The ongoing shortage of silicon microchips, also known as semiconductors, across the globe continues to disrupt numerous industries just at a time when the world is slowly emerging from the constraints of the pandemic. This has had a stark impact on sales, production numbers and companies’ stock prices.

Reports last month, based on research involving more than 150 firms, found that manufacturers’ supplies of microchips had fallen from an average of 40 days' supply in 2019 to just five days’ worth by late 2021.

The pandemic has driven huge demand for particular types of consumer goods, and millions of products - from cars, washing machines, smartphones to laptops - rely on these chips to function. Production of chips has not been able to keep pace with the increased demand. This has led to inevitable pressures on manufacturers who have been left unable to fulfil orders and provide stock. Unfulfilled orders will give rise to disputes between contracting parties, up and down the supply chain, for both delay and non-performance of obligations.

What are the legal implications?

What should you do if you’ve contracted with a manufacturer who is failing to deliver ordered goods, citing that it’s been held up by a shortage of chips or other components? Or maybe you’re a manufacturer who’s experiencing the supply issues?

Those impacted by such performance issues should start with a review of the relevant commercial contract. We set out some of the key legal considerations below:

  • Force majeure: Force majeure provisions are unlikely to be engaged. In respect of the microchip shortage, although the original problem may be traced back to issues with production during the pandemic, it’s unlikely that a supply issue of this kind will be listed in a commercial contract as a force majeure event.
  • Frustration: Most supply issues will only make the performance of the contract more difficult rather than impossible – a manufacturer may be able to source chips or components elsewhere, or it may just take it longer for it to manufacture the goods concerned. Only where an event has occurred beyond the control of the parties which has rendered the performance of the contract physically or commercially impossible to perform will the contract be frustrated.
  • "Material" or "substantial" breach: Typically commercial contracts will include a provision entitling an innocent party to a specified remedy or a right to terminate the contract where certain specified types of breaches have occurred, whether for “material”, “substantial” or, more rarely, “any” breach. A failure to provide specified goods as a result of a shortage of components will need to be assessed against any contractually specified breach standard. 
  • Remedy” or “cure” periods: Contracts may specify a "remedy" or "cure" period in respect of any breach. These kinds of provisions typically require the innocent party to serve a written notice identifying the breach and giving the party in breach a set period to remedy or cure the defect. Such provisions should be complied with strictly before the innocent party takes further action.
  • Is time of the essence? If the time for the performance of an obligation, such as the delivery of specified goods, is stated to be of the essence, that will give the innocent party an immediate right to terminate the contract if there is a failure to perform that obligation.
  • Terminate or affirm? If a party is faced with a failure by a manufacturer which gives rise to a right to terminate, then that party will need to make an immediate assessment as to whether it’s in their interests to terminate or not. Actions taken by any part of the innocent party’s business in compliance with its own contractual obligations after the manufacturer’s breach may amount to an affirmation of the contract.

Commercial considerations will also loom large in any decision on what to do when faced with such supply issues. How time critical is receipt of the goods in question? Is there any prospect of sourcing the same or similar goods from an alternative manufacturer? How important is the commercial relationship with the manufacturer who is facing the supply issues?

Reports seem to confirm that the global chip shortage is here to stay for now, at least until production capacity can be ramped up, which may take some time. In the meantime, those dealing with tech manufacturers would be best advised to pay close attention to their relevant contracts, keep in regular contact with those manufacturers to stay abreast of any potential supply issues and put in place mitigation and contingency plans for supply shortages.