Increasingly, buyers are turning to a new tactic to stem the tide of rising costs: Upstream buyers are demanding longer payment terms. The demands often come from the top (i.e., OEMs and Tier 1s) down and take many forms. Some demand an extension from net 60 to net 90 days to pay, while others demand continued supply of product but deferred payment until next year. Some even demand their suppliers enter into a consignment arrangement where the payment term does not even start to run until the products are sold out of consignment.
The reasons for such demands are varied. Some buyers are seeking extended payment terms to have more cash on hand to spur innovation, to invest in capital, to make one’s balance sheet more attractive to current and new investments, and to otherwise expand one’s business. That can be a positive for suppliers if buyers are willing to share any business gains with their suppliers. Others need longer payment terms to address increased logistical, material and/or other costs. Whatever the reason, if buyers are making these demands without any commitment to pass along any gains to their suppliers, suppliers will end up financing upstream growth and innovation – interest free.
What a supplier can do in response to unfavorable demands to extend payment terms will largely depend on (1) its willingness and ability to engage with its customer to accept its demand in whole or in part and (2) the terms of its contract with its customer.
Regarding the former, every supply situation is different, and in many instances, suppliers may be open to considering customers’ demands for extended payment terms for numerous reasons. That includes, for example, agreeing to delayed payments because of the parties’ historical relationship, the overall business volume with the customer, to engender future loyalty and to share in the business gains the extended payment terms will facilitate, etc. If these suppliers have the financial means to do so, these possibilities may be worth exploring, but they must be properly documented. Particularly where the extended payment terms will deviate from existing long-term contract obligations, a supplier will want to ensure it is reserving all its rights. The bottom line: If extended payment terms are something you want or are willing to consider, get legal counsel involved.
For a supplier unwilling and/or unable to meet its customers’ demands for extended payment terms, the proper response first involves confirming that its buyer has a continuing obligation to buy parts at a specified payment term. Which documents comprise the parties’ agreement, and are payment terms spelled out in those documents? The answers to these questions are not always as straightforward as suppliers think. For instance, even if the parties have been doing business for some time, the customer may just be purchasing on an order-by-order or release-by-release basis. A buyer may not have a continuing obligation to buy if the supply contract gives the buyer or both parties the right to terminate for convenience, allowing for termination for any or no reason at all, or if your supply contract does not obligate your buyer to buy all or a designated portion of its “requirements” from you.
Whether your supply arrangement constitutes an enforceable long-term “requirements” contract can be difficult to determine. Earlier this year, the AirBoss case helped clarify when a long-term, requirements deal exists. MSSC, Inc. v. AirBoss Flexible Products Co., 2023 WL 4476721 (July 11, 2023). See our eAlert “Warner Represented AirBoss in Michigan Supreme Court Landmark Ruling in Automotive Supplier Dispute” for more information about that case. In the wake of AirBoss, suppliers and customers who believed they had a long-term requirements deal, may not; and it has opened the door for buyers with similar blanket orders to demand modified payment and other terms in order to continue sourcing parts from a particular supplier. The reverse is also true, however. A supplier without a long-term requirements obligation can condition future supply on the buyer’s commitment to agreeable payment terms.
If the parties do have a long-term requirements contract, however, a supplier has a right to insist that its buyer continues to buy its required parts at the parties’ agreed-to terms, including any agreed-to payment terms. When faced with a demand to extend the payment terms for a long-term requirements deal, a supplier has a number of ways it can respond. One potential tool at the supplier’s disposal that has proven helpful to suppliers facing such a situation is to demand adequate assurances that the buyer will live up to its continuing obligations to buy its requirements from that supplier and pay according to the contractual payment terms.
Based on particular circumstances, a supplier may decide to make a written demand for adequate assurances if it has “reasonable grounds” to believe the buyer will not perform. MCL 440.2609(1). A demand for assurances will typically state the basis for the supplier’s insecurity about the buyer’s willingness or ability to perform, the “adequate assurances” the supplier seeks to ensure the buyer’s performance under the contract, and the supplier’s plans to suspend (or not suspend) performance until adequate assurances are provided. Such a demand often specifies the buyer’s obligation to respond within a “reasonable” amount of time of no more than 30 days; otherwise, the buyer is considered to have breached the parties’ contract. MCL 440.2609(4).
A demand for adequate assurances can be an extremely effective tool to ensure that another contracting party complies with its obligations. That is especially true in time-sensitive situations, where waiting for the other party to breach the supply contract and then suing for a recovery can leave a supplier without a satisfactory remedy. It can quickly surface the underlying reasons prompting the customer to request extended payment terms, shedding light on their significance for both the customer and the enduring prosperity of your business relationship. These conversations can often bear fruit: Open dialogue regarding the customer’s needs may lead to opportunities for the supplier to negotiate its own concessions in exchange for modified payment terms. Similarly, if the customer overplays its hand, the customer may itself anticipatorily breach the supply agreement, potentially giving the supplier added leverage.
Demands for assurances must be carefully drafted to meet the legal requirements. If not done properly, the party seeking assurances can end up in breach of the contract itself. Messaging through a single and experienced point of contact, preferably counsel, is also critical to ensure consistent and deliberate messaging when demanding assurances.
For questions or concerns regarding any demands made to modify payment or other key supply agreement terms, whether coming from a supplier or a customer, please do not hesitate to contact Lance Zoerhof, Adam Ratliff, Laura You or your Warner attorney to discuss your options and create the best plan for your situation.
