Assessing and Mitigating the Impact of New U.S. Tariffs on Your Contractual Relationships

Canada is going through uncertainty regarding the introduction of new customs tariffs (often referred to as “tariffs”) of up to 25% by the United States and is planning possible retaliatory measures. 

This situation will cause major changes in the supply chain. If, like many other Canadian companies, you have contracts in place with businesses in the U.S., how can you assess the impact of the new tariffs on these contractual relationships and be proactive in mitigating the consequences? That’s what we’ll explore in this article, using a case study involving a long-term supply contract between a Québec supplier and its American client.

Prices and Delivery Terms

The risks associated with the levying of customs duties are obviously very high for suppliers that have agreed to sell products at fixed prices, especially when those prices include delivery to the customer’s premises. This is where the delivery terms in the contract (or purchase order) take on even greater importance. They’re often only briefly described in reference to Incoterms. It’s important to remember that DDP (Delivered Duty Paid) Incoterms mean that the seller is responsible for all import customs duties and taxes on products shipped to the United States. In most cases, however, import costs are paid by the buyer. See the article on Incoterms. 

Even if the Québec-based supplier isn’t required to pay U.S. tariffs under its contract, it may still be affected by the introduction of these tariffs. In fact, the levying of U.S. tariffs, as well as any retaliatory tariffs imposed by Canada or other countries, will impact the entire supply chain, and therefore impact manufacturing prices. The seller may have included a clause to adjust prices in line with increases in the cost of materials and components. It’s important to check whether your contract contains such a clause.

Whether the increase comes from tariffs or a price adjustment, the buyer may wish to terminate the contract if it is too costly or to give priority to other suppliers less affected by the situation. Hence the importance of examining other clauses of the contract, as we’ll do below. 

Contract Duration and Termination Clauses

The contract may provide for the right of either or both parties to terminate the contract or any pending orders. If the contract becomes too costly, the buyer may want to take advantage of this clause by terminating the contract or a specific order, or by not renewing the contract when it expires. 

The reverse is also true: If the contract becomes too expensive for the supplier, he may want to cut its losses by terminating the contract. In many cases, the buyer’s right to terminate is accompanied by a compensation clause for the costs incurred by the seller, especially when they can’t be recovered. These costs must be adequately assessed, and the supply contracts between the manufacturer and its own suppliers must be analyzed. If employees have to be laid off due to loss of orders, severance payments may be included in these costs and billed to the customer. 

Exclusivity and Minimum Purchase

If the buyer can’t source the same product from another supplier, the seller’s position is more secure. That said, the buyer sometimes has the right to source from a third party if the same good is offered on better terms. The scope of exclusivity must, therefore, be carefully analyzed. The seller’s intellectual property rights on the products may also offer it some security by helping to prevent imitations or allowing the seller to negotiate royalties for the manufacture of similar components by a third party. 

Force Majeure, Substantive Changes and Renegotiation

In the event of force majeure, a party may be excused from performing certain obligations and not be held liable for any resulting damages. Force majeure refers to unforeseeable circumstances beyond the parties’ control that render the performance of an obligation impossible. Contractual force majeure clauses often consider government intervention or changes to applicable legislation as force majeure. This might lead you to think that a sudden levying of tariffs would constitute force majeure, but that’s generally not the case. The performance of an obligation isn’t considered impossible simply because it’s become more costly. Furthermore, is an increase in duties really unforeseeable when the threat has been looming for several months? In other words, typical force majeure clauses generally don’t apply in this context, and the parties will be required to fulfill their contractual obligations despite the levying of tariffs. However, your contract may contain a broader definition of force majeure, and the relevant clauses need to be analyzed. 

Finally, your contract may also contain clauses that allow the parties to renegotiate certain aspects of it if changes in market conditions make performance of the contract too expensive for either party, subject to compliance with certain procedures (such as notice and exchange of information) and renegotiation. It’s important to check whether such clauses are present and to understand their conditions and risks, if any. It may also be possible to modify product specifications to limit the impact of supply chain price increases, but customer’s consent is often required for such changes. 

Effective communication and strong customer relationships are often the key to successful trade partnerships. In the current context, it’s crucial to maintain these good relations and communication practices, and to be well-prepared and informed about the contractual arrangements in place. You also need to be aware of your negotiating power and legal alternatives to a negotiated solution. 

BCF’s mission is to support local companies in their day-to-day business, provide reassurance in times of uncertainty, and offer expert advice. We’re committed to providing guidance and expertise to help you navigate complex situations, including matters related to import customs duties and their impacts on the supply chain. Our team understands the challenges you face and is always ready to help you make the best use of available resources. Feel free to contact our team for advice on your contractual obligations.