In recent years, manufacturing companies have invested a lot of time and energy into optimizing their supply chains, including mitigating current risks facing their supply chains, making their supply chains more efficient and making their supply chains more risk resistant in the future. Despite this newfound and important focus, most manufacturers have not considered how climate change may impact their supply chains.
Many believe that climate change will have a domino effect in the environment that may bring extreme temperature fluctuations, storms, flooding, droughts, wildfires and other severe weather that will impact manufacturers, as well as their sub-suppliers and customers. These impacts will vary depending upon a number of factors, such as how companies source raw materials and sub-components, how diversified their supply chains are geographically and whether supply chain inputs include specially manufactured or unique materials/parts versus off-the-shelf materials and components. Regardless of the degree of impact (pun intended), manufacturers will want to take proactive steps to address possible impacts that climate change may have on their supply chains, mitigate likely risks and avoid costly disruptions. Two key strategies are outlined below.
1. Contracting: Front-End Considerations in Negotiating Supply Agreements
A manufacturer’s first line of defense is its supply agreements—whether it be long-term supply agreements or standard terms and conditions of sale or purchase. For years, manufacturing companies have been contracting to mitigate risks outside of their control. The goal is to shift certain risks or spread the impact across the supply chain. Although manufacturing contracts routinely contain standard “force majeure” provisions that are cut and pasted into every single supply agreement, few manufacturers devote appropriate time or consideration to negotiating which party will bear certain risks and costs in a force majeure event. Even fewer manufacturers have given thought to all of the harms that could befall their supply chain as a result of climate change and its widespread impacts. Most manufacturers believe that the force majeure provision set forth in their standard terms and conditions or in their long-term agreement will cover climate change shockwaves, but they may be more exposed than they think.
“Force majeure,” which comes from the French term for “superior force,” refers to circumstances outside of a party’s control that prevent a party from performing under the contract. A typical force majeure provision lists a series of events such as weather-related occurrences, fires, and other “acts of God.” For a supplier that is faced with a force majeure event, the supplier may declare force majeure and it will be excused from performing under the contract for the duration of the event. This means that the suplier is not breaching the contract because it is excused from performing (i.e., manufacturing or delivering parts).
There are two key reasons why most standard force majeure provisions may not protect suppliers from many of the impacts of climate change. First, most force majeure clauses do not list related climate change impacts as a qualifying event. Most do not include extreme high temperatures, flash freezes, acid rain, rising water levels, droughts, etc. as an “event.” Therefore, if the supplier tried to claim force majeure based on climate change, it could be an uphill battle.
Second, increased costs may not be sufficient to qualify as a force majeure event. Instead, the supplier party must be unable to perform and have no alternative means to fulfill the contract. For example, in the circumstance of an extreme heat wave, the electric company that powers the supplier’s manufacturing facility may opt to shut off electric services to avoid power surges . . . unless the manufacturer agrees to pay a costly surcharge to keep its power on. This likely does not qualify as a force majeure event even though the applicable force majeure provision includes “power outages” as a qualifying event. The buyer would claim that the supplier can elect to pay to keep its power on by paying the surcharge.
In yet another example of a heat wave impact, if a supplier is shipping components that are heat sensitive, there may be a concern that an extreme heat wave would damage the components in transit. There may be nothing in the contract that addresses extreme heat waves or which party bears the risk—not in the force majeure provision, packaging instructions or anywhere else. The buyer may claim that the supplier is required to foot the bill for refrigerated shipping containers in order to maintain continuity of supply without damaging the components during the heat wave.
The bottom line is that, at the time of contracting, manufacturing companies should be giving additional thought to how climate change can impact particular product lines and supply relationships. Where possible, force majeure or other provisions should be drafted to take into account the specifics of each contractual relationship and the likely risks outside of each party’s control, including risks associated with climate change.
2. Diversifying, Spreading Risk and Other Internal Preparations
In addition to contracting strategies, suppliers can incorporate other safeguards to protect against supply chain risks associated with climate change. From a risk mitigation standpoint, manufacturers will want to consider—even in light of additional costs and burden—maintaining safety stock of critical components and raw materials, pre-qualifying alternate suppliers for emergency situations, dual-sourcing from different regions when possible to ensure an alternate supplier is lined up, or having the ability to divert supplies and redirect manufacturing processes to alternate facilities that are not impacted by any weather-related event. Any alternate suppliers, dual sources and back-up manufacturing facilities should be located in different regions. Finally, although one of the least desirable risk mitigation avenues – manufacturers may want to investigate expanding certain insurance coverage—to the extent even available depending upon the specific weather-related threat and location—to include events that buyers refuse to negotiate into their contracts.
In conclusion, all parties in the supply chain should be giving more thought, time and attention to forecasting and managing the risks in their supply chains for climate change and its impacts. These considerations can be covered by well-drafted force majeure provisions (or other risk-shifting provisions should certain costs be incurred) at the outset in negotiating and executing the supply agreement. Parties also can prepare by maintaining safety stock, lining up alternative options and/or obtaining appropriate insurance coverage to mitigate risks.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.