International Manufacturing Term Sheets: What to Agree on Before Drafting Your Contract

Our international manufacturing lawyers are frequently asked what companies need to agree on with their foreign manufacturers before we draft an International Manufacturing Agreement. The answer is usually less than people think. In many cases, all we need to begin drafting a manufacturing agreement is clarity on pricing, quantities, and product specifications. Sometimes even two of those three are enough. Our lawyers can then draft an agreement that addresses the legal issues and protects the buyer's interests.

But there are situations where it makes sense to settle more of the business terms before getting the lawyers involved. That is where an International Manufacturing Term Sheet comes in. A term sheet helps the buyer and manufacturer work through important business issues before spending time and money negotiating a full manufacturing contract. It also reveals disagreements that might otherwise surface only after both parties have invested substantial resources in the relationship.

The checklist below covers 21 issues worth considering. You do not need to negotiate all 21 before your lawyers begin drafting, and some will have little relevance to your particular manufacturing arrangement. The goal is to settle the important business issues, not to turn a straightforward manufacturing deal into an unnecessarily complicated exercise.

Why Use an International Manufacturing Term Sheet?

Suppose a U.S. company finds a factory in Vietnam that offers good pricing and appears capable of manufacturing its products. The company is ready to move forward, and the manufacturer is equally enthusiastic. But neither side has discussed what happens if the factory misses its delivery deadlines. The manufacturer expects a minimum annual purchase commitment, while the buyer assumes it can order whatever quantities it wants. The buyer also expects to own the molds it is paying for, while the factory views those molds as its property. These are the sorts of disagreements that can derail a manufacturing relationship before production even begins.

A term sheet allows the parties to identify and resolve these issues early. It can also help a buyer decide whether a prospective manufacturer is worth pursuing. A factory that refuses reasonable quality inspections or insists on keeping tooling the buyer pays for is telling you something important about how the relationship is likely to work. There is also a financial benefit. Lawyers can draft manufacturing contracts more efficiently when the parties have already agreed on the major business terms. Nobody benefits from paying lawyers to exchange multiple drafts over an issue the buyer and manufacturer have never actually discussed.

A term sheet is sometimes called a memorandum of understanding (MOU) or letter of intent (LOI), but those documents are not necessarily interchangeable. In particular, companies doing business in China need to be careful about MOUs and LOIs that create unintended legal obligations. A document does not become nonbinding simply because someone calls it a term sheet.

When Should You Negotiate a Manufacturing Term Sheet?

The best time is generally after you have identified a promising manufacturer and conducted appropriate due diligence, but before you begin negotiating the full Manufacturing Agreement. There is little reason to spend weeks working through manufacturing terms with a factory you have not yet verified as legitimate, capable, and financially reliable.

How much effort the term sheet deserves depends on the deal. A relatively simple manufacturing arrangement might require little more than agreement on prices, quantities, and specifications. A complex relationship involving substantial tooling investments, product development, or exclusive manufacturing rights usually warrants a more detailed discussion. The following 21 subjects provide a starting point.

21 Issues to Consider for Your International Manufacturing Term Sheet

1. Term of Agreement

How long do you expect the manufacturing relationship to last? Will the agreement run for a fixed period, renew automatically, or continue until one party terminates it? A two-year initial term with automatic one-year renewals and a 90-day nonrenewal notice requirement is one possible arrangement. For a new supplier, however, a shorter initial commitment often makes more sense. You want enough stability to establish a productive relationship without making it unnecessarily difficult to leave if the factory performs poorly.

2. Exclusivity

Exclusivity is one of those terms that sounds straightforward until you ask exactly what it means. Does the manufacturer agree not to produce your products for anyone else? Are you promising to buy exclusively from that manufacturer? Does exclusivity apply to a particular product, a geographic market, or an entire product category?

These distinctions matter. A manufacturer agreeing not to produce your proprietary products for competitors is very different from your company agreeing to buy everything from that manufacturer. The latter creates serious problems if the factory raises prices or cannot keep up with demand. Any exclusivity arrangement should clearly define its scope and, where appropriate, tie the manufacturer's exclusive rights to pricing, production capacity, and performance.

