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Managing A Purchasing Crisis

Author(s):

Jeffrey J. Mayer Esq.
Jeffrey J. Mayer Esq., Raymond & Prokop P.C., (248) 357-3010, Southfield, MI 48086-5058, jmayer@raypro.com

86th Annual International Conference Proceedings - 2001 

Abstract. Purchasing professionals often find themselves deeply involved in a legal crisis, unaware that the crisis was already developing and that they lost opportunities to resolve the crisis short of legal action. This paper describes the analytical framework for avoiding such a crisis: (1) understanding and evaluating the contract, non-contractual obligation, and court process; (2) acting appropriately in response with the assistance of counsel; and (3) implementing preventative measures to avoid future crisis. The purchasing professional does not have to exercise legal judgment to avoid a crisis, but does have to recognize restricted activities, the importance of a timely response, and the value of ongoing improvements in the legal relationship between the purchasing and supplying company. This paper will be built around a case study, Cormorant Coatings, Inc. v Buchannan Spindles Worldwide, based on actual events. In this case, the failure to address the crisis turned routine business issues into a significant six-year legal action and a multi-million dollar verdict.

Report. Using actual documents from a purchasing crisis that ended up in a $500 million dollar claim and a multi-million dollar verdict, we will explain the Understand and Evaluate, Act, and Prevent ("UEAP") framework. The underlying facts, letters and documents in Cormorant v. Buchannan Spindles are the same as in the actual crisis. What is critically important to understand about this matter is that it is a crisis that did not inevitably have to happen and in fact, was both predictable and preventable. Additionally, using the same material, we will show how the purchasing professional can work in concert with legal counsel to produce better documents.

Summary of The Cormorant Coating v Buchannan Worldwide Case. Beginning in 1990, Cormorant Coatings coated metal parts for the Durham North Carolina facility of Buchannan Spindles Worldwide under a signed exclusive contract. See Contract #1. The contract, as a result of renewals, was scheduled to continue through 1996. Through the Cormorant contract, Buchannan granted Cormorant the exclusive right to coat its product. Cormorant was a small privately held North Carolina company; Buchannan, as its name implies, is a Worldwide conglomerate that treats the Durham plant as one of its internal suppliers. In light of the volume of parts provided by Buchannan, Cormorant systematically shed itself of other customers. When Cormorant signed the contract in 1990, the Durham facility was a poor performer often unable to keep its internal customers in the Buchannan organization satisfied. During the life of the contract, Cormorant performed poorly, contributing to the Durham plant's problems. From time to time, Cormorant did go the extra mile for Buchannan. Partially as a result of Cormorant's poor performance, but also as a result of Buchannan's own failings and expedited schedule, from time to time Buchannan obtained coating services from other suppliers. Buchannan also outsourced work colloquially called coating work, but properly called Slidosil coating, from other companies. Cormorant admittedly could not perform Slidosil coating, but wanted to do so as it perceived it as profitable. Buchannan also regularly paid Cormorant on a ninety-day schedule even though the contract required payment within a lesser time period. See Contract #1; see also Slide #22. The Durham plant did so because Buchannan Worldwide never paid in less than ninety days and assumed that Cormorant would never complain.

Beginning in 1993, Buchannan senior management decided that the Durham plant was in desperate need of improvement and put in new management determined to shake things up. Shortly thereafter, Buchannan tightened its rating services, and even though Cormorant had received relatively high ratings in the past its ratings plummeted. See Mock Memo #5; see also Mock Procedure #1. As a result of the poor ratings, Buchannan personnel regularly called Cormorant on the carpet and also imposed upon Cormorant various administrative charges for its services. At the same time, Cormorant was skipping a required step in the coating process that led to a potentially serious condition in parts known as fulminating crustation. Cormorant would later claim that Buchannan had requested that the extra-step be omitted for reasons of cost and convenience.

In 1994, as Buchannan systematically tightened its rating systems, Cormorant wrote a series of letters to Buchannan complaining that Buchannan was in breach of the contract because of arbitrary quality procedures and the charge backs. See, for example, Mock Letter #1. Cormorant demanded higher prices; Buchannan refused. Cormorant threatened to shut down Buchannan if it did not comply with its demands.

In the fall of 1994, out of caution, Buchannan began looking for alternate suppliers. Finally Cormorant invoked its right to terminate the contract. Buchannan did not protest, having lined up a new supplier, and Cormorant promptly went out of business. The new supplier charged Buchannan a huge amount and Buchannan, as a result, lost substantial monies because of the changeover. Cormorant subsequently claimed that it was put out of business because it threatened to blow the whistle on the fact that the parts it coated suffered from fulminating crustation.

It would seem, then, given that Cormorant's poor quality was documented in a rating system, that Buchannan lost money because of the change over, and because Cormorant terminated the contract, that Cormorant would not have much of a case. Nevertheless, Cormorant brought suit claiming: a) there were direct breaches including the fact that Buchannan always paid late; b) that it sent coating business to other companies; c) that it further lost profits because rather than completing the contract in 1996 it stopped functioning in 1994; and d) it was put out of business by Buchannan Spindles. Buchannan personnel thought the suit was a joke because Cormorant was a poor supplier who quit. In fact, Cormorant did obtain a substantial verdict.

