Home Contract Manufacturing agreements decoded : insider tips for successful contracts

Manufacturing agreements decoded : insider tips for successful contracts

July 28, 2024

This article has been written by Mickhita Bansal pursuing a Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution from LawSikho. This article explains what a manufacturing agreement is, the kinds of manufacturing contracts, the essentials of a valid contract and the prerequisites for a successful manufacturing agreement, the legal framework in India, the pros and cons of the agreement, and recent trends in contract manufacturing agreements.

This article has been published by Shashwat Kaushik.

Table of Contents

What is a manufacturing contract

A contract manufacturing agreement is an agreement between two parties (the manufacturing company and the contract manufacturer) where the manufacturing company entrusts the other party to meet the same standards as if the product were manufactured by the company itself. Certain standards are being set by the company as a pre-condition for a contract to work efficiently. These include:

Quality of the product
Quantity of the product
Details about the clients, service providers, and suppliers
Delivery terms
Purchase orders

The contract manufacturing agreement helps a contract manufacturer save time, energy and money by not making any design for the product but rather entering into an agreement with the brand and focusing on meeting the standards set by the company. This agreement helps both parties in some way. Example: The Apple brand enters into a manufacturing agreement with, say, XYZ company to sell the product in some other country but it will retain its ownership rights.

Kinds of contract manufacturing agreement

Private label manufacturing

This is the most preferred contract by the contract manufacturers, as it involves the delivery of the product as specified by the manufacturer company. It delivers a finished product as the design, quality, and marketing are all mentioned in the agreement.

End to end manufacturing

This is quite similar to private label manufacturing, as in this agreement all the specifications are mentioned but it differs in the context where the contract manufacturer has to focus highly on the quality of the product.

Individual component manufacturing

This type of agreement is where the manufacturing company needs specialised products but it is a very complex process as it involves more than 1 contract manufacturer. It involves the skills of different contract manufacturers, as the different parts will be manufactured by different people and then gathered together at the same place to consolidate them.

Labour or service subcontracting

This agreement is similar to individual component contracting, as many parties are involved. When the contractor manufacturer is unable to produce the whole of the product on its own, it hires certain small-scale industries to have certain parts of the product manufactured by them.

Essentials of a valid contract

A contract, as defined in Section 2(e) of the Indian Contract Act, 1872, is a legally enforceable agreement between two or more parties. Several crucial components must be present for a contract to be considered legally binding:

Offer: The initial proposal or promise made by one party to the other party outlining the terms and conditions of the agreement. The offer must be clear, specific, and communicated to the other party.
Acceptance by the parties: The other party’s unequivocal consent to the terms and conditions of the offer. Acceptance can be expressed through words, conduct, or a combination of both. It must be communicated to the party making the offer within a reasonable time frame.
Consideration: The exchange of something of value between the parties involved in the contract. Consideration can be in the form of money, goods, services, or a promise of future performance. It is essential for the formation of a legally binding contract.
Intention to create legal relationship: Both parties must have the mutual intention to enter into a legally binding contract. This intention can be inferred from the parties’ words, conduct, and the surrounding circumstances.
3C’s (Certainty, Commitment, and Communication):
- Certainty: The terms of the contract should be clear, precise, and unambiguous. Vague or uncertain terms may render the contract unenforceable.
- Commitment: Both parties must be committed to fulfilling their obligations as outlined in the contract.
- Communication: The terms of the contract must be communicated effectively between the parties. Miscommunication or misunderstandings can lead to disputes.

The presence of these five elements is essential for a contract to be legally binding and enforceable in a court of law. Without these elements, the agreement may not be considered a valid contract and may not be legally enforceable.

In addition to these, there are other essential conditions defined under section 10 of The Indian Contract Act, 1872:

Free consent of parties
Parties must be competent to contract
Lawful consideration and object
Not declared void by any law

Prerequisites for a successful contract manufacturing agreement

To make a contract legally binding, there are certain fundamentals to every contract manufacturing agreement. These are listed below;

Licencing agreement

A licencing agreement is an agreement between two parties (licensor and licensee) where the licensor allows the licensee to access his brand name to produce goods. But if a licensee goes beyond the allowed permissions, he can be sued at any time by the licensor. This agreement is very essential for a brand name that wants to allow a third party to have access to its trademarks.

Non-disclosure agreement (NDA)

It is also known as confidentiality agreement. It is a legal contract which outlines the confidential material or information that parties wish to disclose with each other but wish to restrict access to others. It is necessary when the contracts are entered into with my larger companies. Example: Pepsi’s production formula cannot be given access to the general public and hence whoever it enters into a contract with must sign a non-disclosure agreement.

