This is Part 3 in the Strategic Legal Roadmap series. In this note, we look at how you can use the law to protect your company’s revenue and profit.
Revenue is income from customers. Profit is revenue less the cost of producing that revenue. Both are governed by contracts – the contracts you have with your customers and suppliers. Your customer contracts can be thought of as “downstream” — the direction in which the value you produce flows. Supplier, subcontractor, and vendor contracts are “upstream” of the customer, in the acquisition of raw materials, supplies, and services.
Whether written or oral, the customer contract contains all the essential terms of the deal: what, how much, when and how, and who. A customer contract may be a relatively simple consumer retail sales agreement – “buy one, get one free.” But if your customer is another business, or if the product or service is intricate, the deal can become quite complex, and the way that you have structured it can have profound consequences for revenue.
Services and Deliverables. Though often completed in a hurry, as a statement of work to a boilerplate agreement, the description of the services and deliverables will profoundly affect revenue and expense. Ambiguity in the statement of the activities, services, goods, outcomes, timelines, specifications, performance, and service levels, or a failure to delineate what is and is not being delivered can give rise to disputes or trap the seller or buyer in a deal they did not fully intend. In addition, it is essential that the statement of work speak to how out-of-scope work will be compensated.
Compensation. “How much” is just the starting point. You will want to consider the payment terms (can you wait 60 days?), the conditions for withholding payments, offsets to payments, payments for things that are out of scope, contingencies, or events to which the payment may be tied, etc.
Termination. How and when can you and the customer exit? If the deal becomes unprofitable, can you exit in a timely way?
Competition. Are you an exclusive vendor or can the buyer substitute you? Can you sell the same services to other buyers in the same industry?
On the expense side of the profitability equation are upstream supplier, vendor and subcontractor agreements. If your agreement with your customer depends on third-party goods or services, you must ensure that – to the degree possible – your supplier agreements are a mirror image of your customer agreements.
Delivery Parameters. Commitments to the customer concerning the quality, number, timeliness, return and refund of products or services must be accounted for in the supplier contract, so you are not left holding the bag if the supplier fails to deliver to you. You must have ways of adapting and responding to customer demand – both as a legal matter and as a matter of sound business practice.
Confidentiality Obligations. If you have confidentiality obligations to your customer and share confidential information with your supplier or subcontractor, you must make sure that those obligations intended to raise money are part of your agreement with the supplier.
Intellectual Property. As with confidentiality obligations, it may be necessary for you to pass on any intellectual property licensing, assignment or work for higher provisions that govern your relationship with your customer.
Indemnities and Warranties. here too, your warranties to your customers any any indemnities that they have you agree to maybe transitive in nature and passed along in your relationship with your suppliers and subcontractors. Again, it is a matter of not being left holding the bag.
Remedies and Cover. If your supplier breaches the agreement, will you be able to fulfill your obligations to your customer? Are there ways of ensuring against problems, for example, by using liquidated damages clauses?
Term and Termination. If your supplier exits early, do you have alternatives? Perhaps you should make the supply contract more difficult to exit or have a definite minimum term and notice periods that allow you to adjust should the supplier decide to exit.
A big company might employ a “General Counsel” for strategic guidance, negotiation, and authorship of critical contracts. But if you don’t have such a General Counsel, this email series should provide a strategic roadmap for you to consider in your decision-making.
As a businessperson, you (like every other businessperson) rely on contracts to help manage the future of your business. Because of contracts, you can predict and plan for future revenues, rely on suppliers and supply chains, control expenses, obtain credit, keep information secret and obtain investors. Contracts enable “business as usual.”So, what happens when it’s no longer “business as usual,” as in the case of COVID-19? Take, for example, the case of manufacturing supply chains. According to a study commissioned by Fictiv, “[f]or the first time in modern manufacturing history, the critical variables of demand, supply, and workforce are all impacted globally at the same time.” According to that study, nearly ¼ of all manufacturing businesses have been unable to fulfill customer orders. But what happens if the customer is not content with “we are having supplier problems and can’t fill your order”? What happens when the customer realizes that they might be able to sue and recover not only the cost of finding and using a different supplier, but also damages that flowed from the supply failure, like suits against them by their customers? Contracts are often tough and “iron-clad” but they are not suicide pacts. There are a variety of ways to excuse performance when something like COVID-19 happens along. This article will briefly review some legal options available to you when the world becomes a cruel and hostile environment for the honest businessperson such as yourself.
First, contracts commonly include a force majeure provision, which up until the time of COVID-19 was an obscure 3 or 4 sentence part of the “boilerplate” of the agreement. From the French for “superior strength,” force majeure is a way allocating risk between the parties by excusing contract performance by one or both parties in case that unanticipated or unforeseeable events were to occur.
