The Incredible Disappearing Requirements Promise: Michigan Court holds that an “option to purchase requirements” automotive supply contract is enforceable

Monday, February 17, 2020

A contract for the sale of goods that said “Buyer promises to purchase its requirements for the goods from Seller and Seller promises to supply Buyer’s requirements” is an enforceable “requirements contract” (often referred to in the automotive supply industry as a “blanket order”) under Article 2 of the Uniform Commercial Code, which governs contracts for the sale of goods. Conversely, a contract which stated “Buyer does not promise to buy any goods from Seller, but Seller must supply whatever Buyer chooses to buy” is not enforceable. 

In Cadillac Rubber & Plastics, Inc. v. Tubular Metals Systems, LLC, (February 11, 2020), the Michigan Court of Appeals addressed whether the following language was enforceable:

If the face of the Order . . . specifies. . “blanket order”, then, in consideration for ten US dollars (US$10.00) Seller grants to Buyer an irrevocable option during the term of this Order to purchase Supplies in such quantities as determined by Buyer, . . . provided that Buyer shall purchase no less than one piece or unit of each of the Supplies and no more than one hundred percent (100%) of Buyer’s-requirements for the Supplies.

On its face, this looks very much like the unenforceable promise described above, but the Court of Appeals, in a 2-1 decision, disagreed, finding that the provision was enforceable. 

Below, we briefly review the role of requirements contracts in the automotive supply chain, then discuss the Court’s ruling in Cadillac Rubber, and conclude with a discussion of the practical implications for suppliers.

1.  Requirements Contracting in the Automotive Supply Chain

Automotive parts buyers require a reliable, long term supply of unknown quantities of highly customized parts that cannot be cheaply or quickly resourced.  Automotive parts suppliers require (or at least desire) a long term commitment for the purchase of those parts in order to justify the needed capital and capacity investments.   And over the past 30+ years, OEMs and other tiered manufacturers have increasingly chosen to procure parts from independent lower-tier suppliers, rather than building the parts themselves.  Internal production requires no contracts; procurement from a separate business does.  Thus, both automotive buyers and sellers need “requirements contracts,” in which the supplier promises to provide and the buyer promises to purchase that buyer’s requirements for the parts, whatever those requirements might be, typically over a long period of time at a firm fixed price. Simply stated, such requirements contracts are the legal backbone of the modern automotive supply chain. 

As anyone who is in or has studied the industry recognizes, OEMs and other buyers typically have the stronger hand in determining contract terms, and they have used that strong hand to modify the simple “I promise to buy my requirements from you and you promise to sell my requirements to me” contract model in the buyer’s favor.  Almost from the beginning, industry contracts typically allowed the buyer to “terminate for convenience,” that is, end the contract at any time without reasons, notwithstanding the supplier’s need and expectation that (absent breach) the supply relationship will continue.  More recently (beginning approximately 15 years ago), many buyers began to replace a promise to purchase their requirements with an open-ended “option” like the provision at issue in Cadillac Plastics.  However, until Cadillac Plastics, there was no Michigan case law squarely addressing the enforceability of such an “option” in the automotive supply chain.

2.  The Cadillac Plastics Opinion

The pertinent portion of the majority opinion begins by finding that “non-exclusive” requirements contracts (that is, contracts in which the buyer promises to buy less than 100% of its requirements) are enforceable under Article 2.  That holding is consistent with the weight of Michigan authority, although the question had not been definitively resolved in Michigan before Cadillac Plastics.  Indeed, the dissenting opinion agreed with that portion of the majority opinion.

The majority opinion then turned to a related but separate question: whether an obligation to purchase between one part and 100% of the buyer’s requirements satisfies the “statute of frauds” provision of Article 2.  That provision says, in substance, that except for very small transactions, a contract for the sale of goods must include a written quantity term and that the contract is not enforceable beyond the written quantity.  The requirements contract provision says, in substance, that “requirements” counts as a quantity.  The two provisions, read together, make requirements contracts enforceable. 

The majority opinion found that the option language satisfied the statute of frauds.  The majority’s reasoning is opaque, but it roots its holding in an earlier opinion in Johnson Controls, Inc. v TRW Vehicle Safety Sys, Inc., which addressed the enforceability of a substantially identical option provision in JCI’s terms. 

The problem is, as the dissent notes, the JCI case did not hold that the option provision was enforceable.  Rather, it held that it was uncertain whether it was enforceable and that discovery and potentially a jury trial was necessary to answer the question.  As the dissent explains, “The majority does not cite any case holding that a promise to buy between 1 unit and 100 percent of requirements is sufficient to create a requirements contract. Such a conclusion would severely undercut the UCC’s requirements . . .  Here, the range is nothing more than ‘whatever we order.’”

Nevertheless, whatever the strength of its reasoning, the majority opinion is now the law in Michigan.  However, it should be noted that Cadillac Plastics has the right to ask the Michigan Supreme Court to review the Court of Appeals' opinion.  (In addition, Cadillac Plastics s not controlling when another state’s law applies, illustrating one of the many reasons that contractual choice of law provisions are important, not merely legal boilerplate).

3.  Practical Implications for Suppliers

From a strictly legal standpoint, the implications of Cadillac Plastics are significant.  Simply stated, if Michigan law applies, Cadillac Plastics allows buyers to hold suppliers contractually obligated to supply all of the buyer’s requirements at a firm-fixed-price for the life of the program or other extended period, in exchange for a promise to purchase a single part.  The seller’s commercial expectation that buyer will purchase all of its requirements from seller is, from a contractual standpoint, all but illusory.

From a commercial standpoint, the implications may not be so dire.  It remains difficult and expensive for a buyer to dual source of resource production, so the practical likelihood that a buyer will significantly reduce its purchases to less than requirements is probably low.  Further, in all likelihood, the contract terms will allow the buyer to terminate for convenience at any time.  Although this termination right is not identical to the right to reduce purchases, it too significantly limits the seller’s right to enforce a requirements commitment.

Although commercial considerations temper the harshness of the contractual terms, they do not eliminate the problem.  A supplier that wants a truly enforceable requirements commitment must bargain for three things: (1) an unambiguous requirements promise; (2) an express exclusion of the termination for convenience provision; and (3) an express exclusion of any option contract provision.  As always, the bargaining should occur before entering into a contract.  Once the supplier is locked into the buyer’s terms, there is little or no reason for the buyer to agree to modify them.

For further information about these issues, please contact the authors of this Client Alert.

Sheldon Klein
248 258 1414
klein@butzel.com

Cynthia J. Haffey
313 983 7434
haffey@butzel.com

Daniel Rustmann
313 225 7067
rustmann@butzel.com

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