Whether you are outsourcing production of a component, an entire product or a product range, you will need a bespoke manufacturing agreement. This will enable you to take full advantage of the savings available through outsourcing production and will help you to avoid costly contract disputes and reputational damage if things go wrong.
Your manufacturing agreement should cover business-critical issues such as:
- price, specification and production times
- provision of IT and equipment
- ownership of intellectual property (IP) rights, and
- warranties and indemnities.
In this article, our experienced commercial law solicitors explore why getting your manufacturing agreement right is critical. They can help you to put the right legal framework in place to safeguard your business at every stage of the production process.
Contents:
Considerations before outsourcing production
You have decided that outsourcing production is your preferred business model, and you have chosen the manufacturer you want to work with. Robust and thorough due diligence at the outset of your outsourcing project is essential to avoid consumer claims, reputational damage or a commercial contract dispute. Here are some key considerations for moving forward:
1. Scope of work
What are you outsourcing – the whole manufacturing process, or a component part? Are the specifications clearly defined? If the manufacturer is producing a component part, are the turnaround times specified, so that your production process isn’t delayed? What tooling, technology and equipment are being provided? Can the scope of the work be adapted if any industry-specific regulations change?
When negotiating your agreement, it is vital to:
- get the scope of the work and the specifications clear at the outset, and
- retain the flexibility to adapt the product or process during the contract – whether to keep pace with changes in your commercial environment, to meet consumer demand, or to comply with an evolving legal and regulatory landscape.
2. Testing and quality
Your agreement should cover the testing and quality of the manufactured product. Ask for product samples as a pre-condition of the contract and ensure that factory inspections are allowed during the contract term.
If product quality is unacceptable, your brand and reputation will suffer, so your agreement must include robust rights and remedies if the manufacturer delivers defective products. Additionally, it’s crucial to outline how to handle a product liability claim – clearly defining responsibilities, legal recourse, and insurance requirements in the event a defective product causes harm.
3. Supply chain risks
Your agreement should include obligations on the manufacturer to ensure the ethical manufacture of the products. Whether the product is an IT product or an item of retail clothing, your brand can be damaged if your manufacturer does not follow ethical practices. Factors like the choice and sourcing of raw materials, the employment of workers without the right to work in the UK, or workers who are paid less than the minimum wage, could tarnish your business reputation, especially if you market your business as an ethical and sustainable brand.
Whilst you cannot eliminate these risks, before entering into a manufacturing agreement you should:
- conduct due diligence
- examine your manufacturer’s supply chain contracts, and
- include appropriate warranty, indemnity and termination clauses in your agreement.
Read more about supply chain issues and managing risks in supply chain contracts in our article here. .
4. IP
Prior to outsourcing manufacturing, take steps to protect your IP rights in the product or component parts if you are the IP owner. If you aren’t, ensure that you have valid IP licences to enable the manufacturer to make the product.
The manufacturing agreement must clearly state that your business exclusively owns the IP or, where applicable, that a third party has licensed the IP to you. Check your licence terms, as the IP owner may require additional safeguards, and these will need to be reflected in your manufacturing agreement.
Factors to consider include:
- Whether the manufacturer will have exclusive or non-exclusive use of the IP
- Whether you will indemnify the manufacturer if they are accused of IP infringement or passing off because of their manufacture of your product
- The manufacturer’s obligations to you if they are notified of an IP claim
- Whether the manufacturer has the right to use sub-contractors, and how the grant of sub-licences will be dealt with
- Who owns the IP rights if changes are made to the product during the agreement
- What happens to the IP on termination.
5. Third party suppliers
Your manufacturer is likely to use third party suppliers (depending on your bargaining position, and the potential damage to your brand), so you may want to include the following in your contract:
- a requirement that the manufacturer must notify you if they change supplier
- a warranty from the manufacturer that any supplier will be a member of an industry-specific regulatory body or association
- a right to veto certain suppliers
- if ethical sourcing is important to your brand, a right to refuse materials sourced from suppliers in specified countries.
