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Contracts in the automotive supply industry - tips for suppliers

Leading sectors such as the automotive industry depend on reliable suppliers. However, supplier companies are often presented with very one-sided production contracts or supply contracts. This also applies to the largest automotive suppliers. If you are a tier 2 or tier 3 automotive supplier, you often offer special services and solutions that tier 1 suppliers or the manufacturer itself want to source. However, as a supplier company, especially as an automotive supplier, you should not sign it without checking it, but check it before concluding the contract. Because a supply contract often goes beyond what is in the commercial interest of the manufacturer. It also contradicts the legal and commercial interests of the automotive supplier. In many cases, the gross disadvantage arises only from the synopsis of various clauses, which are often cleverly distributed in different contracts. Therefore, pay particular attention to how the following topics are regulated in the supply contract:

  • Delivery obligations, especially in the case of forecasts, delivery bottlenecks or price explosions for raw materials, especially natural gas
  • Damage and Compensation
  • IP rights, i.e. rights to your intellectual property, in particular the right to use a trademark, a patent, manufacturing know-how or copyrights and other property rights
  • Your obligations in the event of defects and deviations from statutory regulations, in particular statutory claims for damages and the obligation to give notice of defects 
  • Your rights and obligations in the event of termination of contract

1. In advance: checking the contract documents for completeness 

Check carefully whether all contract documents have been submitted to you in full. Only then can you fully understand your legal position as a supplying company. A supply contract is often brief, but often refers to various other regulations and general terms and conditions (GTC) such as purchasing conditions, development conditions, license regulations, agreements on quality management and other sets of rules that you should have. All conditions must be included in the contract review to give you a complete picture of your contractual situation. In particular, clauses that you would not expect in connection with the delivery of components are often found in hidden places. In particular, a claim by your "partner" for compensation in the event of an infringement of IP rights can extend over several clauses.

If the manufacturer is a very large company, such as an automotive supplier, he will often reserve sample contracts. These are formulated for multiple use by a large number of suppliers and producers and are therefore legally to be qualified as general terms and conditions. The title of the contract is irrelevant here, for example whether the term "General Terms and Conditions" is used. The clauses of a delivery contract or purchase contract are also to be treated like general terms and conditions clauses if they are to be used several times and must therefore be regularly checked in accordance with the provisions of the German Civil Code on general terms and conditions. General terms and conditions law also applies to business dealings if German law applies. You should pay attention to this. 

The general terms and conditions law contains many regulations that restrict the drafting of contracts. This applies in particular to liability for damages, i.e. the prerequisites for a claim for compensation for damage and the calculation of the amount of damage. This also includes clauses on contractual penalties, the flat-rate amount of a claim for damages and the statute of limitations on a claim for damages. When examining a supply or production contract and its regulations on IP rights and claims for damages, I, as your lawyer, always check whether your company is disadvantaged by a clause, but also whether a clause is effective at all. In negotiations with the other contracting party, it often helps to point out invalid clauses. This often significantly increases the willingness to negotiate. 

2. Delivery Obligations and Delivery Exclusivity

A production or delivery contract for suppliers regularly contains strict delivery obligations. There it is regulated, for example, that the manufacturing company specifies forecasts, which on the one hand contain binding delivery schedules for the supplier. On the other hand, they are usually not binding for the manufacturer; the manufacturers reserve the right to change the forecast and even delivery schedules that have already been issued at any time. The proviso that the "legitimate interests" of the supplier must be taken into account, which is often found in a supply contract, does not really help. Because what does that mean? A binding forecast as part of a long-term framework supply agreement means sales and planning security for a supplier. However, strict delivery obligations can quickly have a suffocating effect, especially in connection with long notice periods and fixed prices based on annual agreements. Because in such constellations, price increases for energy and raw materials and delivery difficulties at the supplier's suppliers can prove fatal.

Delivery obligations should therefore be reduced economically. This can happen in particular through extraordinary termination rights for forecasts and call-offs, self-delivery reservations and price adjustment rights. However, such clauses in favor of the supplier are never found in contracts specified by the manufacturer. As an entrepreneur and supplier, you usually have to “negotiate” them into the contract.

Also note whether you are being asked to make changes to the contractual products free of charge in accordance with the manufacturer's specifications. This is often associated with the creation of intellectual property and the granting of licenses to rights. Requests for changes should of course be permissible. However, intellectual property in such changes should belong to the party that bears the cost.

If you essentially make your production capacities available to a manufacturer, this must be associated with planning security for you. In particular, it is possible for you to be granted delivery exclusivity for the entire series production. This delivery exclusivity is the “opponent” to binding forecasts and binding price agreements. In addition, you protect your investments against damage caused by a premature termination of the contract. The supply exclusivity is therefore also to be combined with special contractual protection against dismissal.

3. Protection of your IP rights

Make sure you protect your IP rights, i.e. your intellectual property. This includes trademarks, copyrights, patents, designs or manufacturing know-how. You should not grant your contractual partner any rights to this, especially none that are covered by the purchase price. If you have granted intellectual property rights, the producer may use them. Your company is not entitled to claims for damages or compensation, even if the contract is terminated and you no longer receive any remuneration. In this context, it is particularly dangerous to grant a license for transmission to third parties. 

At the very least, a distinction must be made between old and new rights, also known as background ip and foreground ip. Legacy rights are, for example, copyrights or patents that already existed before the contract was concluded. New rights, on the other hand, are those that are only created during the collaboration. If it is realistic to assume that new rights will be created, this should be regulated in an agreement on research and development (R&D).

The risk of becoming liable for damages is also high in the case of obligations to check third-party rights and to indemnify your customer against any claim for damages or compensation in the event of infringement of third-party rights. This means nothing less than that your company must set up worldwide monitoring of such third-party IP rights. This is usually associated with high costs. 

