This post is a continuation of my prior post discussing forced labor issues in U.S. solar supply agreements. If you would like a basic primer of the issues, please check out that first post.
As an update, there are reports estimating that 3 GW of modules bound for the U.S. are presently detained by U.S. Customs (CBP) (see also Bloomberg, also citing the 3 GW estimate from Roth Capital). We don’t know the exact numbers for sure due to the confidentiality of importation proceedings – but I think the broader point still stands that this is presently the critical near-term issue.
In this post, I want to discuss how forced labor concerns are playing out in present negotiations for new module supply agreements. Among the biggest conceptual issues under negotiation are the following:
Which party bears the risk of schedule delay if modules are detained by CBP
Which party bears the cost of delay if modules are detained by CBP (e.g., bonded warehouse storage costs)
What happens if delays at the border are extended in duration
Compliance with law (present and future regulations and implementation)
Third-party traceability audit requests
Requests by buyers for vendors to turn over traceability documents
One important point I want to make about the below discussion is that it remains to be seen where many transactions will actually sign. While negotiations are currently active, I think many parties are still trying to figure out these issues as well as others: the potential for a court challenge to the tariff waiver executive order (discussed a bit here), and the implications of the passage of the Inflation Reduction Act, including domestic content incentives (i.e., the ITC bonus for domestic content, impact of solar manufacturing subsidies, etc.).
CBP Detainment/Schedule Delay Risk
Currently most new supply agreements under negotiation have clauses that suspend the guaranteed delivery dates in the event of a CBP detainment of the modules. In other words, buyers seem poised to have to bear some or most schedule delay risk, akin to when a force majeure occurs. That said, I think in almost all circumstances, there is a clause for termination in the event the detainment drags on too long, and for the buyer to receive their money back for undelivered modules (also akin to an extended force majeure). How heavily this point is negotiated seems to depend in part on specific project delivery needs.
CBP Detainment/Cost Risk
If modules are detained by CBP, there are very high logistics costs of storing the modules in a bonded warehouse at port of entry. This is likely why there are reports of module vendors not presently shipping to the U.S. at all right now – they are likely trying to figure out if they have sufficient documentation before they ship in the first instance rather than face higher storage costs at the border during a CBP detention.
This remains an open and highly variable point in supply agreement negotiations.
Legal Compliance
Another high-level concept to be covered in a supply agreement by both sides is what I’ll call the “legal compliance” contract clause. Buyers obviously want the vendor to “comply with all applicable laws,” and obviously as part of that, comply with the Uyghur Forced Labor Prevention Act (UFLPA).
The thorny issue here, however, is that further regulations and implementation orders could be issued by CBP as part of the UFLPA that are not in existence today/when any particular module supply agreement gets signed. In other words, the UFLPA should not necessarily be thought of just as one discrete law. The UFLPA carries with it the possibility of future additional implementing regulatory changes and CBP directives. This is an important fact that I think many buyers (and even some vendors) do not fully appreciate.
As such, most vendors are essentially taking the view that, “we can comply with what we know today, but not the unknown tomorrow.” Therefore, a point of negotiation is what happens if new regulations or CBP orders issue. The negotiation about this issue will hopefully get easier once most major vendors fully crack the code about what precise documentation CBP will require for module entry. But for now, and probably for at least the coming few months of module supply agreement negotiations, this is still an unknown.
Third-Party Traceability Audits
Some buyers want to have a third-party auditor review the vendor’s traceability processes and systems. Ultimately, for reasons I discuss below, I think this is where the industry will increasingly land. Last year, many Tier 1 vendors were heavily resistant to third-party traceability audits. However, in the past half year or so, resistance to this concept has softened in some corners, and third parties have conducted traceability reviews of at least a few Tier 1 vendors.
The scope of these audits is still negotiated – most module vendors are not completely vertically integrated, and so they can’t necessarily volunteer their sub-suppliers to an unrestricted supply chain audit that would be obviously desired by buyers.
Third-Party Traceability Requests
In module supply agreement contract negotiations, many buyers want the vendor to turn over the relevant traceability documents for the particular modules they’ve ordered. At one level, this request is rational and understandable – the best way to determine if the module vendor is going to get the buyer’s modules through CBP is by having that vendor actually show that they could do so, by providing the very traceability documents to the buyer that the module vendor would have to provide to CBP anyway, in the event of a CBP audit/detainment.
Unfortunately, it’s more complicated. First, many module vendors cannot just turn over confidential records of their sub-suppliers to a module buyer. Non-disclosure agreements typically allow for a party to turn over documents to the government upon request (i.e., for a vendor to provide documents to CBP upon CBP order, into a confidential CBP inquiry) but turning records over to a private third party is another matter. Even if a module vendor was amenable to this type of request of a buyer, the vendor’s sup-suppliers don’t want to turn over any more than they absolutely have to, and only to the people (i.e., CBP) who truly need to see it.
