The outsourced manufacturing agreement should require procedures that limit access to the company’s confidential information to specific, identified manufacturer personnel and solely to the extent they need to know the information for performing the services.
If possible, the company should require the manufacturer to amend its employment contracts with individuals having access to the company’s confidential information to provide for confidentiality and non-compete obligations concerning this information. The outsourced manufacturing agreement should make the manufacturer directly liable to the company for any breach of these obligations.
The company should also consider requiring that key employees with access to company trade secrets execute a confidentiality agreement directly with the company. As a result, the company will be in direct privity with the individuals and may not have to rely on the manufacturer to enforce employee contracts or on potentially limited third-party beneficiary rights.
These employment contracts should provide for the assignment to the company of all IP derived from, and improvements made to, the company’s trade secrets and other IP. Alternatively, the agreements can require assignment to the manufacturer, who should in turn be contractually obligated to assign these rights to the company. This may be particularly important in certain countries such as China, where applicable laws may allow the manufacturer’s employees to make these improvements despite any contractual provisions to the contrary. It is beyond the scope of this series to explore how a company may navigate a situation where local law grants the manufacturer improvements regardless of what any underlying agreements may state.
The manufacturer’s employees working on the joint venture must be educated on best practices for protecting confidential information and preventing disclosure — this may need to be done at the company’s expense. The outsourced manufacturing relationship should include ongoing education and information for employees and managers covering:
The importance of protecting commercially sensitive information;
The commercial benefits from this protection; and
The economic and legal consequences of failing to properly safeguard sensitive information.
The outsourced manufacturing agreement should provide for disclosure to and consent from the company for any new or substitute employees that the manufacturer proposes to use in connection with sensitive employee functions.
Another point to consider is enforcement of foreign judgements. Not all countries will enforce US judgments against local companies, but many, including Chinese, courts will enforce decisions by arbitral tribunals. The company should consider an arbitral forum that offers established procedures and a large number of potential arbitrators who are fluent in English and have experience with outsourced manufacturing transactions, such as:
New York or Miami for a Brazil agreement.
London or Geneva for a Russia agreement.
London or Singapore for an India agreement.
Hong Kong or Singapore for a China agreement.
The agreement should be subject to a neutral governing law with well established principles and well developed precedent for trade secrets, such as Delaware or New York in the US, or English law.
Parties based in different countries generally will seek to resolve disputes through arbitral institutions that principally focus on international disputes. For example, the International Chamber of Commerce (ICC) has a long history of providing an arbitral forum for international commercial disputes, and parties frequently agree on the ICC as the appropriate tribunal for arbitration. In addition, depending on the region in which the manufacturing is to occur, there may be international arbitration tribunals with substantial experience in handling international commercial disputes in that region.
For example, for disputes involving a China-related agreement, the Singapore International Arbitration Center or Hong Kong International Arbitration Center may be preferable among available arbitral institutions on the basis of available remedies, predictability, or enforceability of an award. Accordingly, the company in each instance should consider the appropriate arbitral forum based on its own prior experience and the reputation of the forum in the applicable region.
Additional Deterrents to Prevent Breach
To help safeguard against the worst-case scenario of the manufacturer’s breach, the company may consider including additional contractual deterrents. These may include requiring the manufacturer to:
post a bond in escrow;
purchase insurance;
maintain a letter of credit; or
grant the company a lien on certain assets.
The company’s rights under these safeguards should be triggered by either or both of the following: the manufacturer’s breach or specific provisions set up to protect the company’s trade secrets.
In sum, outsourced manufacturing is a very important part of the global economy. Along with the benefits, there are significant risks. Accordingly, a thoughtful approach to choosing a manufacturing partner and to protecting one’s intellectual crown jewels is paramount.
If you have a legal question related to this topic or require legal services please contact D.L Cohen, P.C legal services. For insight on your innovation strategy please contact D.L Cohen, P.C business consulting.
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