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On Demand 1h 3m 06s

Contracts for Food Businesses

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Contracts for Food Businesses

Brand owners in the packaged food business often contract out many of their essential functions – from product development to manufacturing, sales, and distribution. This course introduces participants to several of the most common contracts that CPG food brands need, especially in their early stages. Lauren Handel of Handel Food Law LLC will provide background on important aspects of the food business that must be considered in crafting and negotiating contracts for brand owners. She also will explain key provisions of five common agreements: non-disclosure, product development, co-manufacturing, sales representation, and distribution.

Transcript

- Hello. My name is Lauren Handel, and I'm the principal attorney at Handel Food Law, which is a law firm focused on food and beverage businesses. And a lot of what I do in my practice is counsel clients on contracts that are common in the food industry, and that is the topic of today's session. So what I'm going to cover first is some background for those of you who might not be familiar with the packaged food business, which is what I'm really focused on in this session, some key aspects of the industry that you should know about that can inform and are important for understanding for contracts. Then I'm going to talk about several contracts that are common in the packaged food business, especially in their early stages, but also for longstanding and large companies. These agreements really cover the major functions of a food business, from the planning and product development stages through manufacturing to sales and distribution. So after the background, I'll discuss key provisions of product development agreements, co-manufacturing or co-packing agreements, and broker and distribution agreements. So regarding background, one of the really important things to understand is that for a lot of food companies, their most important assets are their brand or brands, their trademarks, and their recipes. A lot of food businesses, especially a lot of my clients, own little more than their inventory and their intellectual property, especially in their early stages. A lot of small food businesses aren't doing their own manufacturing or distributing their own products, but rather they contract out those functions to other parties to manufacture, store, sell, and distribute the products. The key IP of a food business, usually it's trade secrets and it's trademarks. Trade secrets are important because recipes and a lot of the other intellectual property and knowhow associated with food generally can't be protected with patents because there's just not that much that's novel about food to qualify for patent protection. And also, trade secret protection has the advantage of lasting indefinitely, at least potentially indefinitely, whereas patents will expire. The branding also is so important to a packaged food business, and so trademarks really need to be protected, and the use of trademarks has to be controlled. It's also important to understand that food is a very highly regulated industry. There are multiple levels of regulation with multiple agencies in the federal government, as well as state agencies that regulate the production, advertising, sale, and labeling of food and beverages. And regulatory compliance therefore needs to be considered in contracts as each party in the contract will have its own compliance obligations. But to some extent, those functions can be delegated by contract and made enforceable through contract law. So for example, under FDA regulations, food manufacturers have a requirement to have a supply chain program to verify the safety and compliance of ingredient suppliers. In a co-manufacturing contract, the parties might wanna put the primary responsibility for those functions of supplier verification on the brand owner, instead of the manufacturer. So that's something that can be handled in the contract, but a contract obviously can't relieve a party of its regulatory obligations, and so it's important also to provide for a cooperation between the parties and access to the information that each one will need to be able to fulfill its compliance duties. Another key aspect of the food business, which might be kind of obvious, is there's a lot of potential liability. Food can be dangerous. And in general, sellers of defective food products, like other kinds of consumer products, can be held strictly liable, meaning they can have liability without fault, without the need to prove negligence. And this is true both under criminal law and civil law, that there is strict liability for adulterated or defective food products. And this slide shows a really good example of this. This was from 2011. The listeria outbreak that was associated with cantaloupes from Jensen Farms in Colorado. Almost 40 people died in that outbreak and many more were sickened. And the grower was a family farm that by all accounts was trying to do everything right and had received very high marks on its food safety audit just before the outbreak, and still the Jensens were criminally prosecuted, and there were dozens of civil lawsuits against them, as well as the distributors and retailers of the cantaloupes. So there's potentially severe liability for causing personal injury and death if food is contaminated, There's also a lot of potential civil liability for false or misleading labeling and advertising of food, which is a very active topic these days of consumer class action litigation. And if that's something you're interested in, I'll plug my other Quimbee CLE on the topic of the risks of, litigation risks of food labeling. Under federal and state laws, anyone who causes a product to be adulterated or misbranded or who distributes an adulterated or misbranded product can be held liable for the violations. So even if the party is not involved in the manufacturer or labeling of the product, they can be held liable for those violations just by virtue of holding a product or distributing it for sale in the United States. Under state law of strict product liability, generally, every party in the stream of commerce, so the manufacturers, wholesalers, retailers, they all can be held liable for injuries that are caused by defective products. So given this potential liability of anyone who's involved in the chain of commerce, entities that are downstream in the supply chain will want to use contracts to push their liability upstream to the manufacturers and suppliers. And so indemnity provisions and contracts are very common. And the indemnities can be especially important because there are gaps in the insurance coverage that's available to food businesses. So for example, product