Outsourced Manufacturing and Trade Secrets: Transaction Structure & Contract (Part 6)

Outsourced Manufacturing and Trade Secrets: Transaction Structure & Contract by David L. Cohen

Transaction Structure

Once the company selects a potential outsourced manufacturing partner, it should design a transaction structure that reinforces its commercial expectations and the manufacturer’s contractual obligations. Specifically, the company should structure the outsourced manufacturing transaction in a manner best suited to protect the company’s key intellectual assets (both registered IP and unregistered IP like trade secrets and know-how). Transaction structure considerations include both the particular corporate and contractual form of the relationship, and how the company will delegate the manufacturing process to the outsourced manufacturer.

Joint Venture or Arm’s-Length Contract

The first decision about transaction structure is the corporate and contractual form of the relationship itself. The two primary possibilities are a joint venture or a simpler contractual relationship.

Forming a contractual joint venture with the proposed manufacturer or a legal-entity joint venture, by moving certain manufacturing assets and personnel of the counterparty into a new entity in which the company will have an ownership interest, offers certain benefits.

The benefits of a joint venture may include:

Greater operational control over the manufacturer.
Increased transparency as to how the intellectual assets are used.
Enhanced ability to influence the manufacturer’s practices and policies on a go-forward basis.

However, there are number of significant risk factors, including:

Higher level of complexity with respect to diligence and documentation.
Greater commitment of time and resources.
Potentially more difficult exit.

Joint ventures also require additional considerations relating to the transfer, licensing, and ownership of trade secrets and other IP required for and developed by the joint venture.

Together, these factors may undercut the cost-cutting rationale for seeking an outsourced-manufacturing solution. Some developing countries, however, only permit outsourced manufacturing in the context of a joint venture. While outside the scope of this series, such requirements create all manner of perverse incentives for the developing country joint-venturer that materially increase risk.

Companies may therefore prefer a more straightforward contract manufacturing relationship in most contexts, and this relationship is assumed for this series.

Next we will discuss various structural approaches to ensuring that key company intellectual assets are protected during the outsourced manufacturing process.