The COVID-19 crisis has revealed the extent to which the United States and other countries are dependent upon a well-functioning global supply chain of critical medical supplies, including ventilators and Personal Protective Equipment (PPE) such as N95 respirator masks, surgical masks and other items essential to protecting doctors, nurses, EMTs and others on the front lines of the pandemic. As with many goods, the supply chain, from raw material to manufacturing to delivery, is global and depends on "just-in-time" supply chains. Indeed, while the various U.S. companies that sell N95 masks have U.S. manufacturing facilities, most masks are manufactured overseas – with roughly half made in China.
In normal times, this degree of global sourcing does not present a problem. But these are not normal times. Immediately after the pandemic outbreak, China moved to obtain most of the N95 masks and other PPE manufactured in that country for use by doctors and other health professionals caring for COVID-19 patients there. Then, as the virus spread globally beyond China, other countries – including PPE producers such as France, Germany and South Korea – similarly bought up available supply, and also severely restricted export of the precious commodities. In a few short weeks, the global market for PPE ground to a halt.
Now, amid the peak of the crisis in this country, the U.S. faces severe shortages of N95 masks and other PPE. In response, U.S. companies are currently manufacturing approximately 50 million N95 masks per month domestically. But this is not nearly enough to meet the demand. The U.S. Department of Health and Human Services (HHS) estimates that the U.S. needs 300 million N95 masks per month to fight the COVID-19 pandemic. This massive need, not only in the U.S. but in other countries as well, has led to a global hunt for PPE supplies.
Given that background, a "Wild West"-style market for PPE has emerged – with governments, hospitals, healthcare companies, entrepreneurs and others all on a worldwide hunt for supplies to buy and sell, logistics companies selling coveted air cargo capacity made scarce by the severe restrictions on international flights, and governments trying to figure out how to bring order to the chaos – all while making sure the equipment is legitimate and policing against scam artists and "virus profiteers," as well as trying to facilitate the flow of genuine equipment to those who need it.
The Federal Emergency Management Agency (FEMA) and HHS are trying to enter the market, not only as a customer but also as regulators – attempting to bring order to the chaos through the creation of FEMA's Supply Chain Stabilization Task Force. FEMA is working with logistics companies to facilitate the large-scale movement of PPE supplies to the U.S., such as through its "Project Airbridge" partnership with UPS. State governments are also making big purchases, with California making the biggest splash – announcing on April 7 that it was committing up to $1.4 billion to secure a monthly supply of 200 million N95 and surgical masks, as well as other crucial equipment, mostly sourced from suppliers in China.
Most recently, the federal government has also moved to restrict the export of N95 masks and other PPE – in much the same way that other governments did at the beginning of the crisis. FEMA released a temporary rule published in the Federal Register on April 10, implementing President Donald Trump's April 3, 2020, Memorandum under the Defense Production Act allocating certain PPE to domestic use by barring the export of most such equipment, absent express authorization by FEMA. U.S. Customs and Border Protection (CBP) has already begun detaining such exports pending further review by FEMA.
For anyone seeking to participate in this volatile market, there are a number of legal, logistical and political issues that must be addressed. Below is an overview of key issues and questions that stakeholders should consider:
1. Is This a Scam or Unrealistic Transaction?
Start with a plausibility check on the parties involved. There have been repeated stories of N95 masks – which sold for 50 cents to $1 prior to the pandemic – that are now being offered for as much as $12 per mask. Certainly, price increases will be expected, given tightened supplies and increased air cargo and logistics costs, but government regulators – and government customers – are extremely focused on reducing this kind of profiteering. Therefore, in evaluating a transaction, some key questions must be asked, including:
- Are the characteristics of the transaction credible and reasonable? Is the commodity, the transaction quantity and pricing within reasonable expectations, based on due diligence about the market and typical traded quantities and sale amounts?
- Is the transaction structure sound? Typically, a successful cross-border sale of goods involves a seller, with access to or control over the goods being sold, selling to a purchaser with the necessary liquidity to pay or guarantee payment to the seller upon loading of the goods to the carrier (air or ship), usually by opening a documentary letter of credit for benefit of the seller, enabling seller to draw the purchase price upon presentment of a commercial invoice, bill of lading and other shipping documents. The seller or supplier may be an original equipment manufacturer (OEM), or a legitimate dealer or reseller; the buyer may have the funds to pay for goods or may obtain financing from a third-party financial institution.
- Is the supplier counterparty actually a producer or official dealer that has control over the quantity of product proposed to be purchased? Can the supplier provide verifiable documentary evidence of ability to perform the transaction (e.g., proof of product availability)?
- Is any middle-man counterparty trading in its own name or as an agent for a disclosed principal capable of performing the contract?
- Can the buyer or its principal post the purchase price in escrow, open a documentary letter of credit or otherwise provide proof of financing availability in a regular format?