liability and contamination insurance will cover when there's actual contamination of food that causes harm, but it won't cover losses from a preemptive recall. So if there's a risk of contamination and the manufacturer or supplier decides that they should remove the product from the market because of the risk of harm, but they haven't yet proven that there's actual contamination and no one has been injured, the liability insurance isn't going to cover that situation, and yet there can be significant costs. Recall insurance can help to fill in those gaps, but small businesses typically don't have that type of insurance. And also, insurance won't cover liability for false labeling type lawsuits because there's not usually any personal injury or property damage claims. Another aspect of the industry that's important to keep in mind is that it's a very competitive business and it's difficult to succeed. The profit margins in food industry are typically low. The costs of inputs and overhead can fluctuate widely and frequently, especially right now in recent times as the whole world is dealing with supply chain problems and inflation. And from a buyer's standpoint, you can try to use contracts to provide some stability, and predictability, and costs, and prices. But if you're representing the seller, you're going to want to have as much flexibility as possible to change pricing when costs increase. So turning to the first type of agreements, non-disclosure agreements or confidentiality agreements. Remember that trade secrets are critical intellectual property of a food business, and yet there are a lot of parties with whom a trade secret owner will need to share that information. So they need to have NDAs with really anyone who might have access to trade secret information or other confidential business information, employee, service providers, investors, suppliers, customers. Anyone with whom that information needs to be shared, there should be confidentiality protections in place. Why is this important? Well, under the trade secret law, the Uniform Trade Secrets Act, state common law of trade secrets and the Federal Defend Trade Secrets Act, the elements of a trade secret is information that is not generally known and not readily ascertainable outside of the owner's organization, from which the owner derives economic value or business advantage by having exclusive use of that information. And the owner makes reasonable efforts to preserve its secrecy. So NDAs are really important as a way that the owner of a trade secret takes reasonable steps to maintain secrecy. Having a written confidentiality agreement also can be helpful if a misappropriation occurs to be able to prove that a disclosure or use of a trade secret was not authorized. NDAs also are important because not all confidential information that a business has might qualify for protection under trade secret law. So for example, the owner of the information may not be able to show that a particular kind of information confers a competitive advantage. They might also have obligations to keep third party information confidential, like information of a supplier or of a customer. Also, an NDA can designate that the terms of the relationship between the parties to the NDA are confidential, or even the fact that they're working together is confidential. One of the key provisions of an NDA is the definition of confidential information, and this should be written so that it's not limited to trade secrets. It should be broader than that. Usually, the agreement will list non-exhaustive examples of confidential information. So for food, that might include recipes, sourcing information, pricing, customer lists, et cetera, Importantly, in an NDA between a food company and a service provider, for example, a product development consultant or a co-manufacturer, the definition of confidential information should include information that the service provider creates or improves for the food company. This is usually missing from standard form NDAs, which usually require that a party who receives confidential information from the other party maintain confidentiality. But in many cases, a food business is hiring a service provider who will not only receive confidential information from its client, but also create confidential information for that client, and that also needs to be protected. So look closely at the definition of confidential information when the parties are in a service provider-contractor relationship. The NDA also should define what information is not considered confidential or becomes excluded from protection, so that the agreement is not overly broad and unenforceable. So obviously, an NDA should restrict the disclosure of confidential information to third parties without consent. It might also provide that confidential information may be disclosed only to employees and consultants of the recipient who have a need to know the information and who are bound by confidentiality restrictions. An NDA also should prohibit unauthorized uses of confidential information, usually requiring that it be used only for the benefit of the disclosing party or of the owner of the information, or by limiting its use to the business purpose that's stated in the NDA. It's a good idea to consider how you define the business purpose. So often, parties enter into non-disclosure agreement at the very early stages when they're exploring a possible business relationship. And a lot of form NDAs are written with the purpose being just those exploratory discussions. But when the parties decide then to move forward with the business relationship, they may neglect to sign a new confidentiality agreement. And so to avoid any ambiguity, you might wanna revise the defined business purpose. So that it's broad enough to cover not only the initial exploratory discussions, but also any resulting business relationship. Regarding the term or the duration of confidentiality obligations, a lot of NDA forms are created for the purpose of a particular transaction or an investment, and they often limit the duration of confidentiality obligations to three to five years for example. And this can make sense because information pertaining to a particular transaction, such as financial information, business plans, or strategy, that kind of information can get stale and lose its value relatively quickly. But in the food industry, there's IP that retains value potentially indefinitely. Product formulations and other trade secrets and knowhow regarding how a food product is made, those can retain value as trade secrets indefinitely. And so the duration of confidentiality obligations should last until the information no longer qualifies as confidential or as a trade secret. Also, an NDA usually provides for the return or destruction of confidential information upon request or at the