Once the pre-work is done —scoping the product's manufacturing needs, performing due diligence, and selecting a manufacturer (as outlined in Part 1)—it's time to memorialize the arrangement with an outsourced manufacturing agreement. Getting the terms of this contract right will help mitigate legal risk and safeguard your business continuity, intellectual property, and product quality.
Here are nine key provisions that may be helpful to consider when developing your outsourced manufacturing agreement:
1. Scope of Work, Specifications, and Standards
Besides playing a large part in the manufacturer selection process (see Part 1), these factors also help to form the foundation of the agreement by providing benchmarks that may be used to hold the manufacturer accountable if things go awry in the future:
- Detailed product specifications, packaging, labeling, and compliance requirements.
- Defined testing, quality control, acceptance, and rejection/rework procedures.
- Clear lead times, delivery windows, and supply schedules.
2. Intellectual Property Protection
In many outsourced manufacturing arrangements, customers share valuable intellectual property (IP) with the manufacturer. Thus, it is important that the commercial terms of the agreement aim to protect your company's IP, such as:
- Include terms that restrict the manufacturer from using your designs, inventions, trademarks, or trade secrets for any purpose other than their performance under the contract.
- Require the certified return or destruction of your IP assets upon contract termination.
- Include robust IP indemnification protections, and ensure that the limitation of liability clause and related disclaimers and governing law align so the indemnification will be enforceable.
- Consider adding a non-compete or non-circumvention provision to prevent your proprietary information from being used to compete against your company, whether directly by the manufacturer or through its other customers.
3. Confidentiality and Data Security
In the same vein, protections for confidential or sensitive information are also an important consideration. For example, the manufacturer might be required to:
- Implement "best in class" data security measures.
- Limit access to confidential data to only those within the manufacturer's organization who have a need to know that is directly related to the manufacturer's contractual obligations.
- Implement data breach notification protocols, ensuring that those align with applicable data-related regulations.
- Align with relevant data privacy regulations if personal data is shared (e.g., GDPR, CCPA).
4. Pricing and Payment Terms
A critical provision in any contract, clearly defined payment terms can help minimize the possibility of disputes down the road, such as:
- Outline the pricing structure (fixed vs. variable); if variable, define how such costs will be determined (e.g., based on production volume, raw materials, etc.).
- In a fixed price contract, specify if that price includes all taxes, import duties and tariffs.
- Establish payment timelines, invoicing procedures, and any penalties for late payment or delivery.
- Address currency fluctuations, tariffs, import duties and taxes for international deals.
5. Liability and Indemnification
Strong representations, warranties and covenants typically address issues such as workmanship; fitness for a particular purpose; compliance with applicable laws, industry standards, and good manufacturing practices; no IP infringement/good title; and acts, errors and omissions of employees and agents. Additionally, these provisions might address the following:
- Allocate liability for defects/non-conforming goods, recalls, delivery delays or other breaches of contract.
- The manufacturer could also be responsible for all related costs, including your incremental costs).
- The manufacturer typically indemnifies the customer in the event the manufacturer breaches its representations and warranties.
6. Termination and Exit Strategy
Having a clear exit strategy can help mitigate risks and
facilitate a smoother transition in the event the relationship
ends. For example, maintain relationships with backup vendors; and,
if feasible, consider using two manufacturers simultaneously (one
primary, one secondary) to hedge your supply needs in case of
unexpected issues, such as a change in the country of manufacture
due to tariff increases.
In the contract, consider outlining the conditions for
termination:
- Whether for cause (e.g., breach) or convenience (e.g., often allowed during short pilot periods); and
- Include appropriate notice periods, penalties, effect of termination and obligations upon exit (e.g., return all customer confidential information).
7. Compliance with Laws and Regulations
Many contracts also include clear expectations for manufacturers to:
- Comply with all applicable laws, regulations, including labor, environmental, export/import, and anti-corruption laws.
- Adhere to relevant industry-specific regulations and standards (e.g., FDA, FDCA, REACH, RoHS, ISO certifications).
8. Reporting and Transparency
It is not uncommon to require manufacturers to certify their ongoing compliance, agree to periodic audits, and provide additional obligations such as:
- Regular production updates, quality metrics, and shipping logs.
- Notice of delays, supply disruptions, or compliance issues.
- Minimum insurance coverage requirements for the duration of the contract
- Financial or insurance coverage certifications upon request.
9. Dispute Resolution
Including a dispute resolution mechanism, such as mediation or arbitration, tends to provide a more efficient means for addressing conflicts without resorting to litigation. Also, consider choosing a neutral jurisdiction or arbitration forum if you and the manufacturer are in different countries, as well as specifying the applicable governing law and venue for enforcement.
Conclusion
Well-structured outsourced manufacturing agreements minimize uncertainty, reduce risk, and protect your company's valuable assets. With consideration given to the above provisions, you are more likely to establish a solid foundation for a reliable, long-term manufacturing relationship that aligns with your business goals and mitigates risks. As always, it is recommended that you consult with a legal professional to tailor your agreement to the specific needs and circumstances of a proposed manufacturing arrangement.
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.
