COVID-19: Challenges for the supply of new rolling stock for the Rail Industry

Although the rail industry is not yet showing the same vulnerability to falling passenger numbers due to COVID-19 as that being experienced by market participants in the airline industry, with over half of UK trains due to be replaced by the mid-2020s, the rail industry is certainly not immune to its effects. As rolling stock manufacturers are hit by issues with their supply chains and assembly facilities in areas most impacted by the virus, the commitments made by nine operators to introduce 1,000 new trains into service in 2020 could be in jeopardy.

The outbreak of COVID-19 has resulted in lockdown and quarantine measures being put in place by governments throughout the world. Even when not officially in lockdown, workers in many countries are being advised to self-isolate and private companies and employers are taking measures to safeguard their workers by putting in place their own restrictions. It is, therefore, inevitable that businesses which are reliant on an available work force will suffer interruptions that may mean they are unable to deliver under their contracts to the agreed time frames. The rolling stock manufacturing industry, with its international supply chain, is no exception.

Manufacturers’ Rights

Manufacturers which are so impacted may be able to seek relief from their contractual obligations under the force majeure provisions in their manufacture and supply contracts (MSAs). In the UK, whether a manufacturer can make a claim for force majeure and whether this constitutes a permitted delay giving them relief from their obligations, will depend on the construction and interpretation of the clauses in question. The industry standard definition of “Force Majeure Event” found in many MSAs specifically includes “epidemic” as such an event. If not expressly included, then the party seeking to rely on the clause would need to carefully consider whether the outbreak of COVID-19 and/or its consequences could fall into one of the other events.

It is not sufficient for an event to have occurred, in most cases the Manufacturer will need to demonstrate how this has impacted its ability to perform its obligations under the MSA and may also be required to show what mitigation measures it is taking, before the event would be considered to constitute a relief event (commonly defined as a “Permitted Delay”). Affected manufacturers should of course be exploring mitigation measures – which may include looking at alternative supply chain arrangements and/or different methods of delivering components to their manufacturing and assembly facilities, and locating alternative testing grounds. The extent of its mitigation obligations and the extent to which it is required to spend money on them, will depend on the terms of the MSA and whether these require reasonable endeavours, all reasonable endeavours or best endeavours to be applied.

If a Permitted Delay is agreed this would typically result in an extension of the dates for delivery of trains under the MSA and relief from delay penalties such as liquidated damages during that extended period - but will not in itself entitle the manufacturer to an increase in prices (though implementing mitigation measures which have been required by their customer may give rise to an ability to reclaim some costs). In extreme circumstances, it may be that a right to terminate the MSA (exercisable by the manufacturer or by one of the other parties) is triggered if the event continues and suspends performance beyond a certain period (which is often 180 days in UK contracts).

Affected manufacturers should also consider to what extent its obligations under any maintenance arrangements for trains already accepted are impacted. There could be similar issues under their train service agreements (TSAs) and/or technical support and spares supply agreements (TSSSAs) and there are likely to be force majeure relief and termination provisions under those agreements that will also need to be considered.

Considerations for Operators and Rolling Stock Owners

Train operators and rolling stock owners faced with a claim of force majeure should consider the following when assessing the claim and determining whether it constitutes a Permitted Delay:

1. Has the force majeure event actually arisen – or is the purported notice in effect a “warning” notice?
2. Has the manufacturer provided all evidence it is required to provide regarding the occurrence of the event, its impact on the performance of the contract, the steps it is taking to mitigate the impact of the event and how the long the event is expected to last?
3. Has the manufacturer properly complied with its notice and/or consultation obligations under the MSA?
4. Are there any other factors that have impacted performance and which could instead be causing the delay? There is precedent in UK case law which suggests that if there are other circumstances causing a delay this may adversely impact the ability of a claimant to rely on force majeure as the reason for its non-performance. It will certainly make demonstrating causation much more difficult.
5. If the requirements for a Permitted Delay are proven can a time period be put on it and how long should it be? This may be difficult to determine with any certainty in a rapidly changing situation such as COVID-19. As the virus moves to new countries it may be that new parts of the supply chain are impacted as other areas are recovering (as we have seen with Italy and China). It will be down to the contract terms as to whether this falls into the same event or whether a new force majeure claim needs to be made.
6. What obligations do they have under their other contracts that may be impacted? Operators may have reporting or other obligations under their franchise agreements and owners that have obtained third party funding to acquire the trains will have obligations to their lenders under the finance documents.
7. If a force majeure termination were to occur (which is typically considered to be a ‘no-fault’ termination), what termination payments will the manufacturer be required to make (if any)?
8. If delivery of the trains has already commenced at the point of termination, what size of fleet will the owner be left with? If termination occurs prior to minimum fleet can the accepted units be returned or will the operator and owner be required to hold onto units already accepted? If the residual fleet is very small, what does this mean for the long-term viability of that fleet once the operator’s lease comes to an end and how does this change their re-leasing strategy?
9. Where trains have already been accepted are maintenance arrangements continuing? If a train is not being maintained and becomes inoperable, whose risk is that?

As COVID-19 spreads throughout the UK this is unlikely to remain solely a problem for the manufacturers. Operators and owners should be mindful of how their own businesses and workforces are being affected by the virus. Given that train acceptance is a collaborative process, will they be able to provide the necessary personnel to accept the trains and/or will the operator have drivers available to carry out the necessary testing? Given where things seem to be heading, operators and owners may want to check that they are also have the benefit of the force majeure provisions. It is not unforeseeable that in due course we might see force majeure claims being made by other parties who are unable to comply with their obligations.

Considerations for Lenders

Lenders that have provided financing to owners for the purchase of trains will, understandably, be concerned about any event which could delay delivery of those trains and, in the case of a Permitted Delay, result in a relief from delay penalties. In lieu of rent, owners are likely to be relying on receipt of those liquidated damages to meet their debt service obligations to the lenders.

Lenders should consider the following:

1. What rights do they have under the finance documents to be kept informed about and/or consulted with in relation to the ongoing events? Is the owner complying with these obligations?
2. Is their consent or agreement required before decisions can be made, particularly decisions crystallising a Permitted Delay?
3. What other consequences are triggered under the finance documents as a result of such an event? These may include distribution lock-up events, trigger events, draw stop events or events of default.
4. If there is no immediate event of default triggered directly by these events, how are they projected to impact future performance by the owner of its obligations under the finance documents? In particular, the funders may want to consider whether any funding shortfall test or forward-looking financial ratios are breached and/or if these events could constitute a material adverse change and, therefore, constitute an event of default under those provisions.
5. What other sources of liquidity does the owner have that might be able to be used to plug any gap and fund debt service?
6. If a force majeure termination were to occur, what rights do the lenders have to be repaid and will they be entitled to break costs or early repayment fees? What resources does the owner have available to it (or should it have available to it if the manufacturer makes any termination payments due from it under the MSA) in order to satisfy these repayment obligations?

Read more about coronavirus and force majeure more generally here.

Read about the challenges facing the aircraft leasing industry as a result of COVID-19 here.