conclusion of the relationship between the parties. And just keep in mind that those provisions might be impractical, given that parties, especially manufacturers, have record keeping regulations that apply in the food industry. So the agreement should contemplate that a party can't always immediately turn over confidential information if it has a regulatory obligation to keep records that might reveal that confidential information. Another important provision for any NDA with an employee or with a contractor who's an individual is the Defend Trade Secrets, so the Federal Defend Trade Secrets Act immunity notice, and that's 18 US Code, Section 1833. The failure to give this notice limits the remedies that the hiring party can obtain for misappropriation of trade secrets. So it's important to include that notice. Turning now to product development agreements. A food company might have product development agreements with food scientists and other consultants who assist with recipe development, the commercialization of a product, or improving an existing product. Sometimes co-manufacturers provide those same types of services. So there might be a product development agreement with a manufacturer. Sometimes ingredient suppliers also provide R&D kinds of services to help identify a suitable ingredient or to develop an ingredient, such as a flavoring perhaps for a particular product. The nature of this kind of agreement is one for professional services, so the state common law of contracts will apply. In the form of the agreement, often you'll see a master services agreement with one or more statements of work that get attached, and the statement of work is where the details of the project are spelled out. Ownership of intellectual property is often the most extensively negotiated part of a product development agreement. And the service provider is going to want to retain ownership of as much intellectual property as possible so that it can apply the technologies and knowhow it has, and that it might learn in the course of a project to its work for other clients. If the service provider is an ingredient supplier or a manufacturer, it's more likely to wanna give the client only a license to the IP it develops under the agreement, rather than an assignment. On the other hand, the client is going to wanna own all of the deliverables of the project exclusively, the agreement should clearly spell out who owns what. Whatever the parties decide and whatever works for the particular circumstances and relationship, it just needs to be very clear in the agreement who is going to own what, and if IP as being assigned, to include clear assignments, or if there are licenses, that all should be included as part of the agreement. Obviously, confidentiality also is important, and so the product development agreement also should either include a confidentiality provision or make reference to a separate NDA between the parties. The goals of food product development are often kind of subjective and can be fuzzy. So it can be difficult to know if the consultant is in breach. For example, if we're talking about recipe development, the client may simply just not like the taste or the texture of the product that's developed, and that doesn't necessarily mean that the consultant breached. So the parties need to be clear about their expectations for the project, so that it's possible to know when the consultant has fulfilled its obligations, and there should be objectively measurable, specific goals and guardrails that are outlined in the statement of work. It also should be clearly stated what deliverables the client will receive, what documentation will be provided and on what timeline. How long was all of this work expected to take? And unfortunately, and I've seen this happen many times, these relationships can fall apart before the entire scope of work is completed. So termination rights are important to spell out. Can either party terminate before moving on to the next phase of a project? If that happens, will the client have rights to all of the work that was completed up to the point of termination, or are they going to have to pay for the full value of the entire project, even if it's not completed? The compensation. Obviously, service provider needs to get paid, and so the compensation which might be fees at a fixed rate, or per project, or per phase, or it might be an hourly rate as well as any reimbursable expenses that should all be clearly stated in the agreement. Product development agreements usually include a section on warranties and disclaimers, and the service provider will want to limit its warranties and liability as much as possible. The typical warranties include compliance with the agreement and with the scope of work, that the consultant complies with the law, that the services will be provided in accordance with industry standards, and that the deliverables won't infringe on the intellectual property of a third party. It's common to see disclaimers of all other warranties that are not expressly stated in the agreement, including implied warranties of fitness for a particular purpose and merchantability. From the client standpoint, these disclaimers might not really make any sense, given that they're hiring the consultant to create a product for a particular purpose and that will be merchantable. So if you're representing the client, the brand donor, you need to look at these warranties and disclaimers really closely. And the client also will need to understand that the promises that might have been made in discussions with the consultant, including in a preliminary quote or project scope, won't become part of the contract, unless they're expressly incorporated in the document. The consultants also typically include limitations of liability and remedies. For example, by limiting the remedy for breach of warranty to a refund or correction with no possibility of recovering damages or capping damages to the amount that was paid or payable under the contract, precluding liability for lost profits, for other consequential, incidental, and punitive damages. Now whether these disclaimers and liability limits are enforceable will depend on the particular facts and state law, but the clients should try to negotiate for excluding certain types of liability from the limitations. For example, liability for breach of confidentiality or breach of the warranty of non-infringement. So moving on to co-manufacturing and co-packing agreements. First, just wanna define some terms relevant to the different types of agreements that can fall within this topic. So when I talk about a co-manufacturing agreement, this is where the manufacturer is hired to make a customer's proprietary product to the customer's specifications for resale under the customer's brand. Co-packing agreements are similar, but usually where the