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How can automotive players mitigate the risk of supply chain shortages?

The global semiconductor shortage could give rise to a surge in supply and resourcing disputes, but these can be avoided. By Michael Stocks and Matthew Padian

The road to recovery was always going to be bumpy. Whilst there are clear signs of a recovery in the car market as society emerges from the pandemic, demand is not being matched by supply. For example, such has been the global demand for semiconductors (the “brain” for every kind of electronic device), that shortages of these parts have slowed vehicle production lines and deliveries to the forecourt.

Automotive World Magazine – October 2021

Any blockage in the supply chain inevitably puts a strain on each party’s obligations to meet contractual commitments. At best, this might cause a short delay in delivery of components. At worst, it could result in deadlines being missed, or the loss of trust between contracting parties leading to disputes. How then can companies mitigate the risk of such disputes arising as the sector attempts to navigate this bumpy road?

Key things to consider

It is important that any company reminds itself of what it has agreed to supply, and by when, by reviewing its customer contract. For example, how is the commitment to supply couched and does it provide any wriggle room? Earlier this year, the much-publicised supply dispute involving the European Commission and Astra Zeneca (see below) had to address what was meant by “best reasonable endeavours” to supply vaccines to the EU, which ultimately gave it scope for arguing its delivery commitments were somewhat flexible.

Another consideration might be the force majeure clause, which is common in commercial agreements and allows a party to suspend or extinguish obligations due to events out of their control, perhaps due to fire, flood, a natural disaster, war, a strike or, if specifically drafted, epidemic or pandemic.

Any blockage in the supply chain inevitably puts a strain on each party’s obligations to meet contractual commitments

Away from the precise contractual wording, a company might also consider whether to openly address a likely supply issue early on to allow a commercial solution to be found. If there are other issues at play not within the supplier’s control, which need to be wrapped up in a revised contract in which a new delivery scheme can be set out, a contract re-set is a pragmatic way forward.

It is also important to remember that it is not generally in the interests of either supplier or customer to resort to a legal process to determine the solution. If the parties are unable to resolve the position through dialogue, highly-skilled mediators can be appointed to engage with both sides in search of a commercially acceptable outcome (at a fraction of the cost of a more formal dispute resolution process). Commercial parties would do well to heed guidance issued by the UK government Cabinet Office in May 2020 during the pandemic that “parties to contracts should act responsibly and fairly, support the response to COVID-19 and protect jobs and the economy”.

What could auto learn from pharma?

The dispute concerning delivery of vaccines to the EU bloc between the European Commission and Astra Zeneca is an example of how a supply dispute can quickly escalate and is not one that played out well for either side. There were, of course, politics at play, with the European Commission needing to be seen to be taking steps given the criticism it was facing with its vaccine rollout programme. Yet, the decision of the European Court to order a staged vaccine delivery programme, with the sting of penalties if deadlines were missed, is helpful in showing how courts can adopt a commercial approach to such cases.

In the automotive world, any supplier currently experiencing delivery problems faced with multiple customers should tread carefully if it is inclined to favour one over another. Whilst it can prioritise a customer (perhaps on the basis of a longer standing relationship or confidence of quicker payment), it will still be bound by delivery commitments in its other contracts.

What about the customer?

From the customer’s perspective, business failure of a supplier can cause severe distress in any supply chain. Customers can be left out of pocket for goods paid for upfront or unable to meet orders for their own products.

Customers can seek to avoid this scenario. This can include due diligence on suppliers before exchanging contracts; for example, to determine their financial health or over-reliance on any key customers who themselves face solvency issues. Supply contracts can provide for ownership of goods to pass to customers upon production rather than delivery, so that those goods can be ring-fenced in any insolvency. A customer may spread risk across several suppliers or take out insurance against supplier insolvency.

However, as the last year has illustrated, unforeseen events can turn any successful business into a struggling one without much warning. If a supplier enters insolvency, some customers may want to cut ties and move on. Fortunately, the restrictions that prevent suppliers terminating supply contracts upon a customer’s insolvency, as introduced under the Corporate Insolvency and Governance Act 2020, do not work the other way. Therefore, if a contract entitles a customer to terminate upon the supplier’s insolvency, the customer should be able to do that.

Audi e-tron production
Audi is just one of many automakers to take a hit from the semiconductor shortage

Depending on the type of insolvency, there are other considerations.

If a supplier enters administration, the statutory moratorium will prevent a customer from taking certain actions (including legal proceedings) against the distressed business without the administrator’s consent or court permission. A similar situation arises if a supplier seeks the benefit of a temporary moratorium as is now possible without entering administration. Providing this does not involve any legal proceedings, in each case, the moratorium will not prevent a customer from exercising its contractual rights, such as termination or retention of title rights (although it will fetter the customer’s ability physically to repossess the goods).

Administration often results in a sale of all, or part, of the business. If the business continues trading, the buyer may want to fulfil any incomplete orders, and there may be scope for negotiation around future supplies. Where there are no other interested buyers or alternative suppliers, a customer may consider purchasing part of the supplier’s business itself to ensure continued supply.

If customers pay for goods in advance and the supplier enters insolvency, the goods are unlikely to be handed over unless title has already passed. The liquidator or administrator will only reimburse deposits if sufficient funds are available.

However, this rarely happens, as customers usually rank as unsecured creditors. Customers may also remain liable to pay any outstanding invoices, unless they have grounds to dispute those invoices or make any counterclaim. The availability of set-off rights may also enable a customer to set off sums owing to it by the supplier against sums claimed by the insolvency practitioner on the supplier’s behalf, thereby reducing the risk that a customer will not recover anything in the supplier’s insolvency.

Unforeseen events can turn any successful business into a struggling one without much warning

An aside: confidentiality

An unusual feature of the Astra Zeneca case was that at the request of the Commission (and with reluctant acceptance by AZ), the terms of the Advance Purchase Agreement were publicised, initially with sensitive material redacted only to be uncovered later by journalists adept at using Adobe Acrobat. That sensitive pricing and other information was out in the open has raised concern in many quarters, which are now questioning the value of confidentiality clauses in contracts.

There is no fixed rule under English law as to what is confidential information, although usually a contract will define what it covers, and if it doesn’t, the court can make such a determination.

Recognising the value of such information in a contract, the courts take a dim view of parties who misuse it and has made a range of remedies available. For example, a party may choose to seek an order from a court preventing the offending party from using or further disclosing the information (known as an injunction), or an order that it be compensated calculated by reference to the royalties/fees the offending party would likely have needed to pay to use the information.

About the author: Michael Stocks and Matthew Padian are Managing Associates at Stevens and Bolton LLP

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