4. Investment protection and damages

Particular damage can result from contractual terms under which high initial investments are agreed, but you have no contractual security to earn these investments again. You will be deprived of this opportunity for amortization in particular if your other services are to be covered by the price according to the contractual conditions or if there are far-reaching rights of termination. It should be noted here that there is no legal right to compensation or compensation for immaterial damage if your company cannot generate investments due to a terminated contract or services that have been compensated. Likewise, it must be expressly taken into account in a contractual arrangement that you are entitled to compensation or damages if the producer stops series production.

A special equivalent to a claim for damages is a contractual provision to secure the annual minimum requirement within the framework of series production. If the respective manufacturer decides to no longer manufacture a certain product, such as a vehicle, the supplier is then entitled to a claim for damages.

5. Protection of your production capacities

The risk of having to pay damages or compensation for a breach of a contractual provision also arises in connection with capacity-related clauses. Suppliers often have to commit to being able to deliver minimum capacities within certain periods of time. At the same time, however, the other contractual party reserves the right to make call-offs only according to its own needs and only at its own discretion. Such clauses are inappropriate because your company can suffer a great deal of damage if you have to reject an offer for another supply contract, but your plants are actually idle. You are not entitled to damages or compensation if the manufacturer has reserved the right to place orders at its own discretion. However, with such contractual conditions you expose yourself to a claim for damages if you do not have production capacities available.

Provisions in a supply contract often provide for a very long post-contractual obligation to supply spare parts, sometimes 15 years after the end of series production. Your contractual partner is therefore also entitled to be supplied with spare parts for this very long period of time. A breach of this obligation can lead to a claim for damages. Therefore, pay attention to the regulations for the delivery of spare parts and whether these are appropriate.

6. Defects and Liability for Damages 

The regulations on liability for defects are among the most important clauses in a contract. In particular, the delivery of faulty parts or components can have serious consequences. The delivery of faulty parts is a breach of duty and may oblige you to pay damages. In the automotive industry in particular, a line standstill can cause serious damage. In the case of a commercial purchase, the buyer of a product is obliged to examine the delivered parts for defects. Manufacturers often try to get rid of this obligation through quality assurance agreements and audits. It is legitimate for an outgoing goods inspection to be carried out on your premises as part of production. However, check whether you can fulfill the obligations imposed on you.

Liability and exemption clauses are also regularly part of a supply contract. Contractual claims for damages often go beyond statutory claims for damages in terms of their requirements and scope. Liability for damages always presupposes fault, i.e. intent or negligence, in the event of a breach of a contractual obligation according to the statutory provisions. The supplier is only liable in the area of product liability or the agreement of a guarantee, even if he is not at fault. Therefore, pay attention to whether your company is liable for the fulfillment of certain requirements and compliance with obligations without fault for damages. Be sure to try to negotiate limitations of liability in your favour, for example in connection with existing insurance coverage. You should also not be liable for lost profits.

A clause that obliges you to indemnify your customer against third-party claims, in particular for damages due to infringement of intellectual property, i.e. rights to trademarks, copyrights, patents, know-how, etc., is also disadvantageous and the risk of claims for damages is high. Your company will often have no realistic means of checking a product for third party rights anywhere in the world.

7. Termination Clauses and License Rights

The manufacturer's rights of termination and clauses that grant the manufacturer license rights for the production of the contract products are also critical in the synopsis. Even with the termination options, it can only be seen from a synopsis of several clauses that your "exploitation" is possible. First of all, unclear regulations on contract termination, such as "with a reasonable notice period at the end of the month", should be avoided because it is completely unclear what "reasonable notice period" means. At the same time, suppliers are often obliged to grant the manufacturer extensive exclusive manufacturing licenses and rights of use. Your customer would then have the option of entering into the contract with you, terminating it at short notice, making use of the licensed manufacturing rights and taking over the manufacturing itself or outsourcing it to a third party. You then have no regular opportunity to claim damages.

In many sectors, such as the automotive industry, many manufacturers have a dominant position. This market dominance is not prohibited, but it must not be abused. Such abuse with the obligation to cease and desist and to pay damages exists, among other things, if the supply contract with an (automotive) supplier is terminated at such short notice that the supplier cannot switch production to a new manufacturer. Termination can then only be permissible if an appropriate expiry period of 12 to 24 months is granted. However, you would have to assert this in court. As a lawyer, I therefore regularly recommend my clients - also to secure their investments and capacity utilization - to agree on a fixed multi-year term, to exclude the right to ordinary termination, at least for the first few years of the contract, and at the same time to set a conversion period.

8. Finally: Is the respective clause really necessary

In the case of a supply contract and the other general terms and conditions (GTC), pay attention to the extent to which clauses are included that do not apply to your company, the components to be supplied or the services you have taken on, for example the auditing of various production sites, the manufacture of prototypes, electrical/ electronic components, obligations in the logistics process, innovations and inventions, joint research and development, the involvement of third-party companies or readiness for series production. All clauses that do not apply to you and your company should be deleted without replacement. The buyer with whom you are negotiating the production contract or supply contract will often take the position that deletions are not possible at all because these are standard contracts specified "from above", that deletions require the approval of management or that they are not relevant clauses would not harm. Don't let yourself be blinded. From my many years of consulting experience as a Specialist lawyer for commercial and corporate law and as Specialist lawyer for international business law I know that as a rule all clauses are negotiable, buyers themselves are happy about "lean contracts" and the management only has to be involved in questions of liability, because this is where the greatest entrepreneurial risk exists.

Anwalt Gesellschaftsrecht und Handelsrecht

dr Andrelang, LL. M

Specialist lawyer for international business law

Specialist lawyer for commercial and corporate law


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