Down to the wire: Managing the automotive supply chain squeeze

Global events are once again threatening to disrupt the production of new cars. Just when the outlook for car production was beginning to brighten following friction from the effects of Brexit, pandemic-related shutdowns and computer chip shortages, the war in Ukraine is reportedly having knock-on effects for the automotive supply chain.

Automotive industry news sources have recently reported that a number of carmakers are struggling to obtain wire harnesses due to suppliers in Ukraine closing their factories, which in turn has led to production halting at some car factories.  The part is needed for organising the more than three miles of cables used in the average car.  It may take several months for suppliers to increase capacity at alternative locations, due to the need to find factory space, source or move machinery and tools, recruit workers and obtain the finance needed.

Other concerns relate to potential shortages of raw materials from Russia, such as palladium, key for the production of catalytic converters, and copper and nickel, which are used  in the production of EV batteries and electrical systems.

While it is not always possible to deal with the impact of significant and unprecedented global events in supply contracts, there are certain steps that carmakers and any other companies entering into long-term supply arrangements can take in their contracts with suppliers which may help identify, resolve, or at least mitigate supply problems.

Forecasts: Require your supplier to tell you if they anticipate being unable to meet your forecasted requirement for a part or component.  If your supplier tells you about any anticipated problems, you could seek to reserve a right to source the missing part or component from a different supplier temporarily.  Where a problem persists for a longer period – and you’ve been unable to negotiate a right to end the contract if the supplier fails to meet a delivery date – you may want to push for a right to terminate the contract if the supplier anticipates being unable to meet your forecasted requirements for an operationally unacceptable period of time.

Preference: Seek a preferment clause that requires your supplier to prioritise your company over its other customers where there are supply issues.  This type of provision could help put your company at the head of the queue for parts or components where a supplier has enough resources to fulfil some of its contracts, but such a clause will be of limited use if your supplier has little or no resources at all.  In practice, the difficulty with this sort of clause is proving (short of resorting to litigation) that the supplier is actually prioritising you over its other customers.  However, including the provision at least makes it possible to stake a claim for your fair share of product.

Compensation: Include an indemnity in your company’s favour for any claim made against your company by a third party arising out of, or in connection with, the supply of the parts or components where such claim arises out of the failure or delay in delivering those parts or components.  Even while you may choose not to enforce such an indemnity, for example, because your company wants to continue to have a good working relationship with the supplier, including such a clause may affect the supplier’s decision-making when it is considering how to fulfil orders where it does not have enough product.

Force majeure: Take a closer look at the force majeure clause in the contract to see whether events such as war or pandemic will constitute an event that excuses the supplier’s performance of its supply obligations.  You could limit the types of event that excuse the supplier’s performance of its supply obligations by express drafting in the contract.  Alternatively, you might make force majeure conditional on the supplier notifying you or taking actions to mitigate its supply problems even if these actions might increase the cost to the supplier.  While such clauses won’t assist in sourcing the missing parts or components, the supplier’s potential exposure to a claim for breach of contract due to the absence of excuse for non-performance may help prompt the supplier into doing everything it can to fulfil your order.  A right to terminate if the supplier’s failure to supply continues for an unacceptable period may help in certain circumstances, but it is unlikely to assist where the issue also affects all other suppliers of similar parts or components.

Service levels:  Agreeing service levels which have financial consequences for the supplier if it breaches its supply obligations may help ensure that your company continues to receive a supply of parts or components in circumstances where a supplier has some product to fulfil customer orders. Faced with choosing between supplying a customer where a failure to meet deliveries doesn’t carry the risk of incurring service credits and a customer whose contract is backed with a service credit regime could be the difference between your supplier delivering product to you or your competitor.

These types of contractual terms are all best relied on where a supply shortage has turned the relationship with your supplier sour or where the issue is otherwise insurmountable.  Typically, the best way forward for both the carmaker and its supplier is to take a less confrontational approach.  Work together to weigh-up the best course of action, meet regularly and plan resources carefully, and cooperate on agile approaches that may help loosen supply chain squeezes.