Product Development Agreements Don’t Get No Respect

When someone emails one of our international manufacturing lawyers asking us what they should be considering to protect themselves when manufacturing overseas, we typically respond with something like the following:

Our clients that manufacture product in China/Vietnam/Mexico/India/Thailand/Taiwan/Malysia (or wherever it is they are asking about) typically use us for some or all of the following

1. Manufacturing Company Reputational Report

If you want to know whether the company from which you are looking to buy product and send money is a safe bet or not, you should consider one of our due diligence reports. We do reputational/credit searches on foreign companies and then compile a 5-8 page report on what we have found. Among other things, these searches typically reveal whether the company pays its taxes, what sorts of IP it owns, the lawsuits in which it has been involved and – most importantly – if it is licensed to make and sell you what it says it will be making and selling for you. These searches also include an English language and an applicable language search of the internet, which much of the time turns up nothing but sometimes turns up amazingly helpful gems. The Reputational Report is advised for the reasons we discuss here. You can find out more about our foreign company due diligence reports here.

2. NNN Agreements/NDA Agreements

We do these in both the local language (this is usually the official version) and in English (for you) and they typically take us 4-5 business days to complete. You can learn more about our NNN Agreements here. We draft our NNN Agreements to protect confidentiality and to prevent your potential or actual manufacturer from revealing your secrets or competing with you or circumventing you. They make sense before you reveal any confidences. If you choose to have us draft an NNN Agreement, we first send you (via DocuSign) a one page Flat Fee Agreement setting out the fee structure for your particular agreement. We next send you a questionnaire and when we have your answers to that we draft the NNN in English for your approval. Once you approve the English language version, one of our lawyers will translate that into Chinese and we then send that to you. You then send the full NNN Agreement to your Chinese counter-party and if they propose any changes we will revise it that one time. Even if you are past the NNN stage, I would urge you to read about it nonetheless because everything substantive we put into our NNN Agreements we also put into our Manufacturing Agreements. Typically, the NNN Agreement we draft for you can be re-used again and again, with very minor changes.

3. Manufacturing Agreements

Once you have chosen your manufacturer, you need a Contract Manufacturing Agreement (a/k/a OEM Agreement or Product Supply Agreement). As is true of the NNN Agreements, we draft this agreement in both the local language (this is usually the official version) and in English (for you) and they typically take us 10-14 days to complete. You can find out more about our Overseas Manufacturing Agreements here. Our drafting process for these agreements is similar to our drafting process for our NNN Agreements. If you are already certain who you will be using as your Chinese manufacturer it usually makes sense toskip the NNN Agreement and go straight to the Manufacturing Agreement as our Manufacturing Agreements contain all the substantive provisions of our NNN Agreements. Typically, the first manufacturing agreement we draft for you can be re-used again and again, with very minor changes.

4. Trademarks

If you plan to put your company name or your brand name or your product name or your logo on your product or on its packaging, you typically will need to register those as trademarks in both the country in which you are manufacturing and in the countries in which you expect to have substantial sales. As we discuss here, it is important to secure a trademark in the country in which you will be doing your manufacturing even if you will not be selling your product in that country. See also Manufacturing in Asia: Let’s Talk United States and Canada and Mexico and EU Trademarks.

5. Other Protections (Patents, Copyrights, Exclusivity,  and Product Development Agreements)

If you product is unique in any way you may also want to consider patent protection for it as well. If your product involves written designs or content (such as phrases, writings, software, or vide0), you may also want to consider copyright protections. If you do not want your manufacturer making similar products for anyone else, we can include such an exclusivity provision in your manufacturing agreement.

If you do not yet have a finished product and you will be working with your foreign manufacturer to finalize some aspect of your product, we should discuss our drafting Product Development Agreement as well. These agreements cover the cost and procedure for developing a product. Many companies fail to enter into this kind of agreement only to discover later that their foreign manufacturing owns “their” product IP or the molds or the tooling at the end of the process.

In our experience, a Product Development Agreement is needed only around five percent of the time. This being the case, we usually do not even mention it in our initial email setting out what is “typically” needed for having a product manufactured overseas. I estimate that an NNN Agreement is needed around 75% of the time (the other 75% of the time there is nothing worth protecting or the secret has already been revealed and therefore the other benefits of an NNN Agreement will go into the OEM Agreement. I estimate that an OEM Agreement is needed 99% of the time. The only time trademark registrations are not needed is if the client does not put its own brand or company name or logo on its product or its packaging. Patents and copyrights make sense maybe 5% of the time.

The problem we as lawyers face is that when a Product Development Agreement is needed, it is almost always needed in addition to everything we mentioned in our email and our clients and potential clients by that point have reached document fatigue. I mean, who knew that something as simple as getting a widget made would require four separate legal line items. This makes our clients/potential clients reluctant to sign up for that “just one more document.” Think Monty Python’s thin mint.

We recently had this situation with a good client and the below is the email (modified slightly to remove any identifiers) one of our manufacturing lawyers wrote to this client on the pros and cons of our doing a China Product Development Contract for this client (called ABC Company):

As discussed, the basic problem with having a Chinese (or Taiwanese) factory do product development without a development agreement is ownership of the IP should ABC Company not end up ordering products from the factory. We talked about what happens if the factory cannot make the product pursuant to your specifications. The variant of this that we see most often is when the factory likes the product and thinks it can do better selling it on its own, and once development is complete, it quotes the buyer (in this case, that’s you) a ridiculously high per-unit price. The buyer says forget it, at which point the factory thanks the buyer for reinvigorating its product line. We have seen this scenario play out dozens of times, and the buyer has absolutely no recourse: it has no agreement covering development, and it did not pay the factory a dime. I don’t think there’s a court in China that would hold the factory accountable.

That being said, I am not unsympathetic to your concerns. A separate development agreement would increase the cost of the process, and it would take additional time – time that you may not have, if your target launch date is mid-2015. I can’t say how your factories would respond, but sophisticated factories are (or should be) familiar with such an agreement.

Your point about your ongoing relationship with Chinese Manufacturer A and Chinese Manufacturer B providing some comfort is also well taken. The sort of behavior I describe above is more likely to happen with a factory that has no previous relationship with the buyer, and therefore more incentive to opt for a “sure thing” short-term gain. And it doesn’t happen every time. But we would be remiss as lawyers, and in particular as professionals with years of experience dealing with Chinese factories, if we didn’t flag the loss of your IP as a significant risk here. And the best way to protect against loss of your IP is to have a separate development agreement.

If you don’t want to do a separate development agreement, the next best option is an OEM agreement with two essential features. First, you will want a paragraph stating that the factory will be doing product development for Company ABC but that Company ABC will own all of the IP. This may not be enforceable, but it is better than nothing, and it will at least memorialize the parties’ understanding. Second, you will need language about mold ownership, and you absolutely must pay for the molds.

Do not let the factory create the molds for free. If you do not pay for the molds your arguments that you own the molds will hold little to no weight. Given Company ABC’s time and cost constraints, and the primacy of product design (and hence molds) to the new product line, a single OEM agreement for each factory seems to be the most realistic course of action.

Don’t hesitate to contact me should you have any questions about the above.

China Product Development Contracts: They Don’t Get No Respect.