Check OEM Contracts Carefully

April 16, 2004
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GRAND RAPIDS — The message is simple: Automotive parts suppliers shouldn’t accept too much risk when signing a contract with an OEM or Tier 1 supplier.

A real no-brainer, right?

Well, if you think all suppliers follow this straightforward rule, think again. Firms fail to do that fairly regularly, and they do so in the hope of being seen as a “good” supplier.

“They’re more than happy to accommodate their business relationships with a Tier 1 or the OEM,” said Joseph Gustavus, an attorney in the Motor City office of Miller, Canfield, Paddock & Stone PLC.

“It is a small automotive community and people network and interact with one another.”

Gustavus has been a legal counsel for software and hardware suppliers to the automotive industry for the past six years. He has negotiated for his clients with automakers, including the Big Three, and with large suppliers such as Delphi and Johnson Controls.

“With a desire to accommodate and please the customer, which is good, (suppliers) are all too eager to dismiss the significance of what they’re signing or agreeing to,” said Gustavus.

“Their counterparts at the OEM level and the Tier 1 level have had a lot of contracting experience in the automotive industry and they are cunningly rigid. (Suppliers) too eagerly sign on the dotted line or accept a purchase order’s terms and conditions on its face value.”

Sometimes a supplier who has fallen into the trap will catch on, but Gustavus said it’ll be too late.

Addressing a disagreement after the ink dries is very difficult, frustrating and costly because the client wants to go ahead with the product without any interference to what was agreed to earlier.

“It’s a touchy-feely situation where suppliers don’t want to upset anyone by bringing up an issue in a contract, but it can become vitally important to do so,” he said.

“Their reluctance to take on an active partnership with an attorney to go through and make certain that these contract terms are tied out to their satisfaction is the No. 1 issue.”

Who will absorb what type of risk is the No. 2 issue. Three areas of warranty responsibility exist and, generally, a supplier should only agree to sign on for one: the manufacturing warranty.

But even accepting that risk can be risky if the specifications of the supplier’s part aren’t concisely spelled out and if the client hasn’t clearly explained the exact role the part will be playing in the product.

“In fact, it’s going to be woven into a very complex sub-system and this complex sub-system is going to have a lot of feature interaction. This feature interaction is going to be used, unbeknown to them, with a particular component and integrated with it,” he said.

For instance, if a firm makes software for a vehicle’s air bag system, it likely does so without knowing what type of sensor will be used to activate the bags. Gustavus said Tier 1s and OEMs will try to hold the software supplier legally responsible for any mishaps that can be traced to a malfunction of the system.

“This has a safety-critical impact. In the air bags, this can end up killing people and they will be absolutely responsible for that,” said Gustavus.

This is the second type of risk for a supplier: the integrated warranty.

He explained that if some aspect of another part causes the supplier’s part to fail, it can be a legal problem for the supplier.

Risk No. 3 is design responsibility. It can cover product liability, recalls, program and developmental delays, and even work stoppages —things over which parts suppliers usually have no control.

Gustavus said suppliers should accept the manufacturing warranty for their parts, once the specs are agreed upon, but he emphasized that they shouldn’t agree to an integrated or a design warranty.

“Design responsibility and integration responsibility are very important because more assuredly your customer has to take responsibility for design and most assuredly they should take on the lion’s share of integration,” he said.

Nor should a supplier offer a customer free advice about the integration of its part with another company’s part.

“Bingo. The trap closes, and then they’re sucked into being an orchestra leader and they become responsible for how that piece sounds, as opposed to being merely responsible for their particular instrument,” he said.

Gustavus cautioned that lawyers for Tier 1s and OEMs will typically keep the language vague as to who accepts what risks when they write a work contract. He also warned that a supplier who doesn’t go over an agreement closely is asking for trouble.

“It’s healthy to have a good exchange of ideas and cooperation,” he said. “But ultimately, the responsibility for integration, and more importantly design, will be on the customer and not on the supplier.

“But once a supplier gets pulled in, to use a bad example, it’s like a wildebeast being snagged by a crocodile and being pulled into a watering hole. You’ll be dragged kicking and screaming, but you went to the watering hole and started drinking on your own.”

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