The novel coronavirus has created significant challenges for some suppliers in fulfilling the terms of their contracts, forcing some of them to seek concessions from their customers at higher tiers in the supply chain. But there are steps companies can take to protect and decrease risk in their supply chains.
Establish a Dedicated Risk-Response Team
Optimally dealing with possible critical production gaps, delays and changes in today’s high-technology global supply chain requires the knowledge and input of various subject matter experts. It’s advisable to establish a team in advance to prepare for incidents that jeopardize the supply chain.
Companies should include members of their engineering, purchasing, sales, finance and legal teams, among others, to fully cover the myriad issues involved in planning and decision-making. These include logistics, customer expectations, technical requirements, legal impacts and costs. This will facilitate quick action to anticipate and address problems.
The supply chain risk team should also receive and conduct training on parameters that drive the underlying needs of the business and customers, as well as the risk factors, options and tactics that can make the difference between good and bad results. The team also requires timely updates on topics such as the status of coronavirus, quarantines and other related government action in countries of relevance to the supply chain.
Analyze the Supply Chain for Risk
Another way to avoid and address unfortunate surprises is to evaluate the companies in your supply chain on a routine basis for warning signs. Warning signs of distress can include requests for price increases or other contract changes, use of factoring, late deliveries, requests for technical support, and delayed payments or receivables.
Moreover, careful tracking and close management of suppliers (or known sub suppliers) that are in China or other areas strongly affected by coronavirus are essential given its effect on factory production. Financial and news analysis and tracking for suppliers (or relevant customers) with public information can also be helpful.
In addition, it is important to meet frequently with critical and vulnerable suppliers to understand their financial positions and their own supply chains and risks. A company’s understanding of its own suppliers’ contingency plans and possible enhancements to them can provide useful advance notice of issues and protections.
Set Contingency Plans for High-Risk Suppliers
A company’s supply chain risk team should establish contingency plans where it identifies unacceptable risk. Examples of contingency plans include establishing resourcing, dual supply or alternative production options, building inventory banks or backup tooling, establishing and protecting setoff rights, and reviewing potential legal rights and actions to force continued supply if necessary.
Know, Bolster and Enforce Your Legal Rights
Given the increasing risk in the marketplace, companies should review and catalog their rights under their contracts, and where necessary update such contracts to reflect the state of the art in commercial terms and protections. Importantly, the recent circumstances surrounding coronavirus may constitute a force majeure event.
Force majeure is a legal doctrine whereby a party under a contract can be excused from performance (which would otherwise constitute a breach of contract) if that failure to perform arises due to events beyond the supplier’s control. If a company faces a potential supply issue due to coronavirus, it should review its supplier and customer contracts for whether this doctrine might be used against it. It also needs to determine whether the company itself might need to put its own customers on notice that it intends to rely on the doctrine of force majeure given the circumstances, as it works out a solution to any supply delay or cessation.
In addition, companies should take steps to perfect any liens in their property that are held by suppliers, such as tooling liens, in preparation for distressed situations. This will help with recovery of the tooling in an emergency if needed.
Furthermore, depending on the circumstances, companies can use creative tactics to use their rights under commercial law to potentially establish modifications to their contracts, including by leveraging for greater or faster payments. This can protect them from troubled customers and suppliers.
If needed to preserve supply, a company may also enter into a “workout” with a distressed supplier to keep the supplier from ceasing supply of necessary goods by facilitating a restructuring of the supplier’s debts. These transactions often include tripartite agreements among the financially distressed supplier, its largest customers and its secured lenders to document the commitments of each party to keep the supplier operating while the workout (or if necessary, a bankruptcy) is progressing toward a safe resolution.
These agreements include access and accommodation agreements. Through an accommodation agreement, the customers may provide (often as a group) accommodations that solidify the lenders’ collateral base through protections on inventory and receivables (such as restrictions against setoffs). This also may include commitments to continue purchasing goods from the distressed supplier while the lenders agree to continue to provide financing and not to foreclose.
An access agreement permits the customer, as a last resort under certain circumstances threatening production, to access the supplier’s plant to produce parts using the supplier’s own equipment and employees, pending transfer of the contract or facility to a healthier supplier. Customers sometimes also provide financing support, in which case the customers should obtain a participation agreement to obtain collateral for any financing provided.
Supply chain disruptions will be a key issue for companies to address in 2020, even as production comes back online once the coronavirus is controlled. Now is the time for companies to take steps to mitigate risk to their supply chain operations as well as the economic impact of the coronavirus.