By Dan Harris
Far too many companies that have their products made overseas wrongly assume they will own the molds and the accompanying IP used to make their products. If you do not pay for your molds upfront and have a contract that both works for the country in which your molds are being made and used and that makes clear the molds and their accompanying IP actually belong to you, they probably do not. If you do not have such a contract, there is a good chance you will find yourself unable to switch product suppliers even if your product supplier raises prices through the roof and produces terrible products. Without the right protections in place, you will be stuck. In this post, we explain why this is the case and what you can and should do to prevent this.
Companies that engage in outsource manufacturing need to retain control over their molds at all costs. To accomplish this for our clients, our international manufacturing lawyers focus on two issues when drafting mold provisions that are part of a larger contract (such as a manufacturing agreement or a product development agreement) or that stand alone as part of a mold ownership contract.
First, we want to make clear that our client owns the molds, period. The overseas factory (be it in Taiwan, Thailand, Mexico, Spain, Poland, China or wherever) can use the molds only for producing our client’s product and not for producing product for any other party. Second, we want it clear that when our client chooses to move its production to a different factory, it will have the right to take its molds and transport them to the new manufacturing location. Negotiation of these terms is usually quite difficult since the manufacturer has a strong incentive to hold molds “hostage” to prevent their foreign buyer from moving its manufacturing to a new factory. The only way to succeed is with a stand alone mold ownership agreement or mold ownership provisions inserted into a written manufacturing or product development agreement.
Second, we want to ensure our client owns all of the IP inherent in the molds. In some products, the form embodied in the mold is in fact the entire value of the product. Take for example a complex part used to manufacture a turbine or a jet engine. After all the engineering and testing is complete, all that remains is a single part produced by casting into one or more molds. In this situation, the molds embody the entire intellectual property in that part and so the party that owns or controls the intellectual property in the molds essentially controls the product. More importantly, if no party owns any IP in the molds, the molds are effectively open source. And if no one owns any IP in the molds or the product, your manufacturer is free to make your product.
As manufacturing overseas has become more complex, molds for products have become correspondingly more complex, as well. In many cases, the mold embodies most or all of the intellectual property in the product. The following two examples highlight this. First, in some products, the interior mechanism is based entirely on open source hardware. The external enclosure surrounding the mechanism is therefore the primary protectable IP for the product. The IP resides entirely in the molds used to manufacture the product case. The”look and feel” of the enclosure then becomes the identity of the product, and if that “look and feel” is not protected, the foreign company that designed the enclosure owns nothing at all in the IP of the product. Without the IP in the molds protected, your overseas factory can freely copy your product.
Mold Fabrication Shops
Factories that engage in contract manufacturing have figured all of this out, making protecting molds difficult. In figuring out what to put into our clients’ contractual mold provisions, our international manufacturing attorneys can no longer focus just on ownership of the molds; we also must focus on ownership of the intellectual property in the molds, as well. The new mold IP issues frequently arise in two settings: (a) third party mold fabrication shops and (b) the outsource factories themselves.
The issues that typically arise with mold fabrication shops arise because of a change in procedure that no one has really noticed. It is standard procedure to provide that the contract manufacturing factory making your product is responsible for fabricating the molds for the product as well. In the old days, the same factory almost always made the molds and the product. However, it has now become more common for the factory to outsource mold fabrication to a third party. In many cases, even the design of the molds is outsourced to that third party.
What this means is that a mold agreement with your factory that has been drafted to control the ownership of the molds and to control the IP in the product is compromised or eliminated when the specifications and the responsibility for fabrication gets sent off to a third party mold manufacturer. Given the economics of mold fabrication, it is not common for your mold fabricator to use your mold design for its own purposes but it is common for them to sell copies of your molds to factories interested in cloning your product.
This type of cloning is of course a thriving business in China and in most other countries known for their contract manufacturing. Foreign designers often wonder how a terrific copy of their product got to market before they themselves have even gone into full scale production. This usually happens because many mold manufacturers conduct a thriving trade in selling the “latest” molds. The factory you use to manufacture your product actually has an incentive to keep the mold for its own use since once it gets out into the world the molds will be used by your factory’s competitors. When this happens, the factory making your product will be damaged in much the same way as you will be.
Though losing one’s molds via a third party mold fabrication shop is an enormous risk, few foreign designers are aware of this risk and even fewer know what needs to go into their contracts to prevent this intentional leakage. The foreign designer rarely even knows the identity of its mold fabricator. They mostly just assume it is the factory that will be making their product. All this leaves a gigantic hole in their IP protection that can and should be closed by using a relatively simple set of contracts.
