the new normal after lockdown should be properly documented, and you should keep a clear, written record of any matters agreed with contract parties (even if that means recording something in writing after it has been agreed verbally). Wherever possible, you should have the record confirmed as accurate by the counterparty.

Failure to do this has a number of key risks, as follows:

  • It is possible that by not strictly performing the terms of a contract for a long enough, the parties will have been deemed under English or Scottish law to have varied that contract permanently. Technically, no written agreement is required for this to happen, as a variation can be effected by conduct. Unfortunately, there is no prescribed period of time after which this will happen; it will depend on the relevant circumstances. If this happens, it is likely to introduce uncertainty as to what the actual terms of the contract might be – and uncertainty is a fertile ground for disputes.
  • Even with the presence of “waiver” clauses in a contract, it is still possible to inadvertently lose the ability to rely on contractual rights and remedies, if you’re engaging in negotiations to find a workaround or to change a contract. So it’s important to make it clear in writing that doing so is without prejudice to contractual rights and remedies, all of which should be reserved.

Coming out of lockdown will involve navigating significant uncertainties – possibly more than going into lockdown. So making sure you’re maintaining open dialogue through governance and having a contractual change control regime that’s fit for purpose will be critical in getting contract changes documented as quickly and efficiently as possible:

  • Usually a contract will prescribe the way the parties must change it (e.g. a variation clause or change control procedure).
  • Sometimes, contracts provide for circumstances when changes must be done quickly or outside of the “usual” procedure – often these are called “Emergency Changes” or “Fast Track Changes.”

Where a contract doesn’t have a fit for purpose change control or governance mechanism, and the parties envisage the need for regular changes when dealing with COVID-19, parties should consider creating one. They needn’t be complicated to operate effectively and efficiently.

Parties should retain all change-related correspondence and other communications between them, including emails and meeting minutes, in an easily auditable way. This is important because, should things go awry, it will make any necessary legal analysis easier, quicker and more precise.

7. Any return to normal will likely not be as immediate as the impact of COVID-19 when it started (e.g, sales/orders will take time to ramp up, raw materials will take time to flow through supply chains, etc.) what should I think about and do to best manage this in my contracts?

For many clients, coming out of lockdown may pose as many, if not more, supply-chain contract issues than going into lockdown. This is because there are likely to be many more moving parts and unknowns to deal with:

  • What will be the new normal look like?
  • Even when one knows the relaxation criteria and stages of a country’s exit plan:
    • its speed/progression won’t be predictable;
    • it will vary by country/region in the UK (e.g. because of devolved governments and regional hotspots for CV-19 infections); and
    • it will vary by sector

For clients with international supply chains, these complications will be exacerbated, as they will be replicated many times over in each relevant country. So in aggregate, the transition period could be much longer than the two-four months that is the typical duration of most countries’ exit plans announced to date.

So how do you mitigate these risks while ensuring parties protect themselves contractually by adhering to best practice when recording contract changes and preserving rights?

The answer is to conduct contract triage to determine which contracts are key to allowing your business to function and then, on a prioritised basis, whether or not your contracts are flexible enough to accommodate this dynamic period.

The good news is that you will have probably identified many of the relevant provisions when conducting contract triage during the move into lockdown. However, this time you’re looking for provisions in your contract that in normal circumstances tend to be “fixed” or “absolutes” and so will be inherently incapable of dealing with dynamic scenarios.

See the next section below for examples of such provisions.

If a force majeure clause was invoked when going into lockdown, you should check whether it provides for the end of the force majeure event and, if it does not, consider engaging with the contract party now, to agree (and ultimately document) what a return to normal may look like.

If it does, the parties will need to comply with those provisions. This is especially relevant for the affected party (usually the supplier of the goods/services), because often its ability to rely on force majeure is strictly conditional on its ongoing compliance with the force majeure clause. For example, some force majeure provisions contain:

  • obligations on the affected party to keep the unaffected party up to date about the effect of the force majeure and/or when it may come to an end;
  • obligations on the affected party to serve notices either on (or in anticipation) of the force majeure event coming to an end; or
  • entitlement for the unaffected party to purchase goods/services from alternative sources to the affected party, and a period of time over which to transfer its purchasing back to the affected party.

