Once you have designed your product and have developed a plan to protect your intellectual property, you’ll still need to get your product manufactured so that you can sell it. This post addresses issues/questions to consider in negotiating a manufacturing and supply agreement (“Supply Agreement” for short).
Dovetail with Distribution Requirements
At the outset, if possible, you should consider your obligations under any distribution agreements you have in place when negotiating the Supply Agreement. The supplier’s obligations under the Supply Agreement should be consistent with your obligations under any distribution agreement. For example, if you have an obligation to deliver product to your distributor 45 days after the distributor places an order, your Supply Agreement should give you ample time for the supplier to deliver the product.
Price and Payment Terms. In addition to setting out pricing for the product, the Supply Agreement should specify whether the price of the product includes:
- all costs and expenses relating to packing, crating, boxing, transporting, loading and unloading, customs, taxes, tariffs and duties,
- insurance and any other similar financial contributions or obligations relating to the production, manufacture, sale and delivery of the product.
The Supply Agreement should specify the payment terms and any discounts that you are entitled to, such as discounts based on the quantity of the product purchased or for early payment of invoices. In addition, the Supply Agreement should contemplate how/when the price of the product may be increased or decreased (e.g., if the cost of raw materials significantly increases or decreases).
Production. The Supply Agreement should address how the product is ordered, and the supplier’s requirements to manufacture the product. Will you have to submit forecasts to ensure a timely production schedule? As mentioned above, consider how the production schedule, if any, complies with any distribution agreement obligations you may have. Consider including penalties for the manufacturer’s failure to deliver the product in accordance with an agreed to delivery schedule. Also consider whether or not the supplier needs a license to your intellectual property in order to supply the product.
Exclusivity. An exclusivity provision means that either (i) you will purchase all of your product from one supplier, or (ii) supplier will only supply the product to you (note that if the supplier is supplying a unique product (and you do not own the intellectual property to the product), there may be restrictions including such a provision). An exclusivity provision may provide you with certain benefits (e.g., price discounts or protection from the supplier supplying product to a competitor), but can also pose problems if the supplier is unable to meet production schedules. If the Supply Agreement contains exclusivity provisions for supplying the product, ensure that there are protections built in if the supplier cannot meet the production schedule or manufactures defective products, or be sure that you can have the product manufactured elsewhere if the supplier is not able to meet demand for your products or the products do not meet your quality standards. Consider that the supplier should be liable for any increased costs associated with contracting with a third-party supplier if such alternative supplier becomes necessary.
Delivery. When negotiating the delivery of the product, consider which party is paying for the shipping of the product. Paying for shipping the product can significantly increase the cost of the product. Also, consider when title of the product transfers from the supplier to you. In particular, consider which party owns the product while it is in transit and which party will bear the risk of loss during transit.
Term and Termination. When determining the term of the Supply Agreement, consider how long it might take you to find a replacement supplier and whether you will receive any benefits from a long-term relationship with the supplier. Do you want the Supply Agreement to renew automatically or should it require an affirmative action on the part of one or both of the parties? Consider the circumstances under which each party can terminate the Supply Agreement. How much notice will you need prior to termination of the Supply Agreement by the supplier. Also consider how the supplier’s rights to terminate affect your ability to meet your commitments to distribute the product.
Quality. Quality provisions cover a variety of issues, including inspection, acceptance and rejection of the product, recalls and returns, and warranties. Any contractual obligations that you may have under a distribution agreement or to an end-customer with respect to quality should flow through to the supplier. The quality provisions should incorporate any legal requirements related to the manufacture of the product.
While this post gives you some general concepts to consider, each Supply Agreement is different, and careful consideration should be given to each provision.