Persatuan Alumni AOTS Malaysia

C O N T E N T S

President's Message

List of PAAM new members

JB Branch -List of new office bearers

Kaizen

FOSAAS Organization Chart

HIPPO Homestay in Japan

Vital Business Tools for Manufacturing Industries

PAAM / AOTS's members business networking

Contract Manufacturer or Competitor in the Making?

Tea Talk - Post AFTA

HIPPO Advertisement and Japanese Language Program

18th. Annual General Meeting

PAAM / AOTS’s members business networking An Avenue for a Better Business Community
	With the recent launching of PAAM/AOTS’s JCB cards, we of the PAAM’s Entrepreneur Sub-committee is planning to add value to the JCB card link. We are now negotiating with Southern Bank (SBB) for special merchant packages meant only for our members. By doing this, you, the entrepreneur can then gain the added exposure to not only PAAM members but that of all SBB/JCB cardholders. So take this opportunity to register with us by sending us an e-mail or fax to thefollowing address : PAAM/AOTS secretariat for the business network e-mail: sec@aots.org Fax: 03-7728 2348 For more details, please contact : Eric Koh at vpresident@aots.org For registration, please provide us the following: Company name: Address: Tel: Fax: Contact person: submitted by:

...........................Contract Manufacturer

or Competitor

In the Making?.............................................

Avoid the pitfalls
When a manufacturer has excess production capacity and the capability, it may enter into a contract manufacturing agreement with a third party to manufacture similar products for the third party. Conversely a marketer of a product who may not have manufacturing facilities or who may not have sufficient manufacturing facilities, would engage the services of a manufacturer to contract manufacture the product for it. Contract manufacturing is a symbiotic relationship beneficial to the entity that commissions the contract manufacturing and the manufacturer. What appears to be a beneficial ”win-win’ relationship between the parties can turn into a nightmare If due care is not given to the terms of the relationship.

Many contract manufacturing agreements/arrangements (’CMA’) are not well thought out ’A’ who is a manufacturer or a distributor of a product ’X’ approaches manufacturer B, shows him product ’X’ and asks whether ’B’ can manufacture Y quantities of product ’X’ according to a pre-determined delivery schedule. This is done probably after A is satisfied that B has the technical and manu-facturing capability to manufacture product ’X’. The arrangement would normally stipulate that ’B’ is to make product X exclusively for A and for no one else. In addition ’B’ is not to sell product X by itself or through its agents. If product X is not a standard type of product made by B then A would provide technical know-how, technical data, mould drawings and possibly some trade secret and other information to B. The contract usually will provide that after the CMA is terminated B is not to make or sell product X and that A will buy back all finished or partially finished product X. Are these clauses alone sufficient to protect all the interests of A?

The contract manufacturer B after a period of time of manufacturing product X for A learns of the following: -
- the gross profit margin of producing and marketing X (the selling price is often public knowledge or is easily ascertainable by appropriate enquiries, the cost of manufacture is known to B);
- the market demand for product X;
- the customers or potential customers for product X;
- the full details of the manufacturing know-how;
- has a new idea as to how improve product X or reduce the unit cost of manufacture of product X.

In short, B is now ready to launch an improved version of product X or a competitive product into the market in direct competition against A. B has armed himself to launch an assault against A. A is probably in a very vulnerable position in comparison to B who has all pertinent details of A unlike other competitors of A. Alternatively B would also be in position to sell this valuable information on product X including the cost of manufacture, selling price, markets, etc. to a direct competitor of A which acts would tantamount to a near industrial espionage.

Has A created an uncontrollable monster who is out to destroy A In the market? The scenario portrayed is no means rare or uncommon. The author has personally come across these situations in Malaysia. What precautions should the Iicensor/commissioner take in appointing B to contact manufacture product X to safeguard his interests?

