Contractual issues in the Pharmaceutical industry

As the world responds to the increasing spread of COVID-19, pharmaceutical companies and contract research organisations are facing disruption to pre-clinical and clinical research, as well as planned production.

According to data analytics firm GlobalData, for example, approximately one-fifth of all drug studies are conducted in China, which has of course been severely affected by COVID-19. China is also a key supplier of materials for pharmaceutical end products. Many international producers are likely to experience disruptions to their supply chains, given they often involve players located in different countries, which could impact production schedules.

For instance, the Indian Director General of Foreign Trade announced on 3 March that India has restricted the export of 26 active pharmaceutical ingredients (APIs), including paracetamol – a significant development given that Indian pharmaceuticals produce 20% of the world’s drug products by volume.

This disruption will have legal consequences.Where supply is disrupted, counterparties may seek to delay or avoid performance (or liability for non-performance) of their contractual obligations, terminate contracts, or renegotiate key contractual provisions (eg price or volumes exported or imported).

We reflect in this article on some of the key issues for pharmaceutical companies to consider when assessing the potential impacts of COVID-19 on their business and, in particular, managing the risk of disputes with contractual counterparties.

Key considerations for pharmaceutical companies

Review and communicate

Horizon scanning to anticipate potential problems is key – identifying potential issues early is critical to effective planning and risk mitigation.

If, for example, a company identifies that there is a real risk that a particular supplier may (at some point) struggle to fulfil its obligations, it can begin to plan how to mitigate that risk (for example, by proactive engagement with the supplier in question or by contingency planning), consider any impact on its own contractual obligations and ensure that it protects its legal position.  Similarly, if a company identifies early that it may not be able to fulfil its obligations, it can ensure that it adopts a legal and commercial strategy to minimise its liability.

For example, an early step is to evaluate supply chains, with due diligence focusing on origin of materials and intermediary ingredients. These supply chains can be very complicated and origin of materials is not always clear, but such an audit will help identify risks and uncertainties at an early stage.This should include monitoring for any signs that a key supplier may be in financial difficulty: for further detail or spotting and managing supplier distress, see here.

Likewise, it makes sense to review the feasibility of R&D schedules, to enable contingency planning and dialogue with key stakeholders or commercial counterparties.

Communication

Effective and timely communication with contractual partners will often be critical, both to keep the business functioning and avoid disputes.

As the situation continues to evolve and further information about COVID-19 comes to light, it is important to maintain clear lines of communication and consistent messaging, both internally and externally. Regular proactive external messaging may prevent speculation or other forms of misinformation.

Consider contractual rights and other relevant law

Whether unable to perform obligations or anticipating that a counterparty may cite COVID-19 as a disruptor affecting its performance, it is important to analyse the relevant contractual provisions and the legal position more generally. This analysis will then inform the commercial strategy, the available legal options and the steps required to protect any potentially applicable legal rights – a failure to serve a timely notification could, for example, prejudice materially a party’s legal position.

Force majeure

One question (which we are already seeing in practice) is whether the outbreak, and/or the governmental measures taken in response to it, can be characterised as a force majeure.

Most civil jurisdictions imply the doctrine of force majeure into contracts. Under English law, however, force majeure is not recognised as a matter of law; it will only apply if the contract in question provides for it.

While of course drafting varies, a typical commercial contract defines force majeure as an event beyond the control of the parties that prevents the performance of contractual obligations and will include a non-exhaustive list of what will, and will not be, force majeure events. Generally, the clause will also require the event to be (1) beyond the reasonable control of the party; (2) not reasonably foreseeable; and (3) unavoidable by taking reasonable steps.

Whether COVID-19and the associated governmental measures will qualify as force majeure events will depend on the drafting of the clause in question and the factual impact on the relevant contract.

It is reported that the China Council for the Promotion of International Trade, a quasi-governmental foreign trade and investment promotion agency, has issued over 1,600 “force majeure certificates” to businesses that have failed to perform on time or failed to fulfil an obligation in an international trade contract. Courts or tribunals in different jurisdictions will no doubt view such certificates differently, and their effect will depend – among other things – on the wording of the relevant contract.