3. Quantities

Manufacturers often want minimum purchase commitments because they need to plan production and purchase raw materials. Buyers generally want flexibility, especially when customer demand is uncertain. A rolling forecast can bridge that gap. For example, a buyer might provide a 12-month forecast that is updated monthly, with only the first three months constituting firm purchase commitments. The distinction between a forecast and a binding obligation needs to be clear. We have seen manufacturers treat optimistic sales projections as promises to purchase products the buyer never actually ordered.

4. Orders

The parties should agree on how purchase orders will work, including required lead times and the circumstances under which the manufacturer can reject an order. Suppose the buyer provides a production forecast and the manufacturer reserves capacity accordingly. Can the factory nevertheless refuse a purchase order that falls within the forecast? Can the buyer suddenly double its order without giving the manufacturer additional production time?

A workable arrangement might require purchase orders 60 days before delivery and allow the manufacturer to reject orders exceeding 125% of the agreed forecast. The appropriate numbers depend on the products and the factory's actual capabilities. What matters is that both sides understand their obligations before production begins.

5. Delivery Terms

International delivery terms are frequently misunderstood, sometimes with expensive consequences. The parties need to determine who arranges shipping, who pays for it, when the manufacturer has fulfilled its delivery obligation, and when the risk of loss passes to the buyer. They should also agree on delivery schedules and what happens when the manufacturer misses them.

Pay particular attention to international shipping terms such as FOB and EXW. These terms have specific meanings. For example, FOB under Incoterms 2020 applies to goods delivered aboard a vessel at a named port, not goods handed over at a factory. FCA is often more appropriate for delivery to a carrier at a factory or other specified location.

6. Customs and Import/Export Compliance

If you manufacture overseas and import into the United States, someone needs to be responsible for customs classification, country-of-origin information, shipping documents, and import duties. Do not assume your manufacturer understands U.S. customs requirements simply because it exports products to the United States. The term sheet should establish who handles the relevant documentation and what information the manufacturer must provide.

Depending on the product and supply chain, this may include detailed records needed to establish origin or demonstrate compliance with U.S. forced labor restrictions. The buyer should also understand its own responsibilities as importer. Contractual promises from a foreign manufacturer do not relieve an importer of its obligations under U.S. customs law.

7. Pricing

Price is usually one of the first things buyers and manufacturers discuss. What gets overlooked is how and when that price can change. Will prices remain fixed for six months? Can the manufacturer increase them if raw material costs rise? Do higher order volumes qualify for discounts? What currency will be used?

We generally favor pricing provisions that give buyers reasonable predictability. For example, the parties might agree to fixed prices for the first six months, with subsequent changes requiring 90 days' notice and written agreement. Be especially careful about provisions allowing the manufacturer to raise prices unilaterally after you have invested heavily in tooling or become dependent on that factory.

8. Payment Terms

Payment terms deserve as much attention as pricing because they determine how much leverage you retain if something goes wrong. The manufacturer wants to be paid early. The buyer wants to avoid paying for products that are defective, late, or never delivered. A common arrangement is a 30% deposit when an order is placed, with the remaining 70% payable after the products pass a pre-shipment inspection.

That is only an example; the right structure depends on the products, production costs, and relative bargaining power of the parties. What matters is that your payment schedule gives the manufacturer an incentive to deliver conforming products. Paying nearly everything before you have an opportunity to inspect the goods leaves you with far fewer options if production goes badly.

9. Product Quality

Everyone agrees that products should be high quality. The trouble starts when the buyer and manufacturer have different ideas about what that means. A good manufacturing agreement uses objective standards wherever possible, including detailed product specifications, approved samples, acceptable tolerances, and agreed testing procedures.

If a product must meet a particular safety standard or performance requirement, that should be identified. The parties should also agree on what constitutes a defect and what the manufacturer must do when products fail to meet the agreed standards. Vague language requiring products to be of "good quality" is an invitation to disagreement.

