By UpCounsel Corporate Attorney Fiona Kaufman

What is a Manufacturing Agreement?

A manufacturing agreement is between a manufacturer and a customer for the manufacture of goods or products. Manufacturing agreements are very complex and typically involve in-depth negotiations. Unlike other types of agreements, there are many provisions specific to the ordering procedure (purchase order, reschedules, cancellations), material components (raw materials, excess & obsolete inventory), shipping (delivery and risk of loss) and recall and/or epidemic failure.

These terms, along with all the other provisions in a manufacturing agreement, make understanding the business deal, the products and the goals of the parties extremely important. Having a solid manufacturing agreement will delineate and define all the details of the manufacturing deal while minimizing risk, confusion and conflict.

What Are the Key Terms in a Manufacturing Agreement?

Product Specifications: A manufacturer needs to know what they are producing, and a customer should provide a clear and specific set of product specifications. Sometimes, this will be set forth in a statement of work.The product specifications should set forth what the product is, the use of the product and any specific rules or regulations that apply to the products.

Forecasts and Purchase Orders: Some of the key provisions in a manufacturing agreement center on forecasts and purchase orders. Before a manufacturer can begin to manufacture goods, they need to know how much they will be producing and when they will be producing it. Some things to consider when negotiating these terms are:

  • How are forecasts issued?
  • What period of time does the forecast cover?
  • Is the forecast binding or non-binding?
  • Does the forecast authorize the procurement of materials?
  • How are purchase orders issued, and how often?
  • What is the process of acceptance or rejection of a purchase order?
  • Can, and under what conditions, can a purchase order be cancelled or rejected?

Material Procurement and Liability: Once a manufacturer has a forecast and a purchase order, they typically will start procuring materials to start production. Sometimes a customer will provide a manufacturer with a build of materials, or BOM, and an approved vendor list, or AVL, to purchase parts and components. Questions to consider in drafting the agreement are:

  • How will materials or components be procured?
  • Have both parties reviewed and approved the AVL and BOM?
  • What materials have long-lead times and who is covering the liability?
  • Are there to be minimum order quantities, and what are the terms?
  • What will happen with non-cancelable or non-returnable materials and any custom parts?
  • What will happen to any excess or obsolete materials?

Product Packaging, Shipping, and Delivery: A manufacturing agreement will typically provide for how products are to be packaged, how they will be shipped and what constitutes delivery. In drafting an agreement, it’s important to consider the following:

  • What are the packaging requirements?
  • What are the shipping terms?
  • Who is responsible for title and risk of loss during shipment?
  • When are the products deemed ‘delivered’?
  • Are there any inspection and/or acceptance criteria? If so, what are they?

Product Pricing and Payment Terms: Like most commercial contracts, price of the products and payments terms should be covered. Pricing is determined by a variety of factors and should be mutually agreeable to the parties. Payment terms must be specified, along with any late payment terms or penalties.

Warranty: Warranties in manufacturing agreements can vary greatly. Some warrant that products will conform to product specifications for a set period of time, so provide a materials warranty (including a pass through warranty from the materials supplier). Some warrant that workmanship is professional and some provide all of the above and more. Some things to consider when drafting a warranty clause for a manufacturing agreement are:

  • Is there a product warranty? If so, what is it?
  • Is there a materials warranty. If so, what is it?
  • Do the warranties of merchantability and/or fitness for a particular purpose apply?
  • What warranties should be disclaimed?
  • What is the process for returning or replacing defective products?
  • What are the remedies for defective products?
  • What is the threshold for an epidemic failure, and what is the process when one occurs?

Intellectual Property and Confidentiality: Most manufacturing agreements cover intellectual property rights of the products and the manufacturing process(es) and how the disclosure of confidential information will be handled. Sometimes, the parties will opt to execute a separate non-disclosure agreement. Some key points to consider in either case are:

  • Does the agreement make clear who owns the products, and any Intellectual Property to the products? Who owns the manufacturing process(es)?
  • If development work or modifications are being made, delineate who owns the modifications and consider ‘work for hire’ language around developments and modifications.
  • Include what information is to be included in the definition of confidential information.
  • Specify what (if any) are the marking requirements of confidentiality and specify how long the information is to remain confidential.
  • Provide what information is to be excluded from the definition of confidential information.

Indemnification and Limitation of Liability: Most manufacturing agreements will have an indemnification clause. Indemnification, by definition, is an obligation by which one party engages to save another from a legal consequence of the conduct of one of the parties, or of some other person.

It is always important to evaluate an indemnification clause within a party’s scope of obligations. A limitation of liability clause is also very common in manufacturing agreements and will tend to strike a balance of acceptable risk for each party. Some things to consider are:

  • Are parties going to indemnify each other? And if so, under what circumstances?
  • Should the parties consider indemnification for breach of the agreement, willful or negligent acts or omissions and/or property damage or personal injury (including death)?
  • Should the parties consider indemnification for infringement of a third party’s intellectual property right(s)?
  • Should there be a negotiated monetary cap on a party’s overall liability?
  • What exclusions should there be from a party’s liability cap?

The Takeaway

In my experience, no two manufacturing deals are ever the same. Manufacturing is a complex business and master agreements are just as complex. It is important to understand the business and the agreement, as well as the business and legal consequences for all the terms negotiated.

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About the author

Fiona Kaufman

Fiona Kaufman

Fiona Newell Kaufman is an experienced Corporate Attorney with boutique practice showcasing extensive experience working in-house for Silicon Valley High Technology companies. As a solo practitioner, her goal is to provide high quality, value-oriented legal services to publicly-traded and privately held technology-based product and service companies. In offering a full-range of 'in-house' counsel services, her focus is to address your specific legal issues in a clear, affordable and flexible 'outside' counsel basis.

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