Managing your supply chain feeling like an uphill battle? 

Increased inflation rates. Shortages of supply.  Uncertain economic climate.  Increase in sanctions.  Increase in regulations.  The list goes on…After many years of taking our supply chains somewhat for granted, in an age of globalisation and “just in time” delivery of services and supplies, the impact of Covid and geopolitical events has caused an unpleasant jolt to many organisations and in many cases had a significant impact upon their business operations.

Don’t panic – take a step back.  Take the time to understand:

1. the risk areas – which are most sensitive to supply chain disruption?
2. which mitigation measures are in place, achievable and will be most effective in high-risk areas?

The contractual angle

From a contractual perspective, there are numerous ways to mitigate risk of disruption, but the key thing to remember is that there is no one size fits all solution – the risk profile will vary across your contracts.  The role of the contract is to balance these risks appropriately. 

Effective management of your supply chain means knowing where the risk sits and mitigating it where possible.  In particular, your supplier contracts should reflect what is agreed with your end customers, where you will be reliant upon them to meet the commitments that you are making to such end customers.  For example, if your customer contracts don’t cater for inflation but your suppliers insist on price increases to track rising inflation, then you will bear the price risk. 

Some contractual mitigation measures to consider:

1. Indexation clauses: Remember to choose a contractual price review mechanism that reflects the reality of your business. Is there a maximum degree of price variation that you would be willing to contemplate across the contract term?
    
2. Change provisions: Outline what happens if, for example, you need to change the delivery dates – what is the impact on price, if any? What procedure needs to be followed to agree this? 
    
3. Certification of origin of materials: With an increase in the prevalence of geographic based sanctions, this is ever more important to understand.  The origination of supplied materials or services should then be proactively tracked against any sanctions regulations.
    
4. Change of law provisions: What is the geographical reach of these provisions? For example, if there is a change in law in the country of manufacture and this imposes additional costs, who will bear such costs? Who bears the risk if the change in law makes the supply more difficult or even impossible? In a global supply chain, risk of change in law outside the country of origin will inevitably come at a price.  Consider which party is best placed to take this risk? 
    
5. Business continuity plan obligations and verification rights: Knowing what your suppliers/customers will do when faced with disruption will help you to understand and manage the risks in these circumstances. Depending on the criticality of the supplier in question, you may want to (a) specify the minimum arrangements which you would need to see in place; (b) require that they be regularly tested; and (c) maintain a right to audit the supplier to ensure that this has happened in reality.
    
6. Increased audit/oversight rights: This will help you understand any vulnerabilities in your supply chain and plan accordingly. The focus here is on taking proactive steps to ensure operational resilience and service supply, rather than reacting to issues once they have already arisen.
    
7. “Financial distress” triggers, including early warning obligations: It’s better if you can be proactive when faced with an upcoming issue, rather than reacting when someone suffers insolvency type events. Once an organisation has fallen into insolvency proceedings, your ability to extricate yourself from the arrangements may be more difficult, and you may likewise find the provision of supplies switched off more abruptly. Seeing the problem coming and making arrangements in advance will always be preferable.
    
8. Visibility and control of extended supply chain (and potential “step-around” rights): Do you know where your suppliers source their goods/services? If your supplier relationship ends, the ability to draw on this resource could be invaluable to you. Consider therefore whether you want to put in place conditional contracts which will enable you to deal directly with such sub-contractors or sub-suppliers, in extremis.
    
9. Force majeure: Each party typically bears its own risks if certain events occur which are beyond its control.  As an increase in what was once considered unlikely risks, become reality (think COVID-19 pandemic), it is important to consider the scope of these types of provisions. For example, historically shortage of raw materials was commonly a non-contentious carve-out in a definition of force majeure events; but, as this scenario becomes more commonplace for many industries, you may want to consider other contractual mechanisms for dealing with shortage of materials - perhaps an extension of time to allow an alternative source to be found.   
    
10. Enhanced termination rights: There will be circumstances when it is no longer viable to continue – be realistic!  It is in no one’s interest to flog a dead horse!

Looking Ahead 

Got all those things covered?  Time to take your foot off the pedal?  Afraid not…here comes some new forms of disruption to keep you on your toes: 

• Environmental, Social, Governance (ESG) regulations (with Europe leading the pace of change thanks to the Corporate Sustainability Reporting Directive and the Draft Corporate Sustainability Due Diligence Directive)
• The proposed EU AI Act, with its extensive obligations which flow all the way back down the supply chain

What next?

If you’d like to discuss this topic in more detail, including any of the new forms of disruption mentioned, do reach out to the authors or your usual DLA Piper contact.

For more discussion regarding the issues raised in this article, please listen to our recent podcast: ‘Successfully navigating international supply chain disruption’ that forms part of DLA Piper’s Better Contracts podcast series. 

Better Contracts Podcast | DLA Piper