From disruption to dispute – Mitigating supply chain risk | S2 EP7

The past two years have brought uncertain, sometimes turbulent times to Canadian businesses and their supply chains. And when forced to make quick adjustments to address short-term bottlenecks, companies are often left with little time to assess long-term risk and liability. For this discussion, we welcome back Randy Sutton, global co-head of our life sciences and healthcare industry group and co-head of our Canadian class actions team. Joining Randy is Kaitlin Smiley, Of counsel in our Vancouver office.

CPD credits: This episode qualifies for 0.42 hours of Substantive credit in Ontario and 0.42 hours of Substantive credit in British Columbia.

Transcript

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Transcript:
Andrew McCoomb  00:11
Welcome to Disputed, a Norton Rose Fulbright podcast. We're your hosts Andrew McCoomb from Toronto and Ailsa Bloomer from Calgary.

Ailsa Bloomer  00:18
In the past two years, dealing with sudden changes and disruptions along the supply chain has become part and parcel of doing business. But in having to pivot quickly and make adjustments to address short term bottlenecks, companies have little time to assess the longer term liability risks. As well, companies also now have to manage social liability issues in addition to the legal liability risk.

Andrew McCoomb  00:42
So in this discussion, we talk about some key issues our lawyers are seeing arise when businesses are forced to make adjustments in their supply chains and how these risks can be managed. From recall plans to force majeure clauses, indemnities and due diligence strategies.

Ailsa Bloomer  00:57
We welcome back Randy Sutton, a previous guest speaker in our class action trends episode. Randy is the global co-head of our life sciences and healthcare industry group and he has represented clients in commercial, class action, environmental, franchise and product liability and recall matters across Canada. Joining Randy is Kaitlin Smiley, of counsel in our Vancouver office, and Kaitlin's practice focuses on complex commercial litigation, class actions, product liability, securities litigation and insurance coverage matters. 

Ailsa Bloomer  01:43
Randy, Kaitlin, welcome to the podcast. Thank you for joining us.

Randy Sutton  01:46
Thanks for having us.

Kaitlin Smiley  01:47
Happy to be here.

Ailsa Bloomer  01:49
Okay, so supply chain disputes, supply chain disruptions. Let's start by setting the scene. This is obviously a very common term that businesses are going to be familiar with in the past two years, but from what you've seen across your practices, how have developments in the past two years impacted supply chains for Canadian businesses?

Randy Sutton  02:07
Why don't I start on just sort of what has occurred and then maybe, Kaitlin, you can talk about the consequences of that. In terms of what we've seen in the past couple of years, supply chain issues have arisen from first off the pandemic. I think 75% of companies have reported supply chain disruptions due to issues around COVID-19. We're seeing in-- in particularly the area that I work, in the life sciences, you know, about 72% of US entities actually import active pharmaceutical ingredients from outside of-- of the United States, for example. So as borders have closed, as jurisdictions have shut down, you've seen significant issues there. Political issues, obviously, Russia-Ukraine conflict is creating issues. We're seeing, you know, right here in Canada, extreme weather events and then also significant rise in cybercrime, cybersecurity issues, which have given rise to issues such as the Colonial Pipeline shutdown and those types of, again, supply chain disruptions. And I think, you know, in terms of thinking about the supply chain and-- and how complicated it is, one of the comments that I've heard, one person, was that, you know, it takes 30,000 parts to make a car but if you're missing one part, you don't make that car. And so from that perspective, the disruption in the supply chain is significant and these events certainly have-- have given rise to issues and-- and Kaitlin, maybe you want to speak about the consequences of that.

Kaitlin Smiley  03:27
Yep, thanks, Randy. So we've seen that businesses and their suppliers have both had to make sudden adjustments to existing supply chains, finding other suppliers, other sources for components, diversifying their geographies, trying to bring supply chains back home and repatriating those where they can, looking for cost savings by acquiring lower tier vendors and substituting products. And all of those come with uncertainties as companies are trying to adapt quickly to unanticipated and unforeseen changes in the global environment in the past few years.

Ailsa Bloomer  04:06
And so, with that, with all the changes that you are referring to, the adjustments that are having to be made, different companies having to source different ingredients, like you mentioned Randy, in the life sciences sector, what legal claims is this-- are these giving rise to? What are the nature of claims that you are seeing and the types of supply chain liabilities that are cropping up as a result of these adjustments?