Step One: Understand and Evaluate. The most basic level of understanding means: (1) reading the written contract and identifying restrictions; (2) understanding what lawyers call non-contractual obligations; and (3) understanding the court process.

Purchasing professionals cannot delegate the process of Understanding and Evaluating. Purchasing managers operate through consensual legal relationships -- that is contracts. Contracts are voluntarily assumed obligations. Purchasing professionals' actions also affect non-contractual obligations or legal obligations that exist quite apart from a contract. A non-contractual obligation might be a promise, it might be a slanderous word, it might be a production estimate. Purchasing professionals are constantly acting by ordering, by evaluating, by negotiating, by accommodating, and obviously many, many other ways. Each of these many actions has a legal significance. Because of these actions, purchasing professionals and lawyers are in an uneasy balance.

While purchasing professionals are acting within these relationships and potentially changing the relationships, lawyers are not present. And too often, purchasing professionals perceive lawyers as burdening their actions, or in the business of saying no and dragging down positive business relationships. At the same time, many purchasing professionals believe that lawyers will, after the fact, seek to fix blame for their actions if something goes wrong. And it certainly is true that purchasing professionals have a need to operate without checking with lawyers throughout the day. Not only would constant checking be cost prohibitive, but it simply would not allow for the swift and unending flow of business that their demanding profession requires.

Thus, for better or worse, the purchasing professional must identify pending legal issues. See Slide #3. Identification of legal issues is, however, not the same thing as resolution of that issue. Resolution is for your legal team, identification is for you.

Contract. Contracts form from words. See Slide #7. The words in a contract matter. It matters, for example, that Buchannan promised to pay Cormorant within 45 days and did not do so. Most importantly, the words in a contract operate as a restriction on your daily activities.

Permitted v Restricted. Permitted activities are those that your contract allows you to do in whatever quantity or fashion you deem fit. See Slide #4. Prominent examples would be ordering goods under these contracts, rating the performance of suppliers, or imposing specific remedies that are set forth in the contract. With regard to the Cormorant contract, for example, there is no specified limit on the amount of goods that can be ordered, there is no limitation on the right to enforce the quality provisions of the contract, there is no limitation on the right to rate the supplier, or the requirement that Cormorant provide all plating racks to this plant.

There are also some clear restrictions. See Slide #4. For example, the contract has a term. The contract has payment requirements. In order to have an adequate understanding of the contract, a purchasing professional does not have to be able to reach a conclusion about what the terms mean, but simply to understand that the length of the contract is something that is, in fact, restricted by the written agreement. Thus, it must be understood that any action that affects the term falls into the category of restricted activity.

Importantly, the contract may also be ambiguous. For example, the contract here does not say whether or not Buchannan can charge Cormorant an administrative fee for rejected parts. While purchasing professionals should not be in the business of evaluating ambiguous contract language, he or she should be in the business of identifying such language. If you do not know what it means, nobody will.

Non-Contractual Obligations. The purchasing professional also needs to understand the non-contractual obligations provided by law. Promises, even promises that are not in writing, can form the basis of a court action. Suppliers often create those obligations by using code words. I "trusted" you, you "promised" me, I "relied" upon you are all phrases that the purchasing professional needs to recognize and understand. For example, Cormorant writes Buchannan and said I pulled your "nuts out of the fire." This is a colorful phrase, but one that is also loaded with meaning because it shows that Cormorant has assisted Buchannan without being required to do so under a contract.

Court Process. Third, the purchasing manager needs to understand the court process. First of all, and this is not exaggeration, the process will pick you clean. E-mails, conversations, off-the-record communications, and your dirty laundry will come out. More importantly, the court process is not a pure truth-seeking function. Nor, however, is it a random function. Sometimes the court process works well, but you must have an understanding of how it works. Generally, oral unbiased testimony trumps oral biased testimony. That is, third-party testimony will trump yours, written record trumps oral conversations, contemporaneous written record trumps after-the-fact written record.

Further, the courts will not agree with you as to the relevancy of your records. For example, your carelessness in an unrelated matter may enter the court record as proof of operating problems.

Applying Those Concepts to Cormorant v Buchannan. What does this framework mean for the issues between Cormorant and Buchannan? To begin with, reading the contract demonstrates that Buchannan was engaged in numerous restricted activities. Again, as noted above, simply because activities are restricted, does not also mean the activities are improper. Nonetheless such restricted activities need to be evaluated with counsel. Counsel's analysis may be extraordinarily complicated. For example, even though the contract is exclusive, Buchannan is sending coating work to other companies. It is not easy to determine whether sending work to other companies is in fact a breach of the exclusivity provision. To the extent Cormorant cannot provide those services, or to the extend that Cormorant did not contemplate providing those services, the sending of coating work to other companies should not be actionable. However, some of the diversion was a result of Buchannan's own problems, and Buchannan's own desires for instant turnaround.

