🔒Contract legal battles brew between OEMs, suppliers

A new battle is emerging between original equipment manufacturers (OEMs) and their suppliers, one in which suppliers must pay close attention to the contracts they sign.

Here's an example of the issue:

A company has just been awarded its biggest contract ever to supply clips to Air National, whose executive vice president of procurement said that she and her team were impressed with the company's focus on quality.

A confirmation email follows with Air National's first purchase order for 10,000 clips. This order consists of two pages. The first is an order form that specifies part numbers, pricing, volume requested and dates of delivery. The second contains Air National's terms and conditions regarding delivery site, warranty and quality standards, change of specification process, product liability obligations to be imposed on the supplier and a clear expression that Air National has the right to seek recourse from the supplier for defective clips or clips that are not within specifications.

The supplier immediately fires back to Air National an invoice, which contains separate terms and conditions, confirming acceptance of the order. The terms include a limitation of damages to the price paid under the contract for the parts, a limitation of remedy to repair or replace defective clips, a limited warranty that merely provides that the clips will be manufactured to the specs within tolerance and that process or product configuration changes are subject to price negotiation. The supplier, which has confidence that the relationship with its new customer will be long and productive, never focused, or even thought about, the differences in the two sets of terms and conditions and the problems those differences could create.

This scenario is repeated daily in production facilities across the country including in Connecticut. What also is occurring more frequently is OEMs, under extreme pressure from their end-user customers, asserting claims against their downstream suppliers based on quality and pricing issues. The terms and conditions that are applicable here have an enormous effect on the outcome of these legal claims.

This is why it's important for suppliers to understand how the law deals with these differing sets of terms and conditions.

The law describes this scenario as a “battle of the forms,” because the parties have crafted conflicting writings. This scenario can produce a wholly unintended contract. While a judge, jury or arbitrator may conclude that there was no contract because the parties' minds never met on all essential terms, modern commercial law allows a fact finder to determine if a contract was formed even when there are contradictory terms and conditions. Implicit in this conclusion is that there was sufficient agreement to create a valid, binding contract.

The biggest problem occurs when the customer's terms and conditions say the supplier can be liable for an award of damages but the supplier's terms and conditions say the opposite. Commercial law tends to favor the customer, and the result for the supplier — liability for consequential damages — can be devastating.

Imagine, for a moment, that one of the parts a supplier has shipped is defective, and, as a result, the customer's assembly line is shut down until the defective part is discovered and removed. The customer's employees are called in but are idled due to the shutdown, and other parts suppliers or fabricators are halted in their work. For an error with a 15-cent part, the supplier could be facing millions of dollars of liability. Consequential damage claims just like this are regularly asserted by the big volume production companies because their customers specifically impose these charges on them.

Based on the supplier's failure to recognize, consider, and overcome the battle of forms problem at the contract formation stage, the company may be unwittingly assuming this type of liability with potentially disastrous results.

The lesson is this: Pay attention at the contract stage to the battle of forms and where the terms and conditions of each party conflicts, negotiate the best protections possible. Suppliers may not get any protections, but at least they will know what the exposures are and can plan for them accordingly — or walk away from the deal. And, of course, suppliers may achieve sufficient protection to avoid the most disastrous of consequences, and that can be enough to conclude that the rewards are worth the risk.

Andrew C. Glassman is chair of the Business and Finance practice at Hartford law firm Pullman & Comley. Contact him at aglassman@pullcom.com.