Kaitlin Smiley  04:31
So we're seeing those disputes crop up in a couple different areas. First are, obviously, when you have these supplier relationships that are existing, you often have contracts that are governing those and where a supplier isn't able to fulfill their obligations under a contract, that's resulting in disputes. We're also seeing that, you know, those-- those contract disputes are arising where quite often you'll have exclusivity agreements where you may not be able to step outside of those relationships to source ingredients or source components in a more faster or more reactive way. There may also be intellectual property aspects to some of those disputes and to some of those relationships where you have, you know, specific suppliers who have specific industrial knowledge or intellectual property knowledge that makes it difficult to find alternatives in the short-term. In a non-contract sense, there are obviously issues when you are adapting quickly and finding new suppliers and you may not have the opportunities to do the same degree of due diligence.

Ailsa Bloomer  05:40
On the contract disputes that you mentioned Kaitlin, along the supply chain with regards to exclusivity agreements or intellectual property, are we seeing a multi-jurisdictional aspect to those claims, too? I'm assuming that contracts in supply chains aren't all consistent when it comes to governing law. So, are clients experiencing difficulties with determining what jurisdiction those contract disputes are heard in?

Kaitlin Smiley  06:07
Absolutely, there's jurisdictional issues arising and there’s also, depending on where the issue is, where the disruption is within the supply chain, there can be problems with those contracts not being back-to-back. You may have the end manufacturer who needs a component that is several steps down the-- the chain that isn't being delivered and, you know, their contractual relationship is with their direct supplier, who then in turn is-- is suing their direct supplier and those contracts may not have consistent jurisdiction clauses. So, it's not a matter of simply being able to sue in one location and drag everyone in because you're several stages down in the contractual relationship and those contracts aren't necessarily back-to-back or-- or mirroring each other with respect to jurisdiction.

Ailsa Bloomer  06:55
And so, Randy, turning to the second area of liability, Kaitlin mentioned the class action risks. So what are you seeing crop up in your practice in that area?

Randy Sutton  07:03
Yeah, I mean, I think we've seen in the past few years a number of class actions particularly in the area of-- of recall where there's been issues about, you know, the quality of a product. And so, certainly to the extent that people are moving to different suppliers, they've not properly vetted them, there may be a situation where a particular batch has been sourced from a different supplier, they don't have quality control. I think you potentially will see class action risk arising from that, and issues around that. Certainly, that's one area and that then gives rise to both recall claims and product liability claims. You know, from a recall perspective, again, one of the issues that you've got to think about is, does your recall plan, which you might have brought in three or four years ago when, you know, recalls were sort of the issue of the day because of amendments, does that still work? Do you still know who the suppliers are? Are you able to source back specific products to specific suppliers to understand how you sort of want to ring fence your recall when regulators are asking who’d you get this from? Are you able to identify that? So, again, that's also from a recall perspective. Can you deal with a recall effectively and efficiently if you change suppliers, if there's been disruptions and you're either, you know, not aware of them, or you're not able to sort of track back exactly where the products came from, and that is a significant issue particularly across borders where you often have cross border recalls and you're dealing with those types of issues.

Ailsa Bloomer  08:24
And I just want to dig a bit deeper on that because supply chain disruption, it has been a part of business, right, for many, many years. It's not just been in the past two years that we're talking about, and presumably recall issues and having a solid recall plan in place and all those communications along the supply chain, it has always been important. So my question is, what in particular is different about the past two years, when it comes to dealing with product liability claims and recall issues along the supply chain? What new dynamic a company is having to deal with now?

Randy Sutton  09:00
Well, I think a little bit of is-- is in terms of knowledge of where your product is coming from, you know, going again right up the chain to the, you know, the-- the car example, the 30,000 products that sort of come down to make the car. Do you know where all those products are coming from or have your suppliers sourced them from a different product-- different supplier? In the context of your supplier, have they had to put in a different ingredient because they couldn't source an ingredient that gives rise to a different issue as-- as it relates to the product itself? You know, and even just sort of the more practical realities, you know, if all of the information is now coming in electronic form, as if it was to hardcopy waybills and documentation, have you retained that somewhere if you need to access that for the purpose of a recall? You know, when you're doing a recall, if everyone's working remotely, do you have a team available to be responding and how do you deal with that? So, again, I think the issue in the past couple of years is that there's been a lot of disruption, and so the existing recall plans and practices that you might have vetted and done three or four years ago, they simply might not be reactive at this point. And I think there's also uncertainty as to where you-- your supplier may have gotten stuff on the supply chain which is critical to recall because you need to understand, you know, what is the issue and how do you identify what products that you're selling are subject to that issue. And if you can't identify that because you don't know who your suppliers are or they've modified their supply arrangements, unbeknownst to you, because of the pandemic, there's just a lot more fluidity and uncertainty I think around the process.

