A primer on contract manufacturing contracts

Dietary supplement brands can create several types of contracts with their contract manufacturer, but they must ensure all provisions and details cover their specific operations.

Robin Koon

June 4, 2018

7 Min Read
A primer on contract manufacturing contracts

“I have signed a lot of contracts in my time, and at some time, I probably knew what the contracts meant, but six months later everything had grown dim, and I could be certain of only two things, to wit: One, I didn't sign any contract; two, the contract means the opposite of what it says.”—Mark Twain

In the dietary supplement industry, many marketers/sellers outsource their manufacturing to a third party. These marketers, or “own-label distributors," may know little about how their dietary supplements are manufactured, nor the regulatory environment involved in today’s marketplace setting. FDA holds marketers/sellers of dietary supplements directly responsible for compliance with cGMPs (current good manufacturing practices), despite outsourcing the product manufacturing.

Sellers/marketers/distributors need to establish their own internal quality systems, including, for example, having the personnel and guidance documents—standard operating procedures (SOPs), which define quality control (QC) responsibilities, product specifications, vendor qualifications and training. Creating a contract with a supplier becomes essential for compliance; it’s a tool companies use to safeguard their resources.

The importance of contracts

Written contracts provide businesses (and individuals) with a legal, printed document stating the expectations of both parties and how to handle negative situations when they arise. They clarify the business relationship and the scope of work so no one party can claim any lack of misunderstanding. Contracts also are legally enforceable in a court of law.

Most contracts only need to contain four essential elements to be legally valid:

  1. An offer

  2. Acceptance by all parties

  3. An intention to create a legal relationship

  4. A consideration (usually money)

Contracts can be verbal (spoken), written or a combination of both. Written contracts may consist of a standard form agreement or a letter confirming the agreement. Verbal agreements rely on the good faith of all parties and can be difficult to prove. It is advisable (where possible) to make sure business arrangements are in writing to avoid problems when trying to prove a contract existed. Regardless of whether the contract is verbal or written, it must contain the four essential elements to be legally binding.

Difference between a contract and an agreement

Many people use the terms "contract" and "agreement" interchangeably, but they are not actually the same thing. All contracts are an agreement, but not all agreements are contracts. An agreement that is enforceable by law is called contract. Agreements may be anything legal or illegal or unlawful between the parties, but contract cannot be unlawful or illegal. The basic difference between contract and agreement is that the remedies for either breach of contract and breach of an agreement are different. A contract starts when there is an offer and acceptance, whereas it is not necessary for an agreement to be started from offer and acceptance. For example, a gentlemen’s agreement is not enforceable by law whereas a contract can be enforceable by law.

A contract is a written or verbal formal agreement enforceable by law for doing or not doing an act. A contract must contain these elements: offer and acceptance, adequate and unconditional consideration, free consent, capacity, lawful object, certainty and intention of creating legal obligations, and the agreement should not be declared void. The contract may be oral or written. It is not illegal to enter into a contract that doesn't have these essential items. If an essential item is missing, however, the contract cannot be enforced by a court.

What types of contracts are there?

Contracts are one of the most common legal transactions used in business. The general types are:

  • Implied contract—Where the actions of both parties indicate a mutual intent to enter into a contract. A written or verbal agreement is not necessary. An implied contract must have an unequivocal offer, an unequivocal acceptance, mutual intention to be bound, and also consideration.

  • Express contract—Contracts that most people are familiar with. Promises are communicated either orally or in written format.

  • Bilateral contract—A mutual agreement where each of the involved parties agrees to perform an act.

  • Unilateral contract—When a person accepts an offer by performing a specified act.

Types of contracts used in contract manufacturing

The types of contracts supplement brands typically use for contract manufacturing are either express or bilateral contracts. Examples include:

  • Non-disclosure agreement (NDA), confidentially agreement (CA) or confidential disclosure agreement (CDA)—A contract where the parties agree not to disclose information covered (listed in the agreement). It outlines confidential material, knowledge or information that the parties wish to share with one another for certain purposes, but wish to restrict access to or by third parties. An NDA creates a confidential relationship between the parties to protect confidential and proprietary information, or trade secrets.

