Overview of Toll Manufacturing Agreement Samples

A Primer on Toll Manufacturing

Toll manufacturing is a type of contract manufacturing where doing business under a toll manufacturing agreement is preferred by one party to a manufacturing arrangement. In the simplest terms, it entails a business sending or "tolling" raw materials or components to another business, a toolmaker or contract manufacturer in this case, who supplies back a quality product at a price and in a particular time as agreed in the manufacturing agreement.
It is a good choice for any business that requires a certain level of control over the production of a product which , while having a strong prospective market for profitability, does not justify tooling costs for small quantities or does not need the associated cost when a local manufacturer is available and has the capacity, labor force and access to lower raw material costs in a particular place.
A good manufacturing agreement protects all parties involved. No one wants surprises later and everyone wants to concentrate on maximizing costs, effort and material so as to be profitable sooner than later.

Elements of a Typical Toll Manufacturing Agreement

The key elements are:
Scope of work. This section will delineate the specific services to be provided by the toll manufacturer. The scope of work may be very specific to the product being manufactured, so it is essential that the parties consider the scope carefully.
Payment. Will the toll manufacturer be paid for its service in cash? If so, the parties must negotiate and document a pricing schedule. The parties should also carefully consider whether the toll manufacturer will be responsible for any costs associated with materials and other supplies. For example, if the product requires certain raw materials or components to be used in its manufacturing, who is responsible for those costs? Will the raw materials and components be purchased by the toll manufacturer and then supplied to the operator or will the operator be responsible for sourcing and supplying those raw materials and components? Who is responsible for sourcing and supplying any packaging? The parties should carefully consider supply issues associated with the product being manufactured.
Time. How long is the toll manufacturing party going to be responsible for the services? A period of time, for example, "1 year", should usually be included. Are there renewal provisions in the agreement? The parties should also consider what happens at the end of the period of time contemplated in the agreement.
Confidentiality. Parties must consider what information of the owner of the technology or brand which is being manufactured is to be kept confidential and how confidential the parties would like this information to be treated.
Other Elements. The parties may negotiate other elements, in addition to the key elements above based on their need of the parties and the business they are engaged in. Ideally, the agreement should be drafted with as much detail as possible being included to avoid ambiguity in the agreement.

Toll Manufacturing Agreement Sample

A sample toll manufacturing agreement can be used to provide guidance, but the contractual terms must be customized for your particular product and situation. Sample agreements may be available from companies that have been in the toll manufacturing or contract manufacturing business for a long time. Such a publisher may review existing toll manufacturing agreements and consult with their counsel to generate a general template to assist their customers in determining the procedure.
A sample toll manufacturing agreement will outline the basic items that should be addressed in a professional toll manufacturing agreement. These items are also discussed below. Some items that should be discussed in a sample toll manufacturing agreement:
The introduction to the sample will identify the parties and designate the manufacturer as the "Manufacturer" and the company that is contracting with the manufacturer for its production, which is dubbed the "Contractor" in the sample.
Recitals are the next section of the sample and usually contain one or two sentences to describe the background of the need for the agreement. In this sample, the Contractor owns and possesses proprietary rights to certain products or formulas that it supplies to the Manufacturer which will be manufactured by the Manufacturer pursuant to the agreement.
Section 1: License grants permission from the Contractor to the Manufacturer to use and reproduce the products or formulas provided by the Contractor to the Manufacturer for the purpose of making the Contractor’s product. The license shall cover the trademarks and copyrights that appear on the Contractor’s product packaging, if any. This section may also restrict the rights of the Manufacturer to sell, transfer, lease, encumber or suffer any lien to arise in connection with the Contractor’s property.
Section 2: Compensation indicates the form of compensation, calculation of the fee, such as hourly, cost per unit or a percentage of the Contractor’s gross sales prices, and the manner of payment, such as monthly.
Section 3: Duties and Responsibilities delineates the responsibilities of the parties under the agreement. The section of the sample also informs the Manufacturer as to what its specific reporting duties are with respect to the Contractor. What tests need to be performed and when, what notifications need to be made, etc. The Manufacturer will be required to keep records and permit access to the Contractor or its agents to the Manufacturer’s facility for inspections and audits without prior notice. If the Contractor requires that the Manufacturer provide insurance coverage for any part of its manufactured product, the sample identifies the minimum amounts and types of coverage.
Section 4: Confidentiality requires the Manufacturer to keep all information secret and confidential that comes into the possession of the Manufacturer by virtue of its relationship with the Contractor. The Manufacturer will be asked to safeguard the Contractor’s proprietary interests and protect its business from divulging its formula, trade secrets, customer lists, etc. The confidentiality section should restrict the Manufacturer from utilizing the Contractor’s information to manufacture its own similar product. A sample toll manufacturing agreement will enumerate the specific information that needs to be treated as confidential, including, but not limited to pricing, business plans, costs, discounts, etc. This section also usually permits the Contractor to seek an injunction to prevent a breach or potential breach of the confidentiality provision. A sample will also specify how long the information will remain confidential.
Section 5: Term and Termination specifies the duration of the agreement and how it can be terminated. If the parties in the sample desire permission to terminate the agreement without cause, they would have to indicate that in this section and attach a schedule that sets forth the numbers of days or months that notice would be required.
Section 6: Miscellaneous includes the jurisdiction in which any disputes will be resolved. It is common for parties to agree to arbitration rather than going to court. The sample will contain a waiver of any right to a jury trial.
Other sections that are sometimes in a sample toll manufacturing agreement include, but are not limited to:
A sample toll manufacturing agreement is a good way to learn what goes into the contract, but the specifics of your particular deal need to be customized to fit your particular situation.

