Pharmaceutical and Biopharmaceutical companies are faced with the need to outsource the manufacture of their products for a variety of reasons. For example, start-up companies frequently do not have the facilities or expertise necessary to produce the type or quantities of drugs or biologics that are necessary for performing preclinical studies and clinical trials of investigational new drugs. Established companies with FDA-approved drugs or biologics may not have manufacturing facilities that comply with current good manufacturing practices, may not have adequate capacity to fulfill the commercial demands for their products or may desire manufacturing back-up. Whatever the reason, the need for the services of contract manufacturing organizations (CMOs) has given rise to a vibrant industry1 that is likely to grow as that need increases.

Although the technical details that are part of any contract manufacturing agreement will vary depending on the nature of the project, a mutually satisfactory agreement that anticipates issues that are likely to arise is key to the production of acceptable product and the long-term success of the relationship. This article discusses some of the issues that should be considered before and during the negotiation of a manufacturing agreement in order to make the process go more smoothly and to increase the chances of a mutually beneficial relationship.

First Steps

As noted above, companies outsource their manufacturing needs for a variety of reasons. One of the first steps that a company should take before even approaching a CMO is to consider carefully the reason or reasons for needing the services of a CMO. In addition to the reasons noted above, other common reasons include (1) a desire to reduce the time and/or cost to market, (2) the need for research, development or scale-up expertise, (3) the need for greater manufacturing capacity, and (4) the desire to free up resources for new product development.

After the reason for needing the CMO is understood, a company should research potential contract manufacturers.2 This research may start with a review of CMO directories, identification of CMOs previously used by the company, consideration of CMOs used by company personnel in previous positions and conversations with other companies about their experiences with specific CMOs. CMOs quickly develop a reputation, and other CMOs that will provide other types of services, for example, fill and finish, and non-manufacturing contactors such as contract research organizations or testing laboratories may have useful information about a specific CMO. In addition, information about a CMO’s regulatory history may be available from a search of the FDA’s website for Warning Letters and other information regarding a specific CMO, as well as FDA’s list of debarred entities. See http://www. fda.gov/ora/compliance_ref/debar/default.htm.

The Term Sheet

Once the CMO is chosen, and before beginning work on the written agreement, the parties should draft a term sheet. This step is often ignored and frequently results in major issues not being identified until the parties are well into the contracting process. Many major issues can be addressed at this stage, including consideration of (1) whether the arrangement will be part of a larger collaboration between the parties; (2) whether personnel from both the CMO and the company will be used during the manufacturing process; (3) whether the CMO possesses proprietary technology that will have to be licensed from the CMO if the company or another CMO takes over the manufacturing of the product; (4) whether this CMO is the only CMO involved in the manufacture or whether it is one of many, each one with a special area of expertise that is necessary for production of the final product and (5) whether the arrangement is an exclusive one. In addition, if the CMO’s responsibilities are clear at the beginning of the negotiations, the associated fees can also be addressed earlier in the process.

The Agreement   

After the major terms of the arrangement are settled, the drafting of the agreement can begin. The form of most manufacturing and other service agreements is essentially the same and typically includes sections with headings such as: Definitions; Scope of Services; Manufacture of Product; Forecast, Orders and Delivery; Warranties and Quality Assurance; Product Recalls; Payment; Term and Termination; Confidentiality; Intellectual Property; Indemnification; Insurance; Dispute Resolution; and General Provisions. While a comprehensive discussion of the content and considerations for each of these sections is beyond the scope of this article, a brief discussion of some of the issues that result in the most discussion or may lead to future problems if not addressed up-front follows.

Definitions

The definition of defined terms, i.e., those words of phrases that begin with upper case letters, may be found in a separate and distinct Definitions Section, in the body or text of the agreement the first time that the defined term is used or in a combination of the approaches. Both approaches can work well, and the choice of format usually depends on the drafter’s preference. If a textual definition approach is used, a glossary at the end of the document, indicating the section in which a particular defined term is first used and defined may be helpful.

