From pandemic to electronic component shortage, unending force majeure?

02 April 2021

The automobile sector worldwide is experiencing the impact of a shortage of electronic components.

Many manufacturers have announced a slowdown and even stoppages in output with no genuine prospects of a return to normal before several months.

The situation today, owing to its exceptional nature, has plunged economic stakeholders in general and those of the automobile sector in particular into great uncertainty. This is exacerbated by the position taken by certain figures who consider that the shortage in question is not a case of force majeure, much like other positions taken nearly a year ago and which have subsequently evolved since. Indeed, those who initially refused to recognise COVID-19 as a case of force majeure then themselves quickly notified their suppliers of the occurrence of a case of force majeure on these grounds.

The purpose of this paper is to propose lines of thought, based on French law, on force majeure, and on the question of its application to the shortage that affects the sector.

The exercise can only focus on areas for reflection, since force majeure is a concept that is assessed on a case-by-case basis and does not lend itself well to theorising on a given and unprecedented event, as has been demonstrated by the various positions adopted when the coronavirus crisis arose, many of which were not followed by the French courts as they stand.

In a contract between a buyer and a supplier, one of the two parties may be prevented from fulfilling their obligations due to special circumstances. The debtor of the obligation to provide (the supplier) or be stocked (the customer) must justify this impossibility in order not to be penalised on the grounds of negligent non-fulfilment. This impediment may be caused by the occurrence of a case of force majeure. In such a case, the debtor of the obligation can be released from their contractual responsibility and an option exists according to whether the impediment is temporary or definitive, the obligation being suspended in the first case, and the contract being terminated in the second.

In any event, it is therefore essential to know whether equipment manufacturers can be exonerated from liability relating to their inability to supply by invoking a case of force majeure with their customers and whether the latter can exonerate themselves from their own obligations on the same grounds.

After a brief presentation of the current situation (I), we will set out the conditions under which the parties, and in particular automotive suppliers, may invoke a case of force majeure (II). Finally, we will formulate a few recommendations in connection with the Code of Performance and Good Practices relating to customer-supplier relations in automobile manufacturing sector (CPBP) of 6 November 2020 (III).

I. Presentation of the current situation

The first meeting of the crisis unit on the shortage of electronic components for the automotive sector, which took place on 10 February 2021 and brought together representatives from the General Directorate for Business (DGE), the automobile sector and the electronics sector (see minutes circulated), led to the formulation of a shared assessment of the situation:

  • The COVID-19 crisis and the successive waves of lockdown led to a substantial slowdown in the automobile industry in the first half of 2020 and thus a significant drop in the demand for electronic components (-10% whereas the rest of demand continued to rise: +14%). This led to supply sources being put on hold and the investments initially planned to meet the demand being postponed. Moreover, the automobile industry only accounts for approximately 10% of total world demand for electronic components and more than 50% of the basic manufacturing elements today are in Asia, whereas at the beginning of the 2000s, 44% of manufacturing was still in Europe. There is therefore a very high dependence on supplies particularly from Taiwan;
  • The health crisis and the successive waves of lockdown resulted in orders from the automotive industry almost coming to a standstill in the 2nd and 3rd quarters of 2020 (all over the world, many automotive plants were at a standstill at the time). Equipment manufacturers were furthermore obliged to tap into their stocks while waiting for visibility from their vehicle manufacturer clients;
  • The faster and stronger-than-expected recovery in Asia, particularly in China, generated strong demand for electronic components. Furthermore, also bearing in mind the consequences of the COVID-19 crisis (explosion of teleworking, distance learning, etc.), orders for PCs, tablets and smartphones, 5G devices etc., exploded. Suppliers therefore reallocated their output to these markets;
  • In September-October, and even more acutely in November-December 2020, vehicle orders increased sharply with, in the wake of government stimulus aid, a strong increase in the sales of EVs and hybrids, increasing the demand for electronic components (on a baseline of 100 in September 2020, the demand in November-December 2020 was 160);
  • These phenomena led to the totally saturated manufacturing capacities of electronic components being inadequate to fulfil the orders of the automobile industry;
  • Today, the problem mainly relates to microcontrollers, given that seven world manufacturers supply 95% of the automotive market. Moreover, they work with a Taiwanese subcontractor which supplies 70 % of the world market;
  • For electronic components specific to the automotive market, the incompressible cycle time, particularly in view of the various mandatory certifications, is 4 to 6 months. This time is in addition to production constraints;
  • Today, many players in the electronics sector have launched investment programmes. However, it is a difficult task to increase production capacities, due to the lack of necessary production tools. The delivery period for certain production tools is one year. A further 3 month qualification period should be added to this before production can be launched;
  • While electronics manufacturers will do their utmost to attempt to reduce the gap between supply and demand (e.g., through the optimisation of production capacities), this gap will remain significant for approximately 6 months at the least. The situation should theoretically improve in the 3rd and especially 4th quarter 2021.

