What You Need To Know about Manufacturing Contracts

If you have invented a product or you own the patents to a product and you are looking for a manufacturer, you will need a formal contract to protect you. But what should be in it?

Many businesses are looking overseas to China and other countries to lower their manufacturing costs and access specialist skills.

So if you are looking for a manufacturer, at home or abroad, here are some tips on what to include in your contract, often taking the form of a Licence to Manufacture. This can be more like a partnership between an inventor and manufacturer, or a simple ‘you make it, but I own it’ agreement.

Manufacturing contracts can vary quite a lot depending on the type of product, location of the factory etc., but there are a number of consideration that are common to most of these contracts.

Clearly, before you get to the stage of agreeing detailed terms, you will need to find the right company for your product and do some due diligence to satisfy yourself that the company can not only produce goods of an acceptable quality but also they can deliver the quantities you need within the right time frame.

You will also want to consider whether your manufacturer is simply going to make the goods and ship them to you, or whether he has the right to sell them as well – and if so, where?

The Licence

First of all, the main purpose of the contract will be set out. This will usually provide for the inventor or patent owner to give a licence to the manufacturer, the licensee, to manufacture the product.

The licence could be exclusive – i.e. the licensee is the only company with manufacturing rights – or non-exclusive.

Sometimes it may be exclusive but within a territory – e.g. the only factory authorised to produce the goods in China.

If your licensee wants the right to subcontract the work to others, you need to be careful, as the more the direct relationship is diluted, the more the risk of patent infringement.  However, if some part needs to be sourced from a specialist, a sublicence can make sense.  Just make sure the contract is clear that subcontracting does not relieve the licensee from his contractual obligations to you.

Duration

An arrangement such as this will generally need to be reasonably long-term, especially if there is a development phase before the product is ready for the market, as this could involve substantial time and expense on the part of the licensee.

So a term of 5 to 10 years could be appropriate, or even longer.

Development Support

Development of a new product is rarely a straightforward matter, so your input into the development is likely to be needed.  You may want a clause that limits the amount of free time that you give your licensee. Sometimes an inventor will get a consultancy fee for this work.

Pricing and Royalties

If the product has already been developed, and all you are looking for is a factory to produce the goods, then the contract can be straightforward and provide for payment against an agreed ex-works price list.

If, however, the manufacturer is going to bring your product up to an acceptable manufacturing standard at his expense and then have the right to sell the goods, you could be better off having a royalty arrangement.

This could include an up-front payment on signing the agreement, and then for the duration of the agreement, a royalty calculated as a percentage of the sales priceThis is likely to be the ex-works or wholesale price.

You might want to have the contract provide for a minimum royalty, so as to reduce the risk that the manufacturer reduces quantities in favour of some other product.

Record-Keeping and Payment

If you are buying the goods for resale, you will normally want to pay on delivery – so as to avoid the risk of paying for goods before you know they meet the specification.

If the manufacturing is overseas, the seller will want payment on shipment, so it can be useful to have your own agent in the country who can check the goods before shipment.  Insurance of goods in transit also needs to be covered, either by the supplier or the buyer.

When there are royalty payments and the manufacturer is also selling some or all of the products, it is usual to have royalties accounted for on a quarterly basis, with interest payable on late payment amounts.

And, whatever the payment terms, be sure to have a clause in the contract that gives you the right to access the Licensee’s accounts – so that you or your local agent can verify the production and sales figures – and, sometimes, the manufacturing costs as well.

Territory

In today’s global market, you need to agree in which countries the manufacturer can sell the products and whether he will have exclusive or non-exclusive access to those territories.

Intellectual Property Rights

It is essential to spell out who owns the designs and other IP rights in the product.  This will normally be the licensor, while the manufacturer as licensee has only the production rights.

As licensor you may be well advised to register your patents in the country of manufacture and anywhere else where the goods may be sold  And your licensee may be required to notify and support you if any third party is found to infringe your rights by producing or selling counterfeit goods.

Improvements

There is always a possibility that either party may want to make changes or improvements to the design and it is sensible to cover this in your contract:

1. by only allowing modifications that you have agreed to

2. by dealing with the ownership rights. A shared ownership is sometimes the right approach if your manufacturer has improved the product; this could also impact on the royalty arrangements.

Confidentiality

Clearly, this is an agreement where confidentiality is quite important and an appropriate clause should be included.

Termination

You need the right to bring the contract to an end if your licensee breaches the agreement or becomes insolvent.

You might also want to terminate if he fails to produce or sell enough products.

And the clause should set out what happens to goods that have already been manufactured when the contract comes to an end.  Do you get them or can he sell them?  A run-off period may be sensible.

Law & Disputes

If the licensor and manufacturer are in different countries, you need to get advice on how to get disputes resolved and which country’s law governs the contract.  A two or three stage dispute resolution process is often recommended– direct negotiation, then mediation (if agreed) and finally the courts or arbitration.

ContractStore has a number of contract templates for manufacturing contracts which you can find here: http://www.contractstore.com/goods-manufacture-supply

They include: