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Manufacturer’s Corner: Apple’s Master Course on Master Supply Agreements

This post comes to you based on a story by the always-excellent Matt Levine of BloombergView.  Evidently Apple loaned a company called GT Advanced Technologies a bunch of money so GTAT could develop and supply Apple with sapphire screens for a long time.  Anyway, there may have been a default under part of that agreement, and GTAT filed for bankruptcy protection because that default was going to ruin everything (at least according to industry speculation).

Levine’s story focuses on GTAT’s bondholders, but he mentions in passing that “GTAT’s contract with Apple is, by most reasonable standards, terrible.”  And he’s absolutely right and absolutely wrong at the same time.  The contract is superb, so long as you’re looking at it from Apple’s perspective, which of course is not at all what Levine was talking about, but it’s what I want to talk about.

There are really two contracts here.[1]  There’s the prepayment agreement by which Apple agreed to give GTAT lots of money in some installments, and GTAT would return those payments by invoice credits or cash, subject to a lump-sum payment provision that required full repayment sometime in 2020.  The other contract is the master development and supply agreement itself, which is what we’re really going to focus on here.

It’s fairly likely I will be using parts of the MDSA as jumping-off points for future posts, but let’s look at it in generalities.  Notice how clear it is on what the parties are to do.  Do you see the word “reasonable” in that contract?  It shows up a few times, but only where it really needs to be there.[2]  It doesn’t say things like “GTAT will use reasonable efforts to meet Apple’s supply requirements.”  No, it says will do everything it can to meet the requirements and, if there are supply constraints, the constrained resources get allocated to Apple before being allocated to anyone else.  This, my friends, is how you draft a supply agreement when you have big bargaining power.

The contract hits pretty much every point you want to see.  Inspection of the goods?  The mechanics are there.  Return of defective goods?  Yes, including applicable shipping terms.  Warranties?  Of course.[3]  Consequences of a recall?  You bet.  Built-in provisions for modifications and flexibility?  All there.  Audit rights?  Sure, why not!

Really the remaining question is whether Apple took the appropriate precautions to protect itself against GTAT’s insolvency.  Obviously, we’ll have an answer to that in a while as the bankruptcy proceedings play out.  But let’s take a look at what Apple did.

First, in the event of GTAT’s supply default, Apple granted itself a license to use any of GTAT’s intellectual property, whether owned or licensed, that could possibly be germane to manufacturing consumer goods incorporating the “Sapphire Technology” (whatever that means, it’s defined, but not in anything I have access to).  So in other words, if GTAT fails to perform, Apple can perform itself.[4]

Second, Apple took a security interest in what appears to be pretty much everything GTAT owns.  In fact, the prepayment agreement mandated that GTAT demonstrate that liens held by Bank of America were released, so it looks like Apple took appropriate steps to ensure its security interest was first in line.  And I can’t quite tell from the public filings, but I think Apple’s ability to take control of GTAT’s equipment, coupled with its right to use GTAT’s IP, perfects Apple’s ability to perform the contract itself if GTAT breaches.

Third, (I think) it required GTAT to hold the pre-payments in a bankruptcy-remote limited liability company.  The pre-payment agreement isn’t clear on this point (though other documents may be), but it looks like maybe the pre-payments would first be received by GTAT itself.  This may leave Apple with some exposure to GTAT’s bankruptcy if the transfers hadn’t been made, but I just don’t know if that’s the case.  Also, it’s kind of hard to do bankruptcy remote entities effectively these days, but I’m sure they figured that out.  The idea is good in concept.

Fourth, Apple allowed itself the right to recoup, both in the pre-payment agreement and in the MDSA.  That’s important, because while a creditor may not use post-petition debts owed to it to set off against a debtor’s pre-petition debts to that creditor, the creditor may use recoupment to reach that goal.  Further, recoupment doesn’t violate the automatic stay in bankruptcy, but set-off would.  The difference between recoupment and set-off is, well, we’ll say it’s hazy sometimes.  But that’s beside the point here.  I’m not sure where exactly Apple and GTAT are under this agreement in terms of performance, but this could be a key protection.

Fifth, Apple included a personal services clause in the MDSA, and limited GTAT’s ability to assign the contract.  Now, I’m not so sure that will be enforced, but it had to be done if Apple wanted to have any chance at protecting itself from assumption and assignment of the contract in case of GTAT’s bankruptcy.  Personally, I would have added language explaining why GTAT’s performance, and nobody else’s, would be acceptable.  That said, reading the MDSA, you’re kind of left wondering who else could possibly perform this contract, so maybe that won’t be an issue.[5]

And that concludes this love letter to Apple and its lawyers.  Manufacturers: you will be well-served by directing this MDSA to your counsel (inside or outside) and asking them whether your supply agreements look this good.  And do it on both sides – there’s stuff in there that should never appear in your contract if you are the supplier and you have even a modicum of bargaining power.  I know I will be continuing to review it for new lessons.

[1] The links provided here are to redacted versions of the agreements filed with the SEC.  My sympathy to the poor associate lawyer tasked with redaction duties.

[2] Almost.  It provides that Apple will give reasonable notice of recoupment or setoff if required by applicable law.  Fair enough, but I think Apple had the bargaining power to say X days or months is agreed to be reasonable.

[3] GTAT didn’t disclaim its implied warranties, which regular readers know I’m always going on about.  I’m giving GTAT a pass here.  I’m sure it would have disclaimed the warranties if it could, but its counterparty had a whole lot of leverage.

[4] I have no idea whether this is enforceable in bankruptcy, but I love it.  Incidentally, I guess Apple decided not to perform itself, and instead ordered different screens from its old supplier.

[5] Though I guess Apple’s retention of the right to use GTAT’s IP suggest at least that Apple could do the job.  That provision is probably geared more towards the development part of the Master Development and Supply Agreement.