The consequences of this are therefore that the coronavirus crisis and the decisions taken by the various countries to deal with it are the trigger for the shortage, with the other causes appearing to be exacerbating factors, much like other elements such as the geopolitical tensions that prompted HUAWEI to build up a stock of components amounting to 2 years of requirements, or a production capacity concentrated on a few players and whose growth (4%) has been entirely out of line with that of demand (80%).

II. In these circumstances, can parties invoke a case of force majeure?

Force majeure in contractual matters is defined, according to article 1218 of the French Civil Code, as "an event beyond the debtor's control, which could not reasonably have been foreseen at the time of the conclusion of the contract and whose effects cannot be avoided by appropriate measures and which prevents the debtor from performing their obligation".

It should be noted that the various terms and conditions (purchase or sale) or contractual clauses brought to our attention are all very similar and do not diverge fundamentally from this definition.

This definition gives rise to three cumulative criteria which we shall examine in turn, although it is not easy in practice to qualify a case of force majeure in the light of jurisprudence which is essentially case-based, a qualification which, moreover, requires examination on a case-by-case basis.

To this end, we will state here that the debtor is the party who must deliver a part, system or subsystem to an automaker, in other words the equipment manufacturer, and who is unable to do so, either totally or partially, due to a shortage of electronic components.

An event beyond the control of the defaulting party

The criterion of externality leads to the event being considered as out of the control of the debtor of the obligation (in this case to deliver) and not their fault according to a classical approach by which force majeure excludes fault.

There seems to be no doubt in our minds that the causes of the worldwide shortage of electronic components and the shortage itself are well beyond the control of the equipment manufacturer who endures them but in no way generates them.

An unforeseeable situation

The criterion of unpredictability leads to the fact that, at the time of the conclusion of the contract, the event could not reasonably have been foreseen, which in turn entails exploring what the professional of average diligence can anticipate by taking into account factual circumstances such as the circumstances of the event and certain qualities of the obligor (i.e., their supposed level of knowledge/expertise).

The application of this criterion has varied over time; beyond its role as a criterion or only as a guide, unpredictability is evaluated according to time and circumstances. What was not predictable at a given time may have become predictable at a later date as a result, for example, of changes in knowledge and technology.

Its variability thus offers the judges flexibility in their assessment. Jurisprudence, while fluctuating significantly, appears to opt for a case-by-case analysis. Attentive analysis of the numerous decisions in this area easily demonstrates that this unpredictability is reasonable and acknowledged in the light of other criteria, such as abnormality, suddenness and rarity.

It appears to be an accepted fact that before the beginning of 2020, the measures taken by the various countries were not reasonably foreseeable.

As a consequence of these measures, which are unprecedented since the last global conflict which nevertheless allowed the economy and trade to continue to function even though this was not the case for part of 2020, the shortage of electronic components seems to us to be an event that could not reasonably have been foreseen.

An irresistible nature

The irresistibility criterion, for its part, leads to an investigation into whether the event produces effects that cannot be avoided and which prevent the equipment manufacturer from fulfilling its obligation to deliver.

This criterion is the hard core of force majeure and the one in respect of which the courts are the most rigorous as regards the administration of its proof by the party who may invoke it but also as regards the party who argues that the event is not irresistible (i.e. let us bear in mind that the burden of proof rests on both parties).

The shortage unquestionably prevents the equipment manufacturer from delivering; without the electronic component(s) to be integrated into its part, subsystem or system, it cannot deliver, except to deliver a non-compliant part which would constitute a fault on its part which no auto manufacturer would permit (notwithstanding the specific case of exemptions).

However, to echo certain voices that argue that the strained situation in the electronic components market was well-known, and consequently that measures should have been taken by equipment manufacturers (i.e. building up buffer stocks or diversifying sources), from a purely theoretical point of view, the argument is not lacking in scope.

This argument is nevertheless at odds with factual circumstances such as the uncertainty which accompanied the upturn in activity in the automobile sector, the absence of visibility (no volume forecasts communicated by vehicle manufacturers for more than three months) and the absence of commitment to volumes by the auto manufacturers, the variability of the latter, a reorientation of volumes towards electric vehicles, pressure on prices requiring strict stock management, the near impossibility of double sourcing due in particular to the specificity of the products and the cost of a double source (the said sources incidentally having a 70% probability of employing the same subcontractor) in addition to circumstances external to the sector such as the increase in demand for IoT devices due to lockdown.

