Structuring an International Manufacturing Agreement and Advisory for Foreign SMEs in India

Posted by Written by Melissa Cyrill Reading Time: 9 minutes

In today’s global economy, successful international manufacturing partnerships are built on clear expectations, mutual understanding, and precise contractual agreements. A well-crafted international manufacturing agreement not only formalizes the relationship but also protects both parties from potential risks, ensures product quality, and controls costs.

Essential terms for structuring manufacturing agreements

Here’s a quick guide to the essential terms and considerations for formalizing a manufacturing agreement.

Term of agreement

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The term of the agreement defines the duration of the contract, renewal conditions, and termination processes. It’s crucial to strike a balance between commitment and flexibility.

  • Initial and renewal terms: Clearly state the initial contract period, whether it’s a short-term or long-term partnership, and outline automatic renewal terms if any. Including a renewal provision can simplify continuity without renegotiation.
  • Termination notice: Define the notice period required for termination, which prevents abrupt disruptions. For example, requiring a 90-day notice for termination allows both parties to transition without immediate operational impact.

Key insight: Choose terms based on forecasted demand stability and market trends. For instance, if demand is volatile, shorter terms with renewal options provide flexibility.

Exclusivity

Exclusivity terms dictate whether a buyer or manufacturer holds exclusive rights, which can be beneficial in building a strategic alliance or controlling competition.

  • Buyer or manufacturer exclusivity: This clause specifies if the buyer is the exclusive customer or if the manufacturer will only produce for one buyer.
  • Benefits and drawbacks: Exclusivity may secure loyalty and minimize competitive risks, yet it can also limit market reach and flexibility.

Key insight: Consider market exclusivity based on volume commitment and brand strength. For a buyer with a large order volume, securing exclusivity may foster stronger manufacturer commitment.

Quantities and forecasts

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Manufacturing agreements must define quantity expectations, especially for long-term planning.

  • Volume commitments: Specify minimum order quantities to ensure that both parties are aware of production capacity and obligations.
  • Rolling forecasts: These allow for more accurate production planning, detailing required order forecasts, updated regularly, to maintain flexibility.

Key insight: Forecasts should be realistic and adaptable. Build rolling forecasts with flexibility, such as 12-month non-binding forecasts updated quarterly, to adjust to fluctuating demand.

Purchase order process

The ordering process and lead times should be transparent and practical.

  • Purchase order (PO) lead times: Define the time required for submitting POs and receiving approvals.
  • Order rejections: Outline conditions under which orders might be rejected, especially if they exceed forecasted amounts.

Key insight: Set clear thresholds for order changes. For instance, allow manufacturers to decline orders that significantly exceed forecasts unless specified conditions are met.

Delivery terms

Delivery terms clarify how products are shipped, transferred, and managed in transit.

  • Shipping terms (e.g., FOB, EXW): These terms define where the risk and title of goods are transferred from the manufacturer to the buyer.
  • Chain of custody: Specifying the chain of custody and transfer of title minimizes risks of loss or damage during transport.

Key insight: Evaluate delivery terms based on logistics capability and customer location. Free On Board (FOB) terms can offer control for buyers managing transport; Ex Works (EXW) terms may suit manufacturers by transferring responsibility earlier.

Customs and import/export compliance

Compliance with international trade regulations is crucial to prevent legal liabilities.

  • Documentation and classification: Assign responsibility for managing customs documentation and classifying goods.
  • Duties and compliance: Specify who is responsible for import/export duties and taxes to avoid unexpected expenses.

Key insight: Work with customs compliance experts to manage regulations across different jurisdictions, ensuring that each party’s responsibilities are well-defined and prevent delays at customs.

Pricing

Pricing terms provide financial stability and avoid unexpected costs.

  • Pricing structure: Define base pricing, volume discounts, and notice periods for price adjustments.
  • Adjustment clauses: These should allow for price changes based on factors like material cost increases, with specified advance notice.

Key insight: Use pricing structures that reflect the supply chain volatility. For example, consider a semi-annual review of pricing terms in markets with high material cost fluctuations.

Payment terms

This term sets clear expectations for payments, reducing cash flow risks.

  • Milestone payments: Specify when payments are due and whether they are tied to milestones, such as deposit upon order and final payment upon delivery.
  • Late payment penalties: Establish penalties for late payments to ensure timely transactions.

Key insight: Choose payment terms that balance cash flow needs. Early payments or deposits can assist manufacturers with production costs, while extended credit terms can support the buyer’s liquidity.

Product quality and inspections

Clear quality standards are vital to meet customer expectations and avoid costly returns or recalls.

  • Quality standards: Define acceptable defect rates and required certifications (e.g., ISO standards).
  • Inspection rights: Grant the buyer inspection rights to verify production standards before dispatch.

Key insight: Implement regular inspections and quality benchmarks. Random inspections ensure standards, and predefined defect rates reduce production disputes.

Warranties

Warranty provisions protect the buyer if products do not meet quality standards.