manufacturer or a packer is repacking bulk foods, often finished foods or foods that might need some additional blending, mixing, or more minimal processing, and packing them into retail type containers. And a private label agreement is where the manufacturer has its own recipe, its own proprietary product, and it makes that product maybe for sale under its own brand, but also under customers' brands. So the manufacturer could make the exact same product that is sold under a variety of different brands. The nature of agreement here is gonna depend on how the relationship is structured between the manufacturer and customer. So it might be a services agreement under the common law of contracts. It might be a UCC Article 2 sale of goods contract, or it might be a hybrid goods and services contract. And it it's important to know if the UCC is likely to apply and therefore that the gap fillers and default rules will apply to fill in issues on which the contract is silent. In deciding whether the UCC applies to hybrid contracts, most courts analyze whether the predominant purpose of the transaction is the sale of goods or services. Now, some courts consider all manufacturing agreements to be contracts for the sale of goods, and I've given you a citation for a Fifth Circuit case that was decided under Texas law and found that. But in general, where the customer is applying the raw materials, it's more likely the agreement will be seen as one for services, rather than for the sale of goods. And I've given you a citation to a Sixth Circuit case for that, that was decided under Michigan law. So in this slide, I've attempted to summarize the different objectives of the brand owner or the customer versus the manufacturer when negotiating a manufacturing and supply agreement. If you're representing the brand owner, they're going to be most concerned with obtaining the inventory they need, predictable pricing as much as possible, ensuring product quality, as much as possible, putting the risk of losses and problems on the manufacturer. And that makes sense, given that usually the customer doesn't have a lot of control over how the product is made. As I've discussed, protection of intellectual property and confidentiality are going to be really important. The customer or the brand owner also needs to fulfill its own legal obligations, both regulatory obligations and also obligations it might have in contracts with other parties, like its customers. The brand owner also needs flexibility to adapt to changes in its business. It might need to discontinue a product or add new products, greatly expand its inventory. It also may be important to the customer to try to prevent the manufacturer from competing against it. In this type of relationship, especially where the brand owner has no other manufacturer and is contracting with the manufacturer that will know exactly how to make the product, the brand owner can be in kind of a vulnerable position, that the manufacturer is in a great position to make the same product in direct competition with its customer, and so trying to negotiate for some kind of non-compete may be important. On the manufacturer's side, they will wanna ensure that they can maximize their production efficiency, for example, that they don't have lost production time because a customer fails to deliver packaging on time for a production run. They maintain their profitability, so if they need the flexibility to increase prices as needed. They get paid on time, obviously. They wanna minimize the risk that the customer is unexpectedly going to reject the product or complain about things. The manufacturer needs to protect its own IP and confidentiality and the confidentiality of its other customers. It wants to limit its liability as much as possible. And the manufacturer also has its own legal obligations, both in terms of regulatory compliance and contractual obligations to other parties that it needs to consider. And finally, whereas the customer might wanna get some protection against competition from the manufacturer, the manufacturer's gonna wanna maintain as much flexibility to make similar products for other customers or even for itself. A very important part of the manufacturing agreement is the product specifications, and these are usually attached to the contract and should be as clear and detailed as possible. Now, as a lawyer, I don't usually write this part of the contract. It's usually a quality assurance person who works for the client who creates this. I usually review it just to make sure it covers all of the things I would expect it to cover, and that it's it's clear enough, but I don't feel confident to write the specifications part of the document. The body of the agreement also typically includes provisions regarding quality control and safety. The customer will wanna have rights in the contract to be able to ensure that the manufacturer is meeting its obligations under the contract and complying with the law. So this can include rights to observe production, to inspect and audit the manufacturer's operations and records, to ensure the manufacturer is complying. The contract also might require the manufacturer to have third party audits for food safety or for various kinds of certifications, like labeling certifications, such as organic or gluten-free. It also will typically require the manufacturer to maintain relevant records for some period of time after the contract terminates for at least as long as the shelf life of the product that's made under the agreement. Pricing is usually covered in an attachment to the agreement as well. And the contract really needs to make clear what services and materials are included or not included in the price and who is responsible for supplying what inputs. Sometimes the price is just a tolling fee that covers the manufacturer services, but none of the materials, and those might be invoiced separately if they're procured by the manufacturer, or they might be supplied by the customer, or a combination of both. As I've mentioned, it's not realistic for pricing to remain fixed for very long. So there needs to be some mechanism for adjusting the pricing. For example, if the manufacturer's costs increase by more than a certain percentage, there can be a price adjustment to compensate the manufacturer for that. If the manufacturer's going to charge for anything else, like storage fees or R&D services, then the contract also should state what fees will be charged for those as well. The manufacturing agreement also should include provisions regarding the ordering process and purchasing. Often, the customer is required to provide non-binding forecasts of its expected demand, so that the manufacturer can plan ahead. Lots of times, these are rolling forecasts that get updated on a monthly basis or a quarterly basis. Now, to secure the promises