Letters of Intent

Pankaj Raval (00:02)
Hey everyone, we've got a special review today of AI contracts. There's obviously a lot of buzz in the world today about artificial intelligence and what it can and can't And we thought because we're getting so many contracts from clients that where they've used AI and told us, improve on this or use this as a first draft, we want to make sure our clients and listeners understanding what you get.

when you ask AI to draft a contract the difference is between AI and what a lawyer does today, so there's no dispute or confusion about the difference in and analysis that you get when you hire a what you go with AI. Not to say AI is bad. There's a lot of great elements to AI and it's a great start for a lot of contracts and even just thinking through agreements, but we wanted to show you guys today AI contract looks like.

and also what a contract that we work on looks like and help you understand the differences and maybe some terms you want to look out you're drafting a we got Sahil with us going to help walk us through label manufacturing agreement and show you guys what exactly you get when you start with what you get when will finish with us. take away.

Sahil (01:13)
Yeah, thank you, Pankaj. I think you're right. This is a very prevalent issue right now where AI is enough to be dangerous so far we have received a number of agreements where clients will send us a draft using chat GPT, for example. But problem with that

are lot of complexities around business transactions that come from experience with these agreements and also you need to know the statutes are, the law says, and also you need to have experience when it comes to drafting.

in terms of what can go wrong when you are working through an agreement. Additionally, there's an understanding that we have of how money and risk flow in certain transactions that can get lost when you're doing a chat GPT draft of an agreement. So what we're gonna do is we're gonna run an experiment. We have here a private label manufacturing agreement that we drafted. This is an agreement that we use as a

So this is something that we've drafted at Carbon Law and it serves as a basis for our conversations around private label manufacturing agreements. We're gonna compare a Carbon Law manufacturing agreement what chat GPT would draft the same So we're gonna type that in here. gonna say draft a private label.

manufacturing agreement.

Let's see

what you got.

Okay, so if we start from the top, so far so got names of the parties, we have a manufacturer and a brand owner, so that shows some understanding that this is an agreement between a brand and a as we keep going down, we first products.

The manufacturer shall manufacture the following products, lists of products with specifications, packaging and labeling in accordance with brand owner specifications. Detailed specifications, quality standards and packaging requirements are set forth in Schedule A. now here's something that we anticipate in our agreement.

Before we even get to products, in our agreement, we start with the terms of manufacturing, which essentially express that this agreement is going to be accompanied by statements of work that document the specific products that are going to be created. This gives flexibility for broad agreement on broad terms, allows also for you to get specific with the statement of work in terms of the...

variety of products that can be produced and also different conditions and situations that might affect a specific statement of work.

So we get into, after the terms of manufacturing, get into materials. This chat GPT agreement right off the bat ignores that there may be raw materials involved that are sourced from other parties. And so we want to first take into account that there could be multiple sources of materials, whether sourced through a subcontractor or oftentimes the customer is providing some customer source materials. So that's the first

First issue we want to highlight when it comes to products. Now, the next component here we get to are purchase orders. All purchases of products shall be made pursuant to written purchase orders submitted by the brand owner. The manufacturer shall confirm all purchase orders in writing within X days of receipt. Lead time for delivery shall be X days from the date of order confirmation unless otherwise agreed. Now here's an issue.

understand that our clients, especially our manufacturing clients, actually manufacturing clients and the brand typically want to have some kind of a pre-production sample that gets approved. It's very risky to go into bulk having a pre-production so,

Pankaj Raval (04:44)
true.

especially like on all types of things manufacturing, right? Whether it's be garments we work with cosmetics, right? All these types of issues. What could be a widget, right? You want to make sure that's approved, the sample's approved before full production.

Sahil (04:58)
That's exactly right. And like you said, it could be garments, could be skincare, be cosmetics, but there needs to be some meeting of the minds between the brand owner and between the manufacturer at each stage of you need to create checkpoints in label agreement

right before your client, in this case, let's say the manufacturer is exposed to a large amount of fact, both of once you go into bulk production, they're both exposed to a large amount of risk because once the production is done, there's nothing you can do. You rewind. it's done, the costs have and there's no way around we and

Now, easy to just in here that payment terms are 50 % deposit upon order, 50 % upon delivery, net 30 days after how do we know exactly costs are that are being incurred by the manufacturer in terms of in terms of how risk is allocated between the buyer and the seller? need to what is the basis for

deposit. A deposit could be 50%, it could be 35%, it could be 20%. It could be that a manufacturer needs the full payment and then is willing to accept to shipping. Yeah.

Pankaj Raval (06:07)
Yeah, and this

is really good point, Sahil, me it the fact that it really depends also who you're representing, right? We're gonna argue different on if we're representing the manufacturer or the these products are very different these parties have.

Sahil (06:14)
Right.

That's right. And in the next point that, we have this point C talking about all prices are inclusive or exclusive applicable taxes, duties and shipping charges. great to highlight. But now what do we do with that? For example, in this tariff say.

you're a country that one of the raw materials is sourced from is subject to a tariff. And let's say the brand put the production in before the tariff rate there any room for an automatic increase of the price on the side of the or are they stuck with their original price? And so on the flip side, if the manufacturer runs into trouble the tariff rate has now skyrocketed the price,

and now the manufacturer is demanding the balance payment from the customer, of the parties could get So these are terms that we need to have negotiated. It's not just as simple as in sentence like this, all prices are inclusive or exclusive of taxes, duties and shipping charges. We need to think through how do we bake in that risk of variable pricing in a manufacturing situation, especially in a dynamic tariff environment like we're in.

Then we get into labeling and intellectual property. So in this case, this agreement says the brand owner shall retain all rights to its trademark, trademarks and product designs. Manufacturers granted a limited non-exclusive license to use brand owners marks solely for the purpose of manufacturing and packaging products. Manufacturers shall not sell or distribute any products bearing brand owners branding to third parties without in this case, we look

levels IP protection that are involved in an agreement like this, start with the grant of license or assignment of IP.

In our case, the manufacturer is granting to the customer a limited non-transferable and non-exclusive license to use any IP necessary to produce the products for customer's private label. However, we also bake into this agreement a provision for the manufacturer to own the IP when it comes to the product design, which the brand is going to then license. So,

Either we need to be able to explore how risk and money flow and how IP flows. For example, if the brand owner is bringing the IP to the manufacturer, that's one thing. And the IP comes in multiple forms. We have trademarks. We also have artwork for labels. But what about if, what about who's developing the formula?

the manufacturer might be developing the formula or the brand might be developing the formula. In this case, for example, where we're representing our client, the manufacturer is developing the formula and is in fact has baked in a buyout be or a minimum purchase, minimum purchase obligation in order to have the IP So a nuance that can't be taken into account when it comes to a draft like this from ChatGPT

Then we get into quality control. Manufacturers shall comply with quality standards and regulatory requirements applicable in the target market. Brand owner reserves the right to inspect facilities and audit quality control processes. is a big when it comes to quality control, we're dealing with is very subjective standards at times. know, what if we're talking about regulatory requirements applicable in the target

That is a very broad abstract concept and we need to pin this down pin approