This article was originally published on Supply Chain Brain, and is republished here with permission.
As the economic fallout from COVID-19 continues to impact manufacturers and their suppliers around the world, many companies are facing significant financial headwinds.
Companies suffering such difficulties will often look for ways to extract additional value from, or push costs down to, their supply chain, particularly where there is an imbalance in negotiating power that favors the customer.
Such efforts generally fall into two categories: commercial concessions and liability claims. This article examines both of these categories, and provides a general overview for some key considerations that suppliers should keep in mind when they receive such demands from their customers.
The first category consists of requests — or, in some cases, demands — for commercial concessions. While the commercial terms of any supply contract are subject to negotiation, this article is focused on requests to alter an existing arrangement between the parties, not discussions that may be taking place for new contracts or new business.
Such requests can take many forms. For example, customers may request price reductions, extended payment terms, or relief from minimum purchase obligations. While these requests can take many forms, the common characteristic that they all share is that they alter the status quo in a manner that benefits the customer at the expense of the supplier, whether by reducing payments to the supplier, or shifting cost or risk to the supplier.
Upon receiving a request for a commercial concession, suppliers should first look to their contracts in order to make sure they fully understand the respective rights and obligations of the parties. While most contracts do not permit unilateral changes to commercial terms, provisions allowing for such changes in some circumstances are not unheard of, particularly in cases where the contract relies on a customer’s standard terms and conditions.
If the applicable contracts allow the customer to make the requested change to the relationship on a unilateral basis, the supplier’s options may be limited. However, just because a customer points to particular provisions of the contract in support of its request does not mean that the supplier should take the customer at its word. The supplier still should take care to review the contract, and confirm whether the provisions in question clearly support the rights that the customer is claiming, or whether the supplier has grounds to dispute the claim.
Even if the contract in question does not provide the customer with a clear right to the requested concession, this does not necessarily end the discussion. Other considerations and forms of leverage often will come into play as suppliers must consider the “big picture” of the customer relationship. Even if a supplier wins the battle and successfully resists the customer’s request for concessions, the supplier may lose the proverbial war if its success winds up costing it business down the road.
For example, in situations where the customer has an ability to easily resource the business — whether because it conducts business on a series of short-term agreements or because the contract provides the customer with a right of early termination — the customer may be able to easily replace a supplier that is not willing to meet revised commercial terms that its competitors may be willing to offer. Suppliers of fungible “commodity” can be particularly vulnerable to such resourcing.
Such immediate loss of business may be less of a concern for suppliers whose products are more difficult to resource in the short term, whether due to the contract terms or because of other barriers to resourcing, such as intellectual property rights or long lead-times/high cost to resource. However, even suppliers whose products are difficult to resource may suffer lost business in the medium to long-term if they fall out of favor with a customer, and lose out on new business or a future contract renewal.
In addition to the risk of losing future business if they refuse to acquiesce to customer demands, suppliers must consider what other issues may exist in the relationship and whether the supplier can turn these to its advantage. For example, if the supplier is facing potential claims from its customer (see discussion below), it may be able to trade agreement on commercial concessions for a release of such claims. Alternatively, if the supplier is bidding on new business with the customer, the supplier may be able to leverage agreement on commercial concessions into an advantage in securing new business, such as a right of last refusal. In either case, a best practice is to ensure that any such agreement is reduced to an appropriate writing — not rely on the goodwill of the customer, or an unwritten understanding or agreement. These less-tangible assurances often are not legally enforceable, and lack durability as memories fade and employees leave the business.
Separate from requests for commercial considerations are situations in which a customer may have an affirmative legal claim for recovery-based deficient (or allegedly deficient) performance by the supplier. Such claims may take a variety of forms. However, some of the most common issues often involve warranty claims for defective products, delays in delivery, or shortfalls in annual productivity savings. In better times, customers may have looked past such issues, or put them on the backburner, for the health of the relationship. However, in leaner times, some customers may look to such claims as a means to extract additional dollars from their suppliers and improve their own bottom line. Such issues can be a particular concern where they are driven by purchasing managers or executives at the customer who may be facing internal pressure to strengthen their personal metrics for the quarter or year.
Efforts by a customer to pursue such historical claims can involve additional issues that may not be present when dealing with other claims asserted on a more timely basis. For example, suppliers may be hampered in their ability to defend against such claims due to increased difficulty in gathering the necessary information. Given the passage of time, memories fade, employees move on, and documents may no longer be available. While these same issues also may impact the information available to the customer in order to support its claim, they can be particularly acute for a supplier trying to establish why they are not legally at fault for a product that may have broken, or otherwise failed, during use.
However, not all of the issues that arise in connection with an old claim present a disadvantage for the supplier. Recognizing the difficulties that may exist when defending against such claims, the law often provides suppliers with additional legal defenses. For example, in the case of contracts involving the sale of goods, Section 2-607 of the Uniform Commercial Code (which has been enacted in all 50 states) requires buyers to provide notice of claims for breach “within a reasonable time” after discovering the breach, or else forfeit any remedies to which it might otherwise have been entitled. While what constitutes a “reasonable time” to give notice is subject to dispute, if a customer failed to give adequate notice of the breach when an issue first occurred, suppliers may be able to argue that the customer cannot now pursue its claim.
In addition to any notice requirements, most jurisdictions impose a statute of limitations that requires claims be brought within a particular period of time, regardless of whether notice was given when the issue first arose. The amount of time allowed under the applicable statute of limitations varies widely depending on the jurisdiction and type of claim. However, in the case of contracts for the sale of goods governed by the Uniform Commercial Code, the statute of limitations typically will be four years.
In addition to legal defenses, there may additional, less tangible issues that accrue to the benefit of the supplier. While not an absolute rule by any means, historical claims often can be of uncertain merit. Simply put, most claims in which supplier responsibility is clear are resolved in the course of business, and do not sit on the proverbial shelf for years before being raised. In addition to the merits, suppliers should consider the customer’s motives. If a customer’s primary motivation for asserting a claim appears to be based on an effort to improve financial performance, the supplier may be able to resolve the claim at a steeper discount if it is willing to resolve the claim quickly.
All disputes must be addressed in light of the specific contracts and circumstances involved. However, the issues presented in this article represent key considerations that suppliers and customers should consider, when attempting to manage the impact of COVID-19 on their commercial relationships.