Advantages and Disadvantages of Toll Manufacturing

Benefits and Risks of Using Toll Manufacturing Agreement Samples
The great promise of toll manufacturing is manufacturing costs savings. However, both costs and top quality are more than a matter of calculating expenses, square feet, and the number of widgets in a box. Successful agreements require manufacturers to do more than simply sign an agreement, write a check, and then put their feet up on the desk for the lifetime of the contract. Companies that enter into tolling arrangements need to be mindful of operations and key milestones along the path to be sure they meet their goals.
But there are risks on the other side of the ledger as well.
Intellectual Property During the Term
Companies need to be mindful of IP concerns when entering into tolling agreements. Will the manufacturer have access to confidential data, specifications, or know-how? How will that data be used, if at all, and if it is disclosed, how is it protected? Many times a toll manufacturing agreement sample will have provisions for subcontracts, disclosures and protection. However, if not, the manufacturer should add them.
With IP, the tolling arrangements can work either way. If a company hires a manufacturer to create its proprietary property, the IP will belong to the company. On the other hand, if the manufacturer has a design or technology that it will use during the agreement, these rights also can be protected.
Third-Party IP
In addition to IP that one party or the other has in-house, many third parties may have rights that can arise during a toll manufacturing relationship. For example, the end product may have input from a third party or the manufacturer is using a patented technique to produce the items. Both companies should audit any technology or material being used under the agreement. Because the tolling agreement is usually long term in nature, the companies must be diligent in making sure that they have rights or licenses to technology and materials that are used throughout the period of the contract.
Quality Control
The tolling agreement usually does not end once the manufacturer delivers the items. The waiting time between delivery and invoice payment can be a multi-step process. The items must be transported and transfered. Then, they must go through a careful quality review.
During this process, the manufacturer often has an opportunity to identify the quality of the items, including discovering whether the items have defects or faults. This is not only a benefit to the company hiring the manufacturer, but also for the contract manufacturer as well.

Legal Issues and Toll Manufacturing

The legal aspects that need to be considered when drafting or entering into a toll manufacturing contract vary on the jurisdiction you are dealing with. In North America, for example, your biggest consideration will be whether the toll manufacturer is in the United States or Canada. The United States tends to be more likely to require extensive product and raw material testing, and because of that, regulations pertaining to that particular type of testing are much stricter.
In addition to determining whether the product has to be tested, you will also have to consider how the product is going to be sold. Again, Canada and the UA have different rules regarding the sale of products. These rules will affect production, as well as the already mentioned testing.
For ideation, starting with a sample is not unusual. If there’s a dispute on the final form or quality of the product delivered by the manufacturer, then the contract should stipulate what recourse is available . For example, can the product be returned for modification or replacement? Also, what are the timelines involved?
Intellectual property is another sticking point that you will need to consider before signing off on the agreement. Does the final product or even the sample use someone else’s intellectual property? The answer you get is going to determine whether or not you even want to do business with this particular manufacturer. In the industry, a secret shop is often done where the potential manufacturer contacts the company and asks for a quote and provides them with all of the information required to give one. If they are possibly infringing upon your intellectual property, you might want to take your business elsewhere.
Finally, you need to think about the ramifications of liability. If the product you receive from the toll manufacturer is not up to code, what happens next? Who pays for that? These are questions that you will want to discuss before you sign anything.

