Even before the coronavirus disease 2019 (COVID-19) upended global shipping demand, the project cargo market was fraught with financial uncertainty. Due diligence has become even more important in light of the financial havoc and rapid adaptations that the COVID-19 crisis has forced on the project supply chain, global logistics consultant Dennis Mottola told JOC.com.
In this new reality, project owners and engineering, procurement, and construction companies (EPCs) will have to include systems integrity, cyber security, and the ability to work remotely in their logistics service provider (LSP) vetting and selection processes, Mottola said. “COVID-19 has taught us that these business continuity considerations for working with LSPs will need to be part of the standard assessment process going forward,” he said. Not only are these contracting necessities, it's likely that EPCs will be, or already are, required to flow down similar requirements to all subcontractors as a matter of contractual agreement with project owners via the prime (project) contract, he said.
John Hark, chartering director with Bertling Logistics, told JOC.com that the entire logistics industry seems more susceptible to increased credit risks from customers, increased delays, missed delivery, increased surcharges from sea carriers, or even abandonment of cargoes due to COVID-19. This puts the sustainability of contracts — i.e., the ability to fulfill the obligations thereof — in jeopardy. “We are also starting to more closely think about counterparty risk and how that affects our ability to perform on contracts,” he said.
As such, liabilities and terms of exculpation should be agreed to on a strict “back-to-back” basis between forwarders, customers, and service suppliers, Hark said, meaning that all subcontractors should be required to adhere to the main contract’s terms. “With tier-one, two, and three suppliers, we will pay even more attention to vetting our partners around sustainability, not just with suppliers of goods but also suppliers of services,” Hark said. This kind of enhanced due diligence will be “the right way forward to achieve supply chain sustainability,” he added.
Accounting for COVID-19 complications
Proactive contracting that accounts for the effects of COVID-19 can save schedules, headaches, and money. For example, inclusion of a pandemic or infectious disease clause in a charter party can allocate risk between owners and charterers, thereby offering greater clarity to the parties and reducing the likelihood of litigation, Utsav Mathur, a senior associate with international law firm Norton Rose Fulbright, told JOC.com.
According to Mottola, successful contracting due diligence means knowing “who you are doing business with,” regardless of the situation. “Make a valid assessment of that entity's ability to perform,” whether you are vetting your client or your subcontractor, he said. A vessel charterer is ultimately responsible to their customers, the cargo owners, for performance. The charterer must ensure that the carrier can meet its obligations. “Can they can make a [specific] port call? Will they have crews? How will they exchange crews in a pandemic?” Mottola said.
Contracts with logistics service providers must also be understood within the context of other interrelated contracts involved in a project — e.g., sales or purchase orders, marine liability insurance, letters of credit, or other payment arrangements, Mottola said. “Is there pandemic-specific or other business interruption language or coverage in place? Don't attempt to form a logistics services contract without knowledge and consideration of other interrelated contracts that could potentially have an impact,” he said.
Grasping the potential implications of the COVID-19 crisis on business agreements, and understanding what gaps might exist, takes experience. If a cargo owner is buying a large quantity of pipe (sufficient for a part or full charter) under a free on board (FOB) purchase order, for example, that means that the supplier is responsible for loading the vessel. Typically, the ship would berth at a private terminal at the supplier’s facility to be loaded by the supplier’s workers. If so, private labor in the supplier's facility will be going aboard a foreign vessel, potentially contracting or spreading COVID-19. This risk should be contemplated in the charter party.
“The success or failure of the charter party between the carrier and buyer [shipper] could be contingent on the ability of the pipe supplier to load and stow the vessel properly, and in accordance with charter-party requirements,” Mottola said. “Before forming the charter agreement, all of this has to be thought out,” particularly in the context of the pandemic.
“The lessons people are learning now will be built into contracts moving forward,” added Mathur. “On the vessel-chartering side, infectious disease clauses that were developed to address the Ebola virus disease a few years ago are being reexamined and incorporated, with some modifications, into charters now to address COVID-19 risks,” he said. “We expect that inclusion of such clauses will become routine and continue well past the current crisis.”