Thinking About Canceling on Your Factory? Here’s What You Need to Know

The pandemic is proving that more than ever, stakeholders across the fashion supply chain have to figure out a way to “make it work,” as the venerable Tim Gunn would say.

As the global spread of the new novel coronavirus makes most operations unsafe at “non-essential” stores and thus clobbers consumer demand, retailers are finding themselves in the unenviable position of figuring out what, if anything, to do with all of the production orders they’ve placed with their suppliers.

Whereas the COVID-19 outbreak’s early days in China saw brands and retailers fretting over widespread store closures across Asia and shuttered factories that choked off their production, now apparel and footwear companies are huddling to brainstorm workable solutions for products coming off the factory line—with no stores to fill.

H&M and Zara made headlines last week when news broke that they and other fashion heavy-hitters were canceling orders already at their factories—a move that could jeopardize garment workers whose livelihoods often hinge on the mercy and whims of Western brands.

But the question of “to cancel or not to cancel” isn’t just on the minds of retail buyers—their wholesale counterparts are grappling with this conundrum, too, and some have pulled the plug on orders that haven’t yet been put into production. One financial agent advised a wholesale client to cancel a mass merchandiser’s order that was set for production in 60 days. The fact that manufacturing hadn’t started yet certainly helped in the wholesaler’s favor, but the larger, looming variable is there’s little clarity on when Western stores will be back online as the outbreak shows little sign of slowing down.

“Smart people are trying to get out of production and just get through this period,” the agent said. That, of course, means a headache for factories relying on the work, not to mention the cascading fallout on inputs from raw materials suppliers for everything ranging from fabrics and materials to trim like buttons, zippers, and embellishments.

Collaboration and negotiation will ensure that all stakeholders emerge from the COVID-19 crisis with their businesses intact—and prepared to seize on a surge in activity once demand returns to its previous level.

As apparel players navigate the outbreak’s choppy, uncharted waters, here are the burning questions on everyone’s minds. Is it legal to cancel orders, especially if wholesalers have already paid for the work and are awaiting payment from retail partners? And do firms have any recourse if they’re on the receiving end of a cancelation and are seemingly left holding the bag?

Avoiding a ‘fashion temper tantrum’

The long and the short of it: orders generally can’t be canceled.

In the fashion sector, purchase orders are considered binding contracts, according to Alan Behr, a partner at the Phillips Nizer law firm who specializes in fashion law. That’s true whether the buyer is the retailer or the wholesaler buying materials and inputs necessary for making finished goods.

“The business risk is on the purchaser,” Behr added. “That’s true for everyone anywhere along the chain.”

While it’s common for P.O.s to contain a “force majeure” clause outlining circumstances when the obligation cannot be met or executed—usually due to an ‘act of God’ like an earthquake or tsunami—“there’s not a lot of law written about diseases” like the coronavirus pandemic, Behr said.

So what to do? Consider the business relationship, he advised, and forge a resolution that offers a win-win for both parties.

“The legal argument should be the last result,” Behr said. “This requires a business solution based on ‘You need me and I need you.’”

Working through the crisis together is the best way to come out stronger on the other side, he added.

And while canceled goods are likely to spark a few lawsuits in the months ahead, “95 percent of all litigation filed is for vengeance, except matrimonial where it’s all 100 percent,” Behr noted. “Avoid getting into the vengeance mentality.

“This is called the fashion business, not the fashion temper tantrum,” he added. “Everyone needs to calm down.”

If parties really choose to bicker over damages, the aggrieved party has a duty to mitigate and find “some other place to sell the goods to,” Behr said, adding that the reality stands even for unfinished goods and inputs. “Even the button maker will have to find someone else to buy your buttons.” That obligation also mitigates how much can be collected in damages, which usually is limited to the difference between the original contracted amount and the total collected when sold to the subsequent second buyer.

Special orders, however, are subject to different rules. A brand that orders proprietary, logoed buttons is “obliged” to collect those goods, for example. “It’s the same rule as you move up the chain. The customer’s purchaser must honor the contract,” Behr said.

‘Panic mode’

Gary Wassner, CEO of top fashion factoring firm Hilldun Corp., strongly advises against the urge to cancel—no matter how dire the outlook might seem.