of the manufacturer, the customer needs to make some commitment to purchase. So this can be in the form of a requirements contract where the customer will buy all of its requirements exclusively from the manufacturer, or it can be a promise to order some minimum volume of product at least one time or at some interval of time. Usually, there'll be language in the agreement about the manufacturers require lead time for orders, a minimum quantity that must be placed per order, and whether the customer has rights to cancel or change an order after it has been accepted by the manufacturer. Part of the contract that I pay especially a close attention to is the section on nonconforming product or what happens when the product does not meet the specifications, and this can happen sometimes for a variety of reasons. This is an area where the UCC has extensive provisions on the rejection and acceptance of goods and the remedies for the seller and the buyer. Under the UCC, the buyer has to reject the goods within a reasonable amount of time. And it's a good idea to use the contract to define what that period of time is so that the parties are clear, rather than leaving it to a kind of vague reasonableness standard. It's also important to recognize that some defects in a food or a beverage product may not be obvious at first. So if there's contamination with foreign objects or microbial contamination, these kinds of things might not be discovered and couldn't reasonably be discovered upon the initial inspection of a finished product. So there should be a provision for handling latent defects that get discovered later. Also, if you look at UCC Article 2, Part 6 and 7, many of the default rules there just don't make sense for co-manufacturing transactions. The rules assume that the seller, in this case, the manufacturer, has full ownership and rights to the goods until they are accepted by the buyer. But that's not the case where the manufacturer is producing goods under the buyer's trademark, often using materials supplied by the buyer. So for example, under section 2-603 of the UCC, a buyer that rightfully rejects goods that are perishable has an obligation to try to resell them for the account of the seller. But if a brand owner is rejecting goods because they don't meet its specifications, it's not going to wanna sell those goods at all. So that default rule just doesn't work in this type of situation. It needs to be contracted around. There are other examples where the default rules also won't work. And so you really should look at those closely. And if it's possible that the contract is going to be governed by the UCC, figure out what changes need to be made to override those UCC rules. Product recalls or big events can be crisis events for any food company and can be very expensive. And there are also situations where decisions and actions need to be made really quickly. So it's a good idea to include in the contract some provision regarding recalls that at a minimum requires the parties to notify each other immediately if they become aware that there's a potential recall situation and to work together to handle that situation, to investigate it, and to manage the recall. The brand owner might also wanna include provisions that give it control over communications about the recall with government agencies and with customers. Just recognize that the manufacturer also has legal obligations. If this is what's considered a class one recall situation, the manufacturer has an obligation to notify the FDA about the recall and will have its own legal obligations. And so, the brand donor can try to exercise control, but can't prohibit the manufacturer from fulfilling its own obligations in a recall situation. The contract might also provide for indemnities and cost sharing to cover the cost of a recall, especially in a situation where the manufacturer caused the recall, which is more likely going to be the situation, but most of the cost is going to be born by the customer who's now distributed the product and has to pay its customers and reimburse its customers for the product that's that's recalled. As far as legal compliance, manufacturing agreements typically include a warranty of the manufacturer that the product was made in compliance with applicable law. The brand owner is usually gonna be responsible though for ensuring that the labels it provides or the design for the labels are compliant, assuming the product is made to the specification and that they don't infringe on any third party's intellectual property. I always include a provision requiring the manufacturer to share information with the customer if the manufacturer receives any relevant notices of regulatory violations or negative safety findings in an audit because brand owners typically have requirements to share this type of information with their distributors and sometimes with retailers too. So I've discussed IP and confidentiality are always important and the contract should make clear who owns the product recipe and specifications as well as any improvements or changes to those that might occur and that the manufacturer might develop or that the parties might jointly develop during their relationship. The agreement also should give the manufacturer a limited license to use the brand owner's trademark and its product IP for purposes of producing the products during the term of the agreement. And there might be a confidentiality provision in the manufacturing agreement itself or it might refer to a separate NDA between the parties. Non-competition. So this would be a covenant that the manufacturer agrees not to make a competitive product for anyone other than this particular customer. And as I mentioned earlier, the brand owner often has an interest in at least trying to get the co-manufacturer to agree to a non-compete, given how easy it would be for the manufacturer to use what it's learned from the customer to make a competitive product, or even to cut the brand owner out entirely and just directly supply the same kind of product to the brand owner's customers. I wanna be clear that non-competes are not very common in a co-manufacturing or a co-packing agreement because it's just kind of against the very nature of a co-manufacturer's business, which usually they make very similar kinds of products for competitors for multiple customers and sort to foreclose that possibility is kind of antithetical to the business model. But in some circumstances, the manufacturer might be willing to agree to a non-compete if it's kind of a unique relationship with a particular customer. For example, the brand owner might be bringing the manufacturer a new kind of product that it hadn't previously made. Sometimes the manufacturer mostly makes its own products and doesn't do very much co-manufacturing. And so in that kind of circumstance, if the