Contract Rights in a Declining Market :

The decrease in market price of an item was the cause of a dispute involving an electronic contract manufacturer (ECM) that supplied the subassemblies to a first-tier military contractor. The ECM purchased the components from a distributor of electronic components for a contract it had received on a major satellite project.

After receiving the subcontract on the satellite project, the ECM sent out bids on a number of components. The distributor was awarded a contract to supply integrated circuits (ICs) and other items on an "as needed" basis. In essence, the ECM agreed to buy all of the ICs needed during the contract period from the distributor.

After nine months, the distributor noticed that the quantities of ICs had dropped dramatically. An email was sent to the supply manager indicating that hardly any ICs had been purchased during the previous six weeks. The supply manager's email reply was that "a competitor is supplying us ICs to the same specification at less than half of the price you charged us. If you can meet the price, fine. Otherwise, we no longer need ICs from your firm." In her reply, the distributor agreed that new technology and lower demand had triggered lower market prices. However, the ECM had agreed to purchase all the ICs at a higher price earlier in the year. Subsequent meetings failed to produce a satisfactory agreement, and the parties agreed to binding arbitration.

In its arguments to the arbitrator, the ECM contended that the contract merely represented its agreement to purchase as few or as many ICs as it desired and that the distributor was obligated to supply the ICs as needed. Because the ECM was well stocked with ICs from the distributor's competitor, it did not require additional ICs. The distributor argued that the ECM was committed to buying all ICs from it at the agreed-upon price. Any purchases from an outside source violated the spirit and terms of the contract.

Arbitrators Ruling The arbitrator ruled that a mere price drop was not a reason to circumvent the terms of the contract. First, the contract was voluntarily made by competent parties. There was no indication of undue pressure, nor any party made to accept the terms. Thus, the contract was not "unconscionable." Second, a needs contract should be given its literal interpretation. In this case, the ECM must purchase any ICs it needs from the distributor named in the contract. Clearly, it needed the ICs it purchased from the competitor. It is unfortunate for the buyer that the market price for the ICs dropped. However, if the price had risen, the distributor would have had to furnish the ICs at the lower price. These are hazards of the marketplace that are faced by both buyers and sellers. The ECM was directed to purchase the entire quantity of the ICs it had contracted for from the distributor and all future requirements needed over the remainder of the contract period.

Questions:

1. What lessons are learned from the example of contracting presented in this reading?

2. Are there any reasons not to follow the contract agreed upon with a supplier or customer?