Intellectual property rights

IPR is of utmost importance in manufacturing contracts. It focuses on specifying ownership so as to avoid infringement. It includes trademarks, copyrights, and patents. There must also be a specification regarding ownership of the new products being made in the process.

Quality assurance and inspection

As we know, the big brands have their own reputation and goodwill in society, which needs to be maintained by the contract manufacturer as well, and for this purpose, the manufacturing company must ascertain the quality of the product and the testing procedures on the product before its sale in the market.

Supply chain agreement

Supply chain agreements are essential documents that outline the terms and conditions of the relationship between the various parties involved in the manufacturing and distribution of a product. These agreements are designed to ensure that all parties are working together efficiently and effectively to deliver the product to the end customer in a timely and cost-effective manner.

One of the key elements of a supply chain agreement is the communication of expectations between the parties involved. This includes not only the manufacturer and the customer but also any other third parties who are involved in the packaging, management, and shipping of the products.

It is important to clearly define the roles and responsibilities of each party in the supply chain. This includes specifying who is responsible for the following:

Sourcing of materials and components
Manufacturing of the products
Packaging of the products
Management of inventory
Shipping of the products
Customer service

In addition to defining the roles and responsibilities of each party, the supply chain agreement should also include the following information:

The price of the products
The payment terms
The delivery terms
The warranty terms
The dispute resolution process

By clearly defining the expectations of all parties involved, a supply chain agreement can help to avoid misunderstandings and disputes. It can also help to improve communication and collaboration between the parties, which can lead to a more efficient and effective supply chain.

Pricing and payment terms

In every contract manufacturing agreement, there must be a specification of the pricing terms, i.e., the price of each manufactured product, the cost of the advertisement for sale, the cost of the raw material for manufacturing, and the salaries of every person involved in this process. It must also contain payment terms as to how much consideration is given to the contract and in what manner the payment will be made. There must also be a specification as to what currency must be used in the payment process and what will be the penalties for defaulting in payment.

Dispute resolution clause

In every contract, there must be a dispute resolution clause that states the resolution method (conciliation, mediation, arbitration, or court) to be used if any dispute arises between the parties and also the procedure that must be adopted for this process. The jurisdiction must also be mentioned when legal proceedings are adopted. Example: if A party is residing in Hyderabad and B in Mumbai, where will the parties go for legal proceedings?

Term and termination clause

In every contract, irrespective of its nature, there must be a term and termination clause. The term clause states when the contract will come to an end, the duration of the contract, and the renewal terms, if any. The termination clause means when and under what circumstances the contract will be terminated. The availability of remedies if the contract is terminated before the expected time.

Indemnity clause

The instances which will lead the defaulting party to indemnity must also be specified. Indemnity means loss caused by the non-defaulting party due to the occurrence of an act or omission by another party. The maximum amount for indemnification and the consequences of default must also be specified.

Besides these clauses, there are certain other clauses that are very important to be mentioned in a contract manufacturing agreement but that are similar to contracts too. Some of them are: Title, date of execution and effective date, details of parties, recitals, definitions and interpretation, obligations, consideration, mode of payment, representation and warranties, breach and consequences of breach, waiver, non-compete and non-solicit, assignment clause, severability. We will not be discussing these in this article as they are similar with respect to other contracts as well.

Legal framework in India

Though there is no specific mention of the manufacturing contract in any Indian law, its reference is contained in many laws. The laws that affect these contracts are:

The Indian Contract Act, 1872 serves as the cornerstone of contract law in India. Enacted on August 25, 1872, this Act provides a comprehensive framework for understanding the fundamental principles, elements, and enforceability of contracts.

Agreement vs. contract:
- An agreement refers to a broader concept involving a meeting of minds between two or more parties, resulting in a consensus on a particular matter.
- A contract, on the other hand, is a legally binding agreement that creates enforceable rights and obligations between the parties involved.
Definition of a contract:
- According to Section 2(h) of the Indian Contract Act, 1872, a contract is “an agreement enforceable by law.”
- This definition encompasses the essential elements of a contract: agreement, enforceability, and legal obligation.
Essential conditions for a valid contract:
- Offer and acceptance: A contract is formed when one party (the offeror) makes an offer to another party (the offeree), and the offeree accepts the offer unconditionally and without modifications.
- Consideration: Consideration refers to the price or value exchanged between the parties in return for the promises made in the contract. It must be of value and must not be illusory.
- Competency to contract: The parties entering into a contract must be legally competent to do so. This includes being of legal age, sound mind, and not under any legal disability.
- Free Consent: Consent to enter into a contract must be freely given and not obtained through coercion, undue influence, fraud, misrepresentation, or mistake.
Parties competent for a contract:
- Individuals: Natural persons who have attained the age of majority (18 years in India) and are of sound mind are competent to enter into contracts.
- Minors: Minors (individuals below the age of majority) generally lack the capacity to enter into legally binding contracts. However, certain exceptions exist, such as contracts for necessaries (basic necessities like food, clothing, and shelter) and contracts of employment.
- Persons of unsound mind: Individuals who are mentally unsound or have been declared legally incompetent by a court of law cannot enter into valid contracts.
- Corporations and other legal entities: Corporations, companies, and other legal entities can enter into contracts through their authorized representatives.

