Author(s):
Andraya Frith, Simon Hodgett, Alan Kenigsberg, Paul Morassutti, Richard M. Borins, Kelly O’Ferrall, Natalie Munroe, Peter Glossop
May 12, 2020
This update provides answers to commonly asked questions to help address the broad range of legal and business issues that companies should consider when assessing and responding to the immediate supply chain impact of COVID-19, as well as when developing a longer range strategy for sourcing supplies and delivering goods and services to end user customers.
Introduction
Traditional supply chains have been disrupted by the dramatic and unpredictable changes in consumer demand and behaviours driven by the COVID-19 pandemic, labour shortages in key sectors, particularly Canada’s food and farming sectors (that latter relying heavily on temporary foreign workers), as well as export restrictions and other protectionist policies introduced by some of Canada’s largest trading partners. In addition, the day-to-day operations and production levels of manufacturers, suppliers and distributors have been impacted to varying degrees by physical distancing rules and enhanced sanitation measures, not to mention recent COVID-19 outbreaks at several Canadian and U.S. meat packing plants raising the spectre of food supply shortages and increased prices.
Some suppliers and manufacturers have been forced to pivot their own business models as their traditional customers have shuttered operations and grocery chains and other food retailers have bolstered their ecommerce channel to meet increased consumer demand. For example, Sysco Canada, the country’s largest supplier to the hard-hit restaurant and hotel industries, has launched an online bulk grocery platform to sell products directly to household consumers for the first time in its history. Grocery retailers will face different competition and suppliers to the grocery channel will need to adjust their marketing and promotion strategies to capture the new online consumer.
While Canadian health authorities in several provinces are beginning to report positive results in response to collective efforts to “flatten the curve” and some provinces are starting to outline plans to reopen businesses, the Canadian and global economies remain largely in “lock-down” and the timeline and path forward remain uncertain. Government leaders around the world are cautioning their citizens that the lifting of current restrictions will be gradual and any reopening of the economy will be slow and staged. This necessarily cautious approach to planning the next phase of the global response to the pandemic, which includes ongoing risk assessment and the possibility of second and third waves of the virus, means that businesses must plan beyond the acute phase of the pandemic and begin to reassess their intermediate and long term supply chain strategies.
Our recent work with clients shows that addressing and monitoring both actual and anticipated disruptions of the supply chain requires a multi-pronged and multi-disciplinary approach. Most enterprises rely on a network of upstream and downstream collaborators or supply arrangements to carry out their business. These collaborations have been set out in contracts with varying degrees of rigor. In the current crisis, performance under these contracts may have failed entirely, been temporarily reduced or adjusted to accommodate new realities. Clients face questions of how to address allocation of cost and liability for failed contracts, how to replace or reestablish supply, or how to deal with contracts that no longer align with the current facts and actual practices.
This Update provides answers to commonly asked questions to help address the broad range of legal and business issues that companies should consider when assessing and responding to the immediate supply chain impact of the pandemic, as well as when developing a longer range strategy for sourcing supplies and delivering goods and services to end user customers.
Contract Issues
Can force majeure clauses be relied upon to excuse non-performance under a supply agreement?
- Force majeure is a concept that only applies if there is a force majeure provision in the agreement (except in the province of Québec where there is a right independent of contract).
- Affected businesses should review the contractual obligation disrupted to determine if the event qualifies as a force majeure event. Clauses often list qualifying events, which may be exclusive and determinative, or might instead state a general principle such as events “beyond the reasonable control” of the party and then provide a list of specific examples.
- In the case of the COVID-19 pandemic, while the existence of the illness in the community is the root cause, it is the inability to staff businesses and government restrictions that most often are the actual blocking events.
- Consider whether there are any requirements to invoke the force majeure clause and whether there are limitations as to how long the excused non-performance can exist (many clauses have termination rights if the service or other supply is not reinstated in a specified time).
Below are additional Osler resources:
What terms in a contract are relevant when considering performance impacts of COVID-19?
- The most commonly affected provisions include:
- timing of delivery commitments (this is true of both contracts for tangible goods and contracts for service with deadlines for project milestones)
- commitments relating to volume of goods delivered or available
- staffing commitments
- designations related to location of service delivery
- payment provisions (i.e., disruption of the ability to pay)
- provisions sensitive to changes in law (in some cases, emergency legislation has upended the business models upon which the contracts are based)
- In addition, terms in the contract related to quality controls and controls on how services are provided should be reviewed. For example, service levels and security and product safety commitments may suffer. Ensuring compliance with performance and quality requirements continues to be vital to avoid or mitigate lapses.
How do we preserve our rights if a supply chain member has breached its contract?
