The contracts entered into by businesses operating in the manufacturing sector take a wide variety of forms.
For the manufacturer in the role of supplier, they range from relatively simple agreements for the supply of goods (entered into with a distributor or a direct customer in respect of the manufactured goods) through to the more complex ‘contract manufacturing’ and ‘toll manufacturing’ contracts considered in our previous article on the topic of outsourcing.
The manufacturer, in the role of customer, may enter into contracts for the design, installation and maintenance of plant and machinery, contracts for the supply of raw materials or components, services agreements with sub-contractors, utilities contracts, IT-related contracts, intellectual property licences and host of other arrangements relevant to its operations.
In that context, our manufacturing experts consider three related clauses commonly included in commercial contracts and discusses some key manufacturing-related issues concerning each in this article.
Of course, this is no more than an illustrative sample—what matters to a particular business will depend on the kind of contract being negotiated (noting the potential range and variety discussed above) and the specifics of the deal, so it is always important to take case-specific advice.
One of the main functions of any commercial contract is to establish the intended duration of the contractual relationship between the parties and in what circumstances it can be terminated early.
Note that contract expiration or termination doesn't always mean all parties' rights and duties end. For instance, a supplier's warranty on goods may persist after termination, and post-termination procedures often cover distributor stock return or disposal.
That said, understanding how long the primary obligations of the contract will continue and how easily you and the other party can end the contract is key to assessing the value and risk associated with a contract.
For example, if a manufacturer will incur significant upfront costs in order to be able to manufacture and supply a customer-specific product, it will need to know how long the customer is committed to purchasing the product, and in what volumes.
Carefully negotiated provisions around forecasting and minimum purchase commitments (necessary from the manufacturer’s perspective to give comfort that initial investment will be recouped) can be undercut if the customer can terminate the contract in circumstances that the manufacturer had not considered in advance.
This makes it crucial for each party to understand the contract’s provisions on term and termination.
Common termination rights for breach or insolvency are often brought together in the same clause, but the contract as a whole needs to be carefully reviewed since wider termination rights will often lurk elsewhere.
Other rights can sometimes be found in service level schedules, clauses dealing with mandatory variations, compliance obligations and provisions dealing with force majeure.
Long-term supply arrangements in the manufacturing sector, featuring varying degrees of purchasing/supply commitments from the parties involved, often include detailed pricing provisions.
Commercial terms are often a primary focus of the parties’ attention during negotiation, and deal-specific elements such as volume discounts, rebates and service credits can create complex pricing structures.
Similarly, pricing provisions can be used to allocate risks associated with changes in input costs between the parties, whether through indexation or other price review mechanisms.
Price-related clauses are often heavily negotiated, and the agreed position should be precisely drafted to avoid uncertainty over how the price is calculated in any given circumstances and when and how any agreed indexation/ price review mechanism will apply.
Worked examples can be highly effective in indicating the intention of the parties, although they should be carefully reviewed alongside the drafting of the relevant clauses to make sure that there are no discrepancies between the example and the operative provisions.
It may also be prudent in a long-term manufacturing contract to address in the contract how disagreements over price review will be resolved, for example, through the use of an expert to determine the correct outcome of the review.
A commercial contract provides a range of tools that can be used to allocate risk between the parties to manufacturing arrangements and control each party’s exposure.
A financial cap on liability can provide a definitive statement of a party’s maximum exposure under the contract.
The certainty provided by the cap may be reduced if certain liabilities, typically intellectual property rights indemnities or data protection-related liabilities, are excluded from or exceed the standard cap.
While pegging the liability cap’s value to the contract’s annual value is a standard negotiation position, both parties should still assess the potential level of exposure resulting from that position, particularly in a high-value contract, and the adequacy of the insurance policies they hold in light of that potential exposure.
Exclusions of liability are designed to mitigate risk by saying, as a matter of agreement between the parties, that certain types of pre-identified losses should not be recoverable, even if the party suffering that loss does so as a result of the other party’s breach or negligence.
Each party should carefully consider the likely impact of the other party’s breach when considering the liabilities it is willing to accept are ‘excluded’.
Excluding liability for loss of profit, revenue, or business could significantly devalue any claim against the manufacturer if the customer relies on the product supply to fulfill downstream commitments or operate its business.
Force majeure clauses are commonplace in commercial contracts and should be considered when considering the issue of risk allocation and liability.
Their intention is to give a party affected by circumstances which are, in broad terms, beyond that party’s reasonable control, relief from contractual liability for its failure to perform its obligations to the extent that those circumstances are responsible for its failure or delay in performance.
What counts as ‘beyond the party’s reasonable control’ can, however, be a matter of negotiation, particularly in long-term manufacturing contracts.
Detailed and heavily negotiated price review clauses may already address matters such as increases in the cost of production arising from shortages in raw materials or utility costs – if these arise as a result of international conflict, commonly viewed as a force majeure event, should the manufacture also get the benefit of the force majeure clause?
And where resource shortages prevent a manufacturer from being able to meet the requirements of all of its customers, the customer may want to negotiate provisions designed to reduce the risk of it being treated in a less favourable manner than other customers.
That is an overview of a small sample of the issues that require consideration in respect of contracts in this sector. Because of the variety of different models, however, there is no ‘one size fits all’ approach, and we always recommend taking legal advice in order to ensure that the provisions of the agreement reflect the intention of the parties.
We have experience in preparing model forms of agreement for businesses that provide contract manufacturing services and have also advised businesses intending to enter into such arrangements as a customer on the review and negotiation of the provider’s standard terms.
We have experience with different contract models in a range of industries.
If you have any questions on this topic or would like more information regarding contracts in the manufacturing sector or any other legal issues in the sector, you can contact our Manufacturing Solicitors below on:
