May The Force Be With You...force majeure in challenging global markets
For Star Wars fans everywhere, although force majeure is French for a “superior or great force,” we are not referring to the famed energy field that gives the Jedi their power and binds the galaxy together. In the world of business and contracts, force majeure is actually defined as an extreme event beyond the control of an obligated party that prevents performance under a contract.
Both history and current events indicate that force majeure events are more common than one may realize. From devastating earthquakes to labor strikes, force majeure events have the potential to significantly impact the contracted exchange of goods and services, especially in an increasingly global marketplace. Examples of such events include, but are not limited to:
- Acts of God - natural disasters or severe weather like Hurricane Katrina, the devastating Southeast Asia tsunami in 2004 or the thousands of earthquakes that occur worldwide each month.
- Violence - war, acts of terror, or civil unrest ranging from the ongoing Middle East conflicts, unrest in South America to terrorism in Europe and the United States.
- Government Actions – expropriation, the action by the state or an authority of taking property from its owner for public use or benefit as we have seen in Venezuela.
- Organized Labor Activities – strikes, such as the recent claims from a Chilean copper mine to Hollywood writers labor strikes. Significant work slow-downs have also been cited force majeure activities.
- Shortages of Power, Supplies, Infrastructure, or Transportation – typically found in emerging markets, but due to an aging infrastructure, have also been an issue in the United States.
- Epidemics and Quarantines – related to a widespread occurrence of an infectious disease or health risk like the Ebola outbreak in West Africa from 2013 – 2016 or the swine flu in China.
To accurately fall under the classification of a force majeure event, the occurrence must typically be unforeseeable. However, with current talks of nuclear warfare, the anticipated long-term weather effects of global warming, and increased political unrest across the globe, the potential future threat of expected force majeure events grows increasingly plausible.
What is the risk for procurement professionals?
Delay, disruption, the permanent termination of supply of a good or service, as well as the financial impact of such an event are heavy risks. As procurement professionals, our priority is to manage the supply of goods and servicesnecessary to the business at the best total value (price, quality and service level). Force majeure events inherently oppose those priorities, creating business risk that should be strategically managed.
How to protect the business?
In today’s challenging environment, we need more than light sabers and blasters for protection against force majeure events!
So, what should strategic procurement professionals do to prepare or protect against such risks?
- Understand the market. By understanding the industry, market developments can be predicted and strategies developed for competitive advantage. Key points to understand are the source of supply (both supplier and geographical options) and drivers of supply (feedstock markets, weather, labor, transportation, government regulations, currency fluctuations, etc.).
- Identify and evaluate risks. Once the market is known, political, economic, environmental, and technological risks should be identified and then evaluated based on the level of exposure and potential business impact.
- Get protection in the contract. Parties typically negotiate contract provisions, known as force majeure clauses that protect against these risks by allowing a party to terminate or temporarily suspend the performance of its obligations when circumstances beyond their control make performance commercially impracticable, illegal or impossible. Suppliers of goods and services are in favor of such language and often push for generic, broad terms and catchall phrases to provide protection against a wide array of events that could impact their ability to supply. Conversely, strategic procurement professionals should push for specific language that limits the force majeure event to only those explicitly listed and that truly fall outside the control of the supplying party. Here are elements that are typically included in force majeure clauses:
- Obligor excused from performance - the clause typically starts with language excusing one or both parties from performing the contract if specified force majeure events occur.
- List of force majeure events - the parties can negotiate the list of force majeure events
- Impacted party’s obligations - the parties can negotiate the impacted party’s obligation to notify the obliged and mitigate risks.
- Other party’s remedies - the parties can negotiate the other party’s remedies, for example, its right to terminate the contract without liability if the force majeure event remains in effect after the specified number of days or consecutive days.
- Develop a back-up plan. For business critical goods and services, a Business Continuity Plan (BCP) should be developed. A BCP outlines threats and specific actions to be followed to minimize negative impacts to the business. Potential strategies could include alternative supply sources, inventory, or reformulation, to name a few. What should be included in your BCP? It depends on the nature of your business. Here are a few ideas:
- Determine which suppliers are “key suppliers” and build a business case to fully understand their impact on your supply chain.
- Develop a supplier continuity capability questionnaire to fully understand key supplier crisis communications, continuity strategies and risks.
- Review and update the BCP annually to ensure it reflects current business and environmental changes.
- Have a “we will survive together” relationship and strategy, especially with sole-providers offering customized products.
- Due diligence checks. All the above-named steps should be repeated periodically as deemed appropriate to the business, to ensure continued validity and effectiveness.
So, in the famous words of Yoda as he encouraged Luke Skywalker, “Do. Or Do Not. There is no try.” As we strategically maneuver complex global environments with the expanding threat of force majeure events, there are things we must DO to protect our business interests… Be Informed, Be Prepared, and Be Diligent. And, as always, MAY THE FORCE BE WITH YOU!
Please visit blog.nitorpartners.com/blog for more Nitor blogs.