  • Warranty period and coverage: Specify the warranty period and coverage for product defects.
  • Remedy for defects: Define how defects are handled, such as through repair, replacement, or credit.

Key insight: Extend warranties based on product lifecycle and buyer needs. Warranties should align with the typical lifecycle of the product to ensure customer satisfaction.

Molds and tooling

Ownership of molds and tooling is crucial for high-cost or proprietary products.

  • Ownership and maintenance: Specify who owns the molds and is responsible for their maintenance and replacement.
  • Cost allocation: Determine if the cost of molds is amortized over time or paid upfront.

Key insight: Secure ownership rights for proprietary molds. For unique products, buyers may want ownership of molds to retain control over designs.

Intellectual property (IP) rights

Protecting IP rights is essential to safeguard designs, trademarks, and proprietary methods.

  • IP ownership: Outline ownership of IP, typically favoring the buyer for proprietary products.
  • Usage restrictions: Limit IP use to the scope of the manufacturing agreement to prevent unauthorized reproduction.

Key insight: Clearly outline IP rights in every jurisdiction. Use legal counsel to safeguard IP rights in both the buyer’s and manufacturer’s countries.

Insurance

Insurance protects both parties against potential liabilities and product risks.

  • Coverage requirements: Specify insurance types like general liability and product liability, and set minimum coverage amounts.

Key insight: Evaluate coverage adequacy based on product type and market requirements. High-risk products may need increased liability insurance to mitigate potential damages.

Limitations of liability

Limiting liability is a way to protect both parties from excessive claims.

  • Exclusions and liability caps: Define exclusions for indirect damages and set financial caps to prevent excessive claims.

Key insight: Set caps based on estimated losses. Consider maximum damages relative to typical order values and liabilities.

Indemnification

This clause assigns responsibility for claims arising from defects, IP infringement, or other issues.

  • Indemnification scope: Define each party’s indemnity responsibilities, especially concerning IP infringement and product liability.

Key insight: Assign indemnity clauses with expert guidance. Use legal expertise to determine fair indemnity scopes, ensuring protection from unintended risks.

Confidentiality and NNN provisions

Confidentiality protects proprietary information and prevents unfair competition.

  • Non-disclosure, non-use, and non-circumvention: These NNN provisions prevent unauthorized use or sharing of confidential information.

Key insight: Confidentiality terms should be enforceable in relevant jurisdictions. Consider confidentiality clauses enforceable in both domestic and international markets.

Termination rights

Termination provisions outline conditions for contract exit, ensuring both parties have defined options.

  • Termination conditions: Set voluntary termination options and specific conditions for immediate termination in cases of significant breach.

Key insight: Allow both parties exit flexibility. Include terms for smooth transitions if termination becomes necessary due to unforeseen events.

Dispute resolution

A well-defined dispute resolution mechanism prevents prolonged legal conflicts.

  • Resolution process: Define preferred methods like mediation, arbitration, or litigation, and set the jurisdiction.
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Key insight: Use arbitration to reduce costs and time in dispute resolution. Arbitration in a neutral location can prevent long legal proceedings.

By understanding and negotiating these essential terms, companies can formalize agreements that support smooth operations, mitigate risks, and foster long-term, successful relationships. Tailoring each term to specific needs ensures that both buyers and manufacturers are aligned, enabling them to maximize efficiency and collaboration in international manufacturing.

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Advisory for investors and international suppliers doing business in India

Manufacturing suppliers and investors doing business with stakeholders in India should consider incorporating the following best practices into their international manufacturing agreements:

Risk mitigation strategies

  • Supply chain resilience: Incorporate flexibility in the agreement to adapt to potential disruptions such as natural disasters, geopolitical issues, or pandemics. This could include force majeure clauses and alternative supply arrangements.
  • Diversification of suppliers: Encourage manufacturers to build a network of alternate suppliers for critical components to ensure continuity in case one source faces issues. This reduces dependency on a single supplier and mitigates risk.

Government policies and compliance

  • Make in India incentives: Indian manufacturers should stay updated on government policies such as the Make in India initiative, which promotes local manufacturing. Agreements should include clauses related to compliance with domestic manufacturing policies and incentives, potentially lowering operational costs for foreign investors.
  • Local regulatory compliance: Ensure that all manufacturing practices comply with the Indian government’s latest environmental, labor, and safety regulations. Failure to do so could result in costly penalties or disruptions. Both parties should agree on local law compliance, especially regarding labor laws and environmental standards.

Sustainability considerations

  • Green manufacturing practices: As part of the global push for sustainability, international manufacturing agreements should incorporate sustainability clauses that require manufacturers to use environmentally friendly materials and processes. These may include energy-efficient operations, waste reduction practices, and sustainability certifications like ISO 14001. ISO 14001 is a set of standards developed by the International Organization for Standardization (ISO). It outlines best practices for organizations aiming to minimize their environmental impact by implementing an effective environmental management system (EMS).

