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Due to the coronavirus (COVID-19) outbreak Baker & McKenzie International published an article entitled How to Protect Yourself from Distress in Your Supply Chain.
The events surrounding the COVID -19 virus have brought to the forefront a concern that already was brewing in some sectors of the global economy — supply chain disruption. Although many manufacturers may have been in the process of putting in place early detection methods to spot the signs of potential distress in their key suppliers and have been considering safeguards to prevent against this disruption, those efforts are now being accelerated. From a legal and commercial perspective, what should you be doing?
The key gating question is whether you want to help your supplier resolve its short- or long-term problems or whether you want to look for alternative sources of supply. You may have to support your supplier at least for the short-term until you work through the alternatives, but understanding the source of the distress that is facing your supplier is critical to answering this question in a way that will provide you comfort that the solution is more than just a Band-aid.
Some suppliers may be experiencing liquidity issues that affect their ability to deliver goods in accordance with the agreed terms of the supply contract. Understanding whether your supplier’s liquidity issues are a result of exogenous factors (e.g., the competitive landscape, regulatory issues, and COVID -19) or endogenous factors (e.g., management issues, high leverage, and limited or no access to credit) can help you decide whether you want to provide assistance to your supplier and what the obstacles are to providing that assistance.
Well before any supply chain disruption occurs, you should have a solid grasp of what rights you have to use an alternative supply source, the steps you will need to take — both legally and commercially — to obtain an alternative supply source, and the amount of time it is likely to take to implement that strategy.
One of the key questions here is whether the supply contract contains an exclusivity provision or minimum purchase requirements that would render you in breach of the contract if you source the products you obtain from your supplier elsewhere. If your supply contract contains these or similar protections for the supplier, then you will need to determine what steps need to be taken to trigger the right to seek an alternative supply and how those steps can be taken in a way that does not threaten your existing supply of products until you are ready to make the switch.
Once you are prepared to take the steps either to re-source the manufacturing of the product or even to manufacture the product yourself, you need to assess whether you possess the equipment, materials, and technology, as well as the right to use (and perhaps sublicense) the supplier’s intellectual property.
The backdrop to all of these considerations is the possibility that, while you are in the process of developing your strategy or exercising your rights, your supplier may commence, or be placed into, some kind of formal restructuring or insolvency proceeding. It is important to understand the possible jurisdictions in which that might occur and, for each such jurisdiction, how its restructuring process may affect the exercise of your rights.
The first question we almost always get is whether a contract party has the right to terminate its contract after the commencement of a formal restructuring or insolvency proceeding because the contract either affords the non-debtor the unilateral right to do so or provides that the contract terminates automatically. The answer to that will depend upon the type of proceeding and the jurisdiction in which the proceeding occurs.
Finally, step back and take a look at how any potential supply chain disruption may affect your own operations and financial results. When distress hits, it is good to remember that cash is king. Do you have sufficient sources of your own liquidity to enable you to execute the strategies described above and to weather the effects of potential disruption on your own business? A close examination of your own credit facilities, understanding the conditions of making any draws, and determining whether to build a cash reserve are part of the internal evaluations that you should consider making.
Baker & McKenzie International, How to Protect Yourself from Distress in Your Supply Chain (09.03.2020)
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