Second, the traceability documents for even a few containers of modules can run into the thousands of pages. Thus, for larger utility-scale orders, the traceability documents could easily be well into hundreds of thousands of pages. I don’t know of any module vendors who are presently able or willing to perform essentially a costly litigation discovery for every buyer, for every order, and turn over these documents to a buyer, just because the buyer wants to see them to make the buyer comfortable.
So, while I think it is presently infeasible for a buyer to request that the vendor turn over all traceability documents to the buyer upon buyer’s request – obviously the vendor needs the ability to be able to produce such documents to CBP upon the request of CBP.
That’s the catch. I think that is where third-party traceability auditors could come in – PI Berlin, CEA, STS, etc. A third-party auditor could audit the vendor’s systems and processes generally, to help a buyer get comfortable answering the question: “can this vendor produce needed documents if requested by CBP?” without requiring the vendor to go through the whole process for an actual order in the absence of an actual request by CBP for such order.
To be clear, however, these audits are not an iron-clad guaranty of a favorable import outcome – the regulations and requirements could change, and if there is indeed a Nostradamus out there who can discern completely what CBP will require in the future – module vendors would be hiring that person right now to get their presently-detained modules in the door. But an audit could provide the buyer a much higher level of comfort/diligence on where the vendor stands with respect to their traceability systems generally, which allows the buyer more accurate information to assess risk probabilities.
Therefore, in current module supply agreement negotiations, I think it is important for both parties to distinguish the concepts of:
(i) having a third-party auditor (e.g., PI Berlin, CEA) audit a vendor’s systems generally;
(ii) having a third-party auditor audit the exact documents required for the particular modules to be delivered under the supply agreement; and
(iii) having the vendor provide to buyer the actual traceability documents for the particular modules to be delivered under the supply agreement.
Presently, it is far easier for (i) to occur than for (ii) and/or (iii) to occur. However, even with (i), the parties need to allow time to negotiate a mutually-agreed audit scope.
We can cover more details in later posts, but to conclude this one, a few thoughts:
Thoughts for Buyers
First, be wary of FOB (overseas port) or CIF (U.S. port) Incoterms, or any other Incoterms that require you to be importer of record. If you agree to such Incoterms, the nightmare scenario is that the vendor “delivers” the modules to you overseas, but your modules get detained by CBP, and you cannot get the modules into the country. But because the modules were delivered in accordance with those Incoterms, you now must pay for modules that you now own but can’t actually bring into the United States. There is a lot more to be said about these Incoterms presently, but I just want to highlight one big example risk.
These Incoterms are not impossible to do, but if you don’t hit the bullseye in how you handle it, your supply agreement may not be financeable, and you could be in a really difficult position if you contracted with the wrong module vendor.
I also worry that, as a practical matter, there is a moral hazard here: FOB (overseas) or CIF terms could incentivize some vendors to throw their least-traceable modules at you as the buyer, if you, as the buyer, must bear all risk of detainment/failure to successfully import. I personally think that some vendors would not do this, but some would. So even if you cannot presently get all desired contract terms around forced labor issues, think about how the combination of terms in the supply agreement can help align vendor incentives properly – or not.
Second, the above-discussed contract terms obviously matter, but diligence matters, too: understand where the vendor is getting their polysilicon, where ingots/wafers/cells/module assembly will occur. Can the vendor’s commercial team talk intelligently on UFLPA issues? Do they have U.S. trade counsel? Who? If they can’t speak at a very detailed level on these issues, it’s a concern.
Third, given the issues surrounding tariffs, forced labor issues, and now domestic manufacturing/ITC incentives, if you are a large buyer you should know where all five of the “big 5” manufacturing steps occur for the modules that you plan to order: polysilicon, ingots, wafers, cells, and final module assembly. What country is listed as the “made in X” on the module product label is not relevant to these critical issues. The industry is in a state where deeper granularity of supply chain understanding is required than ever before.
Thoughts for Vendors
First, the issue of forced labor documentation can be thought of as an onerous hurdle, but also as a potential competitive advantage to those who figure it out quickly. This issue presents both risk but also tremendous opportunity to sell modules at a premium that also give buyers high comfort of the absence of forced labor, and also that such fact can be proven to CBP upon importation, so that the modules are timely delivered. Some vendors will figure out the documentation and traceability issues more quickly than others. The vendors who figure it out more quickly could profit immensely in the next year or two. This is an area of product differentiation. Undoubtedly there will be (and already is) price premium for the premium product.
Second, perhaps in conjunction with third-party auditors, consider pro-actively producing a traceability report on any particular modules, akin to a bankability report. Pretty much every large, sophisticated buyer is asking the same questions and negotiating the same issues, so the more that you streamline this process going forward, the easier it will be to transact. A traceability report would be useful for forced labor issues, but we will soon see if it may also be needed for proving the percentage of domestic content so that buyers can use it towards the ITC bonus under the Inflation Reduction Act. Traceability and the source of manufacturing for modules is now a core part of the solar module product itself for the U.S. market.
Len Conapinski is a partner at DuFour Conapinski Ha LLP. Please note that all views here are my own personal thoughts, are not intended to be taken as legal advice, and are not reflective of the views of my law firm colleagues, or our firm as an organization, or any client of our firm.