manufacturer's own products are different than the new customers, it might be willing to agree that it won't make a competitive product, but it's not typical to kind of sweeten the deal if you're representing the brand owner. If the brand owner is willing to make this an exclusive relationship, that it will buy only from this manufacturer, that can help to convince the manufacturer to agree to a non-compete, especially if the customer has a significant amount of business to bring the manufacturer. From the brand owner's standpoint, it might be worthwhile to push for a non-compete, especially because it can be really valuable protection for the IP that the brand owner has in the recipe and its other product knowhow. If the manufacturer was in a position or if the brand owner, sorry, was in a position of having to try to enforce its IP rights and prove that the manufacturer misappropriated trade secrets or used its confidential information to make a competitive product, that can be really difficult to prove and even to know if that's what happened. 'Cause it can be hard to know exactly what information was used, and was it something that was truly proprietary of this particular brand owner that was used. And it could be a lot easier to just enforce a flat prohibition on making any competitive products. So the non-compete really could help ensure the protection of IP. But contracts that restrain trade, generally, are not favored in the law and can be difficult to enforce. Generally, they are enforceable. Non-competes are enforceable in contracts between businesses, as long as they're narrowly tailored and reasonably needed to protect the brand owner's legitimate business interests. So it has to be a pretty limited scope. The duration of the restriction has to be limited. It's probably enforceable if it only continues during the term of the contract, but there could be good reasons why the brand owner would need it to continue longer than that to protect its own interests. So one way to think about what period of time might be reasonable and enforceable would be to think about how long it would have taken the manufacturer to develop the same type of product and to get up and running and out into the market with that type of product if it had to start from scratch, if it didn't have the experience and the knowhow that it gained from doing the work for the brand owner. Also, the definition of competition has to be pretty narrow and should be very clear. So rather than simply saying that the manufacturer cannot make a competitive product, the contract should define what type of product is considered competitive. For example, if the customer's product is a non-dairy milk made from cashews, a competitive product probably shouldn't be defined as broadly as vegan alternatives to dairy products or even non-dairy milk, but more specifically related to the customer's products, such as non-dairy milk made from tree nuts or even non-dairy milk made from cashews. The geographic scope might also need to be limited if the brand owner's product is distributed only in particular regions. It might not be able to show that it's necessary, reasonably necessary to prohibit the manufacturer from making a competitive product for sale in a completely different region where the brand owner doesn't have business. It's important to keep in mind that a court that's interpreting the non-compete, if it's asked to enforce the non-compete, is going to construe it strictly and could just simply refuse to enforce the provision at all if it's overly broad, rather than to blue pencil it. So blue penciling would be where the court will modify and revise the agreement, so that it's limited to the extent that it would be enforceable under the law. But some jurisdictions are not likely to blue pencil, and it's important therefore to know what a court is likely to do with this, given the law that will apply. It's also important to realize that given that this law is based in public policy, the court may not honor the party's agreement as to choice of law on this issue. So for example, a California court and California law is pretty strong against non-competes. So if a California law were asked, if a California court were asked to enforce a non-compete, it's not very likely to blue pencil that agreement, and it's not likely to defer to the party's choice of another state's law because it's a matter of policy, An option if a manufacturer won't agree to an outright non-compete and a kind of more narrow version of that would be a non circumvention provision. So this would be basically saying that the manufacturer won't go around the brand owner to make the same or a similar product for the brand owner's customers. And this may or may not be realistic, given the manufacturer's business. If it already has relationships with the brand owner's customers, it just might not be able to preclude doing business with those customers. Indemnities are almost always included in manufacturing agreements. Usually there are mutual indemnities covering third party claims that arise from either parties' breach or misconduct. Sometimes the parties will agree to indemnify each other. So for their first party losses, that one party's breach causes the other, but that's not typical. So if the intent is to cover first party indemnity, that needs to be really explicit in the contract. It's also common for manufacturing agreements to require both parties or at least the manufacturer to maintain liability insurance, sometimes also recall insurance, at least during the term of the contract and usually also for some period of time afterwards until the shelf life of the product has expired. The manufacturer is gonna wanna limit its liability as much as possible. And those types of limitations are generally enforceable in contracts between merchants under the UCC, specifically UCC Section 2-719, sub 3 permits contractual limitations of liability as long as they're not unconscionable. With regard to termination, it's really important to recognize that a brand owner cannot quickly move its business from one manufacturer to another. So if a brand owner's been working with one manufacturer, especially if it's an exclusive relationship, and the manufacturer wants to get out of the agreement, it's going to take the brand owner at least several months, sometimes a year or more, to find a new manufacturer and get up and running with that new manufacturer. So if there's a right of the manufacturer to terminate for convenience, the customer's going to need a lot of advanced notice of that. The termination section also could cover what, if anything, the customer will owe the manufacturer after termination. So for example, if the manufacturer has purchased ingredients or other materials that are used specifically for this customer, the brand owner might be required to buy