Case Law Update: Disputes Relating to Supply Chain Disruptions Hit the Courts

Over the last two years, the widespread shortages, stoppages, and other disruptions affecting much of the global supply chain have led manufacturers, suppliers, and buyers alike to examine their contract terms for an available excuse for nonperformance. Contract parties have focused in particular on any applicable force majeure clauses. When such provisions have been absent or inconclusive, the parties have turned to the doctrine of commercial impracticability and the legal theory of frustration of purpose.

Presumably, the use of these contractual and legal defenses has increased greatly since the start of the COVID-19 pandemic, but the list of known adjudicated cases is not long. Those that exist, which are reviewed in this article, exhibit a trend towards interpreting contracts strictly and granting limited relief under the impracticability and frustration of purpose doctrines—especially when the only harm alleged is increased cost. Disputes over these doctrines usually involve battles over injunctive relief—decrees that compel or restrict specific actions—as opposed to traditional monetary remedies. In the final article of this series, we will provide an overview of how courts have recently considered force majeure and commercial impracticability defenses in supplier relationships.

Recent Cases

a.  BAE Indus., Inc. v. Agrati-Medina

Key questions presented:

• Can cost increases of raw materials stemming from in part from pandemic-related supply shortages render compliance with a fixed-price requirements contract commercially impracticable such that the seller is excused from supplying goods at the contractually fixed price?
• Should a provision in a force majeure clause requiring notice within 10 days of the occurrence of an asserted force majeure event be narrowly construed to preclude excuse of a seller’s obligations when the seller failed to establish the date of the event or that timely notice had been provided?

The trend toward interpreting force majeure clauses strictly and applying the impracticability and frustration of purpose doctrines conservatively is evident in BAE Industries, Incorporated v. Agrati-Medina, LLC.¹ The court in BAE granted a manufacturer’s motion for a preliminary injunction prohibiting the defendant supplier from withholding shipment of specialty parts under a long-term fixed-price requirements contract. The defendant in that case, Agrati, agreed to supply BAE with all the rivets, bushings, pivots and other parts that BAE needed to manufacture and supply auto part components to Tier-1 customers. The Tier 1 customers, in turn, assembled car seats for original equipment manufacturers. However, from 2020 through 2022, the price of steel necessary for BAE’s parts rose due in part to COVID-19 lockdowns, steel mill closings, U.S. border restrictions, and the war in Ukraine. As a result, Agrati refused to ship parts unless BAE would pay price increases, arguing that the spike in steel prices rendered the fixed-price requirements contract commercially impracticable. BAE Industries then filed suit and moved for injunctive relief to compel Agrati’s compliance with the terms of the contract.

The court sided with BAE, concluding that an unprofitable contract and an increase in the cost of raw materials does not rise to the level of impracticability of a fixed-price supply agreement as a matter of law. Agrati argued the parties’ force majeure provision encompassed cost increases, but the governing contract expressly stated that cost changes would not give rise to a force majeure event unless the seller gave notice of the event within 10 days. Because Agrati did not state the date of the event or show that it had given timely notice, the Court granted BAE’s motion and compelled Agrati to continue supplying parts as originally agreed.

b.  Isuzu N. Am. Corp. v. Progressive Metal Mfg. Co.

Key questions presented:

• Can a buyer obtain injunctive relief requiring a seller to continue supplying goods under a requirements contract notwithstanding the seller’s claim that its performance was excused under a force majeure provision due to labor shortages?
• Can a seller facing labor shortages prioritize product deliveries based on whether buyers have applicable force majeure clauses with the seller?

Similarly, in Isuzu North America Corporation v. Progressive Metal Manufacturing Company,² a federal district court granted a buyer’s request to restrain a seller from raising prices and rejected the seller’s force majeure argument based on a labor shortage. Defendant Progressive Metal Manufacturing Company agreed to manufacture component parts in quantities as needed to meet plaintiff Isuzu’s yearly requirements. But in June 2021, Progressive sent Isuzu a notice of force majeure, contending that a labor shortage prevented it from producing the agreed-upon parts. Isuzu sued Progressive for breach of contract and sought a temporary restraining order requiring Progressive to continue manufacturing and shipping parts until Isuzu could find an alternative supplier.

During an early hearing, the court took issue with Progressive prioritizing components for other customers with whom Progressive did not have similar force majeure agreements.³ The Court found that Progressive could perform as originally agreed and ordered Progressive to continue producing parts under the parties’ agreement but emphasized that the relief was temporary, lasting until the Court held a more extensive hearing on the plaintiff’s request for a preliminary injunction.⁴ The parties eventually stipulated to an injunction under which Progressive assisted with Izusu’s transition to another supplier.⁵

c.  Drummond Coal Sales Inc. v. Kinder Morgan Operating LP

Key questions presented:

• Can a party successfully invoke the frustration of purpose defense based on non-existential financial distress?
• Can a party seek to excuse its performance under the commercial impracticability doctrine based on foreseeable regulations that significantly impact the party’s bottom line?
• Will courts strictly interpret force majeure clauses limiting relief to government interventions and civil unrest?

