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Legal Insight: Coronavirus and Its Effect on the Supply Chain

Insight Douglas J. Schneller Douglas J. Schneller · Phillip Wang Phillip Wang · February 26, 2020

Reporting and worried speculation about the coronavirus outbreak is widespread, and the potential disruption to global manufacturing and commerce may be profound.[1] Suppliers, distributors, manufacturers and end-users whose businesses rely on vendors or other market participants affected by coronavirus may face significant business and legal risks, to say nothing of financial distress, insolvency or bankruptcy. Consequently, now may be a good time to review your supply chain business exposure and consider commercially viable alternatives.

Coronavirus and Its Effect on the Supply Chain

Reporting and worried speculation about the coronavirus outbreak is widespread, and the potential disruption to global manufacturing and commerce may be profound.[1] Suppliers, distributors, manufacturers and end-users whose businesses rely on vendors or other market participants affected by coronavirus may face significant business and legal risks, to say nothing of financial distress, insolvency or bankruptcy. Consequently, now may be a good time to review your supply chain business exposure and consider commercially viable alternatives.

Dust off your contract

If you have a supply agreement with a vendor in Asia or elsewhere that may be impacted by the coronavirus outbreak, look at the contract terms, in particular those dealing with disruption or breach. Has the vendor breached the agreement? Does coronavirus constitute an event under the contract that excuses performance, mandates notification or mitigation, or triggers a default? What are the relative rights and obligations of the parties under such a circumstance? Does coronavirus constitute an “act of God” (or force majeure) under the supply agreement? If so, what happens under the agreement?

Consider too your downstream obligations to parties that rely on you for goods or services. If your vendor cannot or does not perform under your upstream supply agreement, how does that affect your duties downstream? What does your downstream agreement say? What rights or defenses do you have? What does this mean for your business and your contractual obligations?

If you do not have a written supply agreement, either upstream or downstream, consider your prior course of conduct, industry standards, and communications such as email, letters and telephone calls. What has each party in the supply chain relied on? Speaking with counsel may be sensible too, even if no obvious business difficulties have yet arisen.

Consider your alternatives

Regardless of market disruption or even seeming impossibility to perform, nevertheless, you have a business you are trying to run and various parties, including employees, who likely depend on business as usual. In light of the possibility that coronavirus may disrupt the supply chain for an extended period of time, it may be critical to consider other sources of supply and other customers.

If your affected upstream supplier provides you with goods or services that can be obtained elsewhere, you may wish to move quickly to secure a new supply source. Although pricing may be affected you may have little choice, and indeed the demand may be overwhelming for supply sources who are (relatively) unaffected by coronavirus disruption.[2]

On the other hand, if your upstream supplier provides you with unique goods or services, you may have to be diligent, and lucky, to uncover a new supply source. Consider every alternative, including other suppliers in and outside the industry, whether any of the supply or manufacture process can be handled in-house or by cooperating with competitors, and whether, and how quickly, innovation or technology may provide a solution.

Communicate

If a party in your supply chain is, or might be, adversely affected by the coronavirus outbreak, it may be useful to communicate early and often with everyone upstream and downstream from you, being mindful of course to consider your contractual and legal obligations (including confidentiality and acting in good faith). You may also want to contact others in your industry who may be facing similar problems. An upstream or downstream counterparty may be more willing to work with you and accommodate disruption if you avoid surprising them and are truthful in your communications. Consider consulting with counsel and other appropriate professionals to determine an appropriate communication strategy that protects your rights and is attentive to relevant responsibilities.

Review and revise

Even if your business may not be affected by the coronavirus outbreak, now may be a good time to consider whether your supply contracts and procedures are appropriate and up-to-date. Speak with counsel about whether your contracts adequately reflect your business requirements and how your supply chain operates. If there are specific issues or concerns – for example, how to handle supply chain disruption resulting from coronavirus – think carefully about how your business is or might be affected, what protections might be fair or sensible, how to allocate (and price) risk, and appropriate rights and remedies if bad things happen.

What’s next

If you cannot as a practical matter remedy the disruption to your supply chain, you may be forced to consider enforcing your rights through litigation or arbitration, perhaps internationally.  The sooner you contact your attorney about a potential legal action against the breaching party, the better prepared you will be to understand your remedies and how to respond to a supply chain breach in litigation, arbitration or a potential bankruptcy proceeding.

In addition, supply chain disruptions may trigger financial distress, insolvency or bankruptcy for various parties, which in turn may constrain rights and remedies you, as a creditor, may be able to pursue vis-à-vis upstream and downstream supply chain parties.[3]

Conclusion

Little is currently known about coronavirus, which reportedly is spreading quickly and has resulted in quarantines and other dramatic measures in order to try to minimize or isolate the epidemic. Coronavirus, and efforts to combat it, have however already started to affect global supply chains. Whether or not coronavirus might directly affect your business, nevertheless you may wish to consider what such an event could do to your supply chain, including insolvency or bankruptcy, and how it could impact your contractual and legal rights and obligations.


[1] See, for example, Mike Bird, “Coronavirus Quarantine Will Ripple Through Global Manufacturing” appearing in The Wall Street Journal January 31, 2020: “As the spread of the new coronavirus in China causes more factory shutdowns, the effect on global industrial supply chains could linger for years. … The current lockdown is of a scale beyond either SARS, floods in Thailand or the earthquakes in Japan. China’s industrial heft leaves global manufacturers in a quandary with no obvious parallel, even with shutdowns only just beginning. The impact may be felt for years to come.” A subsequent article in The Wall Street Journal dated February 14, 2020 (Ben Foldy and Eric Sylvers, “Coronavirus Creates Domino Effect in Global Automotive Supply Chain”) reports that Fiat Chrysler is temporarily halting production at a factory in Europe because it cannot obtain parts from China, and there may be production outages at two major General Motors factories in the United States because of shortages of certain parts sourced from China. More recently, stock markets globally have sold off quickly on fears relating in no small part to coronavirus, with the International Monetary Fund indicating it was downgrading its global growth projections (Akane Otani and Caitlin Ostroff, “Dow Industrials Fall More Than 900 Points,” The Wall Street Journal dated February 25, 2020).

[2] Depending on your supply agreement and other relevant facts and circumstances, you will want to track any additional expenses in case you have an opportunity to claim back against the original upstream supplier.

[3] As but one example, the filing of a bankruptcy petition under the United States Bankruptcy Code triggers the automatic stay which, inter alia, prevents parties from taking any action against the debtor in bankruptcy or its property without bankruptcy court approval.


Douglas Schneller handles a broad range of complex transactional matters involving bank finance and lending; restructuring, bankruptcy and insolvency; inter-creditor and subordination arrangements, including for mezzanine, leveraged, multi-lien and unitranche financings; claims analysis and reconciliation; and purchases and sales of par and distressed assets such as bank loans, notes, accounts receivable, trade claims, bankruptcy claims, and equity interests. Read more about Douglas.

Phillip Wang practices in the areas of commercial litigation, bankruptcy, creditors' rights, and real estate, in the San Francisco and Silicon Valley offices of Rimon. Mr. Wang’s commercial litigation practice focuses on representing companies and individuals in complex business disputes including prosecuting and defending litigation of commercial contracts, intellectual property, real estate and related matters in federal and state courts. Read more about Phillip.

 

Nothing contained herein is to be considered as the rendering of legal advice for specific cases or circumstances. The material herein is intended for educational and informational purposes only.