those back or to pay for an unfulfilled amount of a minimum purchasing commitment. Okay, so switching now to broker contracts. A broker is a person or an entity that connects a seller with a buyer to facilitate the sale of goods. So the broker does not take title to the goods and it's not a party to the sale and purchase transaction. The nature of the agreement is one for sales representation services. Sometimes brokers also provide other kinds of services, such as merchandising or business consulting. Most states have independent sales representative statutes. I've given you a few example citations to the New York, California, Illinois, and Texas statutes, but there are others. And these statutes typically require that there be a written contract specifying how the broker is compensated, setting fair payment terms for their commissions. And it's important to know that the protections that these statutes provide cannot be waived. So you cannot contract out of them, and therefore it's important to figure out which state's law applies and what are the provisions that cannot be contracted out of. Whenever viewing or drafting a broker agreement, I usually start with the termination clause because the ease or difficulty of ending the relationship is going to inform a lot of the rest of the agreement. For example, it's less important to define all of the services that the broker is expected to provide if the brand owner can terminate for convenience on relatively short notice. The termination section might also provide for what's called a tail, an ongoing payment of commissions for some period of time after the relationship ends, or there might be a termination fee. And the idea here is that, in fairness, the broker has developed business for the principal, for the brand owner, and that those sales will continue after the relationship with the broker ends, and therefore the broker should continue to be compensated for some amount of time. The scope of the broker's representation is important to define, especially when the company has more than one broker. The brand owner doesn't wanna be in a position of paying commissions to more than one broker for the same sale if that can be avoided. So the contract should define the scope of representation in terms of which products the broker is authorized to sell, what geographic territory or to what customers the broker has representation. The type of customers can be defined either by the classes of trade or by a list of particular accounts. For example, there are some brokers who only focus on one chain. So there are brokers who only focus on Walmart, for example, or they only focus on natural food retailers in the northeast. The contract might also carve out exclusions from the territory. If the brand owner already has existing relationships with particular customers, or if it has other brokers whose territory would overlap, it's important to include exclusions. And the scope of representation can be exclusive or non-exclusive. For the compensation section, again, it's important to check the relevant state sales representative statutes and know what the minimum requirements are. The statutes provide that for brokers to recover enhanced damages and attorney's fees if they're not paid as required by the statute, so that's really important. Brokers usually are paid commissions on the sales that they make or on sales to the buyers in their territory. So even if a broker wasn't directly involved in soliciting a customer, if that customer is within the defined territory, then the broker still can be paid commission on that sale. 5% of net sales is the typical commission rate in the industry. It might be a little bit more or a little bit less than that, but usually it's 5%. You wanna look really closely at what's the definition of net sales. So most favorable to the broker is for the commission percentage to be applied to the invoiced amount, without including any deductions or chargebacks that the buyers might take. On the other hand, the most favorable to the brand owner is to apply the commission only to the amount that they actually receive on a sale. Sometimes brokers will charge a monthly retainer. This can be either on top of commissions or as a minimum commission amount. Sometimes brokers will provide that the brand owners also required to reimburse them for certain expenses, like travel or sales meetings. Sometimes they include, they pay their own expenses. And as I mentioned, there might be a tail that requires ongoing payments to the broker after the contract ends. If you're representing the principal, the brand owner, it's important to make clear that the broker's authority is limited to soliciting orders, that they're not a general agent of the business. So the broker should not have broader authority to enter into transactions on the principal's behalf or to make commitments on the brand owner's behalf unless explicitly authorized to do so. So you don't want a broker having the authority to make representations and warranties about a product, unless that's been specifically authorized and advanced by the brand donor, And the brand donor always needs to retain the right to accept or reject any order for whatever reason it has. Finally, now turning to distributor contracts. Distributors are wholesalers who buy products and resell them to retailers or sometimes to sub distributors. Sometimes they can provide other kinds of services, like broker services, or merchandising, or consulting. And there's basically two types of distributor agreements. There's one version that I refer to as kind of general supplier terms or the general vendor terms and conditions. And these are the general terms that will apply to any purchase order that they place and that is accepted by the supplier, but the distributor in this type of situation isn't really making any commitment to purchase anything. The other kind is a mutual promises type agreement between the parties where the distributor is making a promise to purchase some minimum amount or to serve as the exclusive or master distributor of the product. The nature of this agreement is mostly gonna be a contract for the sale of goods, again, under Article 2 of the UCC, but it can also be mixed with services. Similar to a broker contract, the distributor agreement might define the authorized scope of distribution. This is going to be especially important if it's an exclusive relationship. So again, which products is the distributor authorized to distribute in which territory to what classes of trade or accounts? Are there any exclusions from that territory? And is this an exclusive relationship or not? Pricing. So, obviously, we need to know what is included in the price. Does the price include delivery to the distributor or is it FOB at the manufacturer's site where the distributor is picking up or arranging for