The judiciary’s trend toward enforcing contracts strictly is not limited to the automotive industry. In Drummond Coal Sales Inc. v. Kinder Morgan Operating LP,⁶ the Eleventh Circuit affirmed a decision holding a coal supplier to its service agreement with a shipping terminal operator. With two years left on its contract, the plaintiff in that case, Drummond, stopped paying defendant Kinder Morgan for terminal services, claiming that recently enacted environmental regulations had dried up the coal market, relieving Drummond of its obligation to pay for those services. Drummond sought to be excused from its obligation to pay Kinder Morgan because the new regulations had allegedly (1) frustrated the purpose of the contract, (2) constituted a force majeure event, and (3) rendered Drummond’s performance impossible.

The Court of Appeals adopted the magistrate judge’s order, which rejected all three of Drummond’s arguments. First, as to the frustration of purpose argument, the magistrate judge reasoned that Drummond merely lost money due to the regulations, which did not amount to a “virtually cataclysmic” event sufficient to frustrate the purpose of the contract. Second, the court declined to apply the impossibility doctrine after finding the regulatory changes were foreseeable. Finally, the court denied Drummond’s request for relief under the force majeure clause, which identified government “interventions” or “other civil unrest” as grounds to terminate the contract. Due to the “civil unrest” language and references to blockades and embargoes in the force majeure clause, the court narrowly construed the provision to apply only to events involving civil unrest or military conflicts and not ordinary regulations.

d.  CAI Rail, Inc. v. Badger Mining Corp.

Key questions presented:

• Can a significant economic downturn frustrate the purpose of an equipment lease agreement such that a lessee’s obligation to pay may be excused?
• Can a party rely on the commercial impracticability doctrine to excuse performance due to non-existential financial distress?

A federal court rejected similar arguments that pandemic-related market disruptions and financial distress rendered performance impracticable or frustrated the purpose of a rail car lease agreement. In CAI Rail, Inc. v. Badger Mining Corp.,⁷ the defendant, Badger Mining Corp., leased hopper rail cars from plaintiff CAI Rail to transport sand used for hydraulic fracking. However, Badger fell behind on monthly payments, prompting CAI Rail to sue for breach and eventually move for summary judgment. Badger argued that CAI Rail’s claim for breach was barred by the frustration of purpose and commercial impracticability doctrines because the COVID-19 pandemic, related travel restrictions, and reduced economic activity caused oil consumption to plummet and degraded Badger’s financial position such that it could not continue to make monthly payments.

The court rejected both arguments for similar reasons. Regarding the frustration of purpose argument, the court emphasized that Badger could not identify a specific government order that precluded it from engaging in the business for which it leased the cars, and a mere economic downturn generally is not sufficient to frustrate the purpose of a contract. The court also rejected the commercial impracticability defense, raised on the same grounds, because (a) Badger still used the cars; (b) Badger’s consulting firm opined that Badger had a viable business but just needed to cut costs due to the economic conditions; and (c) Badger sent CAI Rail a proposal to restructure the lease documents, which would have significantly reduced the rent. The court therefore concluded that Badger could still perform its obligations, even if it suffered for it.

e.  Guilbert Tex, Inc. v. United States Fed. Grp. Consortium Syndicate

Key questions presented:

• Can a seller invoke the commercial impracticability doctrine when the seller cannot deliver goods as promised but the agreement provides for alternative forms of performance, such as the refund of a deposit?
• Must a seller without product to deliver attempt to find alternative sources for the product before invoking the commercial impracticability defense?
• Can supply shortages support a frustration of purpose defense where the seller received a deposit for the goods?

Additionally, those seeking to excuse their contractual obligations under the impracticability doctrine must be sure that their agreements do not provide for alternative methods of performance. In Guilbert Tex, Inc. v. United States Federal Group Consortium Syndicate,⁸ a federal district court rejected such a defense raised by a seller of N95 respirator masks because the agreement at issue expressly provided that the seller must refund any deposit received if the seller could not deliver masks. The plaintiff in that case sought to buy 3M N95 respirator masks from Datta Holdings, LLC and the United States Fed Group Consortium Syndicate (US Fed). US Fed represented itself as a DC-based trade consortium that only handled orders in the millions. But the buyer only needed about 135,000 masks. Accordingly, the buyer agreed to purchase masks from US Fed through Datta Holdings, which purportedly bought masks from US Fed for smaller buyers, and submitted deposits for two different purchase agreements. The buyer never received any masks and sued the defendants for breach of contract. US Fed defaulted, and Datta argued that its performance was excused by the frustration of purpose and commercial impracticability doctrines due to “unexpected events or occurrences [that] totally prevented Datta Holdings from performing.”⁹

