Import tariffs and Legal Resilience: Strategies for GCs in a Changing Trade Climate

The United States has announced new import tariffs, resulting initially in unrest on the stock markets and sparking reactions from other countries. What are the consequences for international trade, and what can general counsels do? Martine de Koning, attorney Commercial, Competition & International Trade with Kennedy Van der Laan, and Lize Nauta, economist with Rabobank, discuss the economic and legal consequences, as far as these are known at present.

Geopolitical tensions and changes in the international trade climate followed by announcements of a steep rise in import tariffs impact global trade. Even though many have been paused or lifted, these are uncertain times. ‘At present, we are still busy calculating the effect of these rates’, Lize Nauta says. ‘Not only can the Netherlands be hit directly, via the direct trade with the US, but also via second or third order effects of the shock in international trade. The eventual impact will also depend on the EU’s counterresponse’. 

The impact of tariffs differs per sector. ‘Initially, it will hit sectors with strong ties to the US, such as the manufacturing industry’, Lize says. ‘The import tariffs render European and Dutch products more expensive for Americans, who will turn to national alternatives if they can.’ This follows from several Rabobank studies, including the sectoral prognoses (in Dutch) and an investigation into the impact of the American import tariffs (in Dutch). ’Which tariffs will go through and what the responses will be is difficult to predict’, Martine de Koning says.

The Dutch sectors supply American companies and households not only directly, but also indirectly. They do this via other Dutch or European sectors. Many production processes have international value chains. ‘The services sector may also be hit this way’, Lize says. Rabobank has elaborated the direct and indirect connections with American sectors for a number of European countries (in Dutch). Many companies will be confronted with the effects of the tariffs. This affects not only their cost structure, but also the arrangements they have with trading partners. 

International trade takes place on the basis of contracts between companies. What is the best way for general counsels to respond to the consequences of the new import tariffs? Martine: ‘What the tariffs mean to current contracts, and what you can do, depends on the import tariffs, but also on the type of contract. Is it purchase, supply, contracting of work, distribution franchise, or agency? Certain contracts are subject to mandatory rules in more or more countries. Between trading partners it is also important what the contract states exactly and what law is applicable to the contract. In long-term contracts, generally speaking in most European countries, you cannot unilaterally change the price or other terms of an agreement, unless the contract includes a clause to that effect. Terminating the agreement is often possible, but often not without observing a reasonable notice period. Sometimes, you will have to pay compensation or damages in addition to applying a reasonable notice period. In most cases this is a (too) drastic solution. Tariffs are usually charged on entirely or partially to end users. It may make a difference who in the contract is responsible for arranging the documentation and payment of the import tariffs. The Incoterm that has been declared applicable in the contract (e.g. Incoterms 2020) may also be relevant. There are various Incoterms, which determine the time when the risk passes, and who has to arrange transportation, insurance, and the like.’ 
Martine advises to organise contracts such as allows a certain degree of flexibility. ‘This leaves you room to deal with changes to inflation, import tariffs and exchange rates, for example, and room to negotiate.’

Of course, there are situations in which one contracting party will be negatively impacted but not the other party. Martine: ‘If that is foreseeable, it may not necessarily be favourable to steer for flexibility. The precise impact will need to be forecasted. A solution for parties that foresee being hit by the tariffs is to maintain buffer stocks or to contractually obligate suppliers or customers in the chain to do so. This will make the impact less sudden, and it will allow your company to draw from stocks before the cost change kicks in. The costs and the storage capacity needed will increase, with brings additional costs, but delays or shortages in the supply chain will be softened at the same time. In many sectors companies already take less risk in their supply chain since Brexit, Covid and the issues in the Suez Channel. Unilateral modification (including material adverse change) and indexation clauses can provide a solution, but not all contracts contain such clauses. In the absence thereof, also a carefully drafted termination for convenience clause may provides for leverage in negotiations to change the contract.’

A party that unlawfully terminates a contract may be liable for damages, including lost turnover. Under Dutch law, force majeure or unforeseen circumstances may be legitimate reasons to set aside a contract. Martine: ‘Covid was seen as force majeure if it prevented compliance with the contract. However, in an international commercial contract between large parties, the increase of tariffs or rising inflation or other costs is usually not force majeure. Covid was, however, an unforeseen circumstance that could provide the basis for an adjustment to a contract. Price fluctuations, inflation or changing import tariffs are not usually regarded as an unforeseen circumstance that justifies amendment or termination of the contract in court. Naturally, this depends on the amount and impact of the tariff rate and the extent of unpredictability, and other circumstances of the case. After decades of mostly decreasing import tariffs, the current situation is new. The longer the situation of uncertain (but steep) import tariffs continues, the more this becomes an aspect of business to simply take into account when concluding the agreement.’

Apart from the type and exact contents of a contract, Martine also says it matters how the supply chain is organised. ‘The place where you buy, process and resell your raw materials or semi-finished products is decisive to the impact of events like import tariffs, and whether or not you have alternatives.’ 

In most cases, when faced with raised import tariffs you will simply have to pay more. ‘The tariffs apply to goods with certain classifications’, Martine says. ‘If the classification and therefore the tariff is incorrect, you can object to it.’

An alternative is to switch to relationships with parties in other countries. But it also depends on the regulatory setting to what extent a company can adjust its supply chain. ‘For pharmaceuticals, for example, you can often not simply start using an alternative ingredient’, Martine says. ‘Since government approval usually applies only to the original composition. A similar problem occurs with CE-marked products or products with some form of an official certification or approval.  

Import tariffs affect not only business operations, but also mergers and acquisitions, because they influence the value of a business and thus decision-making processes. The effects on current and planned mergers, acquisitions and investments depend ‘on the question whether the US is involved in the supply chain or as a market. Generally speaking, slowing economic growth is not good for the mergers and acquisitions climate’. A merger or acquisition is preceded by a legal as well as a financial and economic due diligence. Martine: ‘Financial experts weigh all aspects, also those of the supply chain and the market. Uncertainty may create a hesitation in the market, with fewer transactions as a possible result.’

It is not only companies that have to deal with new import tariffs; countries can also do something. Martine: ‘After World War II, the GATT and later the WTO were established to create a forum for multilateral round-table talks to make international trade arrangements. The goal was to create a level playing field without discrimination and to remove trade barriers and lower import tariffs. For quite a long time, this has indeed led to lower tariffs’. The WTO has a body for dispute resolution, which the EU has often used in the past. ‘Canada and China have filed a complaint in response to the recent tariff increases, but there are several cases pending between countries on all kinds of topics and sectors.’ Since no new members were appointed to this body when the members rolled off, it is no longer active. With 25 members the EU has taken the initiative for an alternative mechanism: ‘multi-party interim appeal arrangement’, MPIA, consisting of ten arbitrators. It sometimes works to find a solution via this route of dispute resolution mechanisms, or bilateral meetings.

Martine advises lawyers to map out all contracts carefully and to have this knowledge ready. ‘What types of contracts are there, how flexible are they, how are the supply chains organised, are there any amendment/termination clauses, and how can one adjust existing relationships to respond as agile as possible to developments around import tariffs? Where possible, it may be a good idea to give contracts more flexibility.’

Times will remain uncertain for now, and after finalizing the text of this article (on 8 April) the world may well look different already.