Life sciences A to Z: S is for supply agreements

Supply agreements can come in various guises and, in the case of pharmaceuticals, may take the form of manufacturing services agreements, pure "supply of products" agreements, or a hybrid of the two.

At the outset of drafting the terms of a supply contract, it is of course important to be clear about whether the supplier will be providing a finished product to the customer, or whether the commercial agreement will be more akin to a manufacturing services arrangement. Beyond this, important considerations for both parties may include:

• Raw materials – Who will supply the raw materials such as the active ingredient or the packaging? Will the customer require that these are purchased from its nominated third-party supplier, and who will bear the risk of the third-party failing?
• Filling – Is the customer’s requirement for a bulk supply, a supply to fill containers or finished product supply? In the case of bulk supply or filled containers supply, have the parties considered a tolerance for shortfall?
• Packaging – If the arrangement is not for the supply of a finished product, will packaging, wrappers and leaflet insertion be required by the customer? If so, which party will source these?
• Pricing – Is a fixed price contract, cost-plus contract or another fee arrangement most suitable in the circumstances?
• Type of outsourcing – Is the arrangement a complete outsourcing by the customer of production, packaging and delivery (known as contract manufacturing) or will the supplier be responsible only for the processing of raw materials or semi-finished products into finished products (known as toll manufacturing)?
• Warehousing and logistics – Which party is responsible for these and where does the risk pass?

Ordering process and capacity issues

The recent dispute between the European Commission and AstraZeneca relating to the COVID-19 vaccine highlighted the issues suppliers face where demand for product demand exceeds supply. For more information, read our article about the case here.

To minimise the risk of these problems arising, there are a number of important points for life sciences businesses to consider before entering into supply contracts, such as how customers will be prioritised in the event of the supplier’s shortage, ensuring the contract addresses availability and lead times, at what point (if at all) a customer’s orders become a binding obligation on the supplier, as well as the consequences for breach.

Exclusivity

In the context of a supply agreement, a customer may wish to secure the exclusive right to the supply of a product, usually within a certain territory. Where this is the case, a supplier may seek to impose minimum purchase commitments on the customer to ensure the arrangement is commercially viable.

Minimum purchase commitments

Whilst more likely to be found in exclusive agreements, any supply agreement can stipulate minimum purchase commitments. Considerations for both parties before agreeing to such commitments include:

• Is it binding or non-binding, and what is the penalty for failure to meet the purchase commitment?
• Does the minimum purchase amount refer to a certain number of units or a monetary value? If the latter, should the amount increase over a period of time and, if so, should this be calculated according to actual price increase or by a mechanism such as the RPI?
• Is there an option for the customer to retain exclusivity by “buying out” all available product in the event that the supplier does not produce sufficient product for the minimum purchase commitment to be met by the customer?
• Conversely, can excess volumes purchased by the customer be “carried over” to the next period?

Best endeavours?

In addition to the issue of when orders becoming binding, the supply agreement should address whether the supplier has an obligation to accept a customer’s orders. If so, this could take the form of a strict obligation or an “endeavours” based approach. The latter may be particularly relevant where an agreement contemplates the supply of product in numbers beyond those forecast at the outset.

When drafting the agreement, it is important to be aware that interpretation of terms such as “best endeavours”, “reasonable endeavours”, “all reasonable endeavours” or “commercially reasonable endeavours” can differ under English law and change the weight of the obligation.

Sale and purchase terms

The commercial terms applicable to the sale and purchase of products under the supply agreement will also need to be addressed either in the supply agreement itself or by incorporating appropriate sale and purchase terms. These can address items such as liability, warranties, timing, intellectual property ownership, risk, and retention of title, prices, Incoterms, clearances and other allocation of responsibilities.

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