Tighten Contracts ahead of Supply Chain Delays

Between pandemic effects, the economy, the possibility of a railroad strike and a shortage of chassis in the trucking industry, businesses are likely to experience continued supply chain issues impacting their ability to deliver products and services on time and within budget.

Because delays put them at risk for breach of contract, companies who supply goods and services — and who are themselves dependent upon supplied goods and services — should consider adding or updating language in their contracts to address circumstances beyond their control. Some companies did this during the pandemic, while others did so when tariffs affected manufacturing and created scarcity of materials — but in many cases it is standard language that doesn’t fully address their needs.

One size doesn’t fit all. To minimize lawsuits and liability, companies must tighten their contracts by tailoring them to their individual business conditions.

Think beyond the Boilerplate

Many contracts include a force majeure clause, which outlines limited circumstances when parties may be excused from fulfilling the contract — typically “acts of God” like natural disasters, inclement weather, riots and war. Although most force majeure clauses don’t contain language addressing tariffs, shortages and pandemics, businesses should include them. Unless they have an acknowledged excuse in the contract that they can point to for suspending their performance, companies can be found in breach for failure to deliver as promised.

Consider Two Key Provisions

Proactively identifying potential obstacles and addressing them in the contract provides both parties with a clear understanding of the timeline and consequences for not meeting it. Liability can be addressed in two ways:

Time is of the essence: A “time is of the essence” statement outlines the importance of receiving goods or services by a certain delivery date, while also listing the consequences for breaching the contract. Time is of the essence provisions are common in many industries, especially construction and manufacturing. Homebuyers and commercial tenants expect to move in by a certain date, and a delay will cause the new owner to pay out of pocket to extend a lease and incur an unplanned rent expense or much worse. 

Companies relying on goods or professional services like website design where a delay impedes business should likewise insert a “time is of the essence” clause in their contracts. However, clauses that are too broad can be difficult to enforce in court. Identifying key milestones or tasks and tying them to specific completion dates strengthens a company’s chances of prevailing.

Liquidated damages: In a liquidated damages clause, parties agree in advance for a set amount of money or calculation to quantify what the damages are when a product or service isn’t delivered. Such an agreement is best when estimating the true measure of damage is difficult. 

For example, a retail store having tenant improvements done before opening doesn’t have receipts or data to quantify lost revenue when a construction delay prevents it from opening. Agreeing to a daily damage rate eliminates the need for running formulas to prove the literal amount of catastrophic loss. 

However, liquidated damages are not a penalty; there must be correlation to the loss for the court to rule in a party’s favor.

Crisis-Proof the Company

Besides updating their contracts, business can take several actions to diminish the impact supply chain delays have on their bottom lines.

Obtain and carry business interruption insurance. Also known as contingent business interruption coverage or business income coverage, such policies provide compensation for revenue losses. Carriers may have exculpatory exclusions or require it be on a separate rider with an additional premium, but it can help cover operating expenses. Many insurance carriers offer business interruption insurance. Costs vary by industry, size of the company and location, but it can be a lifesaver.

Get ahead of difficulty. Companies able to anticipate orders and workflow accurately are in a better position to make decisions about how much inventory to carry. Conscientiously staying on top of business data like volume, flow and lead times allows them to predict what they’ll need.

Develop relationships with back-up vendors. Every company has its preferred vendors, but getting to know competitors provides companies with options so they aren’t scrambling when one cannot provide needed items.

Explore domestic options for manufacturing. China’s zero-COVID-19 policies halted production for a time and the war in Ukraine likewise caused manufacturing shutdowns. Acquiring more domestically reduces dependence on foreign goods while boosting America’s economy.

Many materials will be scarce in coming months, driving prices up and creating delays. Companies that proactively address such circumstances in their contracts and actively plan for contingencies will weather the storm best.  

A seasoned litigator, arbitrator and founding member of Guidant Law Firm, Gary Smith focuses on commercial matters, construction, real estate, cannabis and psychedelics law. He is also the author of several books and manuals on contracting and construction law, including The Orange Book: The Regulation of Arizona Contractors, 2nd Ed.

Did You Know: The U.S. transportation system moves a daily average of about 55.2 million tons of freight valued at more than $54.0 billion. (Source: The U.S. Department of Transportation Bureau of Transportation Statistics)