Contract Manufacturer Becomes Your Competitor

This article discusses the possible legal remedies when your Contract Manufacturer becomes your competitor. It is written by Vivek Chandar,  pursuing M.A. in business law from NUJS, Kolkata.

In present times to be competitive, most of the companies are shifting most of the manufacturing act ivies to vendors especially in the hird world. These Contract Manufacturers mostly are also manufacturing for your competitors. This helps in economies of scale and also motivates the contract manufacturer to invest in technology.

Contract manufacturing is basically outsourcing of part of the manufacturing process to a third-party. More specifically a Company outsources to a third party (Contract Manufacturer) certain production activities that were previously performed by the manufacturer. You may outsource the manufacture of certain components for the product or outsource the assembly of the product. Some Contract Manufacturers also design, produce, assemble and distribute, i.e they more or less cover the complete gamut of the business.

However there are disadvantages to this arrangement, some are;

  1. Your competitor may get to know your IP/technology edge /designs. Further you will have to share some of your IP with the Contract Manufacturer.
  2. The contract manufacturer may use your designs and IP and confidential information to make there own product and launch the same in market.

 

As both the above can lead to your losing the edge in the market. To protect your IP and competitive edge a multi-pronged strategy may need to be used.

  1. Protect IP by all available means — patents, design registrations, copyrights, Non Disclosure Agreements (NDA), etc, but these may not be enough.
  2. You need to look at the following aspect also
    • Chose the right partner. Choosing a fly by wire contract manufacturer who has not much to lose, may be more inclined to steal the IP, etc. that a well entrenched contract Manufacturer.
    • Continuously review what needs to be protected i.e.  What others want that is unique to you? Is it your technology, or customers or the brand to protect IP.
    • Structural protections as a minimum are critical.
    • What key activities that the OEM would like to perform by itself, rather than handover these to the Contract Manufacturer. These may include R&D, marketing, after sales service, key technologies or key components.
    • What kind of arrangement should be with the manufacturer Contractor. Will it be JV, a long term Contract and licensing IP to the Contractor, etc.

Once the strategy is finalized you need to finalize the Contract and also as indicated above register IP including  patents in the country the Contract Manufacturer is based. IP and patent registrations will avoid the Contact Manufacturer and others to use your name/logo and designs.

The one thing Company certainly needs to do is to register your trademark in Country of the Contract Manufacturer. Before you use any of your trade names (think brands/ logos or product names) or trademarks in that Country, you must register them or someone else almost will and then you will not be able to use your name, even if all you are doing is exporting your product from that Country. Thus Registration of patents, logos, etc. is very important.

One should not opt for Purchase orders to a well constructed Contract. A Purchase order does not have all the clauses to protect you from IP infringements or non-use.

Depending on he type of work /services that are required to be performed by the Contract Manufacturer, you need to frame the Agreement/Contract. For example if you are going to work with a manufacturer to develop a new product, you need a specific product development agreement. These should be drafted to ensure that ownership rights of the final product are whose is clearly spelt out.

The Contract should also contain the following clauses/ definitions clearly (wording would differ case to case):

  • Confidential Information: This needs to be clear and precise. A sample definition, etc.

Confidential Information” means all data and information whether in written, machine readable or other tangible form, or obtained by recipient through observation or examination of such information and material or disclosed orally, that is of value to the disclosing Party, is not generally known to competitors of the disclosing Party, and which is indicated as such when communicated to the receiving Party. Confidential Information includes, but is not limited to, all information or materials prepared in connection with this or any related subsequent contract and includes, without limitation, all of the following: designs, software, programs, drawings, specifications, techniques, models, data, source code, object code, documentation, diagrams, flow charts, research, development, processes, procedures, ideas, data, “know-how”, new product or new technology information, product prototypes, product copies, manufacturing, development or marketing techniques and materials, development timetables, strategies and development plans, including trade names, trademarks, customer, the Contractor or personal names and other information related to customers, the Contractor or personnel, pricing policies and financial information, and other information of a similar nature, whether or not reduced to writing or other tangible form, and any other trade secrets or non-public business information. Each party acknowledges and agrees that the Confidential Information has been and is being developed by the disclosing Party through the expenditure of substantial time, effort and money and is a valuable proprietary asset of the disclosing party. Each Party represents and warrants that it has the legal right to disclose to the receiving Party any and all information related to the Contract and any additional disclosure of data pursuant to this Contract or any written extensions thereof.

The Confidentiality provisions should in principle include the following:

The Contractor should undertake:

(a) that all Confidential Information shall be and shall remain at all times the sole and exclusive property of the Company;

(b) that its right to use Confidential Information shall wholly cease upon the termination of this Contract; and

(c) to return to the Company on termination of this Contract all material embodying Confidential Information (including, without limitation, information stored on computer disks) or any part thereof and all copies thereof.