Other restrictions are easier to evaluate. Buchannan is chronically paying late and even though Cormorant does not complain, that is a breach of contract. A third set of activities is not directly addressed in the contract. Buchannan is for example, charging Cormorant for its poor quality. The contract neither permits nor forbids such chargebacks.

Finally, and most importantly, the term ends prior to the contemplated date of 1996. Thus, this too is a restricted activity even if Buchannan has done nothing wrong, indeed, even if it is Cormorant who ends the contract. Thus, the varied activities in this matter all required some type of action instead of business as usual.

Non-contractual Obligations. Cormorant also invokes the concept of non-contractual obligations. Its letters repeat the concept that Cormorant has gone the "extra mile" or that Buchannan has made promises that have yet to be fulfilled.

Court Process. Obviously, Buchannan engaged in various activities that are restricted under the contract. Just as importantly, Buchannan's viewpoint is unlikely to be presented favorably. Cormorant took the time to record its concerns in letters. Buchannan's viewpoint depends on oral recollections. For example, Cormorant will claim that Buchannan intended that Cormorant go out of business. In support, Cormorant will note that Buchannan secretly sought out alternative suppliers. Buchannan, of course, will state that Cormorant was already threatening to quit, but those threats are not in writing. Additionally, the Buchannan dirty laundry regarding fulminating crustation will come out. Cormorant will assert that Buchannan terminated the contract because Cormorant wanted to correct the fulminating crustation defect. While Buchannan can argue that Cormorant was involved as well, that argument will not rehabilitate Buchannan in the eyes of the jury and the judge.

Additionally, even though Cormorant was historically a poor performer, the rating system did not reflect this poor performance. Additionally, the late payments were something easily proved in court. The written record when companies appear in court is very straight forward. For years Cormorant received high ratings, and those ratings plummeted when it complained about late payments, diversion of coating business, and the issues relating to fulminating crustation.

Response: What should have been here to prevent the catastrophe for Buchannan and the years of litigation? For each of the restricted activities, Buchannan needed to determine an appropriate course of action in conjunction with its legal staff. With regard to each restricted activity, Buchannan must decide whether to correct the activity, to keep doing business as usual, to seek to create a record for use in court later, to negotiate a new arrangement, or even to proceed to court or some combination of these courses of action. See Slide #6. With regard to payment, for example, Buchannan should not continue to pay late. Such late payment is a direct violation of the contract. First, the Buchannan management should have responded in writing to any expression of concern.

With regard to exclusivity, Buchannan should have documented its need to use other suppliers. Buchannan had sound reasons for using other suppliers both because Cormorant was a poor performer and because some coating services, such as Slidosil, were beyond Cormorant=s capacity. Accordingly, Buchannan should have worked with its counsel to structure the proper use of suppliers. To the extent that Cormorant was unable to provide proper service, Buchannan should have provided notice in writing and proceeded to use alternate suppliers. For the Slidosil procedure, Buchannan should have obtained Cormorant=s acknowledgment that it was not interested in pursuing Slidosil as a product line. With regard to Buchannan=s own failings that prompted the use of other suppliers, Buchannan should have contemporaneously sough to negotiate a resolution with Cormorant. If Cormorant refused to negotiate, and demanded compensation, Buchannan would have been entitled to pay and also inform Cormorant that it was going to look for another supplier.

Prevention: The Buchannan contract may be improved in a variety of ways. Many of the protections normally found in a contract are absent. For example, this contract does not contain a limitation on available damages, a choice of venue provision, or even a right for Buchannan to terminate the contract in the event Cormorant refuses to perform. Many of those issues are matters that may be addressed by counsel in an exercise in legal training. I will leave those issues for a seminar on contract basics. However, the contract also may be improved by developing appropriate provisions relating to specific purchasing concerns.

In particular, the purchasing professional needs to outline for the individual drafting the contract the areas that should be without restriction or, alternatively, with the proper and well-understood restriction. With regard to the payment terms, for example, if the purchasing department knows that 45 days is impossible, the department should reject and contract providing for those terms. Additionally, if the purchasing department believes that it would be appropriate to provide for an administrative fee for poor parts, it should ask that such a provision be included. Consider also the issue of exclusivity. The attorney in charge of the contract may be unaware of all the different types of coating and whether or not an exclusive contract would commit Buchannan to a supplier with insufficient capabilities. Interaction between the purchasing department and those drafting the contract in this regard, may serve to prevent problems with contract compliance before they arise.

Conclusion: Buchannan's relationship with Cormorant was troubled from the start. Buchannan had multiple opportunities to heal or end the relationship at minimal cost. Even at the end, Cormorant demanded payment of $500,000 to end the contract. Buchannan did not even respond to that offer because it seemed outlandish. Yet, six years later, and having expended at least that much in legal and other expenses already, Buchannan faced a hostile jury. The purchasing professionals and other managers also found themselves mired in a lawsuit when they could have been out building their companies and careers.

The investment required to prevent the crisis was relatively minimal and should have been followed.


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