2. Can the Product Leave the Country of Origin?
Is the supplier duly licensed and certificated at origin, i.e., lawfully eligible to make, distribute and export the named products. For example, if the PPE suppliers or products are from China, a new Chinese export regulation – issued on April 1, 2020 – sets forth stringent rules. There must be approval by China's National Medical Products Administration (NMPA) for the supplier/model combination. Otherwise, Chinese customs authorities will detain the shipments before they are able to be exported from China. A number of promising deals have floundered at this stage because the Chinese manufacturer did not have China NMPA approval. (For more detail, see Holland & Knight's previous alert, "PPE Shortages: FDA and Chinese Government Issue New Policies for Masks, Gowns and Gloves," April 6, 2020).
In addition, controls are now in place in the U.S. for any company wanting to export PPE. Such exports are mostly banned, absent express FEMA authorization. (For more detail, see Holland & Knight's previous alert, "United States Restricts Exports of Critical Personal Protective Equipment," April 9, 2020).
3. Is the Product Authorized for Use in the U.S.?
Is the product eligible for import and sale in the U.S.? For medical devices (e.g., ventilators, sterilization systems, operating room equipment) and supplies (e.g., masks, face shields, and gloves), U.S. Food and Drug Administration (FDA) approval is required. This is a rapidly evolving issue, as the FDA has progressively loosened restrictions on imports, so as to facilitate the movement of PPE obtained from abroad to the healthcare professions who need it here –such as the FDA's April 2, 2020, Guidance on "Enforcement Policy for Face Masks and Respirators During the Coronavirus Disease (COVID-19) Public Health Emergency (Revised)," which had the effect of allowing the importation of Chinese-designed "KN95" respirator masks that are analogous to U.S.-designed N95 masks but not FDA approved for medical use. The FDA rules are changing on an almost daily basis, so importers of PPE must keep up to speed.
4. Does the Contract Protect Your Interests?
Many industries and markets have long-standing, well-developed forms of international sales contracts. There are also generally adaptable forms of supply agreements that can be adapted for most transactions. The International Chamber of Commerce (ICC) also publishes a general form of international sale contract that can be completed by filing in blanks and checking boxes. These contracts cover all essential basic transaction elements and supply "boilerplate" provisions for contract integrity and enforceability.
Virtually all contracts for international sales of goods rely on Incoterms 2020 to specify the basic price and delivery terms (e.g., EXW (Ex Works) at seller's facility, FAS (Free Alongside) at the port of export, FOB (Free on Board) the carrier at port of export, CPT or CIF (Carriage Paid To or Cost Insurance Freight) with seller having engaged and paid the carrier, or DDP (Delivery Duty Paid) at destination). Which Incoterms price-delivery term is best depends on circumstances, risk of transport and pricing.
Also, note that Incoterms price-delivery terms set out where possession and risk of loss passes from seller to buyer but do not indicate where legal title to goods passes; the parties must separately state that in the contract.
- A sale contract must state the time for performance, time and method of payment (often a commercial letter of credit – see next item below), any other agreed duties of seller and any product warranty terms. Omission of any of these terms may make the contract virtually unenforceable.
- Time for performance should state the date by which seller must ship goods or meet other performance milestones, as well as the date by which buyer must open its letter of credit for benefit of the seller.
- Other duties of seller may include obtaining an export license or other regulatory consents and providing certain documents; the buyer may be required to obtain an import license and regulatory consents at destination.
- Product warranty terms must be expressly stated; note that the forms of warranties that may be enforceable vary sharply from jurisdiction to jurisdiction.
- Typical product warranties may include an express repair/replace warranty for a term of years, coupled with a disclaimer of implied warranties of merchantability and fitness.
- Be sure international sale contracts have a clear choice of law provision – a U.S. jurisdiction (e.g., New York law or Delaware law) is recommended for U.S. clients. Depending on which law is determined to govern contract formation (which would be left to a court if the parties have not made an express choice of law), a court might find the foreign counterparty's "acceptance" was insufficient so there is no binding contract at all. Additionally, note that if you are in the middle of a series of contracts (e.g., you are buying from the Chinese manufacturer and then separately selling to a U.S. buyer), having matching choice of law and forum provisions will help avoid being caught in the middle between conflicting court rulings should problems arise.
- Remember that the U.S. is a party to the United Nations Convention on Contracts for International Sale of Goods (CISG), and if you are contracting with a counterparty in another CISG signatory state (e.g., China and most major supplier nations other than the United Kingdom), the CISG will apply unless expressly superseded by specific contract language. For example, the choice of law clause between a U.S. and Chinese party states that the contract is governed by the laws of Florida but is silent as to the applicability of the CISG; however, since the CISG, as a ratified U.S. treaty, is the law of the U.S. and all states, the CISG would apply instead of the Uniform Commercial Code (UCC) as adopted in Florida. While the CISG is similar to the UCC in many respects, certain contract remedies under the CISG, especially as to shipments of non-conforming goods, are significantly different than the UCC remedies.
