Outsourced Manufacturing and Trade Secrets: Due Diligence (Part 5)

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Outsourced Manufacturing and Trade Secrets: Due Diligence by David L. CohenPerhaps the single most important part of outsourced manufacturing is to select a trustworthy partner. A company should not enter into any transaction unless it has a good basis to believe that the manufacturer will be an acceptable partner. This requires rigorous due diligence, including:

  • Background checks of the manufacturer’s principal officers, directors, and key personnel.
  • Audits of the manufacturer’s financial statements.
  • Inspections of the manufacturer’s facilities.
  • Investigations of the manufacturer’s supply chain and trading partners.

In addition, a company should require the prospective manufacturer to submit:

  • Business references from past and current clients.
  • References and credentials for key employees.
  • An overview of its complete organizational structure, as well as beneficial ownership documentation.
  • A list of all current clients.

As part of the diligence process, a company should assess to what extent the prospective manufacturer, its affiliates, or its customers are, or in the future may become, competitors in the commercial areas that will be the subject matter of the agreement. This information will play an important role in the assessment of the potential practical risks raised by the particular outsourced manufacturing relationship.

While a company should avoid disclosing any trade secrets or related information until it enters into a definitive agreement with the prospective manufacturer, if some trade secrets must be disclosed in order to properly vet a manufacturer’s capabilities, the company should develop an iterative process by which it discloses confidential information bit by bit, to vet its prospective partner’s capabilities in tandem with ongoing diligence into the prospective partner’s trustworthiness. This way, if anything unfortunate is discovered in diligence, the quantity of trade secrets disclosed is minimized.

That said, in all events, a company should enter into a non-disclosure agreement with the prospective manufacturer before beginning its due diligence process. This is to:

  • Protect the company if any trade secrets or other business information are shared.
  • If appropriate, prevent disclosure of the potential manufacturing arrangement itself.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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