During the most acute periods of the pandemic, parties were managing their commercial arrangements in crisis management mode as the disruption of COVID-19 rippled through the supply chain.
Suppliers monitored developments in real time to gauge their ability to fulfill contractual obligations. Customers likewise assessed the risk of non-performance by their suppliers and the potential impact of non-performance on their business, and whether there was enough cash on hand to pay for services. Advisors helped clients prioritize material contracts and understand their rights and obligations.
As the dust settles, parties should be taking stock of their crisis response performance and ensure that the short-term accommodations put in place during the crisis are properly embodied in amendments, change orders, addenda and side letters. Parties are also implementing changes to their contracting processes to reflect the lessons learned from negotiating new commercial arrangements in a crisis.
This article offers a framework to help organizations apply the learnings from their response to the crisis, discussing recent areas of focus in commercial contracts and identifying longer-term strategic considerations for businesses as they look to evolve their commercial contracting practices and set themselves up for future success.
Learning from your crisis response
Once you have moved on from dealing with issues on an emergency basis, it is helpful to take stock. What are the lessons learned from your response to this crisis?
Both the positive and the negative outcomes of your organization’s crisis management and responses are key to understanding how your organization’s approach to commercial contracting should evolve. Here are some questions to help guide the analysis:
- Did you experience a breakdown in business continuity as a result of a customer or supplier not fulfilling their obligations?
- Was it clear who the point of contact was meant to be at your key customers or suppliers? Were they responsive to your needs?
- Were your own stakeholders and escalation points available to provide guidance in near-real time? Was it always clear what the process and escalation path was?
- Were you able to easily assess which of your commercial arrangements were most material?
- Did you understand what rights and remedies were available to you under your contracts?
- What were some of the clauses in your contracts that were helpful in reaching a positive resolution with your commercial partners? What were some of the clauses that were inadequate to protect your rights?
As you answer these questions, a story will emerge. Clear failures can often produce a clear roadmap for improvement. If it was challenging to find relevant contracts or purchase orders, you will want to invest some time and resources in your document management systems. If your standard form of contract included a force majeure that put you at risk during this crisis, you will want to update those clauses.
It may be more illuminating still to dig deeper into your successes to identify what your organization can do better. It is important to keep in mind that a successful outcome does not necessarily mean that there is nothing left to learn from that experience—heroes and good fortune may have played a role in your crisis response. If your success is attributable to, for example, individuals going above and beyond in their roles or good fortune, those circumstances may not be easily replicable. Sound policies, clear processes and careful contracting are your organization’s bulwarks against future unexpected crises.
What we are seeing today
The first and most important thing that we are seeing in the wake of the COVID-19 outbreak is a drive to properly paper the short-term accommodations that were sometimes necessary to keep commercial relationships afloat—payment deferrals, operational changes to facilitate work-from-home or other alternative means of service delivery, relaxation of performance standards and changes to project milestones.
Many of those accommodations were first made informally as parties sought practical solutions to immediate problems without entering into formal amendments or change orders. Responsible organizations are now taking the opportunity to incorporate these accommodations into their contracts—even if this is done on a retroactive basis—in order to articulate more clearly the accommodation:
- Which contractual obligations were impacted and to what extent?
- What compensating controls or other forms of consideration are being traded in exchange for the accommodation?
- What is the process for the return to normal (and when is it meant to occur)?
Depending on the circumstances, it has also been helpful for contracting parties to modify indemnities and disclaimers in order to address the accommodation:
- Claims by employees related to a change in their working environment or risk of contracting COVID-19.
- Revisiting data-related risks.
- Allocating risk for performance issues caused by the accommodation.
Improving existing contracts
We are also beginning to see parties apply lessons learned to their existing contracts on a go-forward basis. If your organization is undertaking this task, we suggest creating a “wish list” of changes you would like to see in all of your contracts. We would also suggest creating a process for determining which contracts to pursue first and what approach best suits the contract, taking into account:
- Materiality of the relationship.
- The relative leverage of the parties.
- The strength and tenor of the parties’ relationship.
- Timing considerations (is the contract up for renewal? Are there other reasons to open up the contract at this time?).
- How does your “wish list” of improvements map onto the specific obligations of the counterparty (for example, strengthened data security controls for working from home may not be useful in a contract without a significant obligation to handle the other party’s data).
- Assessing whether there are items that are important to your organization but likely non-controversial that can be pushed onto counterparties with relative ease.
Negotiating deals in a pandemic: force majeure, BC/DR, COVID-19-related products and services
Many issues of focus before the pandemic remain of importance, but there are some contractual clauses that are (in most cases) the subject of more intense scrutiny.
Now more than ever, force majeure clauses are being highly scrutinized. Force majeure clauses define set of triggering events that can lead to an excuse of non-performance by a contracting party, often subject to certain processes (notice, updates and mitigation) being followed. The outcome of negotiations will vary depending on the circumstances of the deal, but we are currently seeing:
- Discussion about whether to include pandemics to the list of triggering events.