“Purchase orders shouldn’t be canceled as they are contracts—that’s why they are written up,” he said.

“Everyone’s been in panic mode,” Wassner said, describing last week’s “first couple of days” as “total panic.” Though some in the industry are still coming to terms with the new normal, by the end of the week, he noted, “most business owners have come to a realization of what they need to do, on what are the best practices.”

First and foremost? “You have to preserve cash,” Wassner said, urging brands and retailers to “reduce overhead as much as you can” even if that means making a tough call to lay off some employees.

“The unnecessary things are gone,” he said. “We’re looking at no revenue for three months.”

Wassner is also telling wholesale clients that “they don’t need to accept cancelations—at least not for orders already made and are ready to ship.” Because the P.O.s are binding contracts, “I tell them to work it out,” he added. “They need to come to some kind of agreement where everybody shares the loss. There are ways to do this. It can’t be all the way put on the shoulders of the brands. The goods are already paid for by the manufacturers, just not yet paid for by the stores.”

For goods that are not yet in production, Wassner advises clients to reach out to the factory and cancel the order. “They might be stuck with the fabric, but if it hasn’t been cut yet, it’s not a total loss,” he said, adding, “This is going to be a challenge for everybody going down the line from top to bottom.”

No pandemic playbook

According to Anchin’s Marc A. Federbush, there’s no easy way to wrangle the thorny issue of cancelations.

“If a retailer has placed a P.O. and the goods have not been shipped yet, the retailer usually can cancel,” said Federbush, a partner and leader of the fashion group at the accounting advisory. This scenario is playing out across the industry as “almost every major retailer has shut down” amid government and health officials’ mandates to contain COVID-19’s spread.

The real problem, Federbush said, is there’s no real business playbook for surviving a pandemic, and wholesalers are struggling to rehome canceled orders. “What if it’s made, but not shipped? Where do wholesalers store the goods?” he said. “Should they keep it overseas?  I’m telling clients don’t pay the duty because there’s nobody to accept them if the retailers’ distribution centers are not open.”

For replenishment orders, the solution is easy. “The factories have fulfilled their responsibilities [and you] tell them to hold it for core basic products,” Federbush said, noting that wholesalers can use the product for next year’s spring season, although trends might move on by then.

He’s advising clients to forget about now and to focus work future seasons. Spring 2020 is “lost,” he said, “and maybe part of the summer, too.”

Have strategic vendors? You’re in luck—maybe

Deciding to cancel an order requires “thoughtful negotiation,” according to Adheer Bahulkar, a partner and specialty retail lead in the consumer practice at Kearney, who says yanking production is “absolutely possible.”

“A lot of it also depends on whether the vendor has already bought the fabric or bought the trim, whether they washed or dyed it, did they already start cutting and sewing, and is it ready to ship?” Bahulkar said.

How negotiations proceed often depends on the quality of the relationship between retailer and vendor. “Strategic vendors will likely work with you in tough times and they expect you to work with them through their tough times, whether with financing, guaranteed future business or [other reasons],” said Bahulkar, who’s worked with retailers clawing their way out of distressed circumstances. “But purely transactional relationships don’t make it easy to easily cancel P.O.s.”

Retailers have a few options. When a vendor hasn’t yet started work or is holding finished goods that haven’t left for transit, the buyer can pay an amount equal to 1 percent to 2 percent of the value of the P.O. as an allowance for the cancelation. Another strategy is to cancel the P.O., but promise the vendor a higher or significantly more substantial future business.

“Depending on the situation, the vendor might see this canceled order as an investment in future business,” Bahulkar said.

Sometimes a P.O.’s original quantities can be whittled down to more manageable levels. “We don’t cancel the entire P.O., but reduce the quantities in the P.O.,” he said. “Maybe continue production on what is already cut, but stop the remaining [portion].”

It’s also possible for a single P.O. to specify multiple volumes to be shipped at staggered dates, enabling a split decision in which the brand or retailer might be able to preserve the first shipment but cancel the remainder, he added.

One course of action Bahulkar does not recommend? Canceling an order with a smaller vendor because its pint size likely limits its ability to take “meaningful action.”

“This can be very detrimental to your brand in the industry and you may have a tough time finding vendors who want to work with you in the future,” Bahulkar warned.