Once you have decided to outsource production of a component or your goods, the temptation is to ‘go for it’ and get your selected manufacturer to start making your product so you can get it to market. You may think an online manufacturing agreement will suffice. That approach builds up problems, potentially wiping out any savings made through outsourcing production and leading to contract disputes and reputational damage by association. In non-legalese, those are all ‘nasties’ that a bespoke, industry and company specific manufacturing agreement can help your business avoid.
In this article our commercial solicitors take a look at the importance of getting your manufacturing agreement right and to protect your business interests.
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Considerations before outsourcing production – will the manufacturer suit your business model?
Sometimes commercial decisions are hard. If you have spent a long time designing and developing a product you may want to see the product through from manufacture to market. However, with financial constraints, outsourcing production may be the only economic option or your preferred business model.
Once you have decided to outsource production, the next key step is to choose the manufacturer to suit your business model. After you have completed your due diligence on the third party, the final step is to formalise the relationship by entering into a manufacturing agreement that sets out your respective obligations and covers crucial matters, such as price, specification, warranties and production times.
Here are some of the initial key considerations when exploring a manufacturing agreement:
1. Scope of work
What are you outsourcing- is it the whole manufacturing process or a component part? Are the specifications clearly defined? If the manufacture is producing a component part are the turnaround times specified so delivery of the component doesn’t hold up your production? What happens if any industry specific regulations change requiring adaptations to the scope of the work?
Commercial solicitors emphasise that getting the scope of the work and the specifications right, and the ability to adapt the product to meet consumer demand or changing UK regulations, are the first points to consider when negotiating a manufacturing agreement.
2. Testing and quality
In any new or ongoing business relationship there are bound to be ups and downs but a manufacturing agreement should cover provision for testing and quality of the component part or finished product, both prior to the contract commencement and during it so quality is maintained. After all, if consumers find that the quality of some or all items is not up to an acceptable standard, it is your company brand and reputation that will suffer.
3. Ethical supply chain
Whether it is an IT product or an item of retail clothing, your brand can be brought down by your manufacturer or supply chain not following ethical practices. Whether it is the choice and sourcing of raw materials, the employment of workers in the UK who do not have the right to work, or workers who are being paid less than the minimum wage, all these practices and others could damage the reputation of your company, especially if you hold yourself out as an ethical and sustainable brand.
Whilst no company can totally eliminate ethical supply chain risks, if you are entering a manufacturing agreement you need to do your due diligence first, look at your manufacturer’s supply chain contracts and include carefully worded warranty, indemnity and termination clauses in the agreement.
4. IP
Prior to outsourcing manufacturing, you need to have taken steps to protect the intellectual property relating to the product or component parts or ensure that you have the right IP licences to enable the manufacturer to make the product.
Once the IP rights have been sorted out by you, it is vital that the manufacturing agreement contains an IP clause that acknowledges that your company has the exclusive ownership of the IP or, where applicable, a third party licensor has those rights and your company has the right to use them. It is important to double check any third party licensor requirements if you are outsourcing to a manufacturer as the third party may require additional safeguards.
When considering the IP and manufacturing agreements you need to consider issues, such as:
- Whether the manufacturer will have exclusive or non-exclusive use of your IP
- If you are going to give the manufacturer an indemnity if they are accused of IP infringement or passing off because of their manufacture of your product and the manufacturers obligations to your company if they are notified of a claim
- Whether the manufacturer has the right to use sub-contractors and the grant of sub-licences
- Who owns the IP rights if adaptions and improvements are made to the product during the course of the manufacturing agreement
- What happens to the IP on termination of the manufacturing agreement
5. Due diligence on potential suppliers
Due diligence is underrated. There is little point in due diligence once you are facing a consumer claim or reputational damage or a commercial contract dispute. It is therefore best to front load the work and carry out robust due diligence on potential suppliers.
Depending on the potential damage to your brand and your bargaining position, you may want to include provision in the manufacturing agreement that the manufacturer has to notify your company if they change supplier or has to warrant that any potential supplier will be a member of an industry specific regulatory body or association. Alternatively, you may want to consider a right to veto certain potential suppliers or, depending on if ethical sourcing is a key part of your brand, be able to refuse to accept source materials from suppliers in specified countries.
6. Location – barriers in language, interpretation, delivery times
The location of a manufacturer requires careful consideration because whilst distance may be the most cost effective option it may create barriers such as language, interpretation and supply chain delivery issues. This has to be balanced against the cost of UK or EU manufacturing. In some cases, the cost differential may outweigh the location risks or your business may be confident that the risk level is acceptable through its pre-contract due diligence, bespoke manufacturing agreement and inclusion of warranties, insurances and termination provisions.
