What is a Toll Manufacturing Agreement?
A toll manufacturing agreement is essentially a contract between a manufacturer and a toller. A toll manufacturing agreement between a manufacturer and a toller describes the services a toller will provide to a manufacturer. A toll manufacturing agreement is in the form of a sales contract in which the terms of sale of goods are outlined for a toller to follow.
Toll manufacturing agreements are more common in specific industries, such as the pharmaceutical and chemicals industries. In these industries, for example, large pharmaceutical companies often outsources the production of their products to a third-party toller, as tolling manufactures are more suited for mass production of a product.
Both tollers and manufacturers have their own machinery suited for the purpose of mass-producing certain products. By outsourcing the production it is possible to save time and money in the development of new products. It makes more sense for a business that lacks the necessary machines and expertise for sufficient production to outsource the process to a manufacturer that specializes in the product. Additionally, the specialisation of the toller means more savings in terms of costs , as they can buy materials in bulk. Furthermore, by outsourcing production a business can save a substantial amount of money on machinery and labour.
There are many other reasons for a toll manufacturing agreement to be put in place. A toll manufacturing agreement is developed to protect both the manufacturer and the toller. For instance, if the agreement is not put in place, the toller may be seen as an employee of the manufacturer. This could result in the manufacturer being responsible for the toller’s insurance, government taxes, and other enterprise costs. The toller, on the other hand, may be seen as an independent contractor, responsible for their own insurance and other costs.
A toll manufacturing agreement provides clarity for the parties as to what is expected of each party. When a toll manufacturing agreement is not in place, it can be difficult to outline what each party is responsible for. An agreement also provides certainty to both parties, as breaching the agreement would result in losses for either party. A toll manufacturing agreement, therefore, helps reduce the chances of litigation.
Fundamental Elements of a Toll Manufacturing Agreement Template
Essential elements of a toll manufacturing agreement:
Parties to the Agreement – Much like any other contract, parties must be clearly defined. Clearly identify the Parties with Details including the name, address, and contact information of the parties to the agreement.
Scope of Work or Deliverables – A clear and concise description of the work to be performed allows both parties to understand what is expected out of this agreement. Typically this clause will include a description of the specific activities to be performed and outline the expected timeline.
Payment Terms – Defining the commission structure for each party is arguably the most important clause in a Toll Manufacturing Agreement. The Parties need to address how the toll maker will be paid and whether the toll maker will be compensated proportionately for the services provided on a set schedule or whether there will be a final payment upon completion.
Limitation of liability – Oftentimes, depending on the type of goods being produced or for the size of the deal, the Parties may consider limiting the agreement in terms of financial responsibility. We recommend that the agreement be limited to the reasonable costs created by the contractor’s breach of contract or negligence, which for most is capped at the total amount of money the business pays the contractor.
Term and Termination clause – Establishing the term of the agreement will give the Parties an end date to work towards. The terminating clause is a very important clause to consider. This clause typically requires the parties to provide reasonable notice prior to terminating the contract.
Confidentiality – If necessary, a confidentiality clause should be included to define the confidential relationship between the Parties, and to ensure that the confidential terms of the agreement remain protected and viewed only by those who need to know.
Transferability – Keep in mind that transferring the rights and responsibilities of the agreement to another party requires both parties to consent to the change. Establishing the transferability rights early on will save the Parties time and money when and if one wants to leave the agreement.
Agreement to Agreement in Writing – Make sure you obtain a written agreement that is executed by all Parties.
Advantages of a Toll Manufacturing Agreement
Businesses can reap many advantages when using a toll manufacturing agreement. Cost is often the key concern for a business looking to manufacture products without unnecessary expenses. Using a toll manufacturer is often very cost effective, especially if the product you are selling and or distributing is somewhat seasonal. If you choose to use a third party toll manufacturer, your company will not need to purchase a large amount of equipment. Since you are sharing production with other companies, the manufacturer’s facility already is equipped for mass production of your product. So, in addition to a vote of confidence into third parties being able to produce your product to your specs, share a manufacturing space and load, and save money on space and utilities. The final cost advantage is that a toll manufacturer already has employees trained to operate the equipment needed for your mass production. The lack of staffing expense is a huge advantage for new manufacturing companies.