If the agreement is a Master Agree-ment that will include work orders covering several products or multiple batches of the same product that may be put to different uses, general rather than detailed definitions with a provision for more detail in the applicable work order should be considered. For example, a definition of “Applicable Law” or “Regulatory Authority” might initially be limited to the U.S. FDA. However, if a drug is being manufactured for use in Canada, the European Union or other countries or parts of the world, recognition of the applicable law and regulatory authorities of those countries cannot be overlooked. One way to deal with this situation is to reference U.S. law and the FDA, and to require the identification of other applicable law in each work order that will apply to the later batches.3

Another term that may be defined differently depending on the use of the product is the term “Current Good Manufacturing Practices” (cGMP). If the material has to satisfy FDA standards, definitions for cGMP will likely refer to 21 Code of Federal Regulations, sections 210 and 211 (for drugs) or sections 600 and 610 (for biologics) and relevant manufacturing-related guidance documents that FDA posts on its website, including the guidelines of the International Conference on Harmonization (ICH).4 However, material that will be used in other countries may have to comply with different or additional standards of the regulatory authorities of those countries. If this is the case, the standards should be identified before manufacturing begins and they should be identified in the corresponding work order.  

Other definitions that deserve special attention are those for “Intellectual Property” and “Licensed Technology,” which should be broad enough to cover all technology and/or know-how that will be used in the manufacturing process. While a discussion of intellectual property is beyond the scope of this article, each party must be aware of and protect its intellectual property and limit its use by the other party to the purposes of the agreement. The company will also want to ensure that any product-related discoveries that are made during the manufacture of the product belong to it. Likewise, the CMO will want to ensure that any discoveries that relate to its technology and proprietary manufacturing procedures belong to it. On the other hand, the company will probably want the right to license any CMO-technology that is developed under the agreement and used in the manufacture of its product. This right is particularly important if the company decides to manufacture the product itself or if it enters into an agreement with another CMO.

Manufacture of Product

Both the CMO and company may desire some sort of exclusive relationship. For example, the CMO might want the company to agree to not use the services of another CMO to provide the same services, and the company might want the CMO to agree to not produce the same or related products for the company’s competitors. One or both situations may not be to the benefit of either party. For example, if the CMO cannot meet the company’s demand for product, a company tied to exclusive use of that CMO would not be able to use a back-up manufacturer. In addition, when the agreement with the CMO is terminated, the company could be left without a qualified source of material. A CMO tied to an exclusive manufacturing arrangement could lose significant other business. In either situation, the parties should give some value to the exclusivity and consider what if any effect that should have on the fees that otherwise would have been charged.

Audits

Because the product being produced is ultimately the responsibility of the company, the company must be able to reassure itself that the CMO is performing as required. As a result, the company must have the right to inspect and otherwise audit the CMO. At a minimum, the company should be able to inspect all manufacturing-related paperwork for accuracy and completeness a couple of times a year or more often depending on the frequency and variety of manufacturing being performed by the CMO. In some situations, the presence of a “man in the plant” or a representative of the company during all or part of each manufacturing project may be justified. In addition, if a product problem that could have arisen from the manufacturing procedure is noted, the company must be able to audit all documentation related to the manufacture and testing of the problem lot of material.

CMOs typically want to limit the frequency and duration of company audits and may propose additional costs for personnel time during such audits. It is important that the parties determine in advance how such audits will be handled.

Forecast, Orders and Delivery

Arriving at an acceptable schedule for manufacturing the product is frequently one of the biggest planning challenges for both parties. While the company, particularly one that does not yet have an approved drug, wants as much flexibility as possible before being locked into a production schedule, the CMO wants to know its commitments to the company as far in advance as possible so that it can make maximum use of its manufacturing facility. Many agreements use a rolling forecast where the company has some opportunity to modify its projections up until a certain date after which any schedule modification will result in additional payments and or cancellation fees. Depending on the product and facility, some CMOs may be willing to reduce or waive a penalty if it is able to fill the time that it had reserved for the company with work for another customer.

Occasionally, a CMO is unable to supply the product in the quantities or at the time required under the agreement or the manufactured material may not meet the previously agreed to specifications. If either situation occurs, the agreement must spell out clearly how much time (and whether) the CMO will have to replace the nonconforming product with conforming product or whether another vendor may be used without any penalty.

Often the procedure used to determine whether or not a product meets specifications can be contentious. While the CMO frequently does the initial testing to determine whether the product meets specifications, the company may do its own testing. If the test results don’t agree, i.e., the CMO says that the product is acceptable and the company determines that it is not, the services of an independent testing facility may be required to resolve the disagreement.

