Managing risk in supply chain contracts

Last updated: 3 November 2021

Estimated reading time: 10 minutes

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The logistics of manufacturing and transporting goods and component parts during a global supply chain crisis, fuelled by rises in petrol prices and raw materials, a shortage of HGV drivers and the introduction of new trading regulations and immigration controls after Brexit, is a massive headache for UK business owners. With the potential for the ‘blame game’ in vertical supply chain contracts for failure to meet delivery schedules, commercial solicitors emphasise that your business needs to protect itself by checking whether your supply chain contracts remain fit for purpose or if they expose your company to potential commercial disputes. The risk of which could be minimised by new contracts or commercial contract reviews.

Topics we discuss:

  1. The supply chain contract
  2. Supply chain risk
  3. Due diligence in the supply chain
  4. Managing risk through specialist supply chain contracts
  5. Reviewing your supply chain contracts
  6. Commercial contract clauses to review in a supply chain contract
  7. Tips on managing risk in supply chain contracts

The supply chain contract

Our commercial contract dispute solicitors often deal with requests for legal advice on supply chain contract topics such as:

  • Can a transport company escape a supply chain contract that is no longer economic to fulfil for a transport company because of the sudden rise in salaries for HGV drivers and rapid increase in petrol prices?
  • Can a manufacturer sue their sub-contractor as the company has not met an agreed delivery timescale resulting in the manufacturer being in breach of their sales contract with a retailer?
  • Can a company terminate a contract for non-performance when the fault lies with the supply of goods rather than their quality?
  • Can a retailer claim reputational damage and consequent loss from a manufacturer or supplier as failure to supply goods to the end consumer has led to complaints and refunds?

Whether your company is a start-up, a well-established retail brand or is at the top or bottom of a vertical supply chain contract chain, it is essential that you have a specialist commercial solicitor on board to ensure that your business is not the one ‘holding the can’ for all the supply chain issues. Especially as others in the vertical supply chain will have ensured their contracts review clauses, termination clauses and liability limitation clauses all worked in their favour. In today’s economic climate it is more important than ever that your supply chain contracts plan for the worst, whilst of course hoping for the best.

For more information on vertical agreements read our article: Horizontal and vertical agreements.

Supply chain risk

Gone are the days when a company could contract with another company to supply or deliver goods and ignore any associated legal or reputational risks. When it comes to supply chain contracts, price is not always the determining factor of who wins a tender or gets the contract or at least. In the opinion of commercial solicitors, choosing the cheapest supplier or haulier may actually increase your risk of commercial litigation through contract disputes, ultimately costing your business more and damaging your reputation with a manufacturer further up in the supply chain or with the end consumer.

Supply chain risk factors include:

Risk factorIssues
GovernanceAny hint of bribery, corruption or tax evasive practices can not only result in investigation that damages your supply chain but can also risk your reputation, even if you are only part of the supply chain and not directly concerned in the governance issue.
Data protection and confidentialityIt is inevitable that those in a supply chain need to share data but contractors may not be as diligent as your company in complying with data protection, client confidentiality, cybersecurity and GDPR. This can lead to breaches of data protection legislation that may not affect your business in terms of non-compliance with GDPR but will cause reputational damage to your company if your business is associated in the media to a data breach.
Treatment of supply chain workforceHowever far removed your company may be in a vertical contract supply chain your business can still be affected if a supplier or carrier fails to treat their work force properly. Examples include:

  • Failing to pay the national minimum wage

  • Allowing HGV drivers to work beyond permitted hours

  • Not complying with illegal working legislation or the Modern Slavery Act 2015

  • Discriminating against some workers in contravention of The Equality Act 2010
  • The environmentIf your business has a unique selling point, for example, being environmentally friendly or committed to animal welfare, it is important that those in the supply chain are equally committed to those principles and will adhere to the same standards that you have introduced within your own business. Failure to address environmental issues in the supply chain can create significant damage to your brand.

    Due diligence in the supply chain

    Commercial solicitors say that putting the time in with due diligence prior to the signing of commercial contracts significantly reduces supply chain break down and, just as importantly, the potential for commercial litigation over supply chain disputes. Requiring contractors to complete due diligence questionnaires so that your business knows its supply chain in the same way as you ‘know your client’ should be one element of the due diligence procurement process, as well as ensuring that potential business partners fully understand the environmental or other standards they will need to work to if involved in your supply chain. Understanding the standards expected of them ensures they can properly tender for the work or correctly price the contract.

    Managing risk through specialist supply chain contracts

    The management of risk, after the due diligence phase, includes ensuring that your supply chain contracts limit your risks (whether those are legal or reputational) and your liabilities. Examples of clauses that can help manage supply chain risks include:

    Contractual clauseComments
    The supplier must comply with any industry specific regulations and legislation and, where relevant, must maintain membership of an industry professional body and comply with training regimesIf the supplier fails to comply with these requirements, you could include this as a reason for you to have the right to terminate the contract. If your business is being asked to commit to enhanced standards, beyond the industry norm, this may involve additional contract negotiation.
    The supplier must maintain insurance cover at a specified levelInsurance will not cover every risk and a contracting party may want to include a force majeure clause so that a contracting party is not liable for forces outside its control.
    Confidentiality clauseConfidentiality can be maintained through a confidentiality clause or a separate non-disclosure agreement.
    Data protectionA data protection clause emphasises the importance of a contracting party complying with GDPR, not only in relation to the legislation but the potential for the termination of the contract or penalties.
    Use of sub-contractorsYour business may want to specify that the contracting party should only sub-contract with sub-contractors approved by you or who are members of a recognised industry body. If you are being asked to commit to this type of agreement it could affect profit margins if your hands are tied on your choice of sub-contractor. One way to minimise risk is to include a list of pre-agreed sub-contractors. Where sub-contractors are likely to be used, you may want to include a requirement for flow down provisions so each sub-contractor is bound by the same conditions and adherence to standards.
    Audit provisionsAudit provisions help manage risk by those in the vertical contract regime being clear that their performance is being monitored in accordance with agreed standards, key performance indicators and the consequences of non-compliance with the contractual standards.
    Review provisionsAny supply chain contract should include review provisions that are industry specific.

