In an earlier post, we explored some of the key issues in a contract manufacturing agreement from the perspective of the drug developer. However, Outside GC frequently represents outsourced manufacturers, too. The knowledge we’ve gained from working on both sides of the table enables us to effectively and efficiently negotiate agreements that satisfy both parties.
To achieve a “win-win” result, it’s important to understand what motivates each side at the negotiating table. Armed with this information, buyers (drug developers) and sellers (manufacturers) are better equipped to reach a fair arrangement without belaboring the negotiation phase. In our experience, these key concerns include the following:
- Balancing risk with reward during the development phase
Unlike the drug developer, the manufacturer’s profit margin is fixed. Understandably then, the manufacturer is more risk adverse and will seek to limit its exposure, particularly for risks outside of the manufacturer’s control. Meanwhile, the drug developer is often motivated to bring its drug to market as quickly as possible, and may seek an expedited development process, which might include fewer process development and engineering runs prior to engaging in commercial (i.e., GMP) supply. In such cases, the manufacturer may insist that the increased risk of a truncated approach be borne by the drug developer.
- Preserving ownership of innovation
Developing a Good Manufacturing Process (GMP) process often involves multiple practice runs at different production volumes, with many adjustments and recalibrations along the way. Improvements that result from this effort are potentially valuable assets, which often result in the question of ownership. A drug developer will favor complete ownership of all IP in order to maintain the freedom to operate, produce their product independently of the manufacturer, and potentially block competitors.
On the other hand, the manufacturer has an interest in owning innovations which are generally applicable to the processes it uses throughout its business and for the benefit of other drug developer customers. A frequent compromise on this issue will hinge on the type of innovation. If improvements are drug-specific or require the use or incorporation of drug developer confidential information, the drug developer will own the rights; while general innovations relating to manufacturing know-how will belong to the manufacturer.
- Limiting liability for breach
In a contract manufacturing arrangement, non-conforming product is a major concern for both parties. Often, the parties will include provisions for expedited dispute resolution (e.g., expert review and/or independent lab testing) for the purposes of determining whether or not a product meets specifications, as well as what caused the deviation.
In the event a product is non-conforming and the manufacturer is found liable, the question of who will bear the cost of reproduction is not entirely cut and dried. Since the manufacturer’s profit is fixed (often, a relatively modest percentage of the fees it charges), it will resist being liable for the full cost of reproduction, particularly if the procurement of raw materials is a major component of the overall cost of production. A fair solution typically divides responsibility between the parties, with the manufacturer not charging extra fees for the additional production run and the drug developer covering all or most of the cost of raw materials and other out-of-pocket costs. In this scenario, the drug developer is better positioned to mitigate its own risk through the purchase of property loss insurance and/or maintaining extra inventory of key raw materials in the case of batch failures.
For the same reason, the manufacturer will also seek to limit its liability for other damages under the agreement, such as indirect/consequential damages (e.g., the drug developer’s lost profits), and cap its overall exposure to the fees paid to the manufacturer or a fixed dollar cap. Common exceptions to the cap are indemnification obligations for third party claims, breaches of confidentiality and IP obligations, and “bad acts” by the manufacturer, such as gross negligence or willful misconduct, all of which are tied to actions under its control.
- Scope of warranties
The type of drug in question (e.g., small molecule vs. biological material) will usually affect the type of warranty the manufacturer is willing to give. For instance, with a small molecule that has a straightforward manufacturing process and little variability, the manufacturer may be willing to warrant that the product will meet well-defined final product specifications.
In the case of biologics that involve the use of animal or human tissue, and where the output of the manufacturing process is less consistent, the manufacturer may not warrant to outcome, but rather only that it will follow GMP compliant “recipe” or process. The manufacturer may also expect the drug developer to bear the risk of any uncertain outcomes. This issue may be particularly relevant during the development phase of the product before commercial sale when the GMP process is still being worked out or adjusted.
- Regulatory compliance
Compliance with FDA (and foreign counterpart) requirements is another important concern addressed in a contract manufacturing agreement. Each party will want to ensure that the other is abiding by GMP. The drug developer will insist on (a) audit rights to inspect the manufacturer’s records and observe its operations (and that of any of the manufacturer’s subcontractors), and (b) being notified of, and the right to participate in, any inspections by regulatory authorities. Meanwhile, the manufacturer will seek reasonable parameters for such audits, including limits on time, cost and interference with its operations, as well as assurances that any materials sourced by the drug developer or its vendors meet all regulatory requirements. Finally, the drug developer will typically ask that the manufacturer assist with its responses to regulatory inquiries, such as the FDA; and the manufacturer will request adequate compensation for this effort.
- Commercial Supply Agreements
Once a drug product has been approved for commercial sale, additional considerations drive the terms of the commercial supply agreement. The manufacturer will focus on ensuring the most efficient use of its work force, equipment and facilities by requiring:
- minimum and maximum order amounts
- minimum annual volume commitments
- appropriate lead times for order fulfillment
- GMP suite reservation fees
- late cancellation fees to recoup up-front costs of production and lost opportunity costs
- appropriate lead times for termination of the manufacturing contract by the drug developer
The manufacturer may also push for exclusive manufacturing rights.
Commensurately, the drug developer may seek:
- non-competition protections
- early termination rights in the event the drug developer is acquired or sells or licenses the product to a third party, or if the product is taken off the market or faces generic drug competition
- in the case of exclusive supply arrangements, the ability for back-up supply if the manufacturer cannot deliver
- reduction in annual volume commitments in the event of generic or other competition
- credits for late product delivery
Development and commercialization of drug products and biologics is a high stakes business with lots of upfront costs and substantial risk of failure. Contract manufacturers frequently play a key role. Understanding the potential risks and rewards to the drug developers and the manufacturers is crucial to coming to contract manufacturing arrangements that maximize the chances of success for both parties. If you have questions about these types of agreements, please feel free to contact Jordan Karp at email@example.com or contact us via our website.
A Member of Outside GC's Washington D.C.-based team, Jordan Karp has over 20 years of in-house legal experience in the life sciences and technology industries. He has considerable expertise with biotech-related agreements, including contract research and development agreements, clinical trial agreements, and contract manufacturing agreements. Jordan can be reached at firstname.lastname@example.org or 443-310-6794.