In Part 1 of this series, we discussed how the increasing complexity of products made overseas via product outsourcing has led to a corresponding increase in the complexity of the molds for those products and required our international manufacturing attorneys to draft contracts that protect our clients’ IP within those molds, both against third party mold fabrication shops and the product outsource factories themselves. In Part 2 of this series, we discussed mold IP issues that arise with third party mold fabrication shops. In this, Part 3, we will discuss the sorts of issues our manufacturing lawyers see with foreign (primarily Asian, Eastern European and Latin American) manufacturers on mold issues.
The foreign outsource manufacturer has produced a series of molds for a product for its foreign buyer. Now that the product has become commercially successful, we often see the following three basic problems arise:
- The foreign product manufacturer announces a substantial increase in the price of the product. This is often a surprise to the foreign buyer, who had expected the per unit price of the product to go down as production increased.
- The foreign outsource product manufacturer is not able to keep up with increased production requirements. This is often a surprise to the foreign buyer, who had been assured by the foreign manufacturer that it had ample capacity for any scale of orders.
- The stress of increased production demand causes the quality level from the foreign manufacturer to progressively decline, reaching unacceptable levels. This is often a surprise to the product buyer, who had expected quality to improve over time.
In response to these issues, the foreign buyer gives notice to its foreign outsource product manufacturer that it intends to move production to a different manufacturer, often a direct competitor of the current manufacturer. In the past, the issues that arose at this stage mostly focused on ownership of the physical molds. This issue can be resolved by a relatively simple mold ownership agreement. See Product Molds And Tooling : Three Things You Must Do to Hang on to Yours.
However, with all the recent turmoil and movement in international outsourced manufacturing, we have seen factories make arguments (like those below) that render the situation far more complex:
- The outsource product factory says: “It is true you paid us to make the molds, but that fee covered only our material costs and the time involved. We also spent a lot of time and money on the CAD drawings and the related specifications required to fabricate the molds and we also spent additional engineering time integrating the molds into our production process so before you can take the molds, you must compensate us for these costs.” Then the factory provides an unreasonably high invoice for those costs and if you do not pay the invoice, the factory will continue to hold your molds hostage. This has become a fairly standard practice in outsource manufacturing, particularly in southern China. It is therefore essential for product designers/buyers to make clear with an enforceable written contract that its payments for molds include both design and fabrication costs and — most importantly — that no additional payments will be required when the foreign buyer seeks to take possession of the molds.
- The outsource product factory says: “You do own the molds and you can take them whenever you want. However, because we did the mold design work we own the design embodied by the molds. We will give you a limited license to use the molds for production in another factory, but you may not copy the molds and we retain the right to copy and use the mold design for our own production and to provide copies of the molds to third party factories for their own production. The only thing you own is the physical object. You do not own anything else.”
- The outsource product factory says: “We did all the mold design work so we own the mold design and we registered a design patent in the molds. It does not matter that you paid us for the molds because we invented them and our design patent protects us. You can have the physical molds, but if you want to use those molds for production at a different factory, you must pay us a royalty fee.” This royalty is then quoted at a price so hight that you cannot economically have your product produced at a third party facility. Many country’s laws (especially in Asia) legally support this
The more honest factories make the situation clear. The foreign buyer pays for fabricating the mold, but that payment does not give it any ownership interest in the molds. The factory does the mold design work and it owns the molds, but will agree to use the molds only for producing the product for the foreign buyer. However, the foreign buyer has no right to move the molds to any other factory. Some factories will say that you are free to make new molds at your new factory, but some will assert ownership to the mold design and not allow you to have copies made at the new factory. In other words, the factory is essentially telling you upfront that it intends to hold you hostage by guaranteeing that you cannot go to any other factory as an alternative manufacturer for your product. By holding the product buyer hostage, the factory is free to raise its price or deliver your products late or produce defective products. You are pretty much trapped with no real leverage for dealing with the issues.
Why would a company sign a contract that essentially turns over its product to its manufacturer? Because they do not realize what they are signing, oftentimes because what they are signing is in a foreign language they don’t understand and do not get translated. Other times they simply do not understand what they are signing no matter the language. Sometimes they tell us they thought this sort of thing was “standard.” This mistake is shockingly common and just about every week we get contacted by a company that has fallen prey to this. These contacts usually happen at one or two critical points in the process and in part 4 of this series we will discuss these two points in the process and how we typically seek to remedy the mistake at each point.
Product designers and buyers need to learn how to protect their molds and their mold designs. The simplest way is via enforceable written contracts that provide protection. At the most basic level, however, the key is to be able to recognize when a factory is intending to hold your molds “hostage” and to then and there do a cost-benefit analysis of whether it makes sense to proceed or walk away.