The earthquake and tsunami that struck Japan last Friday caused catastrophic damage to the northeast region of Japan and incapacitated the country’s supply chain as the vital networks that move people, goods, and services around the country were either incapacitated or severely disrupted. As a result, the output of supplies from Japan’s most important industries have either been cut-off or greatly diminished.
Japan’s silicon wafer industry, for example, has been seriously affected. The industry accounts for more than 50 percent of the world’s supply of silicon wafers. Without a steady supply of silicon wafers, the building blocks of the computer and solar industries, equipment manufacturers are left to source this key part from other suppliers– at a higher price.
Corporate in-house counsel and risk analysts have been left to question whether the earthquake and tsunami that collapsed a large portion of Japan’s supply chain would allow a supplier or customer to claim relief from performance on the grounds of "force majeure."
For example, Toshiba Corp., which accounts for approximately 30 percent of the world’s output for Nand flash-memory chips, the primary storage systems for the iPhone and iPad, will likely experience disruptions in output.
Any disruption is likely to increase the price Apple Inc. pays for these components from spot markets and alternative suppliers. Given its solid reputation as a savvy and sophisticated supplier, it is likely that Toshiba will invoke “force majeure” for relief of liability against Apple and other affected manufacturers.
Given the crippling effect of the earthquake and tsunami and other disruptive events, it’s essential that you make your international business agreements ironclad and earthquake-proof with a well-drafted force majeure clause.
Here’s how to do it:
Force majeure means literally "superior force" event. The purpose of a force majeure clause is two-fold: it allocates risk and puts the parties on notice of events that may suspend or excuse service.
The essential requirement of force majeure is that the invoking party’s performance of a contractual obligation must be prevented by a supervening event that is unforeseen and not within the control of either party. Typical force majeure events include Acts of God, superseding governmental authority, civil strife, and labor disputes.
However, there is no standard set of events that constitute force majeure. Rather, force majeure remains a flexible concept that permits the parties to formulate an agreement that corresponds to their unique course of dealings and industry nuances. Moreover, recent events have increased the necessity to include additional, unthinkable events, such as terrorism and the threat of biological and chemical warfare, volcanoes.
Don’t let the other party get one over one you in the negotiation stage of a force majeure clause. Be sure to scrutinize the events and allocation of risk to assure that the clause is not one-sided or unenforceable. You should also review the legal effect of enumerating an event in a force majeure clause. For example, a commonly invoked force majeure event is market fluctuation that renders a contract economically unfeasible. However, a majority of courts refuse to excuse performance on the theory that a contract is no longer profitable.
A well-drafted force majeure clause specifically enumerates the events (e.g. earthquakes, tsunamis) that will prevent performance and entitle a party to suspend or excuse an obligation such as the example below.
Neither party shall lose any rights hereunder or be liable to the other party for damages or losses, except for payment obligations, on account of failure of performance by the defaulting party if the failure is the result of an Act of God (e.g., earthquake, tsunami, fire, flood, inclement weather, or epidemic); war or act of terrorism, including chemical or biological warfare; labor dispute, lockout, strike, embargo; governmental acts, orders, or restrictions; failure of suppliers or third persons; or any other reason where failure to perform is beyond the reasonable control, and is not caused by the negligence, intentional conduct or misconduct of the defaulting party, and the defaulting party has exercised all reasonable efforts to avoid or remedy such force majeure. The defaulting party must provide written notice of the force majeure event to the remaining parties within two (2) business days of such event.
A party may invoke a force majeure clause if an enumerated event occurs that is out of the party’s control and prevents performance of a contractual obligation. The burden of proof is on the party seeking to invoke the force majeure clause. The force majeure event may either suspend or excuse a party’s performance. It is imperative that the party invoking a force majeure clause provide written notice to the other party. This permits the party that is not in default to mitigate against the effects of a force majeure event.
Plan for It
The affected party may mitigate against the effect of a force majeure event at the onset of the contract. For example, a party should consult an insurance broker to determine whether insurance is available to cover financial losses stemming from a force majeure event. If the stakes are high, then insuring performance may limit or prevent adverse consequences associated with nonperformance.
Moreover, develop a "B" plan to soften the landing of a party’s nonperformance. If the contract involves services or supplies, find an alternative source in advance. The bottom line is to limit losses.
For business, investing in redundancy is a form of insurance. The prolonged disruption of Japan’s supply chain infrastructure is likely to impact mainly upon the physical movement of goods. For example, is it possible to have alternative suppliers (to avoid a single point of failure), or to require your suppliers to maintain a local (within driving distance) parts bin to guard against supply chain problems? If your supplier otherwise proposes a just-in-time approach, and the supply in question is business critical, then it may well be prudent to specify this.
Follow the points I described above, and you’ll be well on your way to drafting an earthquake-proof your international business agreements.