6. Location of manufacturer
The manufacturer’s location may create difficulties in relation to language barriers, choice of law, or practical issues around delivery timescales. These must be balanced against the cost of UK or EU manufacturing. In some cases, the cost differential may outweigh the location risks. Your business may be confident that the risk level is acceptable because of your due diligence process and robust manufacturing agreement, which includes the appropriate warranties, insurances and termination provisions.
Timing will be key to your manufacturing requirements. Consider what delivery timeframes you require (taking account of what is realistic if your manufacturer is overseas), and what penalties you will apply if deadlines are not met.
Make sure the contract states which country’s law is to apply, otherwise you could find yourself subject to the laws of a foreign country and forced to litigate through their courts if things go wrong.
What could affect your day-to-day business operations?
Give careful thought to the daily operation of your manufacturing arrangement, so that both parties understand what is required, and meet expectations. This will reduce the risk of commercial contract disputes.
1. Order process
Some manufacturing agreements are straightforward, for example you may know that you need to order 5,000 component parts each month. Alternatively, consumer demand may be unpredictable and subject to weather or other variables. To cater for this, many manufacturing agreements include detailed provisions for placing orders on a periodic basis, with flexibility for amended orders or cancellation.
Consider the bigger picture, so that, for example, IT or high street trends are factored in, together with the manufacturer’s capacity to be flexible. For information on managing contracts, see Contract lifecycle management: what you should be doing.
2. Payment terms
Payment terms vary greatly, depending on the product and sector. For example:
- a product price may be set together with a minimum monthly order, with the product price dependant on the number of orders, allowing parties to benefit from economies of scale or volume order discounts
- payment terms and price may be fixed for the duration of the contract, or
- they may be variable by a price increase notice, or price escalation clause.
Payment terms must be bespoke and need to be considered in line with your termination clause. For example, if the manufacturer gives notice of a price increase, can you terminate the contract early? If you give notice to terminate, is the notice period sufficient for you to find another manufacturer and agree terms?
3. Insurance
The manufacturer must maintain public liability and product liability insurance cover, and ideally your agreement should:
- specify the minimum level of insurance cover required
- ensure that your interest is noted on the policy, and
- allow you to see the insurance renewal certificate, and confirmation that the premium has been paid.
If the manufacturer subcontracts any element of the manufacturing process, they should also require their sub-contractors to maintain a minimum level of insurance cover.
4. Dealing with defects
You will need a contractual process for dealing with defective products. This should include:
- a timescale for you to notify the manufacturer about obvious visual defects,
- a notice of rejection procedure, and
- a requirement for replacement or reimbursement.
If notice of rejection for obvious defects is not given within the agreed time frame, the product will be deemed to have been accepted, so you need effective and timely quality control procedures. You also need to notify the manufacturer about latent defects within a reasonable time frame.
5. Product flexibility
Your products may need to be tweaked or to evolve periodically. Your manufacturing agreement should cater for this, either by allowing you to vary the specification provisions in the agreement, or to terminate.
You should also monitor product evolution as part of your lifecycle contract management process, so that your business continues to get the best out of its manufacturing agreement. See Contract lifecycle management: what you should be doing for more information.
6. Termination
Think about the reasons why you may want to end your arrangements with the manufacturer and ensure that these are covered in the termination clause. Consider the key factors that would justify ending the contract – such as ongoing quality issues, failure to meet deadlines, or breaches of key obligations – and build in terms that allow for a fair and practical exit.
Conclusion
Your manufacturing agreement should cover:
- Product manufacture – including detailed specifications, the supply of any necessary tooling, technology and equipment, and the licence of any IP needed to manufacture the product.
- Product supply – quality control, delivery, title, risk and payment.
- Risk management – limitation of liability, warranties and indemnities, insurance, termination and confidentiality.
- General – compliance with laws and regulations, dispute resolution, and the parties’ choice of law if your manufacturer is overseas.
This is not an exhaustive list, as the agreement must reflect the nature of the products, and the sector or industry you operate in. A bespoke agreement which is tailored to your business and its specific manufacturing requirements is therefore essential. Contact our expert commercial law solicitors today for advice on putting the right manufacturing contract in place to ensure your outsourcing is successful.
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