Suppliers: when a long-term contract is more of an anchor than a windfall.

Many manufacturing suppliers, including those in the metropolitan Detroit area, are facing a dilemma. They have entered into long-term contracts to supply goods, but due to substantially escalating costs, find it difficult to supply them at the contract price.

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In the last two years, this has been especially true for goods that require steel and crude oil. As a result, many suppliers have threatened to halt production, which could, no doubt, result in an immediate lawsuit. In the automotive industry specifically, there is the additional prospect of causing a "shutdown," where the production of an entire line of vehicles ceases because the automaker does not have the requisite parts. This, needless to say, is not good for a supplier-OEM relationship. Suppliers faced with this dilemma, should be keenly aware of controlling Michigan law, and the options available to them.

Contracts for the sale of goods in excess of $500 are covered by the Uniform Commercial Code (the "Code"). A supplier faced with increasing input costs may consider arguing that under the Code, the contract has become "commercially impracticable." In short, the distressed supplier can argue that it has become impracticable to perform under a contract because the inputs have become too expensive. In Michigan, however, the fact that a contract has become unprofitable is generally not the equivalent of the impracticability of performance. In fact, a rise in expenses due to the increased price of raw materials or the increased cost of construction does not typically amount to impracticability since that is the very type of risk a long-term fixed priced contract is intended to address.

Like the impracticability doctrine, force majeure clauses in contracts often single out particular events that justify non-performance. They typically relieve delays or failures in performance related to such events as fires, war, riots and acts of God. As such, suppliers should review the terms and conditions of their contracts to determine if such relief is available under a force majeure clause.

The "frustration of purpose" doctrine is another theory that may be argued by suppliers. It is similar to the impracticability doctrine and equally difficult to prove. For example, Michigan courts have accepted the frustration of purpose defense in a suit for payment of child support payments when the child had died. Similarly, suppliers may attempt to argue the frustration of purpose doctrine to relieve them from continued performance of long-term contracts.

How Long is a Long-Term Contract?

The distressed supplier should also consider whether it is truly subject to an enforceable, long-term contract. To be enforceable, contracts for the sale of goods over $500 must be written, signed by the party to be charged, and have a defined quantity term. A "requirements contract," where a supplier meets all of an entity's needs without indicating a specific number of goods supplied, sufficiently defines the quantity term.

Many purchasers attempt to negotiate long-term contracts while also leaving themselves an out to contract with other suppliers. Many purchasers also have termination at will clauses in their terms and conditions, or arrangements where there are multiple suppliers for a single good. These factors give purchasers increasing flexibility to end the relationship with one supplier and move to another offering more favorable terms.

The distressed supplier should consider these options, as well as other relief that may be available under the specific terms and conditions of their case. Impracticability and frustration of purpose defenses are difficult to establish, but depending on the facts and circumstances, may be available. Further, suppliers should not simply assume that they are at the mercy of the purchaser, as many contracts that were thought to be long-term deals have clauses that relieve the supplier from continued performance.

George S. Fish is a partner at Raymond & Prokop and a member of the Commercial Litigation Practice Group. He can be reached at [e-mail].

Welcome to the first edition of the 2005 Raymond & Prokop Trials, Tools and Trends Newsletter, specifically tailored for members of the Detroit Regional Chamber.

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