1.5 Contract review & commercial controls

A signed contract is primarily a liability container. Discrepancies between legal terms and operational reality cause immediate financial leakage. Contract reviews exist to precisely define the moment risk transfers from the factory to the customer. Every engagement requires verification that “standard terms” genuinely apply to the specific build in question.

NDA parameters (the IP firewall)

The Non-Disclosure Agreement (NDA) serves as a secure gateway for technical discovery, preventing unintentional liability. It is designed to facilitate the exchange of engineering data without anchoring the factory to infinite, unquantifiable risk. We deliberately avoid signing “blank check” legal documents.

Action: NDAs failing to meet the following criteria necessitate immediate redlining to protect the business.

A. mutuality

• Requirement: Mutual (Bidirectional).
• Logic: Manufacturing is not passive. We share proprietary Process IP (DFM, Test Scripts, Stack-ups) just as the customer shares Product IP. Unilateral (One-Way) agreements ignore our contribution and exposure.

B. liability & penalties

• Requirement: Actual Damages Only.
• Restriction: No Liquidated Damages (Fixed Penalties).
• Logic: Clauses stipulating a fixed cash fine per breach (e.g. “$50,000 per occurrence”) must be rejected. This incentivizes litigation over minor infractions. Damages must be proven based on actual financial loss.

C. term (duration)

• Standard: 2 – 3 Years.
  • Why: The technology obsolescence cycle in electronics is ≈ 18 months. Protecting a schematic for 10 years is legal clutter.
• Exception: Max 5 Years.
  • Condition: Allowed only for High-Reliability sectors (MedTech, Automotive) where product lifecycles exceed standard consumer horizons. Requires VP approval.
• Perpetuity: Forbidden. Confidentiality obligations must expire.

Engineering Practice

Caution must be exercised regarding “Residuals” clauses. These often allow the counter-party to use any information “retained in unaided memory” for any purpose. This is a backdoor for IP theft and must be struck out.

Commercial control logic

These seven pillars must be analyzed rigorously. Ambiguous clauses require immediate redlining for clarification.

1. Incoterms (transfer of risk)

Shipping terms define who pays for logistics and, more importantly, who insures the goods during transit.

• Standard: Ex-Works (EXW).
  • Logic: Risk transfers to the customer the moment goods leave our dock. Preferred.
• Deviation: Delivered Duty Paid (DDP).
  • Risk: This scenario shifts ownership of customs clearance, tariffs, and last-mile delivery to the factory.
  • Action: Executing DDP terms generally requires appending a 5% – 10% logistics buffer to the unit price to appropriately offset the assumed risk.

2. Liability & warranty caps

We manufacture to print; we do not design the product. We cannot be liable for the end-device’s performance.

• Cap Logic:
  • Contracts requesting “Unlimited Liability” must be uniformly rejected.
  • Standard: Liability should be explicitly capped at the value of the specific Purchase Order (PO) or the reworked boards.
• Warranty Period:
  • Standard: 12 months from the Date of Manufacture.
  • Exclusion: Unauthorized rework attempts by the customer inherently void the warranty.

Common Pitfall

If a customer pushes for a 2-year warranty, evaluate the product’s reliability based on the “Bathtub Curve”. Most electronics fail early (Infant Mortality) or late (Wear-out). Extending from 12 to 24 months is often low risk if the burn-in process is robust.

3. Intellectual property

“Product IP” must be distinguished from “Process IP.”

• Product IP: The customer owns the schematics, firmware, and form factor.
• Process IP: We own the DFM report, the reflow profiles, and the manufacturing checklists.
• Rule: A contract that grants the customer ownership of internal process methodologies must never be signed.

4. Forecast & inventory liability

Customers want flexibility; factories need stability. The contract must bridge this gap.

• Non-Binding Forecast:
  • Forecasts provided “for reference only” do not authorize material purchases, preventing the accumulation of unbacked inventory risk.
• Binding Horizon:
  • Standard: Weeks 1–12 represent the firm commitment window (Work in Progress). Weeks 13–24 constitute the material authorization window.
  • Clause: “Customer assumes full liability for all material purchased to support the binding forecast in the event of order cancellation.”

5. Change control (ECOs)

Engineering Change Orders (ECOs) disrupt flow.

• Cost Impact:
  • ECO issuance necessarily halts active production.
  • Action: The comprehensive ECO cost (encompassing Scrap, New Tooling, and Administrative Fees) must be quoted to secure customer approval prior to implementation.
• Schedule Relief: The contract must state that ECOs automatically reset the Lead Time clock.

6. RMA & rejection criteria

“Fail” must be defined objectively to prevent subjective returns.

• Criteria: Returns are considered valid exclusively when units fail the mutually agreed “Test Specification” (Chapter 1.2).
• NFF (No Fault Found):
  • Return rates exceeding the acceptable X% NFF threshold authorize the application of a screening fee to compensate the factory for diagnostic time.

Contract review checklist

This checklist must be used for every Master Services Agreement (MSA) or new PO with attached terms.

Clause Category	Validation Standard	Status (Pass/Redline)
Incoterms	Explicitly defined (e.g. EXW [City]).	[ ]
Liability Cap	Capped at PO Value or 1x Revenue.	[ ]
Consequential Damages	Explicitly waived (Lost profits, recalls).	[ ]
Payment Terms	Matches approved Finance terms (e.g. Net 30).	[ ]
Material Liability	Customer owns “Long Lead” and “NCNR” stock.	[ ]
Warranty Window	Defines start date (Ship Date vs. Install Date).	[ ]
Gov. Law	Jurisdiction is our local manufacturing region.	[ ]

Approved deviations register

When we accept risk, we document it. This register tracks deviations from our Standard Terms & Conditions.

Register Format:

Customer	Clause	Standard Term	Accepted Deviation	Risk Owner
Acme Corp	Payment	Net 30	Net 60	CFO
Beta Inc	Liability	100% of PO	200% of PO (Cap: $50k)	CEO
Gamma Ltd	Warranty	12 Months	18 Months (+2% Price Adder)	VP Sales

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Recap: Contract Review & Commercial Controls

Parameter	Requirement	Standard / Value	Action / Condition
NDA - Liability	Damages must be provable	Actual Damages Only	Reject clauses for Liquidated Damages (fixed penalties).
NDA - Term	Obligations must expire	2–3 years standard	Max 5 years only for High-Reliability sectors with VP approval. Perpetuity forbidden.
Incoterms	Define risk transfer point	Ex-Works (EXW)	For DDP terms, append 5–10% logistics buffer to unit price.
Liability Cap	Limit financial exposure	Capped at specific PO value or rework cost	Reject contracts requesting “Unlimited Liability”.
Warranty Period	Define coverage duration	12 months from Date of Manufacture	Voided by unauthorized customer rework.
Forecast Liability	Assign inventory risk	Weeks 1-12: Firm commitment. Weeks 13-24: Material authorization.	Customer assumes full liability for material purchased against binding forecast if order cancels.
ECO Implementation	Recover all costs and reset schedule	Quote full cost (Scrap, New Tooling, Admin) for customer approval prior.	ECOs automatically reset the Lead Time clock.
RMA Validity	Define objective failure	Unit fails mutually agreed Test Specification.	Apply screening fee if NFF returns exceed agreed threshold (X%).