🤿 Sunday Deep Dive: The Supply Chain Crisis & Legal
The global supply chain is like a Rube Goldberg machine. A ball slides down a chute and hits a lever which throws a hammer that switches on a fan that blows a million bits of paper into the air—kinda like this awesome Ok Go music video. In other words, it’s a carefully balanced system that relies on just enough arriving just in time. There isn’t much room for error and disruption can cause an almost endless string of knock-on effects.
There was a time when ‘supply chain’ wasn’t a phrase people brought up in casual conversation like the football score. That time is long gone. The fragility of it all has been thrown into stark focus in the last couple of years. National lockdowns around the world shuttered factories, held up transport systems, and lead to a ton of shortages. Some of those shortages were exacerbated by demand surges resulting from pent-up lockdown savings (e.g. couches, building materials, and cars) and social isolation (hello, sex toys). They even threatened to cancel Christmas.
But the pandemic is just one of many threats the global supply chain has faced in recent years. The U.S.-China trade war caused imports from China to fall by $87B dollars in 2019. When the container ship Ever Given got wedged in the Suez Canal last March, it held up 12% of global trade. Last year in the UK, a shortage of truck drivers caused petrol stations to run dry and Brexit has left trucks stuck at the border for days while logistics teams hack through red tape. As if things weren’t bad enough, Putin’s invasion of Ukraine is serving up a fresh helping of chaos which, aside from its horrifying direct impact, brings with it a heap of new supply chain challenges.
What do petrol, wheat, and electric scooters have in common?
There are supply chain challenges in almost every industry. Here are just 3 commodities causing major havoc:
Gas: You don’t need us to tell you that the price of gasoline hit record highs last month. One reason for this is that the crude oil price has rocketed as the global economy bounces back faster and better from COVID-19 than expected, creating some serious demand for oil. Another is that Russia, which accounts for about 10% of global oil production, is facing heavy sanctions. And since getting anything anywhere requires gas, pretty much everything is getting more expensive.
Fertilizer: The price of natural gas in Europe has been soaring for the past year but the Ukraine crisis has pushed it to a record-high. Natural gas is used in the production of nitrogen-based plant food which means that high prices threaten agriculture. On top of that, Russia and Ukraine account for 29% of global nitrogen-based plant food and Russia is a major exporter of other soil nutrients like potash and ammonia. Farmers on every continent are changing crops, cultivating less, and using less fertilizer which will impact the price of food. For consumers, it’s bye-bye, smashed avocado, hello, beans on toast.
Semiconductor chips: These electronic devices are inside everything from electric scooters to smartphones, cars, washing machines, and pacemakers. There’s a major shortage of these little guys caused by a bunch of factors including a boom in demand for laptops and webcams, lockdown factory closures, a rise in the cost of shipping, and the conflict between the U.S. and Huawei. Chipmakers are increasing capacity and new suppliers will emerge but things are likely to get worse before they get better. Before the invasion, Ukraine supplied half the world’s neon gas which is essential for the production of semiconductor chips. If you’re hoping for a new car or phone for Christmas, you might want to let Santa know now.
General Counsel to the rescue
Supply chains are front and center on many businesses’ agendas these days. In October, a survey of CEOs revealed that supply chain disruption is seen as the number one threat to growth. In Q3 earnings calls by Fortune 500 companies, mentions of ‘supply chain’ increased by 412%. Businesses that aren’t already experiencing delays, high production costs, quality management, and delivery shortfall are evaluating their risk exposure and trying to mitigate it.
Cue the in-house legal team! Executives are turning to legal to answer their questions and help them cope with messy breaches of contract.
Questions businesses are asking include:
What are our rights and obligations if our supplier fails us?
What exactly are the commitments in the contract in terms of quantity, quality, and delivery time?
Does the contract allow the supplier to adjust the price and if so under what conditions?
Are the commitments in the contract backed up by warranties?
Will our insurance provide coverage if we breach a contract, get sued, or face unprecedented costs?
Is there a business continuity clause?
Does the contract allow us to withhold payment or use different suppliers if necessary?
Should we litigate if suppliers fail us?
If our supplier is forced to reduce output, what allocation are we entitled to?
Here are 5 things legal teams can do to help businesses weather the storm:
1. Prepare a situation report.
Other teams in your business are likely taking time to predict potential problems and set up plans B and C. You can assist them and get ahead of some of the questions above by checking your business's contracts with key suppliers and/or customers. Identify pressure points and vulnerabilities and consider what actions the business could take in different scenarios.