  • Intellectual Property Right clause: Other than the standard clauses related to background IPRs. These need to be clear and precise. The following protections may be included (wordings are for reference only and needs to be modified including addl. Standard clause to be included):
    1. No licence or any other right, related to any Intellectual Property Right of the Company- No licence or any other right, related to any Intellectual Property Right of the Company shall be deemed granted when the Company provides the Specifications, special function requirements for the Product, and design and model of the products to the Contractor. Such Specifications and function requirements provided by the Company shall only be used by the Contractor for the purpose of this Contract and no other purpose.
    2. Foreground IPRs: The entire foreground Intellectual Property Rights created, conceived or generated under this Contract by the Contractor in fulfilling the Contractor’s obligation under this Contract shall be jointly owned by the Company. The Contractor shall not use the foreground IPRs and the Company technical specifications, special function requirements and background IPRs for any purpose other than manufacture and supply of the Products to the Company, nor shall the Contractor authorize or knowingly permit them to be used by anyone else for, or in connection with, any purpose other than the manufacture and supply of the Products. With respect to filing of patent application for the above mentioned, foreground IPRs, the right to apply for a patent shall be owned by the Company and all the foreground IPRs created will be owned by the Company. The Company shall have the full right to independently file a patent application and such independently filed patents shall be solely owned by the Company and the Contractor shall have no right to interest in the independently owned Company patents.
  • Termination clause: It should include any breach esp. material breach related to IP and confidentiality provisions as one of the reasons for termination.
  • Governing Law and jurisdiction: Company/you should be careful in choosing the governing law and jurisdiction so as to ensure that it can protect itself in the right court/jurisdiction.
  • Check the language of litigation in the Country of manufacture/ Governing law. Preferably draft the Contract in that language so that all parties (incluing courts/arbitrators) are clear of the intent of the Contract and its provisions.
  • Arbitration rules, where it will be done etc. should be clearly and precisely stated.
  • Make sure contract explicitly forbids Contract Manaufacturer from competing with you or improperly using your IP. A clear non-compete clauses to be included in the Contract.
  • Ensure the Contract also specifically states that the packaging material are to be only used for the products being manufactured for the Company. The quantity and quality control of packages need to be monitored.
  • Ensure regular visits to the Contract Manufacturer premises and seek regular reports on the inventories, handling of defective products (how these have been disposed, etc.)  
  • Include a NNN Agreement to be signed by the Contractor. A typical NNN agreement covers the following;
    1. Non-disclosure
    2. Non- circumvention and
    3. Non Use/ Non-competion

Non-disclosure: For a Contract Manufacturer who is manufacturing not only for you but your competitors you may like to cover internal disclosure within a network.

Non-Use: prevent the Contract Manufacturer from manufacturing or using the product or information sought to be protected. The non-competition provisions are an essential and material part of the total agreement, by which the Contractor needs to  agree that it shall not use any advantages derived from Confidential Information in its own business or affairs, unless the same is done pursuant to amendment signed by both parties.

Non-circumvention: Prevent Contract Manufacturer from circumventing you and going directly to your customers or clients. The Contractor  needs to agree that they (including officers, etc.) will not, directly or indirectly, contact, deal with or otherwise become involved with any entity or any other entities or parties introduced, directly or indirectly, by or through the other party, for the purpose of avoiding the payment to the Company of profits, fees or otherwise, without the specific written approval of the Company.

  1. It is also recommended that a reasonable period of    non-disclosure be agreed between the parties.
  2. Further a clause to restrict sub-contracting can also be included in the Contract. This will avoid the sharing of IP and confidential information to more parties and thus reduce the risk.
  3. In addition to registering your IP including brand name/logo and patents in the relevant registration office, also try to register or provide details as applicable to customs office of the Contract Manufacturer’s Country. This will help them to notice any counterfeits and notify you.
  4. Contract should cover aspects of change management.
  5. Who owns the IP of new and better method of production brought in by the Contract Manufacturer. Who pays for the new method and machinery if any.
  6. Contract should include provisions for mutual agreements before change or inputs while bringing in new product manufacturing. This ensure participation of the Manufacturer and thus higher stake in its success.
  7. Preferably have long term contracts/relationship rather than a one off contract. This avoids Contractor from seeking advantage in stealing your IP, etc.

However it maybe noted that irrespective of a Contract being very robust and thorough, the key to success of the relationship is:

  1. Right choice of Contract manufacturer.
  2. Continuous monitoring of the relationship between the parties.
  3. Have multiple vendors for the product.
  4. Preferably breakdown the equipment and manufacture the parts in different Contract Manufacturer.
  5. Good faith between the parties.
  6. Ensure that agreements/ Contracts are enforceable. For the same you may need to be careful of the wording and provisions and esp. Governing law, Liquadated clauses, arbitration provisions, etc.

Needless to state Legal protections are still probably most important as these act as deterrent to the parties from breaching the agreement/contract.

 

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