Cease to supply, cease to comply - The battle of early termination
Global supply chains have experienced turmoil over the last two years in the face of a global pandemic, Brexit and now most recently with a war on European soil. With prices soaring and supply chains disrupted by the impact of these events, many businesses find themselves struggling to supply the demand of their customers which poses a real commercial threat to the viability of their contracts.
Whether struggling to meet demand due to labour deficiencies or experiencing reduced profit margins as a result of rising fuel and material costs, in many cases it may no longer be commercially viable to continue with contracts to supply. As a result of these unprecedented circumstances, businesses are now reviewing their contracts to clarify their position around ceasing to supply.
However, if the contract does not allow for early termination, a party may risk being in breach of the contract and could face legal proceedings should they cease to supply.
Terminating the contract
Many contracts to supply are governed by terms and conditions which can be particularly onerous and one-sided if not carefully negotiated or considered.
Standard terms and conditions of supply should include termination clauses which allow the parties to terminate the contract in particular circumstances. These will often include, but are not limited to:
- Material breach
- A party in financial difficulty e.g. administration, liquidation, winding up etc.
- Suspending or ceasing to carry on all or a substantial part of business
- Financial jeopardy impacting performance
So what happens if you don't reach these typical criteria?
There may be exceptional circumstances, when termination can be achieved by other means.
A contract may contain a force majeure clause which enables one or both parties to be excused from their contractual obligations following the occurrence of an event outside of the parties' control. In such circumstances, that party may not be liable for a breach of contract.
The events included within a force majeure clause are subject to agreement between the parties but can generally include for example an act of God, flood, drought, earthquake, natural disaster; epidemic or pandemic; terrorist attack or war; imposition of sanctions; industrial action.
The COVID-19 pandemic and current events in Ukraine certainly raise the question of whether a force majeure clause can be relied upon if a contract is affected by such events. The key test to be applied is foreseeability which is often interpreted narrowly by the courts.
A contract may be terminated under the common law doctrine of frustration where the contract becomes impossible to perform. In such cases, the parties may be discharged from their contractual obligations following an event which makes it physically, legally or commercially impossible to perform them.
Frustration is a difficult argument to make and only provides means of termination in exceptional circumstances.
There are businesses that are struggling to supply the contracted amount due to supply chain disruption, lack of materials and rising manufacturing costs. In extreme cases, frustration could offer a means of terminating a contract but if it does not meet the threshold required, it could fall short and be deemed a breach.
The concept of illegality allows parties to be discharged from a contract if the performance of such becomes illegal by law. This was a particular issue during the COVID-19 pandemic when local governments enacted emergency legislation to control the waves of the pandemic which included the closing of retail, hospitality and other commercial premises. In such cases, the performance of some contracts would be deemed contrary to public policy and termination was therefore permitted.
The above termination events may not provide much relief to a party wishing to cease supply due to the commercial viability of continuing with the contract, e.g. if a contract is no longer profitable due to the hike in fuel and material costs.
Where there is no termination event allowing you to cease supply by any of the above means, ceasing supply could be deemed a breach of contract and expose your business to legal proceedings.
As global supply chains change and evolve in response to global events, it's crucial that as a business you ensure that you are well protected within the terms and conditions of supply upon which you contract with other parties. Have you considered your exit plan if things don't go to plan? Careful consideration should be given to the implications that those terms and conditions may have early in the negotiation stage to ensure that you are protected in the face of the unknown.
Although tricky to negotiate, more protective clauses for the supplier may become increasingly popular to respond to the ever-changing commercial landscape as we make our way out of the pandemic into a post-Brexit world and face both economic and physical conflict across Europe.
For further information in relation to this topic, please contact Ciaran McCorry, Associate or any member of ALG's Belfast Litigation and Disputes team.
Date published: 26 May 2022