10. Inspections

A contractual promise to manufacture quality products does not do much good if you cannot verify quality before shipment. Buyers should generally have the right to arrange independent third-party inspections, particularly before the manufacturer ships the goods or receives final payment. The parties should also establish what happens if an inspection reveals defects. Does the factory have to repair or replace the products at its own expense? Who pays for reinspection? Can the buyer reject the shipment? These details matter because once defective products leave the factory and arrive in another country, correcting the problem usually becomes substantially more expensive.

11. Warranties

Some manufacturing defects do not become apparent until products reach the buyer's customers. The manufacturing agreement needs to address those problems as well. The parties should discuss the warranty period, what defects are covered, and whether the manufacturer must repair, replace, or credit defective products. Depending on the product, the manufacturer may also need to cover reasonable costs associated with returned products or corrective action. A one-year warranty against defects in materials and workmanship is a possible starting point, but the warranty should reflect the product and how it is used.

12. Molds and Tooling

Tooling ownership is one of the issues our international manufacturing lawyers worry about most. A buyer spends $100,000 on specialized molds and assumes it owns them. Two years later, the buyer wants to move production to another factory. The original manufacturer refuses to release the molds, claims they belong to the factory, or demands additional money. This is a problem we have seen in various forms many times.

If you are paying for molds, dies, jigs, or other production tooling, the term sheet should address who owns them, who maintains them, and what happens to them when the manufacturing relationship ends. Ownership alone is not enough. You also need practical rights to inspect, retrieve, and transfer your tooling. See our article on protecting molds and tooling when manufacturing overseas.

13. Intellectual Property

If you provide a factory with product designs, specifications, software, or other valuable intellectual property, you need to be clear about what the manufacturer can and cannot do with it. The manufacturer generally should be permitted to use your intellectual property only to produce your products. It should not be free to use that information to make competing products, supply your competitors, or develop its own product line.

Ownership of newly developed intellectual property also needs attention. If the manufacturer helps refine your design or develops a new production method, who owns the result? Do not casually agree to joint ownership of new intellectual property. Joint ownership sounds fair, but it can create serious commercial and legal complications. The appropriate arrangement depends on the nature of the development work and the law governing the relationship.

14. Insurance

Insurance requirements depend on the products being manufactured and the potential consequences of a defect. A manufacturer producing inexpensive decorative items presents a different risk profile from one manufacturing electrical equipment or products that can cause personal injury.

The term sheet should address any required general liability or product liability coverage, including appropriate policy limits. Buyers should also confirm that the coverage actually applies to the relevant products and markets. A foreign manufacturer's insurance policy is not necessarily going to protect you against a product liability lawsuit in the United States.

15. Limitations of Liability

Manufacturers often want to limit the amount they can owe if they breach the agreement. Some also seek broad exclusions for consequential damages. These provisions can undermine protections negotiated elsewhere in the contract. For example, a manufacturer might agree not to use your designs to produce competing products while simultaneously proposing a liability cap that makes violating that promise relatively inexpensive.

Liability limitations should be evaluated in light of the actual risks. Certain obligations, particularly those involving intentional intellectual property misuse or serious confidentiality breaches, may warrant exceptions. Depending on the country and transaction, appropriately drafted liquidated damages provisions may also provide more effective protection.

16. Indemnification

Indemnification provisions determine who bears responsibility when a third party brings a claim arising from the products or manufacturing process. Suppose the manufacturer uses a production process that infringes someone else's patent. Or a product defect attributable to the factory causes an injury, resulting in a lawsuit against the buyer. The agreement should allocate responsibility for these claims based on what each party controls, including defense costs and the handling of settlements.

Of course, an indemnification clause is only as valuable as the manufacturer's ability to honor it. A promise to pay millions means little if the manufacturer has no accessible assets or disappears when a claim arises.

17. Confidentiality

Your manufacturer may receive information you would never give a competitor, including product designs, technical specifications, pricing, and customer information. A standard nondisclosure agreement often does not go far enough. Depending on the country and the relationship, you may need restrictions on the manufacturer's use of your information and its ability to circumvent your company. These are the protections commonly addressed in an NNN Agreement: non-disclosure, non-use, and non-circumvention.

The agreement should also address what happens when the manufacturer shares information with employees, affiliates, or subcontractors. Your protections lose much of their value if the factory can simply pass your information to another company that is free to use it. This is particularly important when your manufacturer has relationships with other factories that produce competing products.