Customs Act, 1962

The Customs Act, 1962, is comprehensive legislation that governs the import and export of goods in India. It provides a framework for the assessment and collection of customs duties, as well as the regulation of various aspects of international trade.

The Act sets out the procedures for the clearance of goods through customs, including the documentation required, the examination of goods, and the assessment of customs duties. It also provides for the imposition of penalties for violations of the Act, such as smuggling and misdeclaration of goods.

The Customs Act, 1962, is administered by the Central Board of Indirect Taxes and Customs (CBIC), which is a department of the Ministry of Finance. The CBIC is responsible for formulating and implementing policies related to customs, as well as for the enforcement of the Customs Act.

The Act has been amended several times since its enactment in 1962, in order to keep up with changes in international trade and to address new challenges, such as the rise of e-commerce.

The Customs Act, 1962, is an important piece of legislation that plays a vital role in regulating international trade in India. It ensures that goods are imported and exported in accordance with the law and that customs duties are collected efficiently and effectively.

In addition to the provisions mentioned above, the Customs Act, 1962, also includes a number of other important features, such as:

The establishment of a Customs Tariff Commission, which is responsible for recommending changes to the customs tariff.
The creation of a Customs House Agents Association, which is a self-regulatory body for customs house agents.
The establishment of a Customs Appellate Tribunal, which hears appeals against decisions made by the customs authorities.
The Act also provides for the establishment of a Customs Intelligence Unit, which is responsible for investigating customs-related crimes, such as smuggling and counterfeiting.

The Customs Act, 1962, is a complex piece of legislation that has a significant impact on international trade in India. It is important for businesses and individuals involved in import and export to be familiar with the provisions of the Act in order to ensure compliance and avoid penalties.

The Specific Relief Act, 1963

The Specific Relief Act, 1963, is a crucial piece of legislation in India that governs the remedies available for breach of contract. It recognises two primary categories of remedies: specific relief and preventive relief.

Specific relief aims to enforce the precise terms of the contract as agreed upon by the parties. Under specific relief, the court may order specific performance of the contract. This means that the party who breached the contract must fulfil their obligations as outlined in the agreement. For instance, if a seller fails to deliver goods as promised, the court may order them to deliver those specific goods to the buyer.

Preventive relief, on the other hand, seeks to prevent a breach of contract or mitigate its consequences. The most common form of preventive relief is an injunction. An injunction is a court order that prohibits a party from doing or continuing to do something that would violate the terms of the contract. For example, if a buyer attempts to cancel a contract without justification, the court may issue an injunction restraining them from doing so.

In addition to specific performance and injunctions, the Specific Relief Act also provides for the remedy of rescission. Recission is the process of cancelling a contract and restoring the parties to their pre-contractual positions. This remedy is available when a breach of contract has occurred and the innocent party wishes to terminate the agreement.

The Specific Relief Act is a comprehensive law that provides a framework for resolving disputes arising from breaches of contract. It ensures that parties to a contract have legal recourse to protect their rights and interests in the event of a breach.

Pros and cons of contract manufacturing agreement

It saves various kinds of costs that businesses incur when they need to start their business from the start. Like the raw materials cost.
It saves the energy which is needed by any new product to form its design and introduce it to the market.
The need to involve more and more labour will decrease as the process will be automated by the brand itself to produce goods on a large scale.
Different expertise can be acquired by involving people from different fields. Once you have the idea of the product, different people with specialised skills can be involved to have knowledge regarding the process.
The product can be advertised and sold in a larger picture by involving companies from areas allocated at a distance from the manufacturing company.

When we discuss the benefits of the contract, there are certain drawbacks too, which cannot be avoided. Some of them are stated below:

Meanwhile the products are being manufactured by the contract manufacturer, there can be new inventions but the drawback is that ownership of this new customised product will be retained by the manufacturing company.
There is a risk in getting into these agreements, as there can be leakage if information is confidential to the manufacturer.
The control of the other party over the quality of the product is equal to zero.
The other party will always remain under the control of the manufacturing company and be bound by the rules and regulations framed by the company.
There can be some language barriers that will not affect the manufacturing company but the other party, as the company can sue it anytime for any breach of condition.

Recent trends in contract manufacturing agreement

Female Health Company v. Hll Lifecare Limited (High Court of Kerala, LAWS(KER)-2017-2-95)

The petitioner is a well registered company in UK and the respondent is the exclusive manufacturer, distributor and marketer in the prescribed area for FCI. On May 29, 2008, the parties entered into a manufacturing agreement for manufacturing FC2. The petitioner granted him the required trade licence for product manufacture but the issue arose when the respondent was actually manufacturing a natural rubber latex version of FC2 for which the petitioner asked for an interim injunction to restrain the respondent from manufacturing and distributing the product. The court dismissed the petitioner’s application stating that the respondent had been manufacturing and selling their products for over 4 years peacefully. Also, there was no satisfactory explanation as to whether the products manufactured were similar.

S.K. Jain v. State of Haryana, (2009) 4 SCC 357

In the landmark case of S.K. Jain vs. State of Haryana (2009), the Supreme Court of India grappled with the validity of contractual pre-deposit requirements in arbitration proceedings. At the heart of the dispute was the question of whether courts could alter or modify such contractual stipulations or whether their role was limited to interpreting them as written.

The appellant, S.K. Jain, entered into a contract with the state of Haryana for the construction of a bridge. The contract stipulated that any disputes arising from the agreement would be resolved through arbitration. However, it also contained a clause requiring the appellant to make a pre-deposit of a significant sum of money as a precondition for initiating arbitration.

Aggrieved by this provision, the appellant approached the court, arguing that the pre-deposit requirement was unfair, arbitrary, and contrary to the doctrine of fairness and public policy. He contended that such a condition would effectively deny him access to arbitration, a fundamental right guaranteed under Article 19(1)(g) of the Indian Constitution.

The Supreme Court carefully considered the appellant’s arguments and examined the nature of arbitration as a dispute resolution mechanism. It recognised that arbitration is a matter of contract and that parties are free to negotiate and agree upon the terms and conditions of their arbitration agreement, including the inclusion of pre-deposit requirements.

However, the court emphasised that the sanctity of contracts should not be used to perpetuate injustice or deprive parties of their fundamental rights. It held that while courts cannot rewrite or alter the terms of a contract, they have a duty to interpret the contract in a manner that upholds principles of fairness and justice.

In the present case, the court found that the pre-deposit condition was not inherently unfair or oppressive. It reasoned that the requirement aimed to ensure that frivolous or vexatious claims were not brought before the arbitral tribunal, thereby protecting the respondent from unnecessary litigation expenses and delays. Additionally, the court noted that the appellant had not demonstrated that he would be unable to comply with the pre-deposit requirement.

The court further observed that the doctrine of fairness, as relied upon by the appellant, was not an abstract principle that could be invoked to override the terms of a valid contract. Instead, fairness must be considered within the context of the specific factual matrix and the applicable legal principles.

Ultimately, the Supreme Court upheld the validity of the pre-deposit requirement, concluding that it did not violate the appellant’s fundamental rights or principles of public policy. The court’s decision underscored the importance of respecting the sanctity of contracts while ensuring that contractual provisions are interpreted and applied in a fair and just manner.

Griffon Laboratories Pvt. Ltd. v. Commissioner of Income Tax, Income Tax Appellate Tribunal (ITAT), 1978

The assessee is a well established pharmaceutical company. During the assessment proceedings, the assessee was treated as a manufacturing company and was taxed as per the taxing laws. The Tribunal stated that the assessee was not a manufacturing company and was just involved in the distribution and marketing of the products on the basis that the company did not possess any machinery for manufacturing the products. But the High Court of Calcutta stated that here the Tribunal made an error in making its decision and hence it was reversed against the assessee.

M/s Impact Metal Limited v. MSR India Ltd, (decision by the High Court in 2016)

The parties were in a contract manufacturing agreement where they shared their trade secrets, designs of the products and specifications. The issue arose when the first party alluded to the second party about infringement of intellectual property and misappropriation of trade secrets and whether this dispute could be referred to arbitral proceedings. The district court stated that when there is any intellectual property rights infringement, the dispute cannot be referred to arbitration for resolution. But the high court reversed its decision and held that when there is an arbitration clause in the agreement, then the dispute can be referred to arbitration.

Conclusion

It is always advisable to involve a legal practitioner while drafting a contract manufacturing agreement, as there are many conditions that common people cannot know and the legal practitioner can give practical knowledge about.