In order to mitigate the effects of significant and unforeseeable disruptions to supply chain operations, businesses should consider adding two clauses to their contracts: expedited arbitration and a requirement to obtain “business interruption” insurance.
In global trade, days matter. A small delay can have serious consequences. Shelves sit empty. Watermelons rot. Or worst of all: your customers lose credibility with their customers.
Alarmingly, for all the things that can be controlled within a given supply chain, quite a bit is left to chance. For instance, in addition to the havoc Hurricane Harvey wrought on the people of Texas this year, it posed a serious threat to American commerce. The Port of Houston – and its connected network of roads and rails – are vital to many businesses’ supply chains; even a few days’ disruption at such a crucial hub can be felt around the world for months.
And although an outsider might think natural disasters like Harvey are once-in-a-lifetime events, that is not the case. Many in the logistics industry recall the impact that the “1,000-year floods” in Tennessee in May 2010 had on global trade. And a natural disaster is just one of the ways a supply chain can be rattled.
In six years working in logistics before beginning a legal career, I saw just about everything that could go wrong do exactly that. One colleague had cargo seized by pirates. Another time, management announced that all produce imports would be subject to more rigorous inspections, because the Drug Enforcement Agency found a large shipment of cocaine being smuggled into a nearby port, hidden in banana peels.
No matter how perfectly you plan, something unexpected can always go wrong.
So with chaos lurking, what can you do to protect your business in the unpredictable world of supply chain logistics? For starters, there are two clauses you might consider adding to contracts with your trade partners: an expedited arbitration clause and a requirement to obtain “business interruption” insurance coverage.
Expedited arbitration is an increasingly popular option for those who do not want to risk straining an important business relationship with a long (and potentially expensive) court battle. By adopting simplified rules with strict timelines, expedited or “fast-track” arbitration can settle a dispute at a seemingly breakneck pace. A number of organizations, like the American Arbitration Association (AAA) and the International Chamber of Commerce (ICC), have adopted specific procedures for this process.
In a famous case commonly referred to as the “Formula One” dispute, parties filed a request for arbitration sometime between Christmas Day and New Year’s Eve, and had a decision by the end of January (See Nigel Blackaby, et. al., Redfern & Hunter: Law and Practice of International Commercial Arbitration, § 6B 6.34-37 (Kluwer Law International, 6th ed., 2015) (describing ICC Case No. 10211)).
In the Formula One case, the dispute was simple. The Federation Internationale de l’Automobile had a rule that all cars on a Formula One racing team had to be painted identically. One team, sponsored by a tobacco company, wanted to paint its cars two different colors, for two different brands of cigarettes the company sold. By using fast-track arbitration, the parties were able to wrap up their dispute well before the start of the season.
The solution? The team painted its cars identically, with one side of each car featuring one brand of cigarettes, and the other side of each car featuring the other brand.
While expedited arbitration’s upside is very attractive, it is not a free lunch. The same procedural rules that move cases along at a fast pace can make it inappropriate for large or complex disputes. Under some rules, arbitrators can limit the number of documents one can seek in discovery, or limit the number of witnesses that can be called. Some arbitration organizations even allow the arbitrators to decide the case on written arguments alone, without a hearing.
Imagine being in a dispute that will decide the fate of your entire company, and not being able to call a single witness. The bottom line is that expedited arbitration is a great option from some, but you should be aware of – and think through – all the implications before deciding if it is right for your business.
A second point to consider adding to your shipping contracts is to specify that the party responsible for freight insurance must also obtain insurance to cover a “business interruption.”
People often think of business interruption insurance in the context of a fire taking out an entire building, resulting in a halt to the company’s operations (and therefore income-generating activities) until repairs are complete. However, coverage can also apply to transportation of goods, as business interruption insurance helps guard against the impact that lost, damaged or delayed shipments have on your company’s bottom line.
For instance, some large construction projects require customized equipment that may have a several month lead-time for construction and shipping. If a general contractor purchases a customized crane from a supplier, and the crane is damaged in transit, the parties’ contract should address who is responsible for fixing the crane or paying for a new one. But if it takes months to build a new crane, the contractor is helpless while the project flounders, and those delays can be extremely costly.
A case from 2003 provides a good example of how one aspect of business interruption coverage, acts of civil authority, can work (see Assurance Company of America v. BBB Service Company, Inc, 593 S.E.2d 7 (Ga. App. 2003)). In that case, the insured, BBB Service Co. (BBB), owned a chain of Wendy’s restaurants in Florida. In September 1999, the chairman of the County Commission declared a state of local emergency for Brevard County, Florida, where a BBB restaurant was located, due to the threat of Hurricane Floyd. As a result, BBB closed its restaurant for two-and-a-half days. BBB and its insurance company disputed whether BBB was covered for its business interruption under the provision of business income coverage referred to as “civil authority.”
In essence, if the actions of a civil authority prevent an insured from operating its business – because of road closures, declared states of emergency, etc. – and cause a loss that would traditionally be covered by a business’s policy, such as a loss from a flood or hurricane, then the insurance is meant to cover that loss. However, the reason the civil authority acted to prevent a business from operating (or operating fully) must be directly tied to the cause of loss, in this case, a hurricane.
For example, if a commercial tenant resides in a building that catches fire, but the fire causes no damage to the tenant’s property, if the building is shut down for two weeks for safety inspections, and the business suffers a business income loss, the policy will apply even though the business itself did not suffer fire damage, but the building did.
In the BBB case, the hurricane ultimately moved along on its path and did not cause destruction to Brevard County, where BBB’s restaurant was located. As such, the insurance company denied coverage, but this coverage denial was ultimately overturned by the court system because there was legitimate and substantial threat of damage, despite no physical damage occurring to the immediate surroundings.
This case demonstrates the need for understanding how and under what circumstances you are able to make a business interruption claim, especially in the instance of an act of government interference.
Any business arrangement that involves a complicated supply chain can be disrupted, damaged or even destroyed by things beyond our control. But understanding that, and preparing properly, can save a lot of time, energy and headaches – not to mention money – when these disruptions occur.
Joe Pangaro is a trial attorney with Duane Morris with experience in class actions and appeals, and can be reached by email at jjpangaro@duanemorris.com. Alexandra Bretschneider is an account executive with Johnson, Kendall & Johnson, with experience in distribution and manufacturing, and can be reached by email at abretschneider@jkj.com.