  • Manufacturing agreements—A written manufacturing agreement is between a manufacturer and a client for the manufacture of goods and services. Manufacturing agreements can be complex and typically involve in-depth negotiations. They usually contain provisions specific to ordering procedures like general business terms and conditions, confidentiality, pricing, purchase orders, forecasts, schedules, cancellations, product specifications, material components (raw materials, and excess and obsolete inventory), insurance (product liability), indemnification and limitation of liability, intellectual property (IP) ownership, shipping (delivery terms and risk of loss), payment terms, warranties, recalls and/or epidemic failures, etc. The supply agreement removes misunderstandings of how goods and services will be ordered and delivered.

  • Supply chain agreements (supply agreements)—Supply contracts are part of the process of procuring goods in manufacturing and retail industries. Suppliers and manufacturers differ in their functions. Suppliers supply the products and/or services, and manufacturers produce and manufacture the products and/or services. A supply chain consists of the entire infrastructure getting a product in the hands of a customer. Supply chain contracts ensure business continuity and cost control, and try to avoid critical threats posed by potential supply chain problems. 

  • Quality agreements (QAs)—Quality agreements are comprehensive, written documents that define and establish the quality responsibilities each party has in following GMPs. The agreement clarifies which GMP activities are to be carried out by each of the parties. It also sets the specific quality parameters for a product. A quality agreement should cover scope, product specifications, raw material specifications (and sometimes specific suppliers), product testing, documentation and records, change control, deviations, re-work (reprocess, batch adjustments, retests, etc.), quality issues resolutions, audits, complaints/recalls/adverse event reports (AERs), SOPs, quality responsibilities table, etc.

  • Purchase orders (POs)—POs are a type of contract. When a seller (a.k.a., supplier, vendor, etc.) accepts a purchase order, a legally binding contract is formed between the two parties. The Uniform Commercial Code (UCC) provides that a contract for the sale of goods may be made in any manner sufficient to show agreement, and that "an order or other offer to buy goods for prompt or current shipment shall be construed as inviting acceptance either by a prompt promise to ship or by the prompt or current shipment of conforming or non-conforming goods."

  • Toll manufacturing agreements—In toll manufacturing, one company owns and provides raw materials (or semi-finished goods) to a third party, which provides the rest of the services (manufacturing). A tolling agreement is a written, legal agreement that sets the terms and conditions, as well and the responsibilities and liabilities, of both parties.

  • Licensing agreements—A licensing agreement allows an IP holder to make money on its invention or creation by allowing someone else to use it. The license agreement outlines terms such as the use of exclusivity, restrictions, logos, payment and on reproduction.

Typical contract provisions

Many contracts may also include special types of provisions or clauses. Examples of these are confidentiality, duration, duties and obligations, representations and warranties, insurance, indemnity (indemnification) or limitation of liability, remedies, terminations, mergers, waivers, dispute resolutions (e.g., arbitration), jurisdiction, force majeure (acts of god), IP ownership, modifications, etc.

Tips for contracts

The contract formation process varies widely, as does the type of contract. Contracts can be formed quickly in face-to-face meetings, or after teams of attorneys have spent months in negotiations.

Here are some general tips for all types of contracts:

  • Write it down.

  • Make sure each party is comfortable with its obligations.

  • Be aware of Murphy's Law (anything that can go wrong will).

  • Cover all options (don’t leave anything out).

  • Use clear language and understand the meaning of the words (terms).

  • Use consistent terms, and define ambiguous terms.

  • Read it before signing.

Robin Koon is executive vice president at Best Formulations, and has more than 35 years of pharmaceutical experience in clinical pharmacy, as a retail drug chain executive, in managed-care and in manufacturing.

About the Author(s)

Robin Koon

Robin Koon is executive vice president at Best Formulations , and has more than 35 years of pharmaceutical experience in clinical pharmacy, as a retail drug chain executive, in managed-care and in manufacturing.


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