This article will discuss the factors that A should consider in its CMA with B. One of the most important issues A should consider what intellectual properties are involved In the design, manufacture and distribution of product X If product X is patented in Malaysia then A should ensure the patent is maintained and not allowed to lapse due to failure to pay the annuity fees. Similarly if product X is covered by registered design rights then A should ensure the Registered Design is maintained by timely renewal. The securing of valid patents and registered designs where such rights are available for the product X or the process of manufacture of product X or even the use of product X ensures that A should be able to enforce patent rights and/or registered design rights against B, in addition to breach of contract rights against B in the event B breaches the CMA

Next the trademarks used on product X should also be registered not only in Malaysia but also in all the countries where product X is sold. This would enable A to institute trademark infringement or passing-off, proceedings against any other person including B who without authority or consent from A distributes product X in the various markets where A had originally sold product X. If A had provided technical drawings, such as mould drawings or manuals or any other written materials such as instructions manuals, advertisement brochures, pamphlets, A should ensure that all rights in copyright in such materials is owned by A and B is only a licensed user of such copyrighted materials. This will enable to A institute copyrights infringement proceedings against B or any other persons reproducing these materials without the authority or consent of A.

If A had provided trade secrets, confidential information to B, as is often the case, it is extremely important that such information is clearly identified and these are communicated to B and B is made to agree to strict confidentiality obligations.

Contract Manufacturer or Competitor in the mak-ing?
B as a contract manufacturer can be required in the CMA to undertake that it will not manufacture the product or any modification of the product it previously made for A, after the termination of the CMA. This restraint must be based on the principle that B is not to profit from or exploit the proprietary information or rights licensed to it by A. Any blanket restraint on B in manufacturing the product or modifications thereof would be invalid under Contracts Act 1950 of Malaysia as a restraint of trade. The clause must be drafted with care as to show the rearrangement of business and not as a pure anti-competition clause.

Can B after termination of the CMA start to manufacture a product, which is an improvement or modification to the product which is subject of the CMA? B may argue that what it is now manufacturing is a product that is totally different from the product in the CMA. Here again the definition of the product in the CMA must be described so as to Include all modifications/improvements that uses the same technology and/or perform the same function as before. The CMA can provide that all/any improvements/or modifications to the product is the property of A (the licensor/commissioner) whether such improvements/modifications are patentable or otherwise.

Where the source of raw materials or equipment for the manufacture of the product in the CMA is arranged by A then A can by separate agreement extract an undertaking from the suppliers that they will not supply the same raw materials/equipment to B on receiving written notice from A Whether A can extract such undertakings from the suppliers, would of course, depend on the bargaining strength of A.

Many contract manufacturers, to enter the market would approach the clients/customers of A often quoting a lower price than A. This offer would be tempting to such customers. Here the presence of a strong trademark or brand is important. Where A’s trademark is well known, it would act as entry barrier to its competitors (who may well produce an equivalent quality product). This principle is well known in the production and distribution of famous branded goods e.g. NIKE shoes, ARROW shirts, DELL computers, etc. In addition to the development and use of well-known trademarks, A has to consider developing/adopting and use of strong business entry barriers to its contact manufacturers. Rights in intellectual property rights are Just one of the strong barriers used to prevent direct competition. The strong reputation and image of A (the licensor) would be another barrier at least in the Initial stages upon the termination of a CMA.

Where A, the licensor, also takes up equity in B, then A should make sure that It maintains a distinction between the shareholders agreement (between A and the other shareholders in B) and the CMA. It could be condition of the CMA that In the event the shareholders agreement is terminated for whatever reasons, then the CMA would be automatically terminated. The presence of A or its nominees as shareholders and possibly as directors of B, would enable A to monitor the proper and authorised use of the technology know-how and intellectual property rights transferred or licensed to B. Further the CMA agreement could provide for the periodic management or intellectual property audit of B, to ensure that the terms of the CMA are not violated. If any significant breach of the CMA is found, then the CMA can be terminated forthwith with payment of pro-agreed upon liquidated damages.

With the growth and development of the K-economy, it is envisaged that more and more manufacturers would resort to the appointment of contract manufacturers to produce products, the former concentrating on the creation and management of intellectual property rights. Unless the Intellectual Property Rights are properly managed and the CMA effectively enforced, it may end up the manufacturer having created a competitor by its own choice.

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