The Five Keys for Reducing Your Contract Manufacturing Risks

I wrote the below way back in 2006, but today a client told me that he still sends it to people in his company to make sure they are doing the right things with their contract manufacturing, and he wanted to be sure it was still current. Turns out it is, which is why I’m re-running it today, with a few small changes. In particular, the risks set out below are still the top risks in manufacturing internationally and the sorts of operational risks in manufacturing our international manufacturing lawyers see all the time.

The most salient change I’ve made to it is to change the instructions from just China to all international contract manufacturing. I’ve done this for obvious reasons, made even more obvious because I am in the midst of an email discussion with a client (that we will be moving to the telephone next week, discussing the pros and cons of manufacturing in China/Turkey/Cambodia/Thailand/Taiwan/Vietnam/Ukraine/India/Mexico. The point being that company’s are diversifying their contract manufacturing and our revised “five keys” reflet this.

Many small and medium sized companies that engage in international OEM manufacturing/outsourcing fail to take the steps necessary to protect themselves. When problems arise, they can do little or nothing to protect themselves because they have no legal basis for protection. The fact is that most outsourcing disputes must be resolved in the country where you are doing your manufacturing (this is particularly true of Asia, less so of Latin America and Europe). Those countries that are racing to capture some of the manufacturing leaving China are — for the most part — also racing to improve their legal sytems to better capture the manufacturing.

The following five basic steps will greatly reduce your problems with your overseas manufacturers, while improving your chances of recovering damages from them should any problems arise.

  • Create and properly register your intellectual property rights in your home country. If you do not have a firm basis for your IP rights in your home country. Protect your brand identity by creating and registering your trademark, slogan and logo with the relevant Patent and Trademark Offices. Register your important copyrights with the relevant Copyright Office. Carefully identify and protect your trade secrets, proprietary information and know how.  All of this will help prevent copies from the country in which you are manufacturing from entering into your home country.
  • In most countries, it also is necessary for you to register your trademarks in the country in which you are manufacturing. Registration can protect your future access to the market in that country, prevent the export of counterfeit goods from that country, and, most importantly, prevent a competitor from registering your brand name as their own trademark in that country and then use that trademark to prevent you from exporting your own product from that country.
  • Use a written agreement to protect your know-how and trade secrets. Small and medium sized companies usually do not have an extensive portfolio of patents. Their most valuable intangible assets typically are oftentimes their know-how and trade secrets, which usually cannot be protected by formal registration. In most countries it is relatively easy to contractually protect your company’s know how and trade secrets by using an NNN contract or by using NNN provisions in some other sort of contract, such as a manufacturing contract. Such agreements /provisions may also address issues such as non-competition and confidentiality. Without such a written agreement, virtually no such protection is available in most countries.
  • Product Quality and Payment Terms. The rule here is simple. If possible, do not make final payment to your manufacturer until you are confident you will be getting an on time shipment of the correct items and quantities at the quality standards you require. This usually means you must incur overseas inspection costs and provide for a clear procedure for dealing with these problems as they arise. You must take the lead on this. You cannot depend on your OEM manufacturer to do this for you.
  • Use comprehensive, country-specific Manufacturing Agreements with each manufacturer. Small and medium sized businesses often enter into OEM manufacturing transactions with a simple purchase order. This is almost always a mistake. Purchase orders usually protect the manufacturer, not you. Your protection depends on your securing a written OEM manufacturing contract with each of your manufacturers. The ideal manufacturing agreement will address all of the issues discussed above, while also addressing other basic legal issues such as jurisdiction and dispute resolution. This agreement typically should be in both English (or the language of your home country) and the language of the country in which your manufacturer is located. It should be clear which is the official language of the contract and that language should usually correspond with where any disputes arising from the contract will be tried. In other words, you do not want a contract with Thai as its official language and your lawsuit in Alicante, Spain.

Above all else, remember that if you are outsourcing your product manufacturing to a foreign country you are in effect doing business in that country and you need to adjust accordingly.

All of this was true 16 years ago and all of this is true today.

What are you seeing out there?