18. Assignment and Subcontracting

Your manufacturer may be an excellent factory, but that does not mean you want it transferring production to another company. Assignment and subcontracting are different issues, and both deserve attention. Assignment concerns the transfer of contractual rights or obligations, while subcontracting concerns who actually manufactures the products. A factory can remain the contracting party while quietly sending your production to another facility.

Unauthorized subcontracting can create serious quality control and intellectual property problems. Buyers should therefore consider requiring advance written approval before production is subcontracted and make clear that the original manufacturer remains responsible for its subcontractors.

19. Termination Rights

Manufacturing relationships end for many reasons. Sometimes the buyer finds a better supplier. Sometimes the manufacturer cannot meet quality requirements. In other cases, the relationship simply stops making commercial sense. The parties should agree on when the contract can be terminated, what notice is required, and whether a material breach must be given an opportunity to be cured.

Just as importantly, the agreement should address what happens after termination. Who owns unfinished products and raw materials? What happens to deposits? How quickly must the manufacturer return tooling and confidential information? A buyer should be able to leave a manufacturing relationship without having its products, intellectual property, or tooling held hostage.

20. Dispute Resolution

This is where international manufacturing agreements require particular care. A U.S. company might naturally prefer California or New York law and courts. But if its manufacturer is in China and has no assets in the United States, a favorable U.S. judgment may be difficult or expensive to enforce. The right dispute resolution provisions depend on where the manufacturer operates, where its assets are located, and what remedies are realistically available.

For mainland China manufacturing, we often favor Chinese law and dispute resolution in China. For Vietnam manufacturing, Singapore arbitration is often worth considering. There is no single answer that works across countries, and the governing law and forum should be selected together with enforceability in mind. These are legal issues your lawyers should help resolve, because a dispute resolution clause is only useful if it gives you a practical way to enforce your rights.

21. Force Majeure and Non-Performance

Natural disasters, government restrictions, and other extraordinary events can disrupt production. The manufacturing agreement should specify when such events excuse or delay performance and what each party must do when they occur. A manufacturer should not automatically escape responsibility simply because producing the goods has become more expensive or inconvenient.

The parties should consider notice requirements, obligations to minimize the disruption, and how long performance can be suspended before the buyer is entitled to cancel an order or terminate the agreement. A buyer waiting for products needed to meet its own customer commitments cannot always afford to wait indefinitely for a factory to resume production.

Turning Your Term Sheet into a Manufacturing Agreement

Once the buyer and manufacturer have worked through the important business terms, the lawyers can use those terms to prepare the Manufacturing Agreement. The term sheet does not need to anticipate every legal issue or contain detailed contract language. In fact, one of the biggest mistakes companies make is spending so much time negotiating a term sheet that they essentially negotiate the same contract twice.

Focus first on the issues the parties themselves need to decide. Price, quantities, payment timing, exclusivity, and tooling ownership are obvious examples. Other provisions, such as governing law, dispute resolution, and enforceable remedies, often benefit from substantial lawyer involvement.

During negotiations, it also helps to understand why the manufacturer is asking for a particular term. A factory demanding large minimum orders may need assurances before purchasing raw materials. A factory seeking a substantial deposit may be concerned about financing production. Once you understand the concern, there is often more than one way to address it. And be willing to walk away. A manufacturer that refuses reasonable protections for your products, intellectual property, or tooling is unlikely to become easier to deal with after you have paid a substantial deposit.

How Our International Manufacturing Lawyers Can Help

Our international manufacturing lawyers regularly help companies determine which manufacturing terms should be negotiated in advance and which are better addressed in the formal agreement. We also draft agreements tailored to the laws and business realities of the country where the manufacturing takes place, including local-language agreements where appropriate.

In many cases, we can begin with little more than your agreed pricing, expected quantities, and product specifications. If the proposed relationship involves unusual risks or unresolved business issues, we can help identify what needs to be settled before drafting. A good manufacturing term sheet accomplishes what it needs to accomplish without becoming an expensive project of its own. The real objective is a manufacturing agreement that protects your products, your money, and your ability to keep doing business when problems arise.