Lessons from the crisis – modeling contracts for the future

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The COVID-19-pandemic has revealed weaknesses in many contracts, as often the agreements do not contain sufficient provisions to deal with such a rare situation. Companies should close these gaps now to prepare themselves for potential future crises.
The coronavirus hit the economy across all industries with unexpected force. Many companies were facing the same problems: ordered material was suddenly no longer available because entire plants were closed by suppliers or material from abroad no longer made it into the country. Major projects were interrupted or even completely suspended.

Many contracts showed significant gaps
Whether it was “only” a matter of time delays or whether orders could no longer be fulfilled at all, the irregularities were quickly followed by the question of liability. An inspection of the legal paperwork often caused a rude awakening: In many cases the underlying contracts contained no regulations on how to deal with Corona-related incidents.

Force majeure clauses
With the onset of the Corona crisis, the term “force majeure” was suddenly on everyone’s lips. But until this year contractual regulations on how to deal with such an event were far from being standard in average supply contracts.
Those lacunas can lead to friction between parties if unforeseen events occur, since German law only provides a fragmentary definition of what is actually meant by “force majeure” and what applies if a contractual duty can no longer be fulfilled due to such events.
Over the course of time, the German courts have developed categories in which force majeure can regularly be assumed and the outbreak of a global pandemic such as COVID-19 may fall under those categories. However, those decisions were primarily held for travel law, but not for typical supply or procurement contracts.
For such supply or procurement contracts, there is no automatic effect stating that with the occurrence of a force majeure event, the parties of the contract must no longer comply with their contractual obligations. Whether the parties have “done their duty” in view of the special situation or not rather depends on the content of the overall agreement between the parties (including the wording of a written contract, but also other circumstances which may be relevant to evaluate the primary intentions of the parties).
German law only provides general regulations on the consequences if the fulfilment of a contractual obligation has become (factually or legally) impossible, while also providing general regulations on how to deal with a drastic change of the circumstances which the parties considered to be the basis for their agreement. However, the outcome of the application of these rules may not be expedient for every business and may even be contrary to the solution the parties might have chosen, if they had foreseen the event in question.
To avoid this uncertainty in already uncertain times, it is therefore advisable to include a well-balanced force majeure clause in the contract. Such a clause should include an exemplary (but preferably not exhaustive) definition of which events will be considered as force majeure and how the occurrence of such events will affect the mutual contractual obligations of the parties.

No force majeure in case of foreseeable obstacles
In this context it is important to note that force majeure can only be invoked if the event in question was unforeseeable at the time of conclusion of the contract. If, however, it was already apparent at that time that delivery problems may arise due to certain circumstances, the parties should include a separate regulation regarding the effects of such a foreseeable event. Regarding COVID-19 – and especially the possibility of a “second wave” – this means that the consequences of potential new restrictions or delivery shortages should be dealt with by implementing special “corona clauses” in the contract.

Not only relevant in a crisis: Clear rules regarding delivery obligations
A phenomenon which is frequently encountered in long-term business relationships without a clear contractual basis is the lack of clear regulation about the extent to which the supplier is obliged to accept orders from the buyer or if and to what extent the buyer must order goods from the supplier during the term of the contract.
Thus, it may turn out that, contrary to expectations of the other party, a long-term supplier is not obliged to continue to supply ordered goods, or a buyer who consistently ordered a certain number of products in the past may be able to stop placing orders under the contract from one day to another. On the other hand, it is possible that either suppliers or customers can still insist on the fulfilment of concluded contracts, even if the general conditions have changed in such a way that the execution has become unprofitable for the other party.
If in such cases there is no binding framework agreement with clear rules, the legal assessment is complex and can depend on many different circumstances. Clear contractual provisions help provide legal certainty in this field.

Diversity pays off – strengthening the supply chain
While long-term (and perhaps even exclusive) supply relationships have often promised security and stability in the past, COVID-19 has also shown that it can be risky to rely on only one or a few suppliers. Also, regarding the term of the contract, the planning security that comes with long-term contracts should be carefully weighed against the advantages of being able to switch to other suppliers at short notice in the event of a crisis.

“Just in time” is not always “just right”
Also, the concept of just in time delivery of material has shown its “dark sides” in light of the crisis. The delivery of required material right before it is processed further is attractive for companies who cannot or do not want to maintain big warehouses (i.e. for logistical reasons or for the sake of liquidity and an overall lower capital commitment). However, external events that lead to delays may have serious consequences in tightly scheduled supply chains.
An appropriate stockpile of materials can be helpful in this regard. The capital commitment usually required for this approach can be reduced by establishing consignment warehouses. In this scenario the supplier sets up a warehouse at the customer’s site from which the customer can cover his demands. The goods in the warehouse remain the property of the supplier, only a purchase contract is concluded, and ownership of the goods is only transferred when the goods are removed from the warehouse.

Editor’s note:
To help companies assess which aspects of their individual contracts may need to be revised in the future, CMS has developed the free Corona Quick Check Verträge. By completing two online questionnaires (in German language)

Ulrich.becker@cms-hs.com

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