Andrew McCoomb  10:33
Going back to something that Kaitlin was talking about on the contract side, I mean, and to your point Randy, about people now needing to keep a very close eye on what their supply chain looks like and what their relationships look like, and how well they're documenting everything. I mean, parties who rely on a supply chain put a great deal of effort into figuring out what their contingency plan is going to be if something goes wrong. And I'm thinking about force majeure clauses, and what value they have in these circumstances. I mean, it's a little bit more than cliché now to refer to the current situation as ‘unprecedented times’, but with so many overlapping disruptive forces, what do we think of the value of force majeure clauses and how are parties to a potential supply chain dispute able to take advantage of them or defend against a party taking advantage of them?

Randy Sutton  11:26
I would say, just in terms of force majeure clauses generally, I think it's --it’s one of those things that as-- as drafters of contracts need litigators, you just never really focused on. You know, it sort of was in there as a boilerplate. I think what we're seeing now is that there's complications around them. What exactly is a force majeure? The Canadian courts, for example, apply a high threshold when determining the applicability of the clause. And there's questions as to what actually gives rise to that. So what you want to think about from a risk management is, what constitutes force majeure? Can you identify specific circumstances and-- and provide more detail around that particular clause as opposed to relying on simply the boilerplate language, that's specific to your supply chain and specific to your business. What-- what I've seen just in my practice is there-- a lot of businesses recognize that everyone's struggling. They're trying to work together collaboratively, to deal with what is unforeseen. Again, there are contractual rights and remedies that people can rely on but in my practice I've seen people try to negotiate and deal with things in an amicable way. But again, in the future, who knows if that will be the case and I think certainly if there was more certainty in your clauses, it would allow people to be more able to deal with things more effectively in terms of a dispute or at least having some more clarity so you can negotiate from a stronger position if that issue arises.

Andrew McCoomb  12:48
Yeah, it's interesting. It seems like I-- I mean I'm thinking of the analogy of, in the M&A context, material adverse effect clauses, that are now sort of more commonly consistently building in COVID-19 language into the disruptions that are possibly contemplated and, just to your point, being really clear about what we're thinking about when we think about force majeure as opposed to just handing down some provision that's been in a hundred contracts prior.

Kaitlin Smiley  13:17
And I-- I think to Randy's point that parties aren't necessarily relying on their strict contractual rights at this point because it's a long process. Whereas companies are wanting to, when there is a supply chain disruption, deal with it in a way that's quick, that means that they can solve the problem in a proactive way through negotiations and get the product back to market. They're in a better position and they can sort out their contractual rights and remedies and damages down the road, but having that more constructive approach in the moment seems to be what companies are doing and for understandable reasons.

Andrew McCoomb  13:53
I think that makes total sense and most of the contracts or-- or many of the contracts that would be in play probably have some balancing features that can be traded off against each other. Like if there's exclusivity or near exclusivity in a supplier arrangement, obviously, that goes out the window when your supplier can't be providing you with product and so that's something that can be traded back and forth, and-- and new-- new relationships can be restructured. So then, what else? What else can Canadian businesses do to plan for, to try to reduce the risk of litigation or regulatory action?

Randy Sutton  14:30
From my perspective, it's-- it’s understanding your supply chain, it's understanding the regulations in the various jurisdictions that you may be governed by. It’s thinking about and-- and working through and-- and really understanding where you get your products from in terms of regulation around environmental issues, social issues, and governance issues. It's just important to understand what your supply chain looks like in that context and-- and doing the due diligence upfront and making sure that when your supplier says x, it's accurate. And you can make that statement and-- and justify that statement.

