I am always amazed when a new client informs me they do not have a written agreement with their third party manufacturer(s). Or, they have one but don’t know the key terms or haven’t looked at it in years. So when I heard about this case, I figured it was a good topic for discussion. Ask yourself this– if your third party manufacturer told you tomorrow they decided to stop manufacturing your products, how long would it take you to find a replacement manufacturer and get your products to market? Would the transition result in delayed shipments and lost sales? According to the beauty giant, L’Oreal, it would need about a year to find a new supplier for at least two of its products and would run out of stock, causing irreparable harm, including losing valuable shelf space at key retailers. Unfortunately for L’Oreal, however, the master manufacturing agreement between it and Spatz Laboratories only required 3-months notice of termination.
Despite the termination provision, in its civil suit against Spatz, L’Oreal requested the court to order Spatz to continue manufacturing 20 of its cosmetic products, and the amounts of those products, for L’Oreal through this year and into 2017. On June 20, 2016, the court tentatively denied L’Oreal’s request.
According to the civil complaint, filed in May 2016, L’Oreal alleged Spatz breached several agreements by announcing in March it would stop making products for the company at the end of June. Also, L’Oreal alleged it had given Spatz “tens of millions of dollars” in business, including $20 million in 2015.
In its defense, Spatz told the court that L’Oreal was overstating the effects of the canceled contract and was asking for “extraordinary relief”; explaining Spatz is one of 2,000 suppliers for L’Oreal in the United States. Spatz’s counsel also challenged L’Oreal’s version of how the relationship between the two companies went sour. He pointed out that L’Oreal began demanding price cuts that Spatz could not afford. When L’Oreal threatened to take its business to other suppliers, Spatz decided to launch a new business manufacturing and selling cosmetics directly to consumers.
Luckily for Spatz, a master agreement drafted by L’Oreal in 2013 allows either party to terminate on three months’ notice, counsel for Spatz said. In response, L’Oreal’s counsel told the court she wasn’t sure how the three-month termination provision made it into the master agreements, surmising it might have been a “form contract.”
Not surprisingly, the judge said the master agreement weighed heavily on his decision-making stating, “I recognize the practice, but it’s hard to ignore this,” Judge Birotte said.
“For whatever reasons the parties said they would be able to terminate the agreement by giving three months’ notice. Perhaps both sides thought it was a provision that both sides never thought they’d use. But it sounds like you’re suggesting this could never be used.”
Moral of the story...no matter your company’s size, contract terms matter and “form contracts” should be reviewed closely in all instances. What may start out as a beautiful marriage can quickly go south and what remains to govern the relationship are the terms originally negotiated between the parties.
With that in mind, the following are a few key issues (not intended to be an exhaustive list) that every manufacturing agreement should address:
- Term: Is it an ongoing agreement or for a given period?
- Termination provisions: How much notice is needed? (just in case you missed that point)
- Indemnification: Who is responsible for what? What about recalls? What happens if you learn the ingredients are adulterated? Is that argan oil or something else?
- Intellectual Property: Who owns the formulas? What happens to the formulas at termination?
- Quality Assurance & Inspections: What specifications and standards must be met? Organic? Natural? Non-GMO? How long must the manufacturer keep books and records?
- Ingredient sourcing: Do you make a Made in USA claim? If so, the agreement should address sourcing issues.
- Labor standards: Your company may be small enough currently, but hopefully some day it will grow. Considering how you will comply with the Supply Chain Verification requirements now will help you down the road.
- Delivery: What is the anticipated delivery schedule from order to delivery?
- Confidentiality: Are your company’s trade secrets protected from disclosure?
So…What do your Manufacturing Agreements say? How much time would you need if your manufacturer canceled the contract?
The case is L’Oreal USA Inc. v. Spatz Laboratories, case No. 2:16-cv-03572 in the California Central District Court.