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The ability to cope with Supply Chain Disruptions in the context of HK

02.09.2019

Joanne Waters

Joanne Waters Senior Registered Foreign Lawyer (England & Wales)

In recent months, Hong Kong’s trade and logistics community has faced a number of challenges. These range from the effects of the ongoing trade war between China and the USA and protests in Hong Kong disrupting road and air travel, to multiple typhoons in the region and fast changing regulations both in China and elsewhere. Looking forward, the implementation on 1 January 2020 of the new IMO regulations on sulphur content in vessels’ fuel is expected to cause disruption to sea carriage operations, at least in the short term.

So where does this leave the logistics and trade industries? In this article we will first discuss the practical steps which can be taken to mitigate against the effects of supply chain disruption. We will then consider the legal and contractual mechanisms which can assist in managing supply chain disruption and the impact arising therefrom.

What does “supply chain disruption” mean?

In this article, we use “supply chain disruption” to mean delay, change or suspension in the supply of goods or significant increase in the costs of moving goods from the producer to the end user. Supply chain disruption can occur in a number of ways but a simple classification is:

  1. Disruption in the production of goods / at the source of goods – for example, export restrictions, factories or mines shutting down or suffering sudden loss of production, suppliers becoming insolvent or cancelling supply contracts.
  2. Disruption in the transport of goods – for example, a typhoon preventing or delaying a vessel or aircraft moving goods from the place of receipt to the place of delivery, a carrier suffering a collision or loss of cargo or a carrier becoming insolvent.
  3. Disruption in the place of receipt – e.g. increased import tariffs.

Given the wide potential for disruption, it is important that parties in the supply chain consider, implement and keep under review the ways in which they can mitigate disruption. It is not possible for a party to prevent or plan for every kind of disruption, but a party can seek to minimise the impact of that disruption on its operations by having contingency plan in place with a clear outline of how to respond to a major disrupting event.

Practical considerations

There are several practical steps that a party can take to make its supply chain adaptive, helping a party to deal with the consequences of a disrupting event, including:

  • using diversified suppliers;
  • ­using diversified transport routes and / or modes, including having the flexibility to redirect shipments;
  • ­front-loading orders and shipments where there are known future disruptions; and
  • ­increasing the use of technology along the supply chain to provide end-to-end visibility of shipments and to provide insights into possible disruptions using big data and predictive analytics.

Taking Hong Kong airport as an example, it is the busiest air cargo hub in the world, handling 5 million tons of cargo last year. The airport acts as a major transit hub and as a vital link for manufacturers in South East Asia. The knock-on effect of a disrupting event here is therefore wide.

Where disruption occurs to passenger flights carrying belly cargo, an alternative is for shippers to switch to freighters or, for cargo which is not time-sensitive, to ocean carriage. However, any large scale switch to a certain mode can of course strain supply, increasing carrier prices and possibly resulting in delays as shipments are rolled to ease supply constraints. One way of avoiding spikes in prices is for parties to enter into long-term service contracts with carriers to provide locked-in rates and some comfort on capacity availability, as discussed further below.

Where significant disruption occurs, for a prolonged period, there is also the possibility of re-routing cargo to nearby Mainland airports or ports, albeit with the increased costs and time loss associated with this.

Legal considerations

As always, contract terms are key. Contracts for the supply of goods usually include an absolute obligation to supply, with limited exceptions, one of which will usually be a mutual force majeure clause. If the supplier cannot supply the goods due to a disrupting event, the contract will have to be reviewed very carefully to verify what remedies it provides to the buyer in the event of a failure to supply and whether there is any entitlement to terminate the contract.

Carriers generally have no obligation to deliver goods within a certain time and standard terms and conditions usually include a liberty to deviate, to go by any geographical route, to call at any ports in any order and to tranship. This gives carriers maximum flexibility in managing their capacity but also provides a level of adaptability when it comes to working around disrupting events. However, it also means that generally carriers are not liable for any delays in delivery caused by events outside of their control but again the terms of the contract of carriage must be carefully reviewed to confirm the scope of the carrier’s responsibility.

One way in which shippers and freight forwarders can obtain more protection from carriers regarding capacity, time for delivery and prices (commitments which are crucial when there is a disrupting event) is to enter into a service agreement. The purpose of a service agreement is to agree with the carrier a higher level of service commitment that would otherwise be offered on spot terms. Care must be taken in drafting the agreement to ensure that the commitments also apply in times of disruption although this will also be a matter for commercial negotiation.

Frustration v Force Majeure

When faced with supply chain disruption one or both parties may wish to terminate the supply / carriage contract. Whether a party is entitled to terminate will always depend on (i) the nature of the disruption and (ii) the terms of the contract.

A party who is unable to perform will often say that certain disrupting events are “force majeure”, entitling them to bring the contract to an end. However, it is very important to carefully consider whether a disrupting event does give rise to a right to terminate as wrongful termination could lead to a claim in damages.

There are generally two ways in which an unforeseen event can impact on a party’s obligations to perform a contract: (i) frustration and (ii) force majeure. These doctrines are entirely separate and have different legal bases but are often confused. For ease, we summarise the key points for each doctrine in the table below:

FrustrationForce majeure
­Arises from common law and statute­Arises from a clause in the contract
­Restricted application­Only applies if the terms of the force majeure clause are fully complied with
­Fortuitous, unforeseeable event, which occurs without fault of either party and which renders performance radically different from that contemplated by the parties either because performance has become illegal or impossible­A force majeure event is only one which falls within the definition of force majeure event as agreed in the contract and the force majeure event must be the sole cause of the failure to perform
­Effect is to automatically bring contract to an end, without the need for more­Clauses often require parties to give notice of the force majeure event and to attempt to remedy or mitigate its consequences
­Frustration is not available:

if the frustrating event is in existence at the time contract was made and does not get worse during contract term;

for mere economic hardship;

if there is an alternative method of performance;

if the parties have included a clause in the contract which makes express provision for the consequences of the frustrating event.
­The mere existence of a force majeure event does not bring a contract to an end automatically, usually it just suspends obligations for the period in which the force majeure event continues or excuses a party from its non-performance due to the force majeure event


Conclusion

Whilst the risk of supply chain disruption is a necessary part of cross-border trade, there are steps that parties in Hong Kong can take to minimise the effect of disruption both on the operations side and when drafting their contracts with suppliers. Should you be exposed to significant supply chain disruption, Ince is well-placed to assist with reviewing and drafting contracts and also with disputes arising as a result of delays, disruption or failure to supply.

Article authors:

Joanne Waters