Ailsa Bloomer  15:07
On the due diligence point, what is the scope of that duty to carry out due diligence along your supply chain? Because we can think of duty in the legal sense to have to take all reasonable steps to understand where you're getting your products from, but with the added layer of ESG and corporate sup-- supply chain responsibility, it’s a new dimension to that level of due diligence now, and so the boundaries between social responsibility and legal liability aren't as clear anymore. So, what's your sense on-- on the scope of reasonable due diligence that companies should be doing along the supply chain and what does that actually look like in practice?

Kaitlin Smiley  15:46
I-- I think it's going to look different for different companies, and for different entities. If you are a company that is, you know, manufacturing a single product and you-- it has five inputs and, you know, those five inputs are-- are coming from, you know, suppliers that you have individual contracts with, the expectation on you to actually carry out more extensive due diligence on those five entities will be greater than if you are a retail location that sells tens of thousands of products that have any number of inputs. So, it really is going to be circumstance-specific.

Andrew McCoomb  16:25
In picking up on that point, I mean, so you can see parties putting in the effort and-- and that scalable effort like you say Kaitlin, that-- that's appropriate for the circumstances, that makes total sense. And I bet a lot of that's done, you know, at an RFP stage if you're looking at multiple suppliers, you're getting commitments from who your suppliers are as to how they do business and you're putting in the work. But of course, things will go wrong and, you know, eventually that may end up landing at the foot of the person at the end of the supply chain. What kind of other protections can you have beyond just putting in the work and the diligence in the event that something goes wrong up to-- up your supply chain with an ESG-type issue that has people looking to you for-- for some kind of compensation.

Kaitlin Smiley  17:15
So there's a couple of ways you can address it. One of them is through contractual indemnity. So again, this is at the-- at the upfront stage when you are, you know, doing your due diligence, you're entering into your-- into your contract, you're dealing with force majeure clauses, but having an effective indemnity provision is important both from a contractual standpoint as well as from a due diligence standpoint because an indemnity provision can be beautifully drafted, wonderfully enforceable, but it's only as good as the assets and the solvency of the company that's owing the indemnity. So doing some due diligence on the financial wherewithal, and ability to fulfill this indemnity obligation, whether it is a hold harmless, whether it is an-- an obligation to defend the company, that liability is being sought from down-- down the chain, whether there are personal guarantees that should be in place, depending on the nature of the company. But, even if the financial wherewithal is great when you're entering into the relationship, the picture may change significantly, especially if this company is in a situation where it is no longer supplying the product and the component that you need for the ultimate product. So then we're looking at things like insurance. And whether the company that owes the indemnity obligation has appropriate insurance in place, whether they're obliged to have insurance in place, either for your benefit or insurance that will respond if they're being called upon to fulfill the indemnity obligation. And then there's just insurance that the company at the end of the chain can have in place to help respond to some of these complaints into these liability claims that they may be facing. And that's why it's critically important to document your due diligence. I mean, if-- if we're at this stage, obviously there's, you know, media attention, and there's public relations and there’s customer issues that we're having to deal with. But best position, the defense of the company, at the end of the day, documenting the due diligence, making it more than just a checklist is part of any corporate due diligence, but actually giving some meaning to the questions that you're asking there, to the level of scrutiny that you're applying to those responses, you know, giving it some sort of air of reality check. 

Ailsa Bloomer  19:36
And when you're doing your due diligence, to what extent do you need to understand the differences between different markets that you are operating in, and make an attempt to bring some consistency back to the domestic market that you're selling your product in?

Randy Sutton  19:55
I mean, I think the regulatory standard in your home jurisdiction is the one that I really-- I think you want to focus because that's sort of standard of care that a regulator is going to expect, particularly in terms of the supply of products. So, I don't think it's sufficient for you to say, well we, you know, we didn't think that we needed to meet a standard here because that's not the case in another jurisdiction. And so, that's why I think it's important to understand what the regulatory standards are in that jurisdiction, how they compare to your own and if there are meaningful gaps then making sure that the supplier knows that, you know, we don't rely on that and this is what we need you to establish. And, you know, we have a third-party who does testing and unless you can comply with that testing and show us that it meets the standard that we need to-- to comply with, you know, we're not going to buy it. And there, you know, one of the benefits in-- in this space is that there are lots of international standards now that are coming forward. Lots of co-operation in terms of trying to develop regulatory standards, so that, hopefully, you know, if it meets a certain standard, it will meet a standard globally. And I think that is helpful, particularly where you've got products coming from a bunch of different countries. And so, if you can all sort of point to that one globalized standard and say, this is what it needs to do, and this is what it needs to meet, then that will help you dealing with any issues and making sure that you've got the compliant product.