2. Explain the pros and cons of litigation.
Enforcing contracts through litigation is not always the best solution. It’s expensive and it can be complicated, especially when dealing with partners in different jurisdictions. And although it may result in compensation, it often doesn’t solve the immediate problem—whether that’s a container of cat food stuck in the Suez or a 30% rise in the cost of wigs. In fact, litigating or refusing/delaying payment could create long-term beef with a supplier or even force them to go under, which is not ideal for anyone involved.
Alternatives to litigation include formal complaints, open discussions around risk and responsibility, and reworking contracts to allow for backup supply arrangements. Businesses can request service credits or liquidated damages as a gesture of goodwill.
3. Competition issues
In times of crisis, governments occasionally relax competition laws to allow companies to collaborate and ensure that consumers get the products they need. Last year, the UK government allowed some cooperation in the grocery sector to ensure that shops stayed supplied and also relaxed competition law for companies responding to COVID-19. French and European competition authorities made similar rulings.
If authorities in your businesses’ jurisdictions do relax competition laws for your sector, take the time to read the small print and make sure your business is compliant. Such rulings will usually be for a limited period and apply to very specific things. The goal is to help consumers and the economy get through an emergency, not to enrich your shareholders. When in doubt, reach out to the regulator for clarity and, if you can’t get an answer, err on the side of caution. It’s wise to keep a trail of all exceptional activities in case you do come under scrutiny.
4. Build back safer
Many businesses are looking for new suppliers. Some lost suppliers in the pandemic. Some want a backup option. Others are trying to diversify and onshore their supply chain (more on that later). Given the fragility of things right now, they’ll be wanting to do some serious vetting before they commit. They’ll also want to set up watertight contracts that treat major disruptions as the norm, rather than an afterthought.
Legal teams can help by drafting contracts that take into account the lessons we’ve learned from the last few years. Force majeure clauses should be specific and provide cover for things that seemed bananas as recently as 2019 but sound pretty normal in 2022 e.g. pandemics, global shortages, and nuclear war. Contracts can require suppliers to do a risk analysis of their own suppliers and to provide regular risk reports on supply chain disruptions. Contracts should also stipulate what happens if delivery time, volume, and quality don’t meet original commitments.
5. Build back better
Now is also a good time for businesses to examine the environmental, social, and government (ESG) status of their supply chain. In other words, as businesses establish new contracts and re-examine old ones, they should consider how the products or materials they buy impact people and the planet.
There are several reasons why that’s a good idea: a) it allows for a proactive (instead of reactive) approach to expected ESG regulations; b) It’s the right thing to do, and c) it provides support to your business’s consumer base and community. 88% of U.S. and UK consumers want brands to help them be more eco-friendly and ethical in daily life. For example, Biden is pushing to mandate that retirement funds incorporate ESG analysis, New York requires food businesses to recycle or donate scraps and the UK requires large employers to report wages by gender.
The Chancery Lane Project has set up a toolkit that gives legal professionals access to ‘net zero aligned clauses’ that you can use in contracts. So far they’ve had 63k downloads. Clauses cover reducing food waste, incentivizing fuel efficiency, sourcing greener energy, and auditing water usage.
The future of supply chains
The war in Ukraine and the latest lockdowns in China have cemented the general sense that supply chain disruptions are the ‘new normal’. For the past 2 years, we’ve been putting band-aids on every leak in the dinghy but now it’s time to build a better boat.
According to a survey by McKinsey, 93% of senior supply chain executives say they intend to make their supply chains more ‘flexible, agile, and resilient’. In the past year:
61% have increased inventory of critical products
55% are sourcing raw materials from more than one source
23% are expanding backup production sites
15% are nearshoring and increasing supplier base
11% are nearshoring production
And 90% say they planned to do some degree of regionalization in the coming 3 years. General Motors, Toyota, and Schneider Electric have all announced plans to boost production in North America. Governments are getting in on the onshoring action too. France is building nuclear plants to reduce its reliance on foreign energy sources while the UK is preparing an ‘energy independence plan’. Innovations in technology make it possible to hyperlocalize productions. Electric vehicle start-up Arrival is pioneering highly automated microfactories, small enough to fit into an urban warehouse, and vertical farming techniques mean plants can even be grown inside grocery stores.
New disruptions are certain to come. As the globalization pendulum swings back and supply chains are reset, in-house teams will be presented with a host of new challenges. But challenges can be opportunities. Now is the time to build resilient, agile contractual relationships that foster ethical and sustainable business practices and protect your business from whatever storm is next on the horizon.
If you’d like to learn more about how you can implement more sustainable practices within your supply chain, check out the replay from our panel, Why Legal Should Lead on Sustainability. Christine Uri, Chief Legal & Sustainability Officer at ENGIE Impact, takes us step-by-step into how legal can get involved.