(b) International manufacture agreement
Main idea: The following section presents the ITC Model Contract that provides a framework for a so-called international contract manufacture agreement. It is only a general framework and must be tailored to specific circumstances. The ITC Model Contract provides a series or “menu” of possibilities depending on the background and the nature of the production. Many provisions may not be relevant to a particular contract and should of course, if not relevant, be deleted.
Manufacturing vs. long-term supply. The setup and outline of the manufacturing ITC Model Contract differ from the ITC Model international long-term supply agreement. Although the two ITC Model Contracts are very similar, in the long-term supply agreement the emphasis is on improvement of the product supply chain: ordering, forecasting, quality assurance, adjustability of specifications and (some) flexibility of pricing. Furthermore, the long-term supply agreement can be used for non-manufacturing related purposes, as well. In the ITC Model international contract manufacture agreement, the emphasis is on design and on improvement of the manufactured product and the manufacturing process. Both contracts enable the client to integrate the delivered goods into its own final products or services.
Manufacturing services vs. supply (sales). The legal characterisation of a manufacturing agreement requires an assessment: does it entail a sale or supply of goods, or is it effectively the provision of a service? Most manufacturing contracts are a mixture of both. When the manufacturer is primarily the party responsible for acquiring raw materials and components, and is also responsible for the adequate quality (‘conformity’) of those raw materials or components, then the manufacturer assumes the risks and obligations of a seller/supplier. However, if the customer procures those raw materials and components, and requires from the manufacturer only its ‘manufacturing trick’, manufacturing can be considered a service. Some legal systems recognise that a manufacturing agreement may have a mixed character, leading to a differentiated approach regarding each party’s rights and obligations.
Unless otherwise specified or agreed, the distinction between manufacturing as sales/supply vs. manufacturing as a service can be made as follows:
| Manufacturing as a service | Manufacturing as a sale |
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Toll manufacturing. In practice, a manufacturing services arrangement (i.e. where the service element predominates) is sometimes also referred to as ‘toll manufacturing’. Although ‘tolling’ is a term of art in several industries, across industries there is no common understanding as to what this term actually means.
Interchangeability of contract clauses. Despite the different focus, mentioned above, in the long-term supply agreement (ordering, lead-time and logistics optimisation) as compared to the manufacturing agreement (joint product or production process improvement with emphasis on IP rights), several contract clauses are interchangeable between the two models. The following ITC model international long-term supply agreement clauses can be copy-pasted into the ITC Model international contract manufacture agreement:
- ordering and forecasting (Article 2):
- order acceptance
- changes to orders
- flexible Incoterm choice
- import/export clearance
- price flexibility and volume discounts (Articles 3.2.2 to 3.4).
The following ITC Model international distribution of goods contract clauses can be copy-pasted into the ITC Model international contract manufacture agreement:[1]
- exclusive, sole or non-excusive appointment restricting the use of certain developed technology (or the supply of certain manufactured goods) to a:
- territory
- market segment
- training and support (Article 8)
- retention of title (§ 4 of Schedule 4)
Goods on loan. Many manufacturing agreements require specialised equipment or tooling to be used during the manufacturing process. The ITC Model Contract provides for the case that such equipment or tooling is made available by the client to the manufacturer. Obviously, in such cases, the client will require a higher level of skill and care as regards the treatment of its equipment or tooling. This possibility of ‘goods on loan’ is provided for in Article 1.5.
Provision of know-how – responsibility for technology level. The Model Contract provides for a basic scheme founded on the assumption that the manufacturer is fully equipped and has the technology to produce conforming goods, in its position as most specialized party. But the Model Contract also provides optionally for cases where the client has to transfer parts of its own technology to the manufacturer to enable it to finalize the products (Article 1.4).
Samples and models. In addition, the Model agreement covers the optional situation where the parties have agreed that the manufacturer shall submit samples before (mass) production is launched (Article 1.6).
Quality assurance. The desired level of quality for the goods produced by the manufacturer is ascertained in several ways. First, the manufacturer must warrant that the goods comply with the warranties stipulated in Article 4.1 of the ITC Model Contract (compliance to the written specifications of Schedule 1; free from defects in design, workmanship and materials; and compliance with applicable laws and regulations) during a warranty period to be agreed under 4.1.2. Second, the client is given the right to audit the premises of the manufacturer, its permitted subcontractors and its storage warehouses (see Article 4.3). Third, the manufacturer undertakes to indemnify the client against third-party claims (see Article 4.4).
Intellectual property aspects. Articles 1.4, 5 and 6 of the ITC Model Contract deal with issues related to intellectual property. It is assumed that the relevant intellectual property rights are properly protected by appropriate registration. Moreover, Article 9 imposes a duty of confidentiality upon both parties, which should provide additional protection, in particular if know-how is communicated by one party to the other. It is best to verify that the regime for improvements set out in Article 6 is acceptable in view of any applicable competition (‘antitrust’) law.
As mentioned above, if the contract triggers or involves the creation or divulgence of any intellectual property rights or know-how, it is strongly recommended that this be addressed in the contract. By default, intellectual property rights are owned by the creating party, in cases involving manufacturing, this will often be the manufacturer. If the creation was partly or entirely paid for by the other party (the client), a reallocation of ownership or the grant of a licence is necessary.
Cooperation on improvements. Especially in long-term relationships (such as manufacturing contracts) the parties will evaluate each other’s performance on a regular basis – depending on the type of goods: annually, quarterly or monthly. The evaluation includes the improvement of the goods (i.e. a product roadmap) and the efficiency or effectiveness of the manufacturing process. In the ITC Model Contract, Article 6.4 provides that (IP rights in) further improvements will be owned by the client. This is because, most often, such improvements will be driven by the efforts of the client. Also, when a client sources its goods from various manufacturers worldwide, all the manufacturers benefit from improvements achieved by any manufacturers engaged by their client.
Duration. For manufacturing, the parties may establish a contract of long duration. The effect may be that each party must take into account the other party’s reasonable interests. Furthermore, a party cannot freely terminate a contract of long duration without an appropriate termination notice period, especially if the terminated party has made client-specific investments in its equipment and production installations, and the terminating party was aware of these client-specific investments. In such cases, the client can be liable for compensating (the remaining economic value of) the investments. It is therefore important to establish the duration of the agreement (see Article 7.1). Another common option (not addressed in the Model Contract) could be to give the contract a specific term with subsequent renewal requiring mutual agreement. Note, however, that if the manufacturer or the client has a dominant market position, this kind of automatic extension may not in the aggregate exceed five years.
[1] But the term Supplier must be changed to “Manufacturer”; and the term Distributor to “Client”.