Most agreements require the company to determine by a certain time after the manufacture of each batch whether it will accept or reject the batch. However, even if the company’s testing confirms the CMO’s test results within that time period, the company should consider whether latent defects could arise that might be attributable to the CMO’s failure to follow the agreed upon procedures. One example of such a situation is where a CMO failed to cool in-process material according to the company’s instructions, and the failure led to stability problems that did not appear until months after the company had accepted the batch. In that situation, the parties were developing a long-term relationship, so the incentive to find a satisfactory sharing of the financial cost was great. In other situations, however, a company might be faced with a useless product batch.    

Fees are generally straightforward, but the company should carefully consider whether there is a way to schedule the payments so that the CMO is incentivized to perform as required. In addition, the payment plan could also include penalties for poor performance and rewards for good performance. As noted above, consideration should also be given to non-manufacturing aspects of the agreement such as the requirement for an exclusive relationship.

Indemnification and Insurance

Every CMO should have adequate liability insurance to cover the services that it provides to its customers, and the agreement should make that requirement clear and if possible specify a minimum amount of insurance coverage that must be maintained. In addition, each party is usually asked to indemnify the other party from and against third party claims arising out of the indemnifying party’s negligence or malfeasance, and as a result the CMO may require the company to maintain sufficient insurance to cover its potential indemnification responsibilities.

Limitation of Liability

The Limitation of Liability section is frequently one of the most contentious sections since the CMO typically wants to limit its liability for damages to the company and any third party to no more than the amount of money that it received under the agreement or for the particular project under which the liability arose. This position is clearly unacceptable to the company for which losses or potential liability to a third party injured by its product likely has little if any relationship to the amount that it paid to the CMO. This is one issue where the relative differences in bargaining power between the CMO and the company may have a great effect on the resolution of the issue. At a minimum, amounts owed under the indemnification provision, which relates to injuries to third parties, should be carved out of any limitation of liability and the parties should consider a monetary limitation that is a reasonable multiple of the amount paid under the agreement or applicable work order.

General Provisions

The General Provisions or Miscellaneous section of the agreement is typically the last section of the agreement, and its sections are often referred to as “boilerplate,” erroneously suggesting that the provisions are routine and perhaps don’t merit any negotiation. While not necessarily the most important sections, one that should be considered is the section dealing with Assignment.

After having spent time researching the CMO that was ultimately chosen, the company should not permit the CMO to assign any of its responsibilities under the agreement to another person without first obtaining the company’s written approval. If the CMO knows that it would like the ability to assign all or part of its responsibilities to a third party or an affiliate, it should discuss that situation during the contracting process and obtain the necessary consent for that specific assignment in the agreement.

The drafting of a contract manufacturing agreement that anticipates the needs of each party and facilitates the development of a mutually rewarding arrangement takes a great deal of thought, planning, effort and patience. The drafting process should involve people with business, technical and legal expertise, and may also require the input of medical and regulatory personnel. The final agreement should also be reevaluated periodically to identify provisions that should be changed in order to maintain a good working relationship.

Notes

1. As an indication of the size of the industry, Contract Pharma’s 2005 Corporate Capabilities/Contract Services Directory, Vol. 6, No. 10, listed forty-four categories of manufacturers, each category containing names of multiple companies that specialize in the manufacture of specific types of pharmaceutical products.

2. Just as the reasons for using a CMO will differ, the nature of the relationship between the company and the CMO will also differ. In some cases, the relationship will be a purely business relationship in which each party is truly working as an independent contractor. In other situations, however, the parties may anticipate or already be involved in a partnership. For example, in some collaboration agreements between biotechnology companies and Big Pharma, Big Pharma not only agrees to assist with certain financial and regulatory tasks crucial to the development and ultimate approval of a new product, but may also serve as the manufacturer after approval. In those situations, some of the issues discussed in this article may not arise.

3. Some Master Services Agreements include a form of work order that will be used for subsequent projects, and the applicable law can be one of the pieces of information that has to be filled in for each work order.

4. While CMOs sometimes balk at listing the guidance documents, those documents reflect FDA’s current thinking on certain issues as well as that of similar regulatory organizations in other countries. They may not be binding, but they do provide some additional insight to what could be cGMP.

Linda D. Bentley is a member at the Boston office of Mintz, Levin, Cohn, Ferris, Glovsky and Popeo P.C., practicing in the Health Section and Biotechnology Group. She can be reached at ldbentley@mintz.com.