    For reasons why you should review your commercial contracts read our article: Why you should regularly update your commercial contracts.
    Termination clauseThe termination clause needs to consider if a supplier can terminate for breach of contract or if there are scenarios where a contracting party can be allowed to remedy their breach of contract. In some scenarios you may want to include provision for immediate termination of contract. Any termination clauses need to consider, on an industry specific basis, difficulties in securing alternate suppliers or carriage of goods and the importance of continuity of business until alternatives can be organised.

    For more information read our article: Can you terminate a commercial contract?
    Dispute resolutionWith an increased risk of commercial contract disputes due to the global supply chain crisis it is essential to be proactive in managing disputes to try to reach a quick and cost-effective resolution. Including a requirement for supply chain disputes to be referred to commercial arbitration is one solution.

    For more information on commercial arbitration read our article: Is arbitration preferable in a business dispute? Alternatively, take a look at commercial mediation as an alternate dispute resolution option and read our article: Your guide to commercial mediation.

    Reviewing your supply chain contracts

    It can take petrol shortages, motorway demonstrations and threats of port blockades for a company to realise just how exposed they are to protracted and expensive commercial supply chain litigation. No commercial litigation solicitor would suggest that a review of a supply chain contract will eradicate all risk but you may be able to minimise your risk, shift the risk and liability to your sub-contractor or review your level of insurance cover or your participation in a market that is too high risk for the level of remuneration and reward.

    Whilst reviewing a supply chain contract may appear to be a job of a commercial solicitor the reality is that a joined-up approach is needed with industry specific accountancy, financial and legal advice. This is because there may be a need to trigger a termination clause in an existing commercial contract rather than review and rewrite an existing commercial contract. For example, you can’t reliably get the component parts to make a certain widget and your manufacturing arm is therefore better focussed on making those items where there is greater profitability combined with better supply chain certainty of component parts.

    Commercial contract clauses to review in a supply chain contract

    Depending on where you are in the vertical supply chain it is critical that you regularly review the following clauses in any supply chain contract:

    Supply chain review clausesRationale
    The partiesDoes the supply chain contract allow for subcontracting the manufacture or transportation of goods to a third-party company? Are there any safe guards in place such as prior approval of sub-contractors?
    The priceIf you can’t make money creating widgets or in transporting them on behalf of the manufacturer to the retailer then can the price be reviewed under the contractual terms? If not, can the contract be terminated and a new one negotiated? If the price can’t be renegotiated can other clauses be reviewed to make the commercial contract economic to continue, such as extending the delivery timescale?
    DeadlinesDoes the contract specify deadlines and the penalties and price rebates for missing them? Should the contract be expressed as using ‘best endeavours’ or best efforts to meet deadlines? A case in point that received much publicity is the Astra Zeneca contract with the EU to deliver COVID-19 vaccines.
    Liability and exclusionsShould liability for failure to comply with deadlines be limited or exclusions for events outside the contractors control be excluded.
    Commercial dispute resolutionAs commercial disputes over supply chain contracts are on the increase it is best to look at commercial contract dispute resolution options and to include those in the contract. For example, arbitration can be a quicker and less expensive means of resolving supply chain disputes.
    Contract review provisionsDoes the supply chain contract provide for reviews and, if so, do the review provisions need to be updated to reflect the current supply chain disrupters, such as petrol shortages or port or motorway blockades.
    Contract terminationIn some situations, a contractor will want to terminate a contract whereas the manufacturer or retailor will want the supply contract to remain in force as they know the price set or current supply deadlines would not be achievable with another contractor. That is why it is important to ensure that termination of contract clauses is carefully considered from your business sector and your company perspective.

    Tips on managing risk in supply chain contracts

    In an ideal world you’ll dot the i’s and cross the t’s from the outset, but often reusing old contracts or relying on email conversations to avoid lengthy negotiations seems the easiest way to move forward. Whether this rings true for your business or not, following these tips will help you reduce the potential risks in your supply chain contracts:   

    1. Be proactive – do not wait until a supply chain problem occurs. If you know that there are manufacturing or transport issues further up the vertical agreements in your supply chain do not wait to address them until they are adversely affecting your manufacture or retail or transportation of goods.
    2. Talk to your commercial solicitor – there is often a reluctance to talk to a commercial solicitor until there is a full-blown commercial dispute and letters before action. Taking early commercial legal advice can avoid expensive litigation through contract review or negotiation.
    3. Give supply chain contract reviews the priority they deserve – often once a contract has been signed there is a tendency to put the contract in a draw or file it on the computer until the contract is formally up for renewal or is reaching its end date. Reviewing contracts proactively can nip problems in the bud, so don’t wait for formal review dates or contract review triggers but look ahead. A commercial solicitor can help you with this. For example, by looking at new potential regulations or legislation or environmental or social awareness issues that may influence your supply chain contracts.
    4. Evolution happens – whether it is Brexit, changes to business immigration and the end of free movement for EU nationals, a global pandemic, a supply chain crisis or something more mundane, the best commercial contractual terms for your business will change and you need to have the internal and external personnel as well as the systems in place to react to it and evolve with the times.

    For more reading on commercial law and related supply chain and review issues we recommend you also read:

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    What next?

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