Consider also the issue of patent protection. To acquire a patent anywhere in the world you must show that you invented the item. In a case where the design of the mold has been outsourced to a third party mold fabrication shop, who actually invented the item can become unclear. Is it the foreign designer who developed the basic idea? Is it the product factory that did some preliminary drawings? Or is it the mold fabricator that did the detailed drawings and produced the final working model? Or is it all three, each entitled to an uncertain percentage of the patent? Our international litigation attorneys have handled too many cases where this issue was not clear. With this sort of tripartite structure, the usual answer is that no one owns any IP in the molds: no patents, no trade secrets. This often means no one owns any IP in the product itself either. This then leads to disaster in commercializing the product.
The Factory that Makes Your Products
The fundamental issue with your own factory is the same as with your mold fabrication shop: who will own the IP in the resulting design? For the product, the question is who owns the design for the product. For the molds, the question is who owns the design in the molds. Where the molds are the product, this becomes a core issue that cannot be ignored.
Our international dispute resolution lawyers usually see the following three basic problems after a series of molds has been made for a product that has become commercially successful:
- The 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 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 manufacturer that it had ample capacity for any scale of orders.
- The stress of increased production demand causes the quality level from the manufacturer to decline to unacceptable levels. This is often a surprise to the foreign buyer, who had expected quality to improve over time.
In response to any of the above three issues, the foreign buyer gives notice to its manufacturer that it intends to move production to a different manufacturer. In the past, the issues that arose at this stage mostly focused on ownership of the physical molds, an issue that can usually be resolved with a relatively simple mold ownership agreement. To the extent that a mold ownership agreement resolves the issues, this is old news.
However, in the past few years we have seen factories make arguments (like those below) that render the situation far more complex:
- The factory says: “It is true you paid the fabrication fee for the molds. But that fee only covered the material costs and the time involved. However, in addition to that, we at the factory spent a lot of time and money doing the CAD drawings and related specifications required to fabricate the molds, and we also spent additional engineering time in integrating the molds into our production process. Before you can take the molds, you have to compensate us for those costs. We won’t charge you a markup but you must pay us for our out of pocket costs.” Then the factory provides an unreasonably high invoice for those costs, and if you do not pay it will hold your molds hostage. This has become almost standard practice in outsource manufacturing. It is therefore essential for foreign designers to make clear in a written contract that all amounts it pays for molds include both design and fabrication costs and no additional payments will be required when the foreign buyer seeks to take possession of the molds.
- The factory says: “It is true you own the molds and you can take them whenever you want. However, we did all the design work on those molds so we own the design embodied by the molds. We will give you a license to use the molds for production in another factory. However, that license is limited. You have no right to copy the molds. We, on the other hand, have the right to copy the molds and use them for our own production and to sell 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.”
- In the more extreme case, the factory says: “We did all the design work for the molds, so we own that design and we already registered a design patent in the molds. Since we did all the work, we are the inventor for patent purposes. It does not matter that you paid us for the molds. We still remain the inventor, 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 high that you cannot economically have your product produced at a third party facility.
Products Held Hostage
The more honest factories make the situation clear during the negotiation process. The foreign buyer pays for fabricating the mold, but that payment does not convey any ownership interest in the molds to the foreign buyer. The factory does the design work and the factory owns the molds. The factory 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 clear from the beginning that intends to hold the foreign buyer hostage by guaranteeing it cannot use another manufacturer for its product. With tariffs and duties leading companies to try to move their production more than ever, our international manufacturing lawyers are getting more calls from companies legally blocked from moving their production, even in the face of crippling price increases. We have many strategies for helping such companies, but none are nearly as good nor nearly as cheap as preventing this problem from occurring in the first place by using good contracts.
The above is where outsource manufacturing is going, and foreign product designers need to deal with it. NOW. The foreign designer needs to ascertain whether its product and/or mold manufacturers will enter into written contracts that provide the foreign designer with the IP protection it needs. And if the manufacturers will not sign such a contract, the foreign designer then must decide whether manufacturing its new and innovative product in a setting where it will be hostage to its factory or whether it can or should try to find another manufacturer. The best move is usually to move on.
What are you seeing out there?
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Dan Harris is founder of the Harris Bricken law firm, a boutique international law firm focusing on small and medium sized businesses that operate internationally. China is the fastest growing area for the firm. Dan writes ChinaLawBlog.com as a source of China legal and business information.