In OEM manufacturing, establishing proper contracts is essential for building trust with manufacturers. This guide comprehensively covers everything from the three core contracts — NDA, manufacturing agreement, and quality assurance agreement — to key considerations under the Subcontracting Act and Product Liability Law, as well as industry-specific requirements.
Proceeding with OEM manufacturing on verbal agreements alone exposes you to significant risk when problems arise. Contracts serve as the foundation for clarifying both parties' rights and obligations and ensuring a fair business relationship.
Protect confidential information such as formulations, recipes, and manufacturing know-how through contracts to prevent technology leaks. Information leakage to competitors can have devastating consequences for your business.
Establish the scope of responsibility for product defects and complaint handling in advance, building a framework for swift and appropriate response when issues arise.
By clearly defining both parties' rights and obligations, you build trust and establish a long-term, stable trading partnership.
In OEM manufacturing, three types of contracts are signed at different stages. Understand the purpose and key clauses of each to build a comprehensive contract framework.
When to Sign
Sign before the first consultation or meeting. The golden rule is to have it in place before disclosing any formulations or recipes.
What It Protects
Trade secrets including formulations/recipes, raw material ratios, manufacturing conditions, customer data, and sales figures.
Duration
Typically 3 to 5 years. Include a survival clause requiring confidentiality obligations to continue for 1 to 3 years after the agreement ends.
Important Note
NDAs are typically mutual (bilateral). A one-sided NDA may impose unfair terms on one party and hinder trust-building. Additionally, if the definition of confidential information is vague, there is a risk that protections won't hold when needed — so it's important to list specific categories of protected information.
The manufacturing agreement is the cornerstone of OEM manufacturing. It establishes all terms between the client and manufacturer regarding product manufacturing. Individual orders are typically handled through separate "individual agreements" or "purchase orders," operating as a combination of the master and individual agreements.
Specifically define product specifications, standards, and quantities. Attach specification sheets and drawings as appendices, and clearly state the procedure for changes.
Agree on order lot sizes, lead times, and delivery schedules. Also consider minimum/maximum lot settings and penalties for delivery delays.
Specify unit prices, methods for adjusting raw material cost fluctuations, payment due dates, and payment methods. Also establish rules for price revisions due to exchange rate changes or raw material price increases.
Clarify which party is responsible for procuring raw materials. If the client specifies certain materials, define the supply conditions as well.
Define shipping acceptance criteria, inspection methods, and inspection frequency. Also specify incoming inspection methods and procedures for handling rejections.
Agree on responses to defects (replacement, refund, or correction), acceptable defect rates, and which party bears the costs.
Clearly define ownership of technology and know-how developed during the process. Typically, the client's formulations belong to the client, and the manufacturer's production technology belongs to the manufacturer.
Define the allocation of responsibility for damages caused by product defects. Also agree on PL insurance requirements and liability caps.
Define the scope and limits of damages for contract breaches. Also specify the distinction between direct and indirect damages and the treatment of lost profits.
Establish the contract period (typically 1 to 3 years) and conditions for automatic renewal. Also specify the advance notice period for non-renewal.
Define conditions for contract termination (material breach, bankruptcy, involvement with antisocial forces, etc.) and procedures for handling inventory and work-in-progress upon termination.
Define restrictions on the manufacturer producing similar products for third parties. Also specify conditions for exclusive agreements.
If the Subcontracting Act applies, specify obligations including written order issuance, payment deadline compliance, and prohibition of price-squeezing.
Include representations and warranties that neither party is affiliated with antisocial forces, with an immediate termination clause if such affiliation is discovered.
Agree on the court of jurisdiction for disputes. Typically, the district court located at the client's headquarters is designated.
The quality assurance agreement supplements the manufacturing agreement by establishing detailed terms regarding product quality. Product specification sheets and quality standard documents are attached as appendices to build a concrete quality management framework.
Define concrete quality standards numerically, including product appearance, physical properties, microbial criteria, and sensory evaluation criteria. Setting both specification and control values is essential.
Define the inspection items and frequency for each stage: incoming material inspection, in-process inspection, and pre-shipment inspection. Include calibration frequency for inspection equipment.
Define isolation and identification methods for out-of-spec products, disposal criteria, rework eligibility, and cost allocation.
Establish a system enabling lot-based tracking from raw material receipt to product shipment. Also define record retention periods.
Clarify procedures for initial response to market complaints, including reporting deadlines, investigation procedures, root cause analysis, and corrective actions.
Establish rules for regular quality review meetings, improvement suggestion systems, and process change management.
Food OEM contracts require clauses addressing industry-specific regulations including the Food Sanitation Act, Food Labeling Act, and HACCP system.
Include manufacturing facility business permits, appointment of food sanitation managers, and verification of additive legality in the contract.
Specify the management framework for the 8 specified raw materials and 20 recommended labeling items, cross-contamination prevention measures, and allocation of labeling responsibility.
Define responsibility for conducting accelerated and storage tests, ownership of test data, and final authority for shelf life decisions.
Clarify responsibility for nutritional information, ingredient lists, and origin labeling. Also agree on recall cost allocation in case of labeling errors.
Verify implementation of HACCP-based sanitation management (mandatory since June 2021) and include HACCP plan compliance in the contract.
For cosmetics OEM, compliance with the Pharmaceutical and Medical Device Act (PMD Act) is the top priority. Understand the licensing system and approval processes before signing contracts.
Specify in the contract the verification of cosmetics manufacturing and marketing licenses, and the allocation of responsibility for product approval and notification procedures.
A marketing authorization license is required for manufacturing and selling cosmetics. The license holder bears ultimate responsibility for quality and safety.
Clarify responsibilities for compliance with full ingredient listing requirements, INCI name verification, and listing in order of formulation quantity.
Agree on ownership of formulation stability test and aging test data, and allocation of testing costs.
For products classified as quasi-drugs, separately define the approval application procedures, ownership of clinical trial data, and change management after approval.
OEM manufacturing outsourcing may fall under the Subcontracting Act (Act against Delay in Payment of Subcontract Proceeds, Etc.). Violations can result in recommendations from the Fair Trade Commission, so careful attention is required.
The act applies when a parent company with capital exceeding 300 million yen (or between 10 million and 300 million yen) transacts with subcontractors with capital of 300 million yen or less (or 10 million yen or less, respectively).
Parent companies are obligated to issue a written document (Article 3 document) at the time of order, specifying product name, quantity, unit price, delivery date, and payment date.
Subcontract payments must be made within 60 days from the date of receipt of goods. If no payment date is set, the date of receipt becomes the payment date.
Important: Violations of the Subcontracting Act result in recommendations from the Fair Trade Commission and public disclosure of the company name. Additionally, late payment interest (14.6% annually) becomes payable. OEM manufacturing clients must verify whether they qualify as a "parent company" under the act.
Before signing OEM manufacturing contracts, verify the following items. Even a single omission can lead to future disputes.
This guide is intended for general informational purposes. For actual contract preparation, please consult a legal professional such as an attorney. OEM JAPAN offers free consultations regarding OEM manufacturing.
OEM JAPAN allows you to search and compare food and cosmetics OEM manufacturers for free. Many manufacturers offering small lot options are listed.