Customizing Your Toll Manufacturing Agreement

A company may customize any sample toll manufacturing agreement to suit its unique needs. It can use its own toll manufacturing agreement or the sample toll manufacturing agreements in this article as a starting point to draft its own custom form. Start with the appropriate sample toll manufacturing agreement from this article. The form should be chosen based on the type of goods being manufactured and the scope of the manufacturing services provided by the manufacturer. In some cases, multiple sample toll manufacturing agreements in this article will be used as the starting point. Next, add terms based on how the particular toll manufacturing arrangement will be configured. If only one party is providing raw materials to the other party during the term of the agreement, the party who is providing raw materials needs a license to use the other party’s intellectual property throughout the term of the agreement. If both parties are providing raw materials during the term, then each party will need the license from the other for this purpose. Third, add a section describing how the manufacturer will return unsold goods to the company. Specify whether unsold goods will be returned at the end of the agreement or whether they will be returned from time to time during the term of the agreement. Specify whether the manufacturer will have to process the returned goods in any way before returning them to the company. Next, add a definition section if the sample toll manufacturing agreement used as the starting point does not already have one. Identify and define any other terms the parties would need to understand the agreement. Finally, check the parties’ jurisdiction requirements to ensure the form will be valid under the applicable laws.

Pitfalls in Toll Manufacturing Agreements

Companies new to the toll manufacturing arena, or those who have not previously engaged a contract manufacturer, may be unaware of the issues that should be refined in their agreement. The following are typical mistakes made when drafting a toll manufacturing agreement. By identifying these issues, companies can avoid costly problems down the road. Everyone should be aware of the issues before they spend too much time negotiating a toll manufacturing agreement. Otherwise, you could find yourself spending time and money on a contract that is not what you thought it was.

• Confidential Information. The agreement does not cover who owns the IP on confidential information. Sometimes the agreement states that all confidential information is owned by the disclosing party, and other times it provides for joint ownership. Companies should seek to protect their confidential information and to provide for it to be used only for the purposes of the agreement (e.g., performing the toll manufacturing process). However, if the toll manufacturer develops its own proprietary process for manufacturing your product, you will want to ensure it is jointly owned by the parties. If not, the manufacturer may wind up owning the rights to such a process. Or even worse, the toll manufacturer may own proprietary rights to the manufacturer’s process, and the toll manufacturer may use that process in other products. This means that the manufacturer will own intellectual property rights to both to the customer’s product and to its own processes. Unless the goal is for the manufacturer to monetize its process, the customer will want to make sure it owns that process as well. And don’t count on the court to clear this up if it goes to court. Time and money could be better spent writing a clear agreement that is intended to reflect what both parties intend.
• Changes to Process or Product. Oftentimes, the agreement will include a specific manufacturing process or a specific formulation. In such cases, changes by the manufacturer to the process or the formulation typically require the customer’s consent. However, the agreement may not specify what happens if the manufacturer changes the manufacturing process or the formulation but fails to get the customer’s consent. Does the customer have any recourse if the product or process is changed? Does the customer have further rights even if it is only a material change? Companies should consider these issues carefully , as it may be harder to correct bad drafting later on than it is to get it right from the beginning. Practically speaking, getting the process right from the beginning may be less costly than requiring an amendment or a restatement to the agreement later on.
• Certification of Product Quality. Typically, the customer wants the product to conform to certain specifications. Oftentimes, the agreement states that the manufacturer warrants that the product will conform to the specifications. However, it does not include which person at the customer has authority to determine whether the product conforms to the specifications. Is it the customer’s quality control manager? Is it the customer’s quality control director? Is it the customer’s purchasing manager? All of these questions may seem trivial, but the devil is in the details. Sometimes, the agreement can be silent on this and it will work in the ordinary course. However, if a dispute arises, it may become fully ripe for litigation to determine what the customer wanted when it did not specify an individual.
• Financial Terms. Companies tend to focus on the product itself, and oftentimes overlook the financial terms. They may focus on the unit rate charged for the toll manufacturing services. However, does that unit rate work in the customer’s favor? For example, assume the customer pays the manufacturer three different payments for each manufacturing run: upfront payment of materials, payment for startup costs, and payment on completion of the run. In such case, who gets the benefit of the materials once they are paid for? Does the customer get the benefit of the materials as soon as it pays for them? Or does the manufacturer retain ownership over the raw materials? Many manufacturers will say that once the materials are purchased and paid for by the customer, the product will be the customer’s property. However, that should be examined carefully when the product is potentially worth millions of dollars.

By being cognizant of these issues at the outset, the parties can focus on issues of importance to them, and avoid the issues that, while they may seem important, have no practical impact on the parties’ business arrangements.