In the aftermath of Japan’s earthquake and tsunami in March, carmakers and suppliers have been sharply focused on the job of restoring supply lines. But the disaster entails much more than purchasing issues. It also raises legal implications that touch everything from supply contracts and insurance to production and finance. Companies should make themselves aware of these factors now and take proactive steps to avoid problems later this year as the impact on the global automotive manufacturing base spreads, according to Dykema Gossett, PLLC, a national law firm whose ties to the automobile industry date to the 1920s.
Aleksandra Miziolek, director of Dykema’s Automotive Industry Group, and Sheryl Toby, co-chair of the firm’s Bankruptcy and Restructuring Group and member of the Automotive Industry Group, say the challenge is greatest among tier one suppliers because of their more complex supply chain. They also caution that suppliers of all sizes need to become more aware of legal issues raised by the disaster in Japan.
What should companies do now?
It’s a step-by-step process. First, you stop the hemorrhaging. Then you need to work through the longer-range issues. There may be some slow bleeding that hasn’t been recognized yet that will become important. Hence, it also will be critical to assess the financial impact of the crises on the supply base. One of the critical issues will be identifying suppliers that face financial difficulty due to production reductions. The strain may not be immediately apparent, but it will occur later this summer after current payables, which are based on sales before the crisis, come in.
You also need to truly know your supply base. What can you do to avoid a problem, fix it early and find solutions that won’t raise problems later? Some of our clients are delving as deeply as the seventh tier of their supply chain for answers.
How broad are the legal issues?
Everything has a legal implication. There are contract, insurance and warranty issues related to a company’s ability to perform that may come into play for everyone affected by the crisis. If you can’t deliver components because a supplier’s operations in Japan have been damaged, you may have an excuse from your contract under its force majeure provisions. But what is your exposure if your inability to produce is caused by your supplier’s supplier, or someone even farther down the supply chain?
Nobody questions the disaster in Japan, which should excuse the performance of companies whose product originates there. Force majeure gives both parties in the contract certain rights and duties if, for example, an affected supplier must allocate its reduced output among several customers. The situation becomes more complicated if a customer must find another source because a shortage of parts leaves its current supplier unable to perform. The new supplier may ask for a long-term contract. But what is the continuing obligation to the current supplier? What happens if there are warranty issues later that involve parts obtained under these conditions? Who pays the additional costs when a customer switches to another supplier or substitutes with a more expensive component?
The answers to these questions are very dynamic, fluid and interdependent.
What other factors should companies consider over the next several months?
There are huge insurance issues. If you can’t produce, you may be able to make an insurance claim. You need to know what documentation is required. Are you covered if you don’t have a direct loss, but your supplier does? What can you claim if the cause of your production problem is more indirect? Companies should review their insurance policies very carefully. Sometimes the coverage goes beyond operations directly affected by the earthquake and tsunami.
In terms of U.S. law, there may be differences in corporate culture that need to be considered. American companies are accustomed to dealing with legal claims every day. But Japanese companies, for example, see legal matters differently. Their purchasing operations in the U.S. may not recognize that a notification about a supply problem is, in fact, a legal claim.
What about longer-term issues?
Not all Japanese suppliers are rebuilding capacity in Japan. Other countries are offering subsidies to help them relocate. This could have a huge impact on national economies.
An equally big issue is how cutbacks in vehicle production caused by parts shortages will hurt suppliers whose own capacity is unharmed. Some of them are still financially weak from the past three years of economic crisis. These companies will face considerable economic strain later this year because their automotive customers are forced to reduce output.
The good news is that consolidation of the supply chain over the past few years has added clarity to the network. It’s a little easier to assess the impact than it would have been if this crisis had occurred five years ago.
What is your advice for suppliers?
Sometimes it helps to call in an outsider to help sort out the issues and identify what you don’t know or haven’t yet considered. The best companies also assemble an internal team that includes the CEO, risk managers, purchasing, in-house counsel and other stakeholders to make sure the company is doing proper due diligence.