Watch or read any news source, and the severity of today’s global supply chain problem becomes abundantly clear. A nightmare combination of factors has led to the present crisis—including COVID-19 reducing production rates, labor shortages impairing transportation capacity, and many others. Moreover, the prevalence of “on demand” or “just in time” manufacturing principles and the global nature of today’s economy contribute to the domino effect. The end result is that most companies are experiencing tremendous supply chain problems. What companies may not realize, however, is that this challenge also presents a potential intellectual property win.
As many companies urgently investigate alternative sourcing for their finished goods or components, the process—if approached strategically (versus reactively)—may present an opportunity to improve the client’s competitive posture by strengthening its IP portfolio. That said, developing additional supply chain resources is certainly a wise business practice, but due care should be taken to carefully consider and address potential intellectual property issues.
Notwithstanding the exigent circumstances, the first step is to “take a breath” and recall the amount of time and effort that was no doubt invested when the existing supply chain relationship was developed by the client. Review the rationale for making the original selection. Ensure the present crisis does not create a “blind spot” causing the client to ignore critical long-term issues for the sake of short-term expediency.
Next, create a data room of sorts. Gather all upstream (supplier) contracts and downstream (customer) contracts that may contain terms and conditions directly or indirectly affecting intellectual property. Then create a comprehensive inventory identifying any intellectual property necessary to create the goods or components. Consider all forms of intellectual property, including patents (design and utility), trademarks, trade dress, copyrights, and trade secrets, and separately address each different territory that is part of the supply chain. Include the obvious forms of IP that directly cover the specific good or component, but also include any manufacturing processes or techniques necessary to achieve the desired price point, manufacturability, quality and efficiency. Are there any third-party exclusive materials or processes used with the good? For example, a unique material that can only be obtained from a single source. Failure to fully and completely identify all of the affected intellectual property may lead to unwelcome surprises down the road.
Once the full population of contracts and intellectual property is established, perform a careful analysis of both to determine any rights or obligations that may be triggered by establishing an alternate source. For example, who owns the intellectual property asset? What about ownership of improvements that may have been developed over time by the existing supplier? Do the contracts clarify exclusivity versus non-exclusivity and/or the right to transfer or sublicense? Are there any restrictions as to working with competitors of the existing supplier? Are there any territorial restrictions in place? The possibilities are endless, but this review is necessary to ensure the client does not unwittingly breach any contractual obligations.
Depending on the specific circumstances, the client may desire to: (a) create a relationship with a new third-party supplier; or (b) develop an in-house manufacturing capability to obviate the need for the existing supplier. Certain intellectual property issues are common to both options. For example, the client may own intellectual property fundamental to the good being supplied, but the existing supplier may have developed improvements to such good or unique processes for manufacturing such good. Unless the contractual relationship with the existing supplier expressly assigns ownership to the client, the client assumes great risk if the improved good or the unique process is practiced by the new third-party supplier or by the client. Additionally, the client should carefully consider the existing territorial scope of any intellectual property in the good to be manufactured. Do the exclusive rights extend to the territory in which the new supplier operates or in the client’s own territory? If not, then the client should explore freedom to operate issues and consider potential IP protection in the new territory.
If a new third-party supplier is desired, the quality, reliability, timeliness and security of such supplier are quite important. Beyond these basics, however, the client will need to negotiate a new contractual relationship that will address a multitude of issues, including ownership of improvements to existing IP, ownership of processes and techniques, ownership of manufacturing tools, information security, as well as audit and enforcement rights to ensure compliance by the new supplier. The client should view this as an opportunity to shore up any weaknesses identified in the relationship with the prior supplier.
If the client desires to bring manufacturing in-house, one key issue to be considered is the potential loss of indemnity. In a typical supplier relationship, the third-party supplier assumes an indemnification obligation protecting the client from claims that the supplied good infringes a third party’s IP. Forgoing such indemnity by removing the third-party supplier from the supply chain presents increased risk that should be considered.
The client may also wish to consider a “delayed differentiation” supply chain strategy in which certain generic components are manufactured in advance by a third-party supplier. The unique component embodying the valuable intellectual property is subsequently integrated with the generic component to create the finished good, but the unique component is handled either in-house or by a highly trusted third-party supplier. The client may therefore reduce supply chain timing issues while maximizing IP protection.
In summary, clients are currently experiencing tremendous supply chain challenges and those challenges are likely driving many to explore alternative sourcing arrangements. Such initiatives carry significant risk. However, by handling strategically and exercising appropriate diligence, the client can avoid intellectual property pitfalls and strengthen its competitive position.