- In international supply contracts, it is best to provide that disputes will be resolved by arbitration. The U.S., China and most major trading nations are signatories to the 1958 New York Convention on Recognition and Enforcement of Foreign Arbitral Awards. Court judgments from one country may be difficult or impossible to enforce in another.
- The American Arbitration Association or well-established international arbitration appointing authorities such as the ICC, London Court of International Arbitration (LCIA) or the United Nations Commission on International Trade Law (UNCITRAL) are preferable. Suppliers may prefer to contract for local arbitration at origin. If Chinese arbitration is required, U.S. companies are generally advised to avoid the China International Economic and Trade Arbitration Commission (CIETAC) and use the Hong Kong International Arbitration Centre (HKIAC). There have been instances of CIETAC awards irrationally favoring the Chinese party. Also, Chinese parties are sometimes willing to accept the Singapore International Arbitration Centre (SIAC) as a neutral site.
5. How Will Payment Be Made?
One crucial issue arisen in this new market is payment – both the method of payment, as well as dealing with Chinese supplier demands for up-front payments by the distributors or ultimate customers. This situation may continue in the coming weeks, or even months, given the current strong seller's market for PPE.
The seller may accept and ship goods against the open commercial invoice obligation to pay of a solvent buyer, (i.e., the seller presents its commercial invoice due for payment in 30 days), especially a buyer that could readily be sued in the seller's home courts. More commonly, especially with a counterparty that is smaller and unavailable for suit in the courts of the seller's country, the seller will require external credit to be in place before the seller ships goods.
The most common form of arrangement for credit and payment is a commercial or "documentary" letter of credit, governed by credit rules published by the ICC in Uniform Customs and Practices (UCP 600). Other less common but bona fide credit arrangements may include a bank guaranty of buyer's payment obligations governed by the ICC's Uniform Rules for Demand Guarantees (URDG 758), or rarely (usually only with Chinese counterparties) a collection instruction issued to a bank at buyer's location, governed by the ICC Uniform Rules for Collections (URC 522).
Occasionally, where the contract calls for regular shipments, the parties may agree to open invoicing with buyer to provide a standby letter of credit governed either by the UCP 600 letter of credit rules, or by the ICC's International Standby Practices 1998 (ISP98).
The most common payment instrument is a Documentary Letter of Credit. The buyer, identified in the credit as the "applicant", deposits cash collateral with a bank acceptable to seller and usually at seller's location (the "issuer" of the credit), which in turn commits to the seller (the beneficiary" under the credit) to pay seller the stated purchase price for the goods upon seller's shipment of conforming goods, evidenced by seller presenting to the bank certain specified documents. These documents always include the seller's commercial invoice for the goods and a carrier's document evidencing shipment of the goods in good order (this is typically a clean on-board ocean bill of lading (B/L) or air waybill) plus certain other specified documents, which often include a packing list, certificate of origin of the goods and sometimes a certificate of an independent surveyor or inspector, confirming that the quantity and quality of the goods shipped meet the supply contract requirements. If the sale terms include a Documentary Letter of Credit, the original B/L will go to the issuing bank. If accepted (and the bank pays the seller/beneficiary), the bank sends the B/L on to the buyer, so the buyer can collect the goods from the carrier at destination on arrival.
If the buyer's bank is not acceptable to the seller, which may be the case if the bank does not have a branch in the seller's country where the seller could sue for non-performance, the buyer may arrange for a bank acceptable to the seller to "confirm" the letter of credit. A confirming bank acts in place of the issuer, and is fully liable to the beneficiary to make payment if the beneficiary presents conforming documents. However, sometimes the buyer arranges for an "advising" bank at the seller's location to receive and examine the documents. An "advising" bank is not liable to the beneficiary for wrongful refusal to honor presentment of conforming documents.
Note that bills of lading issued by international carriers come in different formats. This can make a difference in both the transaction structure and in the form of the letter of credit. A negotiable bill of lading is one that has the word "ORDER" in the consignee box. A negotiable B/L is a title document. The carrier issuing the negotiable B/L may only deliver the goods to the holder of a duly endorsed original counterpart of the B/L. Possession of the "ORDER" B/L is critical, and in structuring the sale transaction the parties have to account for it properly.
A direct consignment or "straight" B/L is consigned to a named party, and the word "ORDER" does not appear in the consignee box on the front of the B/L. The carrier must deliver to the named consignee only. Also, up to the time of delivery, the shipper can instruct the carrier to deliver to a party different than the named consignee.