Here’s a typical example of a force majeure provision: Neither Party shall be held responsible for any delay or failure in performance of any part of the Agreement to the extent such delay or failure is caused by fire, flood, explosion, war, strike, embargo, government requirement, civil or military authority, act of God, or other similar causes beyond its control and without the fault or negligence of the delayed or non-performing Party (“force majeure condition”). If any force majeure condition occurs, the Party affected by the other’s delay or inability to perform may elect to (1) suspend this Agreement for the duration of the force majeure condition and, once the force majeure condition ceases, resume performance under this Agreement with an option in the affected Party to extend the period of this Agreement up to the length of time the force majeure condition was endured; and/or (2) when the delay or non-performance continues for a period of at least thirty (30) days, terminate, at no charge, this Agreement or the part of it relating to material not already delivered or Services not already performed. Unless written notice is given within forty-five (45) days after the affected Party is notified of the force majeure condition, election (1) shall be deemed selected.Though it would seem to be a ‘slam-dunk’ with respect to COVID-19, not all kinds of contracts or contract obligations are excused by this force majeure provision. First, courts, and especially courts in Pennsylvania, interpret the clause very narrowly. If the event is not listed (and you’ll note that the above example does not include pandemics or epidemics), and even if it includes a catch-all like “or other similar causes,” the event must of the same type and character as the listed event. Even the phrase “act of God” will not serve to excuse performance unless it is an accident “due directly and exclusively to natural causes without human intervention, which by no amount of foresight, pain or care, reasonable to have been expected, could have been prevented.” Is COVID-19 a force majeure that would excuse performance under the sample paragraph above? It is different than the events listed, which are all sudden and violent, whereas the onset of COVID-19 has been gradual (even if exponential) and may even have been predictable in 2019. Perhaps the hook to hang one’s force majeure hat on is the phase “government requirement.” A supplier who is forbidden by state and local authorities to call its manufacturing employees back to work at a physical location should be able to invoke this force majeure clause, but a knowledge-based business (say, an advertising agency) whose employees can work virtually may not be in the same situation.
Finally, even if an event such as the COVID-19 pandemic is a force majeure as defined by the contract, the burden is on the non-performing party to establish the occurrence of the force majeure, and perhaps to show that it attempted to perform but could not perform or that the event was unforeseeable at the time the parties made the contract. In many cases, these can be high hurdles.
Impracticability is a long-established doctrine of common law contract. Think of impracticability as a “it goes without saying” excuse for non-performance. Three elements must be present to make out impracticability: 1) An unforeseeable event must occur, 2) the non-occurrence of that event was a basic assumption of the contract, and 3) the party seeking to be excused from performance must not be at fault.
Let’s say I agree to drive you to a city for $30, but suddenly find that a gasoline shortage has made the cost of doing so $1000. We both basically assumed that $30 would adequately compensate me for driving you, but that’s no longer true. Impracticability might well apply, and I might be excused from driving you. But note: I won’t be excused simply because my profit margin has been reduced or even if I will suffer a loss. Nor will it work if I have suddenly taken ill and have to find an alternative driver. Impracticability will not save a party from a bad deal.
How does this play in the world of COVID-19? A reasonable case for impracticability can be made where we both contracted on the belief that I had or could obtain employees to “deliver the goods” that we agreed to in the contract. But, where government policy or the risk of legal liability for forcing workers back to work makes it impractical for me to deliver what I promised based on our mutual assumption about my capacity to deliver, a solid argument can be made that COVID-19 excuses my performance for as long as government prohibitions or health risks persist. Once COVID-19 has passed and/or after a vaccine is widely available, my obligations to perform may return and I may no longer be excused from performing.
A closely related excuse from performance is impossibility. It is similar to impracticability in that the event(s) must be unforeseeable by the parties and not the fault of the non-performing party, but it adds the requirement that performance must be “objectively impossible.”
The bar is much higher to prove impossibility of performance in the case of COVID-19. For example, a supplier of engine parts for an automobile manufacturer would not only have to show that its employees are unable to come to work to build the parts, but that there is no other possible way (including purchasing the parts from other suppliers worldwide) to perform.
Frustration of Purpose
Frustration of purpose is a sister doctrine to Impracticability and Impossibility, but the ability of a party to perform is not at issue. In other words, frustration may excuse performance even though a party is fully capable of performing. Instead, frustration of purpose may excuse performance if one party’s principle purpose in entering into the contract is substantially stymied by the occurrence of an event the non-occurrence of which was a basic assumption of the contract when it was made.
To see how this works in the context of COVID-19, consider a contract to purchase placards, hats and flyers for use in a Republican or Democratic national political convention for the year 2020. The names on the collateral are given by the candidates up for election and their use is for a limited time. Yet, the physical conventions have been cancelled due to COVID-19. Although the manufacturing capacity of the supplier to supply and the financial ability of the purchaser to purchase are not threatened by COVID-19, the entire purpose of the purchase – to distribute (and perhaps sell) the collateral to people at the convention – has been vitiated. In this case, frustration of purpose may well excuse the purchaser from performance (though it is also possible that the manufacturer may at least recover its cost in creating the collateral, if it has already made them).
A contract is not a suicide pact, and it’s very possible that COVID-19 may mitigate your firm’s obligations to perform its contractual obligations. Of course, it may have the same effect on your firm’s business partners and excuse their obligations to you. Everything depends on the particulars of your firm’s contracts and its conditions on-the-ground – this article does not constitute legal advice for you should seek counsel from your attorney for guidance in your own business contractual decisions.
We welcome your inquiries at General Counsel Online and, should you decide to become a client, we welcome the opportunity to guide your firm in its own decisions about its contracts during the time of COVID-19. It is precisely these kinds of details that we worry about when delivering our Document Creation and Document Review Service Packages.  See https://www.fictiv.com/Travelers InsuranceCo.v.Randall,264F.2d1,2(5th Cir. 1959) Images copyright of their respective owners. Click on images to navigate to sources.