India’s Central Consumer Protection Authority (CCPA) has issued guidelines aimed at preventing greenwashing and misleading environmental claims. These guidelines mandate that companies substantiate their environmental claims with credible evidence, ensuring transparency and accuracy in their advertising. Greenwashing refers to the practice of falsely claiming environmental benefits or using vague terms like “eco-friendly” without substantiation. The guidelines prohibit such misleading practices and require companies to provide clear disclosures about the environmental aspects of their products, such as manufacturing processes or packaging. Third-party certifications and reliable scientific evidence are encouraged to support claims. The goal is to promote genuine environmental responsibility and protect consumers from deceptive marketing.

  • Circular economy clauses: Consider including clauses for product take-back programs or recycling efforts, especially if the product is prone to obsolescence. This can be an attractive selling point for buyers looking to align with sustainability trends.

Technology integration and innovation

  • Smart manufacturing and automation: With the growing importance of Industry 4.0, ensure that the agreement includes provisions for technology upgrades. Manufacturers in India should adopt smart manufacturing solutions, which can enhance production efficiency and product quality. Such clauses ensure that both parties remain competitive.
  • Innovation sharing: If the buyer has proprietary manufacturing techniques or innovations, the agreement should clearly define how intellectual property will be shared, protected, and monetized. Additionally, provisions for co-developing new products or processes can be a strong value proposition.

Dispute resolution and arbitration framework

  • Neutral arbitration centers: For international agreements, especially when dealing with parties from different jurisdictions, it is crucial to define a neutral arbitration center for dispute resolution. India offers several arbitration institutions that are recognized internationally, such as the Indian Council of Arbitration (ICA). This is a crucial factor to consider, as legal disputes in India can often be protracted. Establishing effective strategies and alternative dispute resolution mechanisms in advance is essential for maintaining operational stability and minimizing legal expenses.

Section 8 – Power of Court to Refer the Parties to Arbitration

Section 8 of the Arbitration and Conciliation Act, 1996 mandates that if there is an arbitration agreement between the parties and a dispute arises within the scope of that agreement, the judicial authority must refer the matter to arbitration. This provision applies when either party initiates legal proceedings.

The 2015 amendment expanded this provision by ensuring the court refers the parties to arbitration regardless of any court orders or judgments. To invoke arbitration, the party must notify the judicial authority about the arbitration agreement before submitting the first statement on the substance of the dispute.

Key elements of Section 8 include:

  1. A valid arbitration agreement between the parties.
  2. The dispute must be one that is subject to the arbitration agreement.
  3. The party must invoke the arbitration clause before submitting the first statement.
  4. The party seeking referral must provide the original or certified copy of the arbitration agreement.

  • Multi-tier dispute resolution: Implement a tiered dispute resolution mechanism, starting with amicable discussions and escalating to arbitration if needed. This approach allows both parties to resolve issues quickly without resorting to lengthy and expensive legal processes.

Cost control and payment security

  • Currency exchange management: Since international contracts may involve cross-border payments, a clause that addresses currency fluctuations and payment terms in stable currencies (such as USD or EUR) can prevent unexpected costs due to exchange rate volatility.
  • Escrow accounts for payments: To ensure that both parties fulfill their financial obligations, consider using escrow accounts for milestone payments. This adds an additional layer of security for the buyer and guarantees that the manufacturer has the funds needed to complete production.

Supplier relationship management

  • Performance metrics and KPIs: In addition to defining quantities and forecasts, establish performance metrics and KPIs that will be used to assess the supplier’s performance regularly. These metrics could include on-time delivery, quality standards, cost management, and responsiveness to demand fluctuations.
  • Supplier development programs: Consider including a clause for continuous improvement, where both parties agree to work together on enhancing production efficiency, reducing defects, and innovating products. Suppliers may benefit from training and development programs offered by buyers.

Cultural and communication considerations

  • Cultural sensitivity in operations: Foster an understanding of cultural differences in business operations, particularly in communication and decision-making. This is important for manufacturers and investors entering the Indian market, as a culturally aware approach can streamline negotiations and prevent misunderstandings.
  • Clear communication channels: Establish clear communication protocols for both parties, ensuring transparency in decision-making and problem-solving. Designate specific individuals or teams for key communications to avoid delays or misinterpretations in product orders and requirements.

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India Briefing is one of five regional publications under the Asia Briefing brand. It is supported by Dezan Shira & Associates, a pan-Asia, multi-disciplinary professional services firm that assists foreign investors throughout Asia, including through offices in Delhi, Mumbai, and Bengaluru in India. Readers may write to india@dezshira.com for support on doing business in India. For a complimentary subscription to India Briefing’s content products, please click here.

Dezan Shira & Associates also maintains offices or has alliance partners assisting foreign investors in China, Hong Kong SAR, Dubai (UAE), Indonesia, Singapore, Vietnam, Philippines, Malaysia, Thailand, Bangladesh, Italy, Germany, the United States, and Australia.