Another big advantage to a third party toll manufacturer is their flexibility. Due to the increasing importance placed on customer service, today’s manufacturers are looking for more ways to offer more freedom to their clients. So, what does this mean for you?
If your manufacturing run will end at specific interval, the company’s workload may allow you to use their facilities with less than a full load. For example:
Today’s third party manufacturers tend to be able to adapt to your needs more now than a manufacturer could thirty years ago.
The final big advantage of using a third party is that the manufacturer can focus their time on their core competencies. By not focusing on your company’s product, it can spend its time focused on what they do best, which enables them to save you money and time.
Toll Manufacturing Agreements: Frequently Seen Clauses
The following is a list of the key clauses that are standardly found in toll manufacturing agreements:
Confidentiality: Many toll manufacturing agreements will include confidentiality provisions. This is done to protect the Company’s confidential information and trade secrets, as well as to protect the Manufacturers from divulging the Company’s information to any other clients who may be requesting similar services from the Manufacturer.
Liability: Often, toll manufacturing agreements include exculpatory language or indemnification clauses, which limit the liability of one over the other. These provisions restrict the types of damages that one party can claim against the other; however, be advised that it is customary to limit only those damages that are not the result of gross negligence or willful misconduct. Therefore, parties should be careful about relying on these language when liability is incurred.
Quality Control: Often, both the Manufacturer and the Company want a say about how the product is manufactured. Therefore, there will often be clauses that address where the Manufacturer must follow the parameters set forth in the Company’s proprietary specifications, and clauses that allow for the Manufacturer to offer input on different ways to manufacture the Company’s products. It is not uncommon for there to be some conflict between these two sections of the agreements, so one should be careful about drafting these provisions in such a way that both the companies’ needs are met.
Termination: These agreements frequently contain two types of termination provisions. First, termination provisions that allow for either party to terminate the agreement for any reason upon the provision of a specific amount of notice (usually 30-90 days, depending on the circumstances). Next, these agreements will usually have provisions that allow for immediate termination for various causes (which may include, but are not limited to: failure to comply with the operating and delivery schedule set forth by the Company, the Manufacturer’s bankruptcy or insolvency, repeated delivery non-compliance by Manufacturer, or other causes agreed upon by the parties).
How to Create a Toll Manufacturing Agreement Template
1. Identifying the Parties
It is crucial to begin the agreement by clearly identifying the relevant parties. For example, "This Toll Manufacturing Agreement ("Agreement") is entered into as of [date] (the "Effective Date") between [Company 1 name], a [State] corporation with offices located at [Company 1 address] ("Supplier"), and [Company 2 name], a [State] corporation with offices located at [Company 2 address] ("Customer")." Any alternative names or short names used for the parties throughout the Agreement should be clearly defined here.
2. Scope of Services
The agreement should clearly define the scope of services to be provided, which can be done in several ways. If the scope of services is straightforward or relatively self-explanatory, it may be sufficient to describe the scope of manufacturing services in brief, but sufficiently detailed terms. If so, it is always better to include a detailed schedule of the specific products that the Supplier will manufacture (including specifications). This may also be evident from the Customer’s purchase orders.
3. Pricing and Payment Terms
All relevant pricing and payment terms should be identified in the agreement. For example, the agreement may state: "The price of manufacturing shall be determined based on the Services performed by the Supplier, as set forth on a mutually agreed-upon Purchase Order ("P.O.") to be issued by the Customer from time to time." If applicable, the agreement should also address any applicable licenses or royalties to be paid for the use of intellectual property owned by Supplier or any third party.
4. Warranties and Liabilities
All relevant warranties and liabilities should be identified in the agreement . For example, the agreement may state: "Supplier warrants that all Goods will conform to the relevant specifications, as reflected on the relevant P.O., and that all Goods will be free from defects in material and workmanship. In the event of any non-conformity to the specifications or any defect in material or workmanship of the Goods, Supplier will promptly as its option, upon supplier’s receipt of a written notice of exercise from Customer, either replace or repair said Goods at Supplier’s expense. As Customer’s sole and exclusive remedy for any breach of this warranty, all costs of labor and material required to remove rejected or defective Goods and to install replacement Goods shall be borne by the Supplier, and normal office and overhead expenses shall be borne by the Customer."
