In today's uncertain times, companies across the supply chain are trying to find ways to regain their edge and hedge against risks. Most contracts between Original Equipment Manufacturers (OEMs) and their supply bases already contain buyer-friendly terms that incorporate by reference the OEM's standard terms and conditions of purchase. Those terms contain broad warranty provisions that, among other things, require the parts to meet all specifications, be free from defect, conform to all laws, be merchantable, and be fit for the intended purpose. These provisions are intended to protect an OEM in the event that there is a warranty issue, warranty campaign, or recall such that the OEM can turn to the supplier to recover damages if the OEM can show that the supplier failed to meet one of the requirements in the broad warranty provision.

In an effort to increase their bottom line, OEMs are now aggressively passing down costs to suppliers by requiring suppliers to agree to pay a portion of "ordinary warranty charges." Ordinary warranty can refer to any dealer repair that does not rise to the level of a warranty campaign or recall. To recover for ordinary warranty, the OEM does not need to show that the supplier's part was defective or that it failed to meet an express warranty. Instead, the OEM's policy may just provide a formula for assessing ordinary warranty charges against its supply base, regardless of fault.

Although many OEMs have had ordinary warranty policies in place for years, through supplier handbooks or separate ordinary warranty contracts OEMs now are advising their supply base that they will be strictly enforcing these policies. Suppliers should be prepared to analyze these charges, negotiate limitations or clarifications to the policy and how it will be applied, and avoid associated pitfalls since these costs can accumulate quickly. In addition, the anticipated total ordinary costs for the life of the program that the supplier may incur need to be taken into account when providing a quotation for new business.

What is an Ordinary Warranty Agreement?

"Ordinary warranty" is the phrase used to describe standard one-off warranty claims of customers that do not rise to the level of necessitating a warranty campaign or recall. Typically, ordinary warranty agreements are found in the OEM's supplier manual or a standalone ordinary warranty contract that covers all parts/programs, and they describe a predesignated split of costs associated with ordinary warranty claims. Depending on the agreement and the parties' relative bargaining strength, there may be a flat percentage split of any ordinary warranty claims implicating the part sold — whether by dealer code or description — or there may be a sample of parts analyzed for failure to obtain a percentage of fault attributable to the supplier, which is then extrapolated across the universe of failed parts and future failures.

With warranty campaigns and recalls, if an OEM seeks to impose charges on a supplier, they must be able to tie the defect to a breach by the supplier; there needs to be some nexus to the supplier's warranty obligations. This is not the case under standard ordinary warranty agreement language. Ordinary warranty agreements exist outside the realm of "cause" or "fault" and instead impose obligations that are tantamount to strict liability. Payments related to ordinary warranty claims are expected to be made without a detailed root cause investigation or determination.

What Key Changes Should Suppliers Watch For?

In the past, even though many OEMs had policies in place that allowed them to pass down ordinary warranty costs to suppliers, OEMs would largely undertake the financial responsibility for these damages. In the wake of the backlash of COVID-19 and global supply chain disruptions, OEMs seeking ways to increase cash flow are starting to be more consistent and aggressive in pushing down ordinary warranty costs to suppliers. OEMs are demanding that suppliers split or completely cover ordinary warranty costs. OEMs also are requiring suppliers to provide replacement parts free –of charge and sticking suppliers with costs associated with expedited shipping and freight to dealers.

Issues with Ordinary Warranty Charges

There are numerous issues surrounding ordinary warranty charges. The most obvious issue is that there is no requirement that the warranty issue be definitively tied to the supplier's part defect or breach. Under many ordinary warranty agreements where a "strict liability" standard is implicated, for the supplier to foot the bill it can be enough for a dealer simply to log a code implicating the supplier's part or for a very small sample of parts to show failures without necessarily establishing the cause of those failures (usually analyzed solely by the OEM). Having to bear these ordinary warranty charges certainly will drive up costs for suppliers and drive down profitability.

Suppliers preparing to navigate ordinary warranty agreements and charges should consider the following:

  • First, as mentioned above, there may be no root cause analysis undertaken before ordinary warranty charges are passed on to suppliers. This means that the OEM may seek to hold the supplier responsible for the warranty claim even if there is no clear tie to any breach by the supplier or defect in the supplier's part, and sometimes even if it is not confirmed that the issue is with the part that the supplier provided to the OEM.
  • Second, ordinary warranty agreements do not often include provisions that prohibit the OEM from recovering charges against more than one supplier. Presumably, if an ordinary warranty claim implicates multiple parts or an assembly, then the OEM could attempt to recover costs against each supplier involved, leading to potential double-recovery for the same warranty charge. The supplier should be able to access data ensuring that assembly-level failures are properly allocated or that there is some analysis applied to ascertain the responsible supplier.
  • Third, if there is a sampling of failed parts or a cursory analysis undertaken by the OEM as part of its ordinary warranty process, then the supplier should ask to be involved and/or conduct its own analysis of a sample of failed parts. It would be best to negotiate this requirement into the ordinary warranty agreement.
  • Fourth, warranty codes used by dealers may have accuracy issues. Often, one code is used to cover multiple warranty issues, making it difficult to differentiate the cause of the problem without a full-blown root cause investigation. Dealers also often rely upon "NTF" or "No Trouble Found" codes, meaning that the customer's issue could not be replicated or duplicated. Despite this, the supplier still is expected to incur the costs of the ordinary warranty charge unless there is an explicit exception in the ordinary warranty agreement for NTF codes.
  • Fifth, ensure that your team understands and is comfortable with the OEM's ordinary warranty process, including the ability to identify errors in charges, the timing and mechanism for objecting to such charges, what charges may be included, and the process used to identify the supplier's share of ordinary warranty costs.
  • Sixth, these costs need to be taken into account for all future parts/programs going forward. They should be part of a supplier's cost walk since the OEMs now have indicated that they are shifting these risks and costs to their supply base.

Takeaways

Suppliers must be ready in the event that OEMs try to impose new ordinary warranty agreements or enforce agreements already in place. This can result in unexpected financial liabilities, including costs for repair, replacement parts, labor (at rates set by the dealer network), shipping, and handling. Now is the time to revisit your OEM contracts and supplier manuals to ensure you know the terms of any ordinary warranty agreement already in place, and be prepared for OEMs to enforce those terms or impose new terms.

Suppliers should negotiate with OEMs to ensure that any ordinary warranty charges imposed on the supplier are directly tied to the supplier's parts. Suppliers also should negotiate a provision prohibiting OEMs from recovering the same ordinary warranty costs from more than one supplier, effectively preventing the OEM from "double-dipping" and recovering from multiple suppliers for the same warranty charge. Suppliers should demand that OEMs provide underlying warranty details and dealer warranty code information. While it may not be possible to conduct root cause investigations for all ordinary warranty charges, having this information will allow suppliers to recognize patterns and push back on charges if something seems amiss. Finally, suppliers should take these costs into account when preparing their quotations for new parts/programs since these policies shift costs that previously were borne by OEMs to the supply base.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.