The consequences of a force majeure event also vary contract by contract: for example, a party may be excused(temporarily) the performance of the entire contract or only a specific obligation. It will be expected to resume performance as soon as the force majeure event ceases to prevent it from doing so.Some contracts will also provide termination rights in the event of prolonged force majeure.

Parties in the middle of a chain of related contracts should be aware that even if their sub-contractor is able to claim force majeure, that does not mean that they will automatically be relieved from their obligations to their own customer:that will depend on the terms (and governing law) of each contract.

Finally, and importantly, some force majeure clauses impose additional requirements on the party declaring force majeure, such as a duty to mitigate the impact of the event and an obligation to comply with notice provisions. As already alluded to, it is critical to follow these requirements strictly and ensure that you keep appropriate records to show what was done and why: a failure to do so may leave a party that could have otherwise have claimed force majeure without any protection.

Frustration

At English common law, the doctrine of frustration may terminate a contract automatically on the occurrence of a subsequent event, which is (1) unexpected; (2) beyond the control of the parties; and (3) makes performance impossible, or renders the relevant obligations radically different from those contemplated by the parties at the time of contracting.

As a key distinction from force majeure, the doctrine of frustration does not need to be reflected in a contract. The threshold for frustration is high, but a party faced with (for example) a government ban on the exportation of certain medical products may claim that the contract has been frustrated because it has become illegal to perform as a result of change in law. The prospects of such an argument succeeding will depend on the nature of law in question and its exact impact on the contract.

Exclusion and/or limitation clauses

Many commercial contracts contain an exclusion or limitation clause as a form of risk allocation, either seeking to exclude certain types of liability altogether or limiting a party’s exposure, for example by capping the maximum amount payable.

Any such provisions will be important considerations in determining how to respond to a threatened or actual breach of contract by a counter-party, or where a party is reflecting on the consequences of its own breach. For example, a party may find that the costs of trying to maintain contractual performance (for example, by taking steps to source alternative products to satisfy supply obligations, or making use of alternative modes and routes of transport) exceed its potential liabilities on breach – although it will also be critical to consider and test the applicability and enforceability of any such clauses.

Termination

The impact of COVID-19 on a contract and the parties’ performance may give rise to a right to terminate a contract either on its terms or under the governing law (such as the English common law right to terminate for a repudiatory breach). It is, however, important to consider termination carefully – not only because of the commercial impact, but also because a wrongful termination carries significant potential exposure and, given that, how a party terminates can affect significantly its damages claim.

Any other contractual clauses?

There may be other contractual clauses that may limit, delay, excuse or discharge parties’ obligations under the contract. Examples include clauses dealing with termination, material adverse change (MAC), price adjustment and change of law.Whether these clauses will be relevant will depend on their wording and the impact of COVID-19 on the contract.

For further analysis on how COVID-19 may affect your contractual obligations, please refer to our briefing here.

Are the disruptions covered by insurance?

Insurance may provide some relief, but much depends on the applicable law and the wording of the policy.

The fact that a pharmaceutical company cannot source the correct raw materials or APIs from its own suppliers is unlikely to trigger a business interruption policy. Such policies are usually predicated on physical damage to the insured’s own premises, with possible enhancements (contingent cover) for matters such as interruption due to damage to a supplier’s premises. There can be cover for matters such as clean-up costs following known incidents of specific types of diseases or contamination at the premises, or possibly more widely, depending on the wording.

If such pressures on the supply chain lead to widespread financial stress and default then credit risk insurance policies may be relevant. Comprehensive credit risk policies will sometimes be taken to protect traders for non-payment by those they supply goods to and/or in respect of pre-payments to suppliers. There are usually requirements of prompt notification and non-variation of terms (eg amount and time of repaying debt) without insurer’s consent.

Accordingly, a company anticipating significant problems (either itself or with its suppliers) would be well advised to consider potential coverage, and review the policies carefully, at an early stage.

Conclusion

The progress of COVID-19, its impact on the world's economy at large, and on the pharmaceutical sector specifically, is very uncertain. However, disputes will inevitably follow the crisis and companies who actively consider these issues, and develop and implement a strategy accordingly, will be in a better position to deal with those disputes, whether in the shoes of a likely contract-breaker or contract-enforcer.

More on navigating the COVID-19 outbreak