Port of Long Beach at Night

Although the West Coast Ports labor dispute has more or less resolved, the consequences continue to be felt across supply chains both in the U.S. and internationally. Especially hard hit have been the retail, automotive, and agricultural industries, with several companies (such as the Gap, Lululemon, and Williams-Sonoma) negatively revising their financial outlooks. Honda took measures to airlift components into the country, but had to shut down production lines at three U.S. plants anyway, for lack of critical components. KFC and McDonalds in Japan briefly stopped selling french fries because they were unable to get U.S. potatoes.

Until the congestion is resolved, the backlog at the ports is projected to negatively impact the economy for months to come. According to a report issued by consultancy firm Kurt Salmon, the West Coast Ports slowdown could cost retailers as much as $7 billion in 2015 and $36.9 billion in the next 24 months.

The only good consequence of the ports debacle, in our view, is that because U.S. meat producers were unable to export their products, a lot of the surplus ended up in U.S. grocery stores – giving domestic purchasers more access to delicious meaty meat! (Although we acknowledge that probably wasn’t great for the meat producers.)

What does the West Coast Ports labor dispute mean for supply chains from a legal perspective?

It is only a matter of time before the litigation begins. We know that orders were dropped, assembly lines shut down, and perishable good spoiled in containers – rampantly. If supply chain partners have not clearly allocated the risk of these negative consequences in their contracts, there will be fighting about who should bear the costs, just as Hurricane Sandy produced a raft of litigation involving retailers who did not receive critical goods in time for the busy 2013 holiday season.

Which presents us with a good opportunity to discuss allocating the risk of disaster, and other unexpected events, in supply chain contracts.

Supply chain partners commonly allocate the risk of disaster through force majeure clauses in their contracts. From the French, meaning “superior force,” a force majeure clause allows parties to excuse or delay contract performance in the event a specified risk materializes. Often, the force majeure events that excuse performance are weather disasters, but sometimes they extend to labor issues, political disruptions, and even sub-supplier nonperformance as well.

Not surprisingly, buyers generally do not like broad force majeure clauses, and suppliers often want them. What is surprising, however, is that when force majeure clauses are included in supply chain contracts, they are often treated as mere boilerplate and are not the result of a thoughtful examination of what the potential supply chain risks actually are. It makes sense to apply thought and analysis to force majeure clauses, however, singe disaster related disputes can turn into high-stakes, high-dollar fights.

Drafting appropriately tailored force majeure clauses requires planning and forethought, and a comprehensive discussion of the considerations supply chain partners should take into account is beyond the scope of this blog post. However, we did want to share an example of a force majeure clause failure.

Honey cupIn Melford Olson Honey, Inc. v. Adee, 452 F.3d 956 (8th Cir. 2006), the Eighth Circuit addressed a supply chain contract for the purchase of honey between a honey wholesaler and the owner of a series of honey farms in various places in the U.S. The contract stated that the supplier’s performance was excused in the event of “an act of God such as a drought or flood.” And indeed in the summer of 2002, South Dakota experienced “drought-like conditions” that impacted the supplier’s production. Rather than attempt to excuse its performance, however, the supplier argued that he was justified in raising prices. The buyer disagreed and filed suit.

At the trial court level, the district court denied summary judgment for both parties, and allowed the case to proceed to trial on the grounds that the force majeure clause was ambiguous because it did not specify how serious the drought had to be to excuse performance; nor was it clear that the force majeure clause allowed the supplier to raise prices. The jury found that the supplier breached the contract and that its performance was not excused by the force majeure clause. The Eighth Circuit agreed, reasoning, “Because the force majeure clause does not include language explicitly resolving any of these issues, the district court did not err in submitting these issues to the jury.”

The lesson here is that an effective force majeure clause should resolve ambiguities and avoid disputes, not create ambiguities and cause disputes. There is no “standard” force majeure clause, but to be effective, all force majeure clauses should explicitly address (1) what events excuse performance, (2) to what degree performance is excused, and (3) what notice is required to the other party.

If a supply contract does not contain a force majeure clause, then (at least for U.S. supply chain contracts), excuse of performance is most likely governed by UCC 2-615, governing “Excuse by Failure of Presupposed Conditions.” But that is a blog post for another day.