Supply chain litigation and what to expect when your supply chain stops

Blog Post

Original equipment manufacturers (OEMs) and their suppliers have had a challenging three and a half years. Nearly every industry was impacted by the COVID-19 pandemic, manufacturing shutdowns, material and component shortages, natural disasters, government mandates, and labor shortages. Today, as we move towards the end of 2023, geopolitical conflicts, inflationary pressure, cost increases, capacity restraints, an ever-fluctuating labor market, and changing consumer demand still threaten supply and the flow of goods.

It is inevitable that other unexpected events will occur that disrupt the industry. McDonald Hopkins’s manufacturing and supply chain practice is well-versed in what happens when the supply chain fails and how to best position your company if you are faced with costly and lengthy litigation due to a supply disruption.

Step 1: Determine what type of contract you have with your supplier

Step one in evaluating any supply dispute is to determine what type of contract you have with your supplier (or the OEM). It is not always obvious whether you have a requirements contract, release-by-release, or spot-buy contract, as the laws that constitute a requirements contract can vary state by state and have undergone recent changes.

Requirements contract

In some instances, if you obtain some of your parts from other suppliers, or if there is not a certain specified quantity of parts to be ordered, a court may determine that the contract does not constitute a “requirements contract.” The term “requirements contract” does not necessarily need to appear on the face of the contract (or purchase order) for it to be construed as one. On the other hand, if a purchase order states that it is a “blanket order,” or “requirements contract,” it does not necessarily mean it will be found to be a requirements contract by a court. Courts will review the relevant purchase order and terms and conditions to determine if the contract has the necessary elements to constitute a binding requirements contract for a specific duration. If you intend to enter into a requirements contract, it is best practice to specifically identify not only the duration of the contract, but dictate the set share of the total need the buyer requires from the supplier (such as “all” or a set percentage of the requirements of the buyer). This will help prevent a supplier from arguing that the requirements contract is not enforceable due to the lack of a quantity term.

Spot-buy contract

The distinction between a requirements contract and a spot-buy contract (or one time order) is critical. It can mean the difference between continued supply at the previously agreed upon price, or a forced renegotiation of the price, quantity, or any other material term in every order. It could even mean that your supplier has no duty to perform whatsoever.

Whether a contract constitutes a requirements contract, release-by-release, or a spot-buy contract dramatically changes the balance of leverage in both pre-lawsuit and post-lawsuit filing negotiations, and is often a key issue if the matter proceeds in litigation. Accordingly, it is best practice to shore up terms and conditions to ensure that the contract you intend is the one that you have in place if a supply dispute arises.

Step 2: Review contract terms for specific rights and obligations

After determining what type of contract is at issue, you should review contract terms to know the parties’ respective specific rights and obligations. Various provisions, such as force majeure (excuse of performance), tooling, and pricing relief provisions can be used to leverage a situation pre-litigation. For example, if a supplier owns tooling, in most states, it can place a lien on the tooling for amounts owed for parts manufactured with the tooling. Additionally, if a situation arises that is covered by a force majeure provision, it may mean that timely supply under the contract is excused. Defenses to an alleged breach of contract are very fact specific and are thus often met with two interpretations.

When a dispute escalates to litigation

If pre-litigation discussions related to resolution of the dispute fail, the last option is litigation. One of the primary reasons business discussions fail and the dispute escalates to litigation is because a supplier refuses to ship goods (due to capacity restraints, pricing disputes, or another reason). If that happens, it is important to immediately assess the amount of inventory on hand, the availability of alternative suppliers, and any resulting damage that may occur from a prolonged supply shutdown. If “irreparable” harm would result (potentially including a plant-wide shutdown) and the harmed party has a sufficiently valid claim, the harmed party will file a complaint and motion for temporary restraining order/preliminary injunction in court, which, if successful, would compel continued supply by court order. Of course, the supplier on the other end of a motion for temporary restraining order/preliminary injunction will argue that the contract either did not require or excused performance, or that damages could be satisfied by money, and thus not be irreparable. The success of such a motion is largely dependent on the specific contract, facts, and court in which it is filed.

While it is impossible to fully ensure that a supplier will continue on-time supply for the full duration of a contract, if there is any sign that a supplier may be troubled it is important to involve your customer early, begin building a bank of inventory, and investigate alternative supply solutions in the event of any supply disruption. McDonald Hopkins manufacturing and supply chain team can help you navigate these often treacherous waters.

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