Similar considerations will arise if you have invoked a “step in” right in a contract and possibly any other provisions dealing with such things as suspension and material adverse change.

8. What additional protections or changes to existing provisions (e.g. force majeure) should I put into any new supply arrangements having regard to COVID-19?

Naturally, the provisions you will need to change in your contacts will be contract-specific, but here are some of the more common categories/examples.

Making provisions more flexible

Some provisions are commonly drafted in a way that will not be flexible enough for the dynamics of coming out of lockdown. Examples include:

  • Supply pinch-points and customer demand changes: coming out of lockdown is likely to present businesses with a moving target when it comes to managing supply chain pinch-points. The result is the relevant supply chain only being capable of operating at the maximum capacity/rate/volume of the relevant pinch-point. Customers may find they have less visibility of demand, and are therefore reluctant to commit as they would have before. This issue is particularly relevant to contract provisions dealing with the following types of issues:
    • exclusivity provisions
    • minimum order quantities
    • minimum purchase requirements
    • under- and over-delivery
    • lead times

    Parties should review such provisions and modify them as required. For example, sometimes suppliers are discouraged from delivering quantities that don’t precisely tally with the quantities ordered – and sometimes are even penalised when they do so. However, when coming out of lockdown over-deliveries to make up for previous under-deliveries (and vice versa) may actually be extremely beneficial to both parties in smoothing out peaks and troughs in available supply. From a customer perspective, the consequences of not meeting minimum commitments could be softened (for example a price adjustment formula rather than a breach of contract), or additional time given to the customer to meet its commitments (for example, annual targets can be rolled over in certain circumstances).

  • Financial models/costs savings/gainshare regimes: while the parties may have adjusted these to deal with the lockdown, they will need transitional arrangements until they revert back to their BAU operation/calculation.
  • Service levels: customers will want these to evolve as lockdown is relaxed so they know their suppliers are always doing the best they can in the circumstances rather than a single step from lockdown levels to new normal levels, when new normal (itself a moving target) occurs.

Contract management

The heightened focus on contract management and governance we have advocated during lockdown will need to continue (and possibly be even more vigilant) during the more dynamic exit from lockdown.

Provisions dealing with regular governance meetings to monitor, predict and react to the changing situation will be key. So will be the provisions dealing with the provision of (more frequent/detailed) management information in support of decision-making by those governance meetings.

Robust change control will also be critical in this phase, for the reasons covered in the section above.

Lessons learned

Update your contract to reflect the lessons you have learned to date. Often, this will result in changing the way certain policies or regimes in the contract operate. For example:

  • Change control procedure: does your contract need one, or does it have one but lack a “fast-track” process to be fit for purpose (see the section above).
  • Business-continuity plans: have they been refreshed/updated to reflect the lessons you’ve learned from going into lockdown, and do they have adequate provisions dealing with ending the invocation of a BC/DR plan?

Force majeure clauses

Care must be taken when addressing COVID-19, global pandemics and state-mandated lockdowns in force majeure clauses in new or renegotiated contracts. The fact that COVID-19 exists, and that the knowledge of the potential impact of global pandemics, and its ability to prevent or delay contractual performance in the future is easily foreseeable, doesn’t mean that COVID-19 is automatically precluded from being a valid force majeure event in the future.

Make sure the drafting expressly covers the outcome you want to achieve – if you want to make sure global pandemics and/or state mandated lockdowns give rise to relief under the force majeure clause, then be sure to include them in the definition.

Similarly, if you are a customer looking to ensure that relief for a force majeure event would not arise for a supplier in similar circumstances in the future, you may want to include a provision stating that the relief is not available if the circumstances were reasonably foreseeable and, in such cases, that the supplier should have provided for these circumstances in its business-continuity plan.