Managing Warranty, Recall, and Litigation Risk for Automotive Suppliers
Although the number of total vehicle recall campaigns is likely to be down this year, lower volume recall campaigns are expected to continue to trend upwards, including those involving electrical system components.
Electrical system components and networks that provide advanced control systems, collision avoidance, adaptive cruise control, lane-keeping assistance, vehicle-to-vehicle communication, and “hands off’ steering are increasingly being integrated in new vehicles. As these components, systems, and networks become increasingly complex, the possibility of defects—along with the associated warranty and recall costs—increases. The proliferation of new technologies and integration of software into new vehicles is also bound to create new risk areas for automotive suppliers.
As liability shifts away from human drivers and toward electrical system components and their software, managing warranty and recall risk will be key for suppliers. Following are some steps that automotive suppliers can take to mitigate this risk.
- Think about warranty risk management at the contracting phase. OEM purchase orders and corresponding general terms and conditions contain highly OEM-favorable terms, making exceptions and limitations to supplier warranties difficult to negotiate. Specifications for components or systems should be clearly set forth in contract documents and efforts should be made to limit or disclaim any inapplicable warranties, including warranties outside the scope of design responsibility.
- Clearly document responsibilities for testing and validation. Automotive suppliers should document their responsibilities for testing electrical system components, systems, and networks, as well as clarify the limits of their responsibility for testing and validation at the component, system, and vehicle level.
- Address any warranty issues promptly. If a warranty issue arises, it’s important for the supplier to react quickly to identify the root cause(s), implement containment procedures, and establish clean points. In addition, protocols should be established for handling warranty claims and analyzing the root causes of dealer repair codes that could implicate the product.
- Clearly document quality issues. If a claim involves multiple parties, the tier 1 supplier should work closely with the OEM to identify and document quality issues early and promptly communicate responsibilities. If a claim involves a lower-tier supplier, notice of the warranty claim, notice of a breach of applicable agreements, documentation of root cause(s) and documentary evidence supporting the damages are critical should litigation arise.
- Ensure proper internal safety review procedures are in place. These procedures will guide the reporting of safety defect determinations concerning components or systems to the National Highway Traffic Safety Administration (NHTSA). When a potential defect may involve components supplied by a lower-tier supplier, the supplier must review all relevant purchasing contracts for provisions relating to recalls, decision-making, reporting, cooperation, design responsibility, and allocation of cost recoveries.
- Consider confidentiality of documents. If NHTSA commences a defect investigation, it is likely the OEM will be asked to submit confidential information relating to design and engineering documents, as well as test data. Suppliers should consider the confidentiality of such documents and request that the OEM seek confidential treatment of the information in accordance with NHTSA’s regulations.
- Plan ahead and monitor recalls and investigations. Suppliers should develop their own positions concerning whether components or vehicles contain safety-related defects within the meaning of the Highway Safety Act and NHTSA’s regulations, taking into consideration past NHTSA recalls and investigations involving similar components and circumstances. It’s also important to monitor new recalls and investigations, including OEM submissions and regulatory developments that may affect the supplier or its products, such as proposals for new safety standards or amendments to existing standards.
- Take steps prior to contracting to reduce litigation risk. There are simple steps that can be taken early to reduce risk, including confirming the specific corporate entity that will be the counterparty in the contract, and reviewing the counterparty’s litigation history, credit history, and reputation in the industry. Suppliers should also confirm that the written contract accurately defines all relevant prior agreements, negotiated rights, and obligations; consider a forum selection clause or arbitration clause if the contract involves parties from different jurisdictions; and confirm that the risks of early termination have been addressed for long-term agreements.
- Ensure compliance and documentation during performance of the contract. It’s also important to task a point of contact with ensuring compliance with the contract, and that applicable contract documents and relevant communications are readily accessible if, and when, needed. When a dispute arises, important communications should be carefully documented, and the company should ensure that all documents relating to damages are gathered.
While the above steps cannot eliminate the risk of litigation, they can reduce the likelihood of litigation and better position the company for success when litigation is unavoidable.
Managing Supply Chain Disputes Arising From Aluminum and Steel Tariffs
Trade issues and tariffs likely will be an important issue for automotive suppliers and manufacturers to manage in 2019 and beyond. On March 1, 2018, a 25 percent tariff was imposed on imported steel and a 10 percent tariff on imported aluminum under Section 232 of the Trade Expansion Act of 1962 (19 U.S.C. § 1862). Automotive suppliers typically purchase raw materials and supply components and assemblies to OEMs under long-term agreements with fixed prices, therefore those without appropriate clauses addressing such cost changes for raw materials, components, or assemblies may have limited ability to pass on increased production costs related to the tariffs.
For these suppliers, it will be important to examine their contractual relationships to determine their ability to pass on increased costs related to raw materials and/or tariffs. Force majeure clauses and commercial impracticability under the Uniform Commercial Code (UCC 2-615) should be reviewed but may be a difficult avenue for relief. Suppliers must also review duration, termination, and quantity terms to determine leverage points for discussions on revised terms. Additionally, suppliers should ensure that they are using risk mitigation strategies such as excluding or adjusting tariffs and duties in the product price, as well as indexing, considering available raw materials, or hedging programs.
Indexing avoids the renegotiation of prices every time the raw material price fluctuates by allowing component part prices to fluctuate with the cost(s) of their raw materials monthly, quarterly, or annually. However, some raw material such as plastics and rubber are not traded on commodity exchanges and, therefore, are not able to be indexed. OEM raw material programs allow the supplier to participate in the OEM’s supply arrangement with raw materials suppliers. Hedging strategies also can be used to transfer risk to third-parties.