the pickup of the products? Other kinds of provisions that distributors will commonly include in their agreements are most-favored-nation clauses or sometimes mandatory discounts. And these kinds of pricing provisions can raise concerns under antitrust laws, specifically sections one and two of the Sherman Act, the Robinson-Patman Act, and state antitrust statutes. Under those statutes, it's possible for both the seller and the buyer to be held liable. So it's important to consider. A most favored nation clause requires the seller to give the buyer pricing that's at least as good as that offered to any other buyer. And that type of agreement generally does not violate antitrust laws. I've given you a citation to Blue Cross Blue Shield versus Marshfield clinic case in the Seventh Circuit for that. Mandatory discounts are more problematic. Under the Robinson-Patman Act, it's illegal to discriminate in pricing, sales terms, or marketing support that's offered to competitor buyers. So if you give a better deal to one distributor versus another one that it competes with, you need to have a justification for that. And so if the favored distributor, for example, is purchasing larger volumes or the cost of selling to them is lower, then there might be an economic justification for that, so that there's not a violation. If you're representing the seller in a distribution agreement, pay really close attention to the payment terms and counsel the client on what they can expect. In the packaged food industry, there are a lot of reasons why a buyer will not end up paying the full invoice price of the goods. There's promotional allowances, free fills, chargeback for various reasons, off-invoice allowances. These are all common. And the distributor is generally going to reserve the right to offset the amounts that it's owed from the seller on what it pays to the seller. So it will deduct whatever it has determined the seller owes the distributor from the amount that the distributor pays on an invoice. The seller should try to reserve the right to suspend or cancel orders for a nonpayment. So it's not in a situation of not getting paid and still having orders to fill. Distributor agreements always require the seller to give warranties. The pure food guarantee, as it's known in the industry, is very standard and it allows innocent buyers who are not involved in the manufacturer of a product to have a defense against liability for distributing adulterated or misbranded food. So it has its origins in the Pure Food And Drug Act, but has been really greatly expanded to a much broader guarantee and warranties that the product complies with all kinds of laws, and is not defective, and basically anything you can think of. The distributor might also require that the products be warranted to comply with laws from which the supplier might actually be exempt. And therefore the supplier would end up taking non-compliance obligations that it otherwise does not have. So this is really important to understand, especially when you're representing small businesses for which there might be exemptions under applicable regulations, but these businesses will end up effectively having to comply with these rules because their contracts are requiring it. A good example of that is for products sold in California. Distributors usually require a warranty of compliance with California's Prop 65. That's a law that requires warning labels on a product if it exposes consumers to chemicals that are carcinogens or reproductive toxins. Now under that law, if a company has fewer than 10 employees, they're exempt from Prop 65. But if they're doing any business in California, their distribution agreements, and even retailer-vendor terms will require them to comply to do business with those larger buyers. Distributor contracts often require vendors to have annual food safety audits and to share information about any food safety problems or potential violations. And so this can be problematic if the seller is using co-manufacturers and doesn't immediately have that information or have rights to that information. It won't be able to fulfill its obligations to its buyer. That's why I mentioned earlier in the co-manufacturing agreement, I include provisions that require the manufacturer to give immediate notice to its customer if there are any violations found, if there's any reason to believe there's a food safety problem. Really, you have to look at the distribution agreements and agreements with other customers and see what is the brand owner required to give its customers and make sure in its manufacturing contract that it actually has the right to get notice and to get that information. Distributor agreements also should have provisions regarding unacceptable products, right? So here again, the UCC rules are likely to apply. This is mostly a contract for the sale of goods, and the distributor's gonna wanna put all the responsibility on the supplier if the product is unsellable for any reason. So even broader than the UCC, distribution contracts usually require that the supplier guarantee that the product is sellable. So if it's reached a certain shelf life or a certain remaining percentage of its shelf life and the distributor hasn't sold it for any reason, typically, these agreements require the brand owner to buy that product back. And even if it's because the distributor damaged the goods or the retailer damaged the goods, the distributor's gonna wanna put responsibility and the cost of all of that onto the supplier. And so it's really common to see that kind of provision in an agreement especially with the larger distributors. So look carefully for that. For this reason, it's also important to try to get the distributor to agree to at least basic inventory management principles, like first in first out practices, so that the supplier isn't in a situation where it's being charged to buy back nearly expired inventory that the distributor really should have sold earlier. These are important things to look at in the agreement. Also, if the distributor is going to reject goods because there's some problem with them when they're received, the brand owner's gonna wanna put a time limit on that. So just like within the manufacturing agreement, there should be an inspection period of what is a reasonable period of time to inspect the goods after they're delivered and provide notice that there is some problem, also to require some evidence of damages, photographs or other evidence of what the problem is, before the goods can be rejected. And there's a lot more I could talk about, but that is all I have time for in this session. So I hope you found it useful. Feel free to reach out to me if you have questions. Thanks very much.

Presenter(s)

Lauren Handel
Principal Attorney
Handel Food Law LLC

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