1. On the benefits of term sheets
International manufacturing term sheets save time and money. They help potential product buyers and product sellers figure out whether they are on the “same page” and whether they will ever get on the same page. They also reduce attorneys’ fees because drafting a contract when parties agree is invariably faster, easier and cheaper than drafting a contract before the terms are clear.
Our international manufacturing lawyers believe the best way for us to draft Manufacturing Agreements is for our clients to reach oral or “term sheet” agreements with their foreign manufacturers and then come back to us with the terms. We then draft the manufacturing agreement based on those terms (and many more) and our client then presents that draft agreement to its potential product supplier. At that point, the manufacturer/product supplier signs off on the agreement provided it, or additional negotiations ensue.
2. International manufacturing term sheets
A few weeks ago, a regular client of ours was looking to negotiate a manufacturing agreement with a new supplier in Thailand. This client sent us an email a before it was to meet with its soon-to-be-new manufacturer, listing out the following “deal points” and asked us what more they should get clear with their new factory:
- payment 50% by LC, 50% net 45
- tooling amortized over 30,000 [widgets], with remainder due after 3 years if 30,000 in widget purchases are not made.
- sales samples charged at 1.5x confirmed FOB pricing.
The client’s email noted the following still needed to be discussed:
- agreement and process in case of defective product;
- agreement in case of late shipment.
3. International manufacturing term sheet questions to ask
We responded by sending the below e-mail (modified to remove any possible identifiers) setting out a number of items our client should consider for its term sheet.
You do not need to answer all of the below questions for a term sheet, but now is a good time for you to start thinking about them. If you have any questions regarding the below — I expect that you will — please do not hesitate to reach back out to us before you go back to this potential supplier.
1. Identify the entity you will be paying; it may not be the factory itself but rather a holding company in Hong Kong/Singapore/Taiwan/etc. This sort of thing is very common in Asia. In general, unless this entity is acting as an import/export agent for the factory, the contract should be with the entity you are paying, and if things go south, your recourse will also be against that entity.
2. Think about more than just shipping terms. Think also about packaging terms, for each widget, and for each box, etc.
3. You should consider having an inspection clause. Quality control is extremely important. In an ideal world, you would inspect after delivery and before you pay anything, but few contracts are ideal. Think about when you want to inspect — probably both before and after delivery.
4. What will happen with any defective product? The inspection process is closely linked to what you do with defective product. The worst outcome for you would be for the factory to sell your defective widgets on the grey market. Do you want to witness the destruction of defective product? Or will a certification of destruction suffice? Do you want to require your supplier ship you the defective widgets so you can destroy them? Note that these days this can be incredibly expensive and with the price and cost of your widgets, I do not think it likely your supplier will agree to this. Something else? Also, think not just about when to inspect, but also what your inspection will consist of. Will you inspect every widget? A statistically significant number?
5. What will constitute “epidemic failure”? Five percent of a shipment? Three percent? One percent? What?
6. Think about warranty provisions, and how they will be implemented. How long will the warranty last? Who will pay for you shipping back the returns or will you want to require your supplier to take your word for it?
7. What about timing on shipments? Late shipments are obviously bad, but early shipments can be bad too, especially for seasonal items.
8. How and when will prices be determined? If the factory wants to change prices, how much notice must they give you? Are there built-in volume discounts?
9. What happens if you submit a purchase order and the factory doesn’t accept it? How long do they have to accept or reject a purchase order?
10. How much lead time must you give between a purchase order and the delivery date for that order?
11. Will you be selling the widgets all over the world? Will you be selling any in Thailand? Who will be responsible for figuring out all the export and import issues?
12. We are going to need to talk to you about all sorts of IP and even some potential IP licensing issues.
13. Will the factory be using subcontractors? Do you want to allow this? If so, do you want any requirements regarding choosing subcontractors?
14. Do you want to restrict the factory from working with and/or contacting any of your competitors? For just this one product or for all products?
For more on what goes into International Manufacturing Agreements, check out International Manufacturing Agreements and the Questions We Ask.