For some business functions, the outbreak of COVID-19 was the perfect illustration of why planning for a pandemic should be out of scope for the parties and non-performance should be excused. For others, it would be clear that the parties should now have adapted their business continuity and disaster recovery models to adequately address pandemic circumstances.
- Increased focus on process.
Many organizations now have a better sense of what type of information and mitigation processes are necessary or useful for them in their agreements. For customers, early notification, strong mitigation obligations, and regular updates are likely quite desirable. For suppliers, a streamlined enterprise-wide process and flexibility as to when and how an event of force majeure can be declared will be important items to look for.
- Treatment of the ongoing effect of the pandemic.
Parties are discussing whether the current COVID-19 outbreak should be carved out of force majeure clauses and replaced with specific protocols and remedies for non-performance.
We are also seeing renewed focus on business continuity/disaster recovery (BC/DR) provisions. As with force majeure clauses, the importance of prompt communication about incidents and business interruption has been brought to the fore. Suppliers who have had to communicate their activities to multiple clients are likely seeing some value in setting up a more standardized process, such as conference call updates with their customers as opposed to one-on-one communications where possible.
Physical distancing as a best practice has laid bare the inadequacy of setting up a single fail-over site without a framework for work-from-home as an alternative for many business functions. We are seeing (and should expect to continue to see) updated requirements being pushed by customers on their suppliers in this area. We are expecting, too, to see more prescriptive minimum BC/DR requirements and increased customer access to review plans, processes and test results.
As parties modify their current procurement and contracting strategies, longer-term issues to consider have also emerged.
The pandemic has broadened the way that people think about concentration risk: that is, the risk associated with too many services or functions being provided by a single outsourcing service provider or same jurisdiction. If that single provider is in peril or if there is a geographically defined disaster or change in law, there is a greater risk of failure of supply1.
Concentration of services or functions at what is sometimes called the “fourth-party” level—in other words, your service provider’s subcontractors—should now also be on customers’ radar. For suppliers, the importance of a diversified customer base will be more apparent than ever, as even during this global crisis, industries and geographical regions were impacted very differently.
Finally, for both customers and suppliers, relying too much on a single form of technology became a very real risk during this crisis. For example, when postal services formed the backbone of an organization’s delivery model, warnings of widespread delivery delays2 created a real threat to business continuity.
These concerns should be pushing parties to develop sales and procurement practices that dig deeper beneath the surface of their commercial arrangements to focus on how a service is delivered from a technological perspective (and what fail-safes are in place), where obligations are being performed, and whether the contracting party is heavily reliant on third parties to perform their obligations (and what sort of control or diligence can brought to bear with respect to those parties).
One caveat on concentration risk analysis is that in many instances parties will also have seen the benefits of being a “top customer” or “preferred supplier” (labels generally driven by volume of business). The ability to exert leverage in a crisis is often driven by the size and importance of a relationship, and so organizations will need to tread carefully in being too conservative when it comes to concentration risk if they want to avoid being “just another customer”.
The COVID-19 outbreak has shed light on just how precarious some businesses really are. Many regulated entities have been seeking audit rights and access to their commercial partners’ financial statements for some time, and that practice will likely become an even more widespread practice.
Similarly, we expect more focus on notices and updates when it comes to material changes to an organization’s circumstances, such as defaults on loans, changes of control or regulatory findings. Knowledge of a counterparty’s financial and operational vulnerabilities enables mitigating steps to be taken and can facilitate difficult (but often productive) conversations to maintain the health and stability of a commercial relationship.
There are other contractual tools at organizations’ disposal to help ensure the stability of commercial partners. For example, we expect to see greater emphasis on stringent requirements for insurance policies to be maintained by suppliers, with more detail—this includes ratings of insurers, requirements to be added as an additional insured and notices of changes. These sorts of requirements will not always be appropriate in the circumstances but in some cases, they can provide much greater comfort for the parties that their relationship is on stable footing.
A key lesson from this pandemic for many suppliers was that the more standardized their contracts and processes, the easier they were able to manage the crisis. Suppliers intent on applying that lesson while remaining responsive to their customer base will want to take the time to craft processes for relationship management that allow demands of their most exacting customers to be met in a way that can be replicated across multiple customer relationships.
We will likely see a similar push toward standardization from suppliers on many of the points that customers are most interested in—an approach to audits and oversight that relies heavily on standardized reporting (as opposed to bespoke rights), governance and incident management that allows for the same communication to go out to multiple customers, and BC/DR as a service—creating multiple standard offerings for resiliency which can be opted into a la carte by customers.
The challenge will be that customers too will have been working on updated standards for these key concerns. The most successful suppliers will be able to show their customers that they have learned the lessons of this pandemic and take their customers’ needs seriously. They will find that among their most powerful sales tactics will be to effectively compare their offerings to their customers’ standards to show how they are meeting or exceeding the new requirements or—if not meeting them—what compensating measures they are providing.
1 See, for example, https://www.federalreserve.gov/supervisionreg/srletters/sr1319a1.pdf, page 1.