OEMs and CMs: Risks and Precautions

OEMs (original equipment manufacturers) are prevalent in today’s cost competitive environment. Despite the popularity, intellectual property risks lie on both sides --OEMs and CMs (contract manufacturers).

For OEMs, one major risk is that CMs may over-manufacture the designated products without OEMs’ authorization, and re-sell such products to third parties or directly to end users, which may dilute OEMs’ market. Another risk is that CMs may use, disclose or disseminate OEMs’ confidential information, without due authorization. Such act may be intentionally taken by CMs for profit-making, or due to negligence in restricting their employees in complying with their confidentiality obligations. Whatever the reason, such undue disclosure of confidential information exposes OEMs to business risks and harm.

For CMs, the primary risk is their inadvertent infringement of third party intellectual property rights due to OEMs’ lack of relevant rights. In this scenario, third party right holders may directly sue CMs for infringement, and if CMs are not properly protected under OEM contracts, CMs’ losses can hardly be indemnified by OEMs.

Awareness of risks leads to design of precautions. Suggested steps for OEMs and CMs include:

1. CMs should conduct intellectual property due diligence of OEMs, making sure that OEMs are legitimate holders of relevant intellectual property rights;
2. OEMs and CMs should specify detailed rights, obligations and remedies under their contracts, especially with respect to potential intellectual property disputes;
3. OEMs may require CMs to keep detailed records of how the designated products are manufactured, and entitle themselves to review and inspect; and
4. CMs should take precautions to protect confidential information of OEMs (including, without limitation, entering into confidentiality and non-compete agreements with employees).