The court rejected both arguments on summary judgment. As to the frustration of purpose argument, the court observed that Datta conflated the defense with commercial impracticability. The frustration of purpose doctrine did not apply to the facts at hand because, regardless of US Fed’s performance, the buyer’s deposit provided Datta with the same value for which it had bargained. The court then rejected Datta’s impracticability argument for two reasons. First, the defendant presented no evidence that it attempted to find an alternative source of masks or that purchasing masks from another source would be prohibitively costly. Second, and more importantly, the agreement “provided for alternative performance: a refund of Plaintiff’s [deposit].”¹⁰ Because the purchase agreement made a refund an alternative (and in this case, feasible) form of performance, Datta could not contend that its performance was truly impracticable.

f.  JVIS-USA, LLC v. NXP Semiconductors USA, Inc.

Key question presented:

• Can unforeseen plant shutdowns, such as those stemming from COVID-19-related supply shortages, excuse a seller’s performance under the commercial impracticability doctrine where the seller cannot physically deliver the products regardless of price?

Although succeeding under commercial impracticability, force majeure, and frustration of purpose arguments is an uphill battle, it is not impossible. This is particularly true where a party can show it physically cannot meet production demands, as opposed to proving only that it will suffer financially from cost increases. For example, a federal district court recently denied a buyer’s request for temporary injunctive relief after concluding that compelling the seller’s performance would be commercially impracticable. In JVIS-USA, LLC v. NXP Semiconductors USA, Inc.,¹¹ plaintiff JVIS-USA sought a temporary restraining order compelling the defendant suppliers to continue shipping semiconductors after it became clear the defendants were experiencing supply shortages and could not meet the contractual production volumes. In analyzing the “likelihood of success on the merits,” as required for the entry of injunctive relief, the court noted an issue about whether the agreement contained a force majeure provision. The court did not resolve that issue, however, because it held that commercial impracticability provided a valid defense for the non-shipment, citing “unforeseen shutdowns” caused by factors including the upheaval of global supply chains due to the Covid-19 pandemic.¹² The Court therefore declined to compel the defendants to perform as agreed.

g.  Tufco L.P. v Reckitt Benckiser (ENA) B.V.

Key question presented:

• Can labor shortages stemming from the COVID-19 pandemic and related shutdown orders that physically prevent a seller from producing as many products as promised excuse performance under a force majeure clause that applies to reasonably unforeseeable events?

Similarly, in Tufco L.P. v Reckitt Benckiser (ENA) B.V.,¹³ a federal district court in Wisconsin denied a motion to dismiss a breach of contract claim upon finding that pandemic-related labor shortages could justify the plaintiff’s failure to produce under a supply contract. In that case, plaintiff Tufco agreed to supply defendant Reckitt Benckiser with name-brand disinfectant wipes under a contract with fixed prices and minimum production quantities. However, in early 2021, Tufco experienced labor shortages caused by rising COVID-19 infections in Wisconsin (where the wipes were manufactured) and the extension of U.S. lockdown orders. As a result, Tufco warned Reckitt that it would not be able to produce the agreed volume of wipes and invoked the agreement’s force majeure clause. Reckitt disputed the clause’s application and, after negotiations broke down, terminated the agreement. In response, Tufco sued for breach of contract, contending that the termination was premature. The parties primarily disputed the applicability of the force majeure provision, which excused performance for reasonably unforeseeable events. Tufco argued that the pandemic-related labor shortages clearly constituted a force majeure event, while Reckitt argued that the shortages were sufficiently foreseeable to render the force majeure clause inapplicable.

The Court ultimately denied the motion to dismiss, concluding that the parties should engage in discovery before the court could rule on the issue. In doing so, the Court expressly found “nothing implausible about Tufco’s allegation that it experienced ‘significant and unforeseen labor shortages’ as a result of an increase in COVID-19 infections and corresponding legislation.”¹⁴ The Court’s ruling in Tufco L.P. v Reckitt Benckiser demonstrates that the force majeure and commercial impracticability doctrines are much more likely to gain traction where a party can show physical limitations in its ability to perform rather than simple — even debilitating — losses in profits.

Conclusion

Although manufacturers and suppliers can take comfort in having legal arguments at their disposal to justify a failure to meet supply obligations, suppliers should also be aware that courts are unlikely to grant such relief outside of applicable contract terms or extreme circumstances. Even during the height of the pandemic and the subsequent supply chain fallout, courts continue to interpret force majeure provisions strictly and narrowly. Accordingly, as the recent case law suggests, those seeking to excuse or alter their contractual performance should be prepared to point to precisely drafted and directly applicable force majeure provisions or demonstrate an urgent, pressing need based on truly unforeseeable circumstances.