Ailsa Bloomer  21:12
We have several jurisdictions now like the UK, Netherlands, Australia and Canada soon, to implement modern slavery legislation. And it-- it seems to me that we have several different laws that companies could be trying to deal with in managing or trying to comply with human rights due diligence legislation. Will we see in the same way that we might have consistent standards for food and pharmaceutical products, will we see that perhaps in the Human Rights context, or are we still going to be dealing with multiple modern slavery regimes in-- in different jurisdictions?

Randy Sutton  21:56
I mean, I think it's much too-- too early probably to say. I think-- I think the challenge, you know, and when you look at sort of regulatory issues, you know, even look at them in Canada, is there's always sort of the little change in the wording in one province versus another province, and you know, does it fall within this category here, that category there? It's hard to come up with harmonized legislation across even Canada, we've seen that in a bunch of different areas. And so, whether we can do that, globally is a-- is an open question. But I think, from my perspective, you know, the devil often is in the details and there could be subtle variations which will need to ensure, you know, we're complying with and we're focusing on. And so, I think it will take a long time, for there to be an ability for us to say, well, we've got one global standard on those types of issues, that everyone is complying with and given the world right now and the-- the fractured nature of many things, I think it's going to be difficult to bring that-- that to the floor and get that to the point where we have a-- an international standard on some of those types of issues. And so, I think you'll have to look jurisdiction by jurisdiction.

Andrew McCoomb  22:57
So, sometimes we end these episodes by asking our guests to tell us-- tell us if they notice any interesting trends, or if they're watching out for anything developing in the law in this area in particular. Is there anything you guys want to flag going forward as an area of interest?

Randy Sutton  23:16
I think for me under the-- the key area that we're just seeing is a lot of increased regulation in a-- in a bunch of different areas. I mean, I-- I focus on Health Canada a lot, and the number of new initiatives in terms of labelling, in terms of product characteristics, all of that, it just continues to expand. So I think, you know, given the issues we've seen in terms of disruption, we're seeing issues around, you know, potential class actions around recalls, that kind of thing and as there are more complicated supply chain, you're gonna see a lot more regulation in a bunch of different jurisdictions about that. So, I would say the trend is just more regulation. And I really think businesses need to be aware of what's going on and-- and understand the regulations and make sure you've got a robust compliance system and so those-- those regulations get updated and changed. You're-- you’re flagging them for your-- your business team and-- and so they're aware of what's going on.

Kaitlin Smiley  24:13
And I think that one of the real areas of emerging regulation within Canada is, as Randy touched on earlier, the legislation and the regulations surrounding modern slavery in supply chains. And that's, you know, something that we see is more advanced in terms of the legislative situation in Europe and in-- in other jurisdictions. We are seeing draft legislation that was reintroduced recently in Canada that is touching on this. So, companies staying apprised of their obligations, trying to get ahead of some of the potential regulations that may be coming into force in the future by implementing those sorts of considerations into their due diligence now so that they're not needing to revisit and kind of rework the wheel down the road. So keeping an eye out for those and making sure, as-- as Randy said, that companies are staying on top of the regulatory developments and changes within the various jurisdictions that they operate in.

Andrew McCoomb  25:20
That is a perfect segue because we have episodes in our production schedule doing a deep dive on modern slavery legislation in the future, so that is very exciting and it's a perfect tip-off for what we have in the pipeline, but for this conversation, Kaitlin, Randy, thank you guys so much for joining us. 

Randy Sutton 25:41
Our pleasure. Thank you. 

Kaitlin Smiley 25:42
Thanks.

Ailsa Bloomer  25:43
We hope you enjoyed this episode of Disputed. If you'd like to find out more about this topic, or how to contact our guests, please visit nortonrosefulbright.com/disputed. Also, if you have any questions, feedback, or topics that you'd like us to cover in a future episode, please do email us at disputed@nortonrosefulbright.com. And if you would like to hear more, please subscribe to Disputed on Apple Podcasts, Spotify or wherever you get your podcasts. 

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