Automobile equipment makers have been under stress since supply chain interruptions began in January. The COVID-19 pandemic led initially to lock down in China creating for certain suppliers force majeure and hardship situations due to sub-supplier and delivery impediments.
Today, the situation has evolved whereby automobile manufacturers have themselves suspended operations and declared force majeure. This freeze on automotive production is without precedent and takes the whole industry into uncharted waters.
Often the immediate question facing suppliers is whether payment obligations of customers pertaining to outstanding invoices of suppliers are suspended. Generally, in the absence of specific contract clauses or government orders, a force majeure event will not suspend payment obligations for deliveries that occurred or services performed prior to the event of the force majeure. However, although payment obligations for past deliveries should remain in force, liquidated damages or financial penalties associated with late payment may be suspended or declared inapplicable for the duration of the force majeure; such has been the case in France by government decree. For orders that have not been completed, suppliers may have to suspend production to avoid incurring further costs.
Once production restarts, the purchase volume for 2020 will be substantially reduced compared to expectations while pricing is generally locked in by long term contracts. This raises a number of issues:
- Frequently, under OEM part supply programs, a portion of the negotiated unit price in long term contracts corresponds to the equipment supplier’s investment in product development or tooling and this portion is typically amortized over several years. The question arises whether these supplier investment amounts should be repaid by OEMs separately in the event purchase volumes are too weak to cover the costs as had been envisaged by parties at the outset of the program. Is it possible to separate the payment obligations on product deliveries from development costs when they are wrapped together in product prices on purchase orders? Obviously, it depends on the relevant contract terms.
Nonetheless, it seems that investment costs in many instances are treated as a loan by the supplier and repayment could be sought where purchase volumes are missing.
- Where the relevant tooling is designated as property of the OEM, a supplier may be able to seek accelerated repayment of those costs.
- Lastly, there lies the question of renegotiating unit pricing where volumes are largely deficient. Again, the contract terms are important but frequently nothing in the contract is stated in the event of dramatic shortfalls. Where renegotiation is resisted, the supplier frequently faces questions of hardship, frustration and possible termination based on changed circumstances. Suppliers may also consider challenging certain one-sided contract terms if they were imposed and could not be negotiated. Germany has longstanding protective Civil Code provisions limiting the effects of such contract clauses while France has only recently adopted revisions to its Code Civile that open the door to challenging the enforceability of non-negotiable terms in the B2B settings.
The exceptional times in the industry may call for exceptional solutions. Timely cooperation among industry actors is likely to be the key to finding the best route through this unmapped territory.