COVID-19 Emergency Preparedness Enterprise Risk Management (ERM) Financial Legal & Regulatory Strategic

Making Hospital Supply Chain Disruptions Manageable Inconveniences

For hospitals and health care systems nationwide, disruption to the supply chain process has resulted in a scarcity of resources and supplies. These shortages are more than inconvenient and uncomfortable, they are life threatening and can be unmanageable. Like individual consumers, the health care industry has been plagued by purchasing limitations, price increases, and lack of supply availability. Hospitals (buyers) have turned to their normal supply chain partners (sellers) to help meet continued patient needs. Like buyers, however, sellers have faced their own set of supply chain struggles, which has placed added burden on meeting buyer needs. As a result, sellers have been unable to guarantee product or supply availability, raised prices and have simultaneously attempted to shift risk for supply chain disruptions to buyers.

As a response to the above challenges, the contractual relationship between buyer and seller is being negotiated in a different way. Often benign or unremarkable “boilerplate” clauses are now tediously negotiated and sellers are pushing to incorporate language that narrows liability while buyers are being asked to accept a new level of uncertainty around seller performance. Price increases are built in at more regular intervals and additional price increases can be triggered by an increase in supply or manufacturing costs linked to supply chain disruptions.

Force Majeure Adjustments
As a result, renewed attention should be paid to traditional force majeure clauses that were once boilerplate but are now being used as opportunities to avoid performance. Under the traditional force majeure clause, the parties agree that if certain acts occur that are outside of the control of a party, then a party is no longer obligated to meet certain contractual requirements. Most often, for example, these clauses permit a party to limit performance or altogether fail to perform due to “acts of god,” power failures, transportation issues, government orders or terrorism. Since the beginning of the pandemic, sellers and buyers have sought to add “pandemic, epidemic or declared disaster” to this list. The addition of these conditions is helpful to both the seller and the buyer, giving each the ability to pivot the relationship if a declared public health emergency or declared natural or human-made disaster warrants.

Often times a seller will seek to exclude payment obligations from a force majeure clause. This means that even where there is an “act of god,” the buyer is still required to make payment. Consequently, buyers should consider removing the payment carve out entirely or modifying to give flexibility. Additionally, a buyer should consider incorporating some flexibilities that limit a buyer’s liability, if the force majeure event continues to impact the buyer’s business. For example, a right to terminate if a seller’s force majeure event continues for a certain period of time, making performance impracticable or language permitting a buyer to seek competitive products without breaching the current contract. This protects a buyer from prolonged supply chain disruptions and builds in a remedy in the event a seller does not perform. It would also benefit a buyer to narrow the list of triggering events that result in a force majeure event. The permitted actions should be those that are actually out of the seller’s control, that cannot be mitigated and where performance is impracticable.

Reallocation Risk
There has been a trend by sellers to add provisions that allow a seller to reallocate supplies without buyer permission, which greatly reduces a seller’s liability for failing to perform. Under these reallocation provisions, a seller is permitted, in its sole discretion, to reallocate products or supplies to the extent the seller determines a shortage of such supplies or products exists. Often these clauses are in addition to a force majeure clause and do not give the buyer much recourse. On their face, the provisions appear to be somewhat altruistic — ensuring equitable distribution of products and supplies when supply shortages exist. Upon a closer look however, these risk allocation clauses provide a seller with a significant amount of discretion and legal “cover” in the event the seller determines that it cannot perform as promised. As often drafted, a seller has the authority to make a reallocation decision at any time and for whatever reason. This means that if a seller has limited product due to poor planning, then the seller can reallocate goods in the same way as if the seller was experiencing a power failure or transportation delay due to a severe snow storm. At the same time, a buyer has little, if any, remedy if products are reallocated. Sellers may argue that the buyer at least “gets something” but this is a weak argument and, in a sense, nullifies the purpose of the contract.

When negotiating these types of risk allocation provisions, buyers should consider two points. First, buyers should consider removal of this clause in its entirety so that any failure to provide products or supplies (outside of a traditional force majeure event) would be a breach of the agreement. Second, if removal is not possible, consider building in requirements around reallocation, such as language requiring the supplier to fill a minimum or a percentage of open purchase orders before reallocating to another buyer. Or buyers could require that when the seller gets back to “normal” operations, the buyer gets their open purchase orders filled first. In all cases, a buyer would benefit from narrowing the scope of any permitted reallocation to only situations such as a declared disaster or global pandemic.

Disruption Preparations
In addition to negotiating the most favorable contractual arrangement, buyers should put systems in place to prepare for supply chain disruptions. There may be times when a usual seller is unable to perform, even though contractually obligated, and buyers need to build in safeguards to prevent a gap in supplies. Buyers should make plans now to safeguard against continued or future supply chain slowdowns or stoppages by considering agreements with various sellers and reconsidering sole-source relationships or exclusivity provisions. Anecdotally, sellers have been more generous in waiving exclusivity provisions during the past two years of the COVID-19 pandemic, but there is no guarantee that this generosity will continue. If there is still an exclusivity obligation in the contract, buyers should carve out that obligation from force majeure or reallocation provisions. This gives a buyer some flexibility if a seller fails to perform for any reason. A buyer should also consider the geographic region of the vendors and potentially choose vendors who are geographically diverse to increase the likelihood that a buyer can still receive supplies in the event of a supply chain disruption contained to one geographic region.

Finally, buyers should consider building in operational activities to take advantage of available external funding sources. Supply chain disruptions can cause significant financial burdens. In addition to insurance reimbursement for services and bundled supplies, COVID-19 has highlighted the importance of detailed cost tracking. Federal Emergency Management Agency (FEMA) funding, Coronavirus Aid, Relief and Economic Security (CARES) Act funding, and other government grants can be used to supplement or reimburse certain nonprofit business for services and supplies not otherwise covered by insurance. FEMA and CARES Act funding have specific documentation and eligibility requirements that make application arduous but still beneficial. Building cost tracking mechanisms into daily operations can save time and lessen stress when external funding sources become available and doing so helps to maintain the continuity of business and, most importantly, patient care.

COVID-19 triggered supply chain disruptions within an already frail national supply chain infrastructure. Suppliers are working hard to bridge the gap of a fragmented system while hospitals and health care systems are working hard to ensure products and supplies are available for patients. Supply chain disruptions are inconvenient and uncomfortable for the average consumer but for hospitals and health care systems, they are often unmanageable. Accordingly, sellers and buyers need to work together to make access to needed supplies a priority.

Exceptional care delivery and treatment needs to remain the primary role of hospitals and health care systems, while supply chain disruptions become minor, but manageable, inconveniences.

This article contributed by the Enterprise Risk Management Affinity Group of AHLA’s Hospitals and Health Systems Practice Group.
Author: Vallerie H. Propper, JD, MPH, is an Assistant General Counsel at University Hospitals Health System in Cleveland, Ohio. Her practice focuses on a broad range of topics in the health care regulatory and transactional space. She holds a Masters in Public Health and worked in emergency management before her current role.

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