As lockdown measures start to be lifted, from a commercial point of view, businesses are now stepping away from discussion of force majeure and frustration where performance is impossible (as opposed to commercially undesirable) and instead stepping into performance in a vastly different commercial context.
Unfortunately, this may be worse than the protective bubble of force majeure, especially if contracts include service level agreements, penalties and/or liquidated damages. Indeed, the whole situation has taken us into the murky realms of the boiler plate of contracts and obscure insurance provisions.
Everyone from across industry is affected in one way or another (or multiple ways). A return to business as usual is not going to be possible or practical. A lack of public transport, social distancing, shielding and illness will lead to labour shortages; new working practices will change the hand-offs between businesses; travel restrictions are already impacting international trade and will continue to do so; and the supply chain for many is in disarray in terms of stock availability and will re-start at different scales and speeds.
Government guidance issued on 7 May urged businesses to play fair and allow contractual counterparties some slack, imploring parties to show “responsible and fair behaviour” in order to:
- Maintain the supply chain to deal with the emergency
- Keep businesses in the emergency supply chain financially viable
- Moth-ball contractual relationships that can’t be fulfilled
- Become ready to kick-start the economy when feasible; and by implication
- Avoid a calamitous recession
As organisations start to get back to work in this new normal, there are three main areas to consider.
- Looking backwards: Suppliers and the supply chain
Perform a critical analysis
- Decide which suppliers are critical? Follow the critical path…
- Look at payment terms with suppliers; if you have cash and they don’t, consider a pre-pay arrangement. Alternatively, if you are in arrears, discuss a time to pay arrangement or enhanced credit terms
- Understand where the stock is in the supply chain?
Consider your options
- Ideally, seek to vary contracts by agreement but please check variation clause requirements and notice requirements. If there is a “no oral modification” clause, ensure that variations are documented in writing. Consider flexibility in the variation agreement, as this may be a one-time chance to deal with the future possibles. Think about
- What if restrictions are re-tightened?
- What if stock is unavailable?
- What if a key supplier falls out of the supply chain?
- What if the business is closed on health and safety grounds (case of COVID-19)?
- Potentially look into invoking material adverse change clauses – be certain that the circumstances warrant this. The clauses are interpreted narrowly. The “change” needs to be substantial and permanent. Inappropriately invoking this clause could be a repudiatory breach of contract, so it is best to take legal advice before proceeding.
- Remember that under some standard construction contracts “change in law” clauses are drafted broadly to capture regulatory change and may be helpful in the circumstances.
- As a last resort, consider termination on notice, but check notice requirements are strictly adhered to
Consider Back-up/Optional contracts
- Identify new suppliers to provide back-up for your current suppliers if they are unable to deliver
- If necessary you can buy an option based contract – where you pay a sum for capacity being available if you need it at short notice. This is like a form of insurance against the loss of a supplier
New Insolvency provision changes
These were mentioned by the Government as coming but there is no implementing legislation yet. Under the proposed legislation:
- Suppliers in long term supply agreements will be prohibited from terminating supply agreements in exchange for preferred creditor status
- This is unless they can show this will cause hardship. In which case the supplier will need to apply for a Court Order to terminate supply agreement
- To avoid getting caught by such a provision, the alternative is to enter rolling short term contracts, but this option offers less security.
- Looking forward: Customers
- What does demand look like? Look to match supply to demand
- What value is already sitting in stock? Try to monetise this first
- Consider the financial status of customers
Review your options
- Review your standard terms and conditions – introduce more wiggle room in terms of delivery
- Consider variation of bespoke agreements such as:
- More generous delivery terms
- Changing payment terms to withdraw credit or require pre-payments or pay when paid clauses. However, if you have credit insurance or factoring arrangements in place, ensure that changing these terms does not breach these financing agreements.
- If you cannot change payment terms, look to use retention of title clauses, so that stock can be recovered outside an insolvency process. In order to be effective, you need to ensure your customer is keeping your stock separate and identified as belonging to you
- Look into financing alternatives such as factoring or credit insurance to provide more cashflow
- Again as a last resort, you may be able to terminate for cause if your customer is financially unstable and the contract includes a relevant clause concerning the actual status or in your reason opinion status of the customer or;
- Consider termination on notice if the relationship is no longer commercially sensible, but you must adhere to the notice provisions
Consider changing demand
- What new products and services will be in demand going forward?
- What are the new needs and wants of your customers such as on-line or additional technology?
- Looking around: Finance, Compliance, Tax, Infrastructure
- Prepare a realistic cashflow projection and then talk to your funders and explore any potential need to restructure debt and payment provisions
- Look carefully into the Government loan and grant options such as CBILS
- Remember deferred VAT and time to pay arrangements from HMRC as other ways to manage cash
- Your landlord is another supplier, and the contract in question is your lease or licence to occupy. The same options apply as for all suppliers…
- If needed, explore options for rent holidays, asking for forbearance or varied rent payment arrangements but again, please check the terms of the lease/licence with regard to variation clauses and always get waivers in writing.
- Check if named individuals can still perform the role assigned to them – if they are shielding or shielding in order to protect a vulnerable member of their household, you may need to get the licence amended
- Consider if the hours or nature of your current trading mean that licences need to be altered to reflect the new normal.
- Make sure to do renewals in good time, as local authorities will similarly be working with reduced staffing and a backlog
- Remember there has been a moratorium on wrongful trading provisions in place since 1 March. As such, directors are not currently personally liable for wrongful trading. However, directors are still responsible for understanding the financial health of the business and can still act fraudulently, if they misrepresent the financial status of their business.
Going back to the Government Guidance
The guidance is relatively short. The request for “reasonable and fair” behaviour is exemplified in section 15 and covers a staggering fifteen areas of commercial interaction, where businesses are requested to act reasonably and fairly.
The guidance has caused some raised eyebrows in the legal sphere because it implies a step away from the freedom to contract and the right to enforce freely entered into commercial contracts. However, the guidance is purely advisory and has no legislative force. There are very limited circumstances where an implied duty of good faith will exist in a contract or the contract is relational in nature, where the guidance’s requirement for fairness may bite, but these are rare in our legal system.
Nonetheless, even without the force of legislation, there are risks to an aggressive approach.
I urge you to consider the guidance in light of the risk of a back-lash in public perception if a business is seen to be hard-nosed in relation to its commercial counterparties or if your business needs to work with public authorities or Government in the future. Also, the advice might have sway in other regulatory enforcement situations not guided by contract law principles in the same way. Finally, if the Government are of the opinion that businesses are generally not acting “reasonably and fairly,” they may seek to implement new legislation to force a new approach, in order to protect the wider economy over individual business rights