Above all, the argument appears to us to be contrary to the obligation of loyalty and good faith to which the parties are bound. It should be recalled that Article 1104 of the Civil Code provides that "Contracts must be negotiated, formed and performed in good faith", this provision being mandatory.

Indeed, if the situation were known and measures could be taken without going as far as "contractual solidarity", it could be argued, for example, that the auto manufacturer had a duty to alert their supplier before the crisis occurred or even to give them formal notice to take such measures; the full and complete performance of a contract is, in actual fact, the endeavour of both parties as it embodies the common interest of the parties.

Moreover, one need only refer to the decisions handed down since the beginning of the coronavirus crisis, for example on commercial leases, to note the central function that judges give to loyalty in the performance of contracts.

In practice, judges examine the behaviour of the parties: not only that of the debtor of the obligation but also that of the creditor. However, if the creditor has been intransigent or non-collaborative, the judge will refer the parties to negotiation via conciliation or mediation.

Therefore, assuming that force majeure is not accepted, it is reasonably conceivable that a manufacturer who is intransigent in requiring their equipment manufacturer to deliver and who charges penalties in the current circumstances would be sanctioned by a judge on the grounds of obligation of loyalty, if not in the field of prohibited competition practices.

On this last point, it should be noted that in order to justify penalties, some auto manufacturers refer to the provisions contained in their terms and conditions of purchase (TCP), which, however, are only effective with respect to suppliers if they have been accepted by the latter (art. 1119 of the Civil Code). However, it is not uncommon for a supplier to refuse to accept their client's TCPs. Furthermore, they may "accept" them under duress or in a context that does not make it possible to prove their free consent (e.g., obligatory acceptance via a portal to access a call for tenders), which makes it possible to challenge their application.

Once again, it should be recalled that the terms and conditions of sale (TCS) constitute the sole basis for commercial negotiations (Article L.441-1 of the Commercial Code) and that in the event of a discrepancy between terms and conditions invoked by either party, the incompatible clauses are unenforceable (Article 1119 of the Civil Code).

In conclusion, since the shortage of electronic components is caused (in the sense of adequate causality) by the decisions taken by the various countries in response to the coronavirus crisis, it appears to us to meet the criteria of force majeure. While the auto manufacturers have acknowledged that the COVID-19 crisis and the decisions taken by the different countries to counteract the public health crisis constituted force majeure, it would seem inconsistent to us that they now reject this qualification for the current world shortage, which is merely a consequence of the public health crisis.

It is obvious that the legal rules mentioned above apply to all operators, regardless of their level in the supply chain, and that consequently we believe that manufacturers can naturally claim a case of force majeure to justify the non-performance of their own obligations.

However, this position is only valid subject to recognition by a judge.

The same applies to the opposite position.

III. Recommendations

The recognition by a judge implies the introduction of a lawsuit and therefore a legal procedure, which requires all parties to spend time and money on them.

This is why we believe that the period we are going through should not lead the parties to "stick to their guns", however well-founded their arguments may be.

We believe that the period we are going through must be based on a shared willingness to perform the contract loyally and in good faith, leading to a joint search for solutions that preserve the interests of both parties.

In the current circumstances, it is the loyal execution of the contract - and not the application of penalties - that will ultimately enable the supply of parts to recommence and production to restart.

These exchanges should take place in the spirit of the Code of Performance and Good Practices (Code de Performance et de Bonnes Pratiques) relating to customer-supplier relations in the automobile manufacturing sector (CPBP) of 6 November 2020, signed under the auspices of the implementation of the Commitment Charter (Charte d'Engagement) on relations between customers and suppliers in the automobile sector, signed on 26 May 2020.

In view of the particular circumstances created by the COVID-19 crisis, and as part of the support plan set up by the Government to accompany the industry's companies in meeting the substantial challenges ahead, all the parties have in fact agreed on the need to reinforce relations between auto manufacturers, equipment manufacturers and suppliers.

At the aforementioned meeting of the crisis unit on the shortage of electronic components for the automotive industry, held on 10 February 2021, it was underlined that the players in the electronics sector require visibility and transparency from the players in the automobile sector.

Three-way meetings between component manufacturers, automakers and equipment manufacturers to provide regular updates, in particular on week-by-week delivery schedules, have been set up by certain players. This type of meeting allows for a good mutual exchange of information and greater transparency between these players. This is undoubtedly a good practice to follow.

Article written with Charles Aronica, Managing Director of FIEV.

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