Practical Law

COVID-19 has decimated supply chains for goods and labour across the world. It is inevitable that many businesses are now facing the same dilemma: what to do when they have enough resources to fulfill some of their contracts, but not all.

What do you do when you have orders for 50 pallets of toilet roll, for ten different customers, but only 25 pallets have been manufactured and delivered? Do you give everyone 2.5 pallets, or give your biggest customer their full 25 pallet order and hope that the other nine customers won’t sue you for breach?

There is no principle of English law that tells you how to make this decision. Rather you will need to conduct a careful balancing act based on your organisation’s specific circumstances. This balancing act will need to consider dimensions of risk, profit, relationships, ethics and the public good.

Key questions to consider

In making that decision there are several key questions to ask which will help you weigh up all the important factors.

1. Do any of your contracts have a preferment-type clause which requires you to prioritise that contract over any others? This clause may contain wording which obliges you to fulfill that contract as a priority, including taking resources allocated for other customers during a time of crisis to do so.

2. Which of your contracts have good faith obligations? There is a strong argument that if you ignored these contracts in favour of more lucrative contracts or contracts with a preferment clause then you would be breaching your good faith obligation.

3. Do you have contracts which have a moral imperative to them or a public policy angle? You may wish to prioritise NHS contracts or contracts that ultimately serve more vulnerable customers.

4. Which contracts have the harshest consequences for breach or the greatest rewards for delivery? You may be a party to contracts with severe service credit regimes or tempting profit-sharing clauses.

5. Which of your contracts have the most useful limitations on liability, either in terms of the breadth of the clause or the quantum of the financial cap?

6. Will your insurance policies apply to some of your contracts but not others? Most insurance policies cover property damage or personal injury rather than losses due to a breach of contract. However, you may have litigation insurance or business interruption insurance that could cover the losses of you and your customer. Either way it will be essential for you to engage with your broker and insurer to confirm:

• What insurance policies you have.
• What those policies cover.
• Whether your planned actions (that is, not performing under some contracts due to a decision to divert resources) could jeopardise the cover that is available.

7. Which contracts might have reputational issues attached if you ignore them in favour of more lucrative contracts?

8. Which of your customers has the greatest appetite for litigation and is more likely to make a claim?

9. Which of your contracts have bonds, collateral warranties or parent company guarantees attached that could be triggered by a failure to perform?

10. Which of your customers is best able to bear your failure to deliver? This question can give you vital information in both directions. Firstly, you may have customers where your decision to supply to them over a larger company may save their business from insolvency. Likewise, if you are concerned that a customer is almost insolvent and will be unlikely to pay you then you may decide to supply to other, more robust companies to better secure your cashflow.

11. Finally, consider if it is better to under-deliver to all your customers by a smaller amount or completely fail to deliver to some so that you can completely fulfill others. The advantage of the former case is that it would probably not amount to a repudiatory breach, so claims would be for damages, rather than termination of any long-term supply arrangements. The disadvantage of the former solution is that all your customers would be able to claim for damages, rather than only a handful.

This list of questions is not exhaustive and there will always be industry and business-specific considerations, but it should provide a strong starting point for reviewing your position.

COVID-19 related constraints

Keep a careful record of what COVID-19 related constraints you encounter in delivering your contracts. This information could prove a strong defence in later court action. You may also wish to document your decision-making process in case some of those customers decide to make a claim, although this is another difficult balancing act.

Documenting your decision-making process with contemporaneous evidence can be a vital tool, ensuring that important knowledge isn’t lost. In difficult economic times the likelihood of redundancies also means a likely loss of knowledge. It can be incredibly damaging if you do not know why certain decisions were made in a crisis and on what basis because individuals have left the business.

However, if the record of your decision-making is not covered by privilege, and it almost certainly won’t be, then it may be disclosable and potentially undermine any defence you later attempt at court. As always you will have to exercise caution and judgement, but it would be best to assume that such documents will be made public at a later point.

Dominant market position

Earlier I said that there was no principle of English law to inform your choice. However, there is one area in which this may not be true: where your organisation enjoys a dominant market position. If you are dominant in your market, how you choose to fulfill orders may fall under the competition regulations. If this applies to your organisation, you should take specialist legal advice on how to proceed, bearing in mind that the normal rules on price fixing and price gouging will apply regardless.

As a tool for solving the problems of COVID-19, contract terms alone will not be sufficient as they are too blunt. Negotiating a solution that allows both your organisation and your customers to survive as businesses, regardless of the contractual terms, may be best for everyone, including shareholders.

Communicating your intentions and constraints to your customers will at least allow them to make their own contingency plans and adjustments. If you assist them in finding an alternative solution it will reduce the risk of later claims and leave everyone in a stronger position to recover after the crisis is over.