5. Term and Termination
The agreement should include a reasonable term and termination clause. Both parties should agree on a reasonable time for the completion of services and the termination date. It may also be relevant to include a termination clause that governs how either party may terminate the entire agreement. For example, "This Agreement shall continue for a period of [number of months or years] from the Effective Date of this Agreement, unless sooner terminated by either party on [number of days] days’ written notice, with or without cause."
6. Miscellaneous Terms
Finally, it is important to include any standard miscellaneous clauses and terms, such as any language related to: dispute resolution (i.e. any required alternatives to litigation); governing law; notice; and any amendments, waivers or assignability of the agreement.
Regulatory and Legal Background
Toll manufacturing agreements must comply with a number of legal and regulatory considerations, including the enforceability of contracts in general, the enforceability of specific provisions in a contract, intellectual property considerations, and industry-specific regulations.
Contract Enforceability
Courts will not enforce an unconscionable contract. In most jurisdictions, in general, a court will not enforce a contract against a party who did not receive meaningful consideration. Thus, a contract may be unenforceable if the party did not receive anything of value in exchange for its performance or not obtaining the other party’s consent to the contract.
Contract Challenges
A party may also challenge the enforceability of a contract on the grounds that the contract should be void based on a lack of capacity, illegality, the statute of frauds, or an unconscionability doctrine. Capacity should not be an issue in toll manufacturing agreements. However, if the contract is contrary to public policy or if it is illegal, then the court may refuse to enforce it on those grounds. Additionally, if a contract does not meet the statute of frauds, the court may also find it to be unenforceable.
Industry Specific Regulation
Certain industries have specific regulatory requirements, such as the food, drug, and cosmetics and hazardous waste industries. СНС, Inc. v. HTC Global Services Inc., 802 F. Supp. 2d 1000, 1005 (S.D. Ind. 2011). Courts generally find it against public policy to enforce a contract that violates an industry-specific regulation, as well as a court being permitted, in some jurisdictions, to refuse to enforce a contract that violates a regulation relevant to protecting consumers, health, safety, or public morals.
Modifying a Toll Manufacturing Agreement Template
A generic toll manufacturing agreement template establishes the baseline framework for the parties’ rights, responsibilities, and release of claims. However, each transaction is unique, requiring businesses to customize the terms of its toll manufacturing agreement template to reflect their specific agreement. Among the various terms that are typically altered, or added, in a toll manufacturing agreement template are the following:
• Equipment vs. Services. A toll manufacturing agreement template will generally set forth whether the toll manufacturer is manufacturing the toll products using the toll manufacturer’s equipment or providing tolling services using the toll customer’s owned or leased equipment.
• Product Development. Many businesses’ toll manufacturing agreement templates require the toll manufacturer to develop new products on behalf of the toll customer. In such situations, how the costs of developed products are borne and the ownership of the intellectual property should be addressed in the customized agreement.
• Exclusivity. Formalizing the agreement’s exclusivity will help avoid future disagreements. For example, a toll manufacturing agreement template can be customized to exclude certain customer cancellations or terminations from the exclusivity period.
• Capacity Payments. If either party requires the other to commit to purchasing minimum amounts, capacity payment clauses can help protect each factory’s manufacturing costs. Capacity payment provisions also can help ensure the viability of the contract for both parties.
• Revenues. If the contract requires either party to share revenues, the agreement’s template can be modified to include revenue sharing and costs allocation provisions.
• Insurance. If either party requires the other to carry adequate liability coverage, their respective insurance provisions should be customized.
• Price Adjustments. Contracts that last for extended periods of time should anticipate price increases by including a price adjustment provision.
• Credit. If more than one business is involved, the creditworthiness of each participant should be carefully considered and factored into the customized agreement.
An experienced contract attorney can help businesses navigate the industry-specific and unique terms necessary for their business transactions.
Final Thoughts: The Significance of Toll Manufacturing Agreements
In conclusion, toll manufacturing agreements are a fundamental element in the manufacturing and supply chain processes for myriad businesses. The templates provide an efficient and cost-effective way to create both consistency in the industry and legal safeguards for individual companies. By using a template , businesses can create highly customized agreements that ensure compliance with both state and federal laws, while also specifying the terms of their relationship with the manufacturer. As manufacturing continues to be a key sector for many economies, implementing a well-drafted toll manufacturing agreement is essential for successful business operations.