- In normal circumstances a failure by a supplier will likely have some element of fault associated with it. That may not be the case where a failure arises in the current context of the COVID-19 pandemic where disruption is widespread and largely uncontrollable.
- It is usually preferable to adjust contracts through negotiation to allow the parties to preserve as much business value as possible rather than merely demanding performance where such demands are unlikely to net results.
- Consider establishing “without prejudice” discussions to allow more open discussion of whether the contract needs to be adjusted or a party needs to prepare itself for future contract failure. It is important that these discussions be without prejudice to the parties’ respective rights and focus on mitigating future breaches while not giving up the ability to seek redress for past breaches (or, if you are the breaching party, not having these discussions come back as admissions of liability later).
- Be aware that if a contract is amended non-compliance may be repaired. For example, if a delivery date is revised, the party late with delivery will likely be excused from compensating for losses for that commitment since it will now be in conformity with the new amended contract.
Our supplier is not an essential business under emergency legislation - what impacts can we expect?
- If your supplier is not on a relevant list of essential services, in most jurisdictions in Canada it will be subject to closure or work at home requirements. Whether this constitutes an excuse under the contract depends on whether a force majeure clause is present in the contract and whether it is effective in the circumstances. There are also less easily accessed doctrines excusing non-performance - impossibility and frustration of contract – which may apply.
- Being unable able to perform a contract does not necessarily resolve the question of who should bear losses associated with such non-performance. Breach of contract is not a fault-based concept, and there does not have to be intentional or even careless performance in order to be allocated liability for failing to perform under the contract.
Below are additional Osler resources:
What are the best practices for sorting through and reviewing contracts related to our supply chain?
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Generally, and especially in the current crisis, there are limited resources to undertake reviews of potentially thousands of contracts in a complex organization -- at least not in a timeframe that is likely to be practically useful. Priority setting is essential and involves the factors illustrated by the following simple matrix:
An organization generally knows its highest impact contracts and these are generally subject to the most rigorous negotiation with the most careful monitoring of performance. Some contracts, however, are high impact and are based on less than ideal forms, were negotiated in a less than rigorous fashion or negotiated from a position of weakness. These may represent significant risk, but lack significant safeguards.
These high risk/high impact contracts are the highest priority, since they are the most likely to result in material business disruption with little recourse.
Helpful Tools
Are you overwhelmed by the volume of contract review resulting from supply chain disruption? Here’s how Osler can help streamline this process using our expertise and technology:
- Our legal document review experts at Osler Works – Transactional (OWT) have extensive experience reviewing provisions and documents using market leading AI technology to efficiently identify and report on force majeure and related clauses in your supply chain contracts.
- Your easy to understand report from OWT will provide a summary and clearly show where force majeure and other relevant clauses appear across your supply contract portfolio. You also have the ability to drill down and use filters to select specific areas of focus, review relevant sections of your contracts and compare across your portfolio.
- OWT provides an end-to-end solution by leveraging our expertise and partnering with our supply chain experts to provide actionable recommendations to reduce your exposure in a timely fashion.
Managing and Financing Inventory
What impact will the COVID-19 pandemic have on our global supply chain?
- Increased logistical challenges created by relying on international supply chains coupled with a heightened consumer awareness of the source of goods and supplies, exacerbated by a call from some government leaders to “source at home,” has resulted in some economists predicting a shift away from global supply chains and just-in-time inventories towards a greater reliance on a diversified and domestic portfolio of suppliers.
How should we adjust our supply chain protocols to address product shortages experienced during the COVID-19 pandemic as a result of “panic buying”?
- To address panic buying surges, a “just in time” protocol may need to be replaced by “just in case” protocol – i.e., the usual 30-day amount of supply in the warehouse could be replaced by a 90-day supply to prevent shortages of product. However, this will increase the need for warehousing capacity and inventory financing.
How will supply chains be impacted by the large increase in online shopping as a result of the pandemic considering that a significant amount of this increase is expected to remain?
- Warehousing was already in short supply in most Canadian urban centres and an increased volume of online shopping will exacerbate this problem. We expect that this increased demand will result in higher clear height buildings and multi-storey warehouse buildings. And higher rents, so higher costs as well.
How can we alleviate our need for increased warehousing, at least during times when warehouse space is simply not available?
- During the pandemic, some retail stores that had been shuttered were converted into mini-fulfilment centres. This could assist in “last mile” distribution centres, especially in downtown areas of urban centres. However, this will likely be a short-term fix, as the rent for such retail premises would be much more expensive than warehousing.
How will disruptions in inventory levels affect lending and borrowing?
- Having stockpiles on hand will come at a premium as businesses will face higher inventory financing and increased warehousing costs.
