Manufacturing Contracts in Distress

The automotive industry has recently enjoyed a strong period of sales growth and productivity. But even during this period, some manufacturers and raw materials suppliers continue to face pressures presented by financially troubled customers and suppliers. Witness for example the recent chapter 11 filings of Lee Steel Corporation and Chassix Holdings, Inc. In order to manage supply chain contracts during this period, manufacturers should identify early signs of financial distress in their customer or supplier base and quickly react to that distress in order to successfully navigate through stressful times.

Manufacturers should watch for supplier requests for price increases, accelerated payment terms, or customer financing support. In addition, a manufacturer’s failure to effectuate cost reductions, a deteriorating market position, and changes in key management positions are all factors that may indicate financial distress. Manufacturers should employ unique strategies in order to secure continued supply when faced with a financially troubled supplier. Manufacturers who manage their contracts during these stressful periods can usually improve their positions in the face of such pressures.

Manufacturers should prioritize, understand, and address troubled supplier situations with greater advance awareness. They should continually analyze their contracts to maximize leverage, and therefore make legal options available, when dealing with troubled suppliers. To alleviate the pressures of financial distress, manufacturers should exercise common law and statutory remedies in order to achieve proactive changes to standard terms and conditions of new contracts (or negotiated changes to existing contracts). The terms of these contracts significantly impact the manufacturer’s ability to resource production to a healthier supplier, recover tooling, and utilize certain contract remedies.

Common effective remedies include making demands of adequate assurance of future performance pursuant to section 2-609 of the Uniform Commercial Code or considering the contracts repudiated by the supplier. Contracts may also impact the supplier’s ability to stop shipment and impose “hostage” demands, while being able to assume and assign, or reject, the contract in bankruptcy. The contract’s terms have a significant impact on each party’s lien rights, setoff rights, and their ability to terminate the contracts. Furthermore it may affect whether a contract is considered an “executory” contract in bankruptcy, whether it is integrated with other contracts, and the impact of this on the duty to perform in bankruptcy. Through the imposition and application of statutory and common law contract rights, manufacturers can avoid troubled companies’ use of their own ordinarily broad bankruptcy rights to reject contracts for continued supply of goods.

The authors of this post would like to thank Foley & Lardner Summer Associates, Claudia Ajluni and Amanda Lee, for their contributions to this post.

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