Tariff turmoil in Asia-Pacific supply chains: bracing for impact

Supply chains being re-written

A tariff is a fee imposed by government on imported goods. The imposition of a tariff can instantly alter the commercial bargain struck by businesses engaged in cross-border trade.

1. The importing party, if it is responsible for paying a tariff, must assess whether it can pass on the new cost to its customers.
2. If it cannot absorb or pass on the cost, then the importing party may switch its source of supply to domestic sources (if available) or a country whose goods are subject to lower tariffs.
3. The exporting party, too, may consider moving its production to a country whose goods are subject to lower tariffs.
4. Even if the exporting party does not supply directly to the United States, if its goods are an input in a product that is shipped to the United States then the supply chain may be affected by US tariffs.

In short, tariffs affect the profitability of supply chains and businesses will re-evaluate their existing commitments. For some businesses that will mean seeking to modify contract terms, whereas for others it will mean withdrawing from commercial relationships altogether.

Reviewing contract terms

If a new tariff is levied on your supply chain, then you need to consider whether the terms of an existing contract allocate the responsibility to pay tariffs to one of the parties.

• Pricing terms. Some contracts delineate responsibility for taxes or duties in a way that allocates the burden of tariffs to one party. For example, a contract stipulating that price includes all taxes and duties may be interpreted as allocating tariff burdens to the seller (i.e. the exporting party), whereas a contract stipulating that price is net of taxes and duties may be read as allocating tariff burdens to the buyer (i.e. the importing party). Alternatively, if a contract permits price escalation, then parties should consider whether the imposition of a new tariff can trigger that adjustment.
• Delivery terms. Other contracts allocate the burden of tariffs by using one of the so-called Incoterms published by the ICC. For example, the delivery term DDP means “Delivered Duty Paid” and usually requires the seller (exporting party) to cover the cost of tariffs. By contrast, the delivery term FOB means “Free On Board” and typically requires the buyer (importing party) to pay tariffs. Likewise, EXW which means “Ex Works” and CIF which means “Cost, Insurance, Freight” typically require the buyer to cover tariffs. Any inconsistency between Incoterms and payment terms can produce tension and delay.

If a new tariff displaces either party’s financial incentive to perform, then you need to consider whether that party may rely on existing contract terms to avoid or suspend its obligations.

• Change in law clause. These provisions can permit re-negotiation of contract terms, or termination of the contract, if a “change in law” or “change in tax” modifies the legal regime in such a way as to prevent a party from performing its obligations.
• Force majeure clause. These provisions can excuse non-compliance with contractual obligations if an unexpected event outside a party’s control prevents performance. Force majeure clauses turn on the precise language used, and some cover governmental actions.
• Material adverse change clause. These provisions often appear in purchase agreements and can excuse non-performance if a “material adverse change” or “material adverse event” occurs between the time of signing and the time of closing.
• Termination clause. These provisions establish an express right to terminate on stated grounds, e.g. for convenience (subject to contractual requirements or other duties at law), for cause, or upon occurrence of certain events. Careful consideration is required to assess whether a new tariff would constitute a cause or event entitling one party to terminate.

Looking beyond express contract terms, many legal traditions recognise a doctrine akin to frustration whereby a party is discharged from performance by an extreme event occurring after the contract was entered into. However, for that doctrine to apply, performance must typically have been rendered impossible and not merely difficult or uneconomic.

Preparing for commercial disputes

If the contract does not provide a clear path forward, or if views differ on legal options available, then parties should promptly confront and try to resolve their disagreement.

Ideally, disputes can be resolved by negotiation. For long-term supply contracts, both sides may have an interest in amicable resolution. Parties can seek to amend existing terms, insert new terms, or re-negotiate price.

However, even if negotiating in good faith, it is advisable to identify key position points settled with the benefit of legal advice. It is also recommended to avoid making concessions without the benefit of legal advice, which could turn out to be unnecessary or, worse, weaken your position if negotiations fail. Businesses should establish communication protocols so that only nominated personnel are responsible for discussing issues with the counterparty, which can minimise the chance of inadvertent waiver or concession.

If a dispute cannot be resolved by negotiation, then you should be prepared for either arbitration or litigation. For cross-border supply contracts, international arbitration is often the chosen method of resolving disputes. Businesses need to take three steps to prepare.

A. Preserving the claim. As an initial practical matter, preserve the necessary documentation and evidence to prove or defend a claim. This includes maintaining relevant written records, as well as documenting important interactions with the counterparty related to a potential claim.

B. Satisfying conditions precedent. Whether making or defending a claim, identify any conditions that need to be satisfied before proceedings can be commenced in accordance with the contract. This often includes giving written notice within a set timeframe or endeavouring to settle the dispute through mediation before initiating formal proceedings.

C. Mitigating losses. A party wishing to claim for damages should ensure it has taken reasonable steps to mitigate its losses. For example, if the buyer wishes to bring a claim for damages, then it should consider identifying alternative suppliers. Conversely, if the supplier wishes to claim damages, it may need to find alternative markets.

Of course, the consequences of a protracted trade war would be felt beyond the supply chain context. The disruption and uncertainty sparked by rolling tariffs threaten to cause business failures in parts of the economy without any obvious link to trans-pacific trade. Moreover, new barriers to the movement of goods risk provoking a withdrawal of co-operation in other areas, too, including cross-border capital flows and data transfers. In that environment, careful management of business-to-business conflict, focused on prompt and effective resolution strategies, will be paramount.

If you require assistance or would like to discuss the impact of tariffs on your business, please contact a member of our cross-border disputes team throughout the Asia-Pacific region.