- Disruptions in inventory levels can have an impact on borrowing bases in your credit facilities and may also result in covenant or other credit agreement breaches requiring either amendments (in advance) or waivers (after the fact).
- Also consider whether suppliers should be taking new or different security from their customers such as purchase money security interests (PMSIs).
Customs & Importation
Is the Canada Border Services Agency requiring that goods imported into Canada be quarantined for a period of time?
- At this time, Canada is not imposing any customs delays on commercially imported goods.
Has Canada provided any tax relief for the importation of goods into Canada?
- Imported goods by businesses are generally subject to the GST, at a rate of 5%, as well as applicable customs duties, which vary by product and country of origin. The Canadian government announced on March 27, 2020, that it has deferred to June 30, 2020, the payment deadlines for statements of accounts for March, April and May. As such, the payment of duties and GST on goods imported in these months will generally not be due until at least June 30, 2020.
Competition
Is it illegal to work with our competitors to implement supply chain efficiencies during the COVID-19 crisis?
- No. The Competition Bureau has said that so long as competitors are collaborating in the short term to respond to the crisis, in good faith, and are not collaborating further than what is needed, it will generally refrain from considering enforcement action under Canada’s Competition Act.
Are some areas of collaboration more risky than others?
- Yes. Collaborations that simply use the crisis as an excuse to fix selling prices, reduce production or allocate markets or customers can still be subject to criminal prosecution. They would not be protected by the Bureau’s restrained enforcement approach during the crisis. Collaborations that involve procurement efficiencies are much less likely to be a problem. Collaborations that involve firms that are not competitors would not be captured by the collusion provisions of the Competition Act.
How can we be sure our collaboration will not be offside the Competition Act?
- You can ask for an opinion from knowledgeable competition counsel, ask your counsel to seek guidance from the Competition Bureau, or do both. However, the Bureau is under no obligation to respond according to a specific timeline and its guidance may be subject to conditions, including a time limitation on how long the participants can collaborate and the possibility of public disclosure.
- In a policy statement issued on April 8, 2020, the Commissioner of Competition acknowledged the extraordinary circumstances of the COVID-19 pandemic and advised businesses that the Bureau would be unlikely to challenge good faith efforts at competitor collaboration that were aimed at responding to the crisis and meeting the essential needs of Canadians. Find out more information about the Commissioner’s statement in our blog post entitled “Competition compliance during the COVID-19 crisis: Price-gouging, deceptive marketing and collusion.”
Employment
What are the effects of employment and occupational health and safety laws on supply chain performance?
- Due to economic circumstances, many employers have had no choice but to layoff or downsize their workforces as a result of the impact the COVID-19 pandemic has had on their businesses.
- As businesses slowly begin to reopen, employers will have to keep in mind their obligation to provide employees with a safe workplace to return to. For the foreseeable future, providing a safe workplace will likely require that employers implement physical distancing measures and, in some cases, measures to reduce the number of employees in the physical workplace as outlined in Osler’s The Employer’s COVID-19 Return to the Workplace Playbook.
As a result of having fewer employees in the physical workplace, it may be difficult for suppliers in certain industries to meet surges in demand as quarantine restrictions ease and consumers re-enter the marketplace. One trend we expect to see increasingly for businesses that reopen, is the engagement of temporary employees to assist with surges in demand and to increase agility in the event of a second wave of the pandemic.
Business Continuity Planning
What should be our approach to business continuity planning?
Business continuity planning has long been a feature for “always on” technology services. These generally were driven by the ever present threat of cybersecurity attacks and the historically relatively high rate of failure of components of IT infrastructure. Sophisticated enterprises, such as financial institutions, utilities and health care institutions, have historically engaged in thorough business continuity planning. Such plans anticipate various types of disaster scenarios and in some cases include mock disaster exercises simulating the most likely or most disruptive events.
Now is the time for wider application of business continuity planning anticipating the various types of disruptions that may occur in the coming months as commerce and essential services continue under the shadow of the COVID-19 pandemic.
With respect to supply chain measures, include the following in your planning:
- Reviewing contracts with suppliers to understand which have business continuity plan obligations and where there are contractual gaps, whether due to inadequate contractual language or the absence of any relevant terms;
- Checking in with suppliers as to whether they are operating under business continuity plans currently or anticipate invoking their plans under the current pandemic disruptions, including by asking pointed questions regarding availability of resources and personnel required to continue to perform and maintain the supply of goods and services;
- Consider augmenting the plans or requesting improvements that take into account the anticipated effects of the COVID-19 pandemic, restrictions on operations anticipated during upcoming relaxation of emergency closures and disruptions that may occur as a result of a potential resurgence of the pandemic in the coming months.