Considerations that impact business operations – what could affect your day to day?
The daily operation of a manufacturing agreement needs working through so both parties understand what is required of them and expectations are met. That way the risk of commercial contract disputes is reduced.
1. How orders will be submitted, amended or cancelled?
Some manufacturing agreements are straightforward in that your business knows it wants to order 5,000 component parts each month. In other scenarios, consumer demand is unpredictable and subject to weather or other variables. Accordingly, many manufacturing agreements will include detailed provision for submission of orders on a monthly, or other periodic basis, with provision for amended orders or cancellation.
In any contractual relationship, it is important that the contract is managed so things don’t escalate from a minor issue into a dispute. It is also crucial that the wider picture is considered so, for example, IT or high street trends are factored in together with the manufacturer’s ability to adapt to your changing contractual needs. For more information on managing contracts take a look at our article Contract lifecycle management: what you should be doing.
2. Payment terms
Payment terms in manufacturing agreements are many and varied, depending on the outsourced product and sector. A product price may be set together with a minimum monthly order, with the product price dependant on the number of orders so parties can benefit from economies of scale or volume order discounts.
Payment terms and price can be set for the duration of the contract or capable of variation by way of price notice increase or price escalation clause. The payment terms in a manufacturing agreement need to be considered with the provisions in the termination clause so they work to your advantage. For example, if the manufacturer gives notice of a price increase can you terminate the contract early? If you are able to give notice, is the notice period sufficient for you to find another manufacturer and agree terms?
3. Minimum limits for insurance
An insurance policy is only as good as the detail so if the manufacturing agreement contains provision that the manufacturer will maintain public liability and product liability insurance cover, your business may want to specify the minimum level of insurance cover and ensure your interest is noted on the policy as well as having the right to see the renewal insurance certificate and confirmation that the premium has been paid. Likewise, if a manufacturer is subcontracting an element of the manufacturing process, you may want to include a term that the manufacturer requires any sub-contractors to maintain a minimum level of insurance cover.
4. Time period to notify of defects
It is standard practice to include provision for defective products and to include a time period to notify the manufacturer about obvious visual defects with provision for a notice of rejection to be given to the manufacturer and a requirement for replacement or reimbursement. Latent defects should be notified within a reasonable time frame. If notice of rejection is not given within the specified time frame for obvious defects, then the product will be deemed to have been accepted.
5. How will you evolve or expand the product range – would this require a new contract?
Every business needs to adapt, and depending on your sector, your products may need to be tweaked or to evolve every few months, annually or bi-annually. That’s why it is crucial that your manufacturing agreement looks ahead to allow for product range evolution or expansion through either allowing you to terminate the existing manufacturing agreement or by varying the specification provisions in the agreement. As well as product evolution needing to be considered when drawing up the contract, it also needs to be monitored as part of your lifecycle contract management process so your business continues to get the best out of its manufacturing agreement.
What should a manufacturing agreement include?
Every manufacturing agreement needs to comprehensively cover:
- IP licencing
- Non-disclosure agreements and confidentiality
- Warranties and liability
- Termination provisions
The needs of businesses will depend on the nature of their product and the sector or industry. That’s why many online manufacturing agreements are not actually fit for purpose as they don’t consider the manufacturing and contractual process from your perspective. For example, IP sub-licensing may be a particular headache with digital products. For example, the need for confidentiality may be essential for brand protection if you are upselling a basic manufactured product, produced for many other retailers, but your USP is your high end packaging or your household name and reputation for quality.
For more information on termination provision options and how they need to fit in with the contract provisions take a look at Can you terminate a commercial contract? | Termination clauses .
Tips for negotiating a manufacturing agreement
Negotiating a manufacturing agreement can mean the difference between company success or failure so it is something that should be given priority. Here are our commercial solicitors top tips for negotiating a manufacturing agreement:
- Be realistic and don’t expect too much – if you are a small start-up using an established manufacturer, or you are only ordering a small run of products, don’t expect a manufacturer to want to reinvent the wheel in negotiating your manufacturing agreement. Accept that you may have limited bargaining power if there are only a limited number of manufacturers with the specialist skills you need
- Look at the detail – that doesn’t just mean the product specification schedule but also delivery timeframes and penalties if deadlines are not met or the fine detail of payment escalation terms or when title to the product passes to your business
- Getting started - ensure your manufacturing agreement includes provision for product samples as a pre-condition of the contract and allows for factory inspection
- Think carefully about the reasons why you may want to disassociate your business from the manufacturer and ensure those points are covered in the termination clause
- Think big – orders can change and products can evolve so make sure the manufacturing agreement is flexible or keep the contract under tight review to make sure it remains fit for purpose
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