The third type of ocean shipping document is a "sea waybill" (not a "seaway bill"). There is no original of a sea waybill, and it is not a title document but a contract of carriage only.
In the air cargo business, only "air waybills" (AWBs) are issued. They are not title documents.
With regard to the issue involving suppliers demanding up-front payments, the threshold question will be whether the supplier is genuinely legitimate – or whether the supplier is, in fact, a scam artist. Many government customers are refusing to provide such up-front payments to suppliers, absent close inspections of merchandise for legitimacy and regulatory compliance, for fear of being scammed. In addition, to the extent that distributors are willing to pay suppliers up front, a secondary market has arisen of private equity firms, lenders and other sources of funding – which has raised the costs of the PPE ultimately to be sold, given the additional party to the transaction also wanting to make a profit.
6. How Will Goods Get from the Manufacturer to the End User?
Whether the seller is shipping against payment of commercial invoices, or shipping against a credit or guaranty, the seller will need to be able to book the shipment with an international carrier, either a common carrier vessel operator, an intermediary or "Non-Vessel Operating Common Carrier" (NVOCC) or an international air cargo line, such as the major international airlines or cargo companies. The carrier must issue a bill of lading to the seller when goods are shipped. Some have attempted to bypass logistics companies by sending charter aircraft to China to pick up supply. But the complexities of complying with Chinese export laws, the vulnerabilities to corrupt actors in source countries, and the complexities of importing PPE into the United States consistent with FDA and other laws counsel strongly in favor of employing professionals – the logistics companies that employ customs brokers and other experts who do this every day.
Unfortunately, logistics companies are overstretched – especially in the air freight market, which has seen a massive cut in its capacity with the cancellation of most passenger flights, which formerly carried half of all air cargo. Currently, air carriers will accept bookings, but deliveries can be substantially delayed. Supply contracts with specific delivery deadline terms may be at risk for timely performance. Carriers may charge premium freight rates for priority delivery.
Ocean carriers are sailing on modified schedules, but can accept bookings. As with the air cargo lines, delivery times may be delayed. Transpacific ocean shipments, plus inland transport to many destinations, can take three to four weeks – which may be far too long to meet immediate needs for PPE.
In addition, and as discussed above, well-established logistics companies generally have deep and long-standing relationships with CBP or other nations' customs services – and are likely to be certified under CBP's Customs-Trade Partnership Against Terrorism (C-TPAT) program, could be "Known Shippers" for air cargo approved by the Transportation Security Administration, or certified by similar Authorized Economic Operator (AEO) programs administered by other countries. In choosing a logistics company, it will be advisable to choose one that is C-TPAT or similarly certified, in order to expedite clearance by CBP or other customs agencies.
7. Do You Have Insurance to Cover the Risk of Loss?
For ocean shipments, under the Hague-Visby Rules – embodied in the U.S. Carriage of Goods by Sea Act (COGSA) – the ocean carrier may limit its liability for loss or damage to goods, unless caused by certain circumstances, to US$500 per customary shipping unit. (This limit under Hague-Visby in other countries is 666.67 Special Drawing Rights (SDR), which is currently about US$911.) The ocean carrier may extend this limit per package to its subcontractors, including truckers, railroads, marine terminals or warehouses. The "package" to which this limit applies may be an individually packaged item, a carton of goods or possibly a pallet with multiple cartons, or in some cases, the marine container itself, depending upon the wording in the "Packages" column on the front of the bill of lading.
Note that this limit per unit is extremely low with respect to medical equipment, supplies and pharmaceuticals, where $10 million or more of products may be shipped in a single 40-foot marine container.
Under COGSA and Hague-Visby, the shipper may avoid this limitation by "declaring higher value" and paying the carrier for all-risks marine cargo insurance.
Under the Montreal Convention, air cargo carriers may also limit liability, and air cargo shippers may obtain insurance in higher amounts.
8. Customs Duties: How High Are They and Who's Paying?
A number of customs issues need to be addressed, including who will be the importer of record, who is filing the customs paperwork, what the proper customs classification of the goods are, what the tariff rate is and who is responsible for paying the tariffs.
Note that many of the medical equipment and supplies included in this discussion have had additional duties previously placed on them by the Trump Administration. These so-called "Section 301" duties have ranged as high as 25 percent. However, these additional duties have been suspended for certain items in response to the pandemic. Additionally, the Office of the U.S. Trade Representative has called for comments regarding removing or suspending duties on needed medical equipment and supplies in a more formal manner. Overall, it is important to know what duties might be applied (and who will be responsible for paying them) prior to the goods arriving.
Other issues that might get the goods detained by CBP as they come into the country include whether the goods infringe upon U.S. intellectual property rights (i.e., patent, trademark, copyright) and whether the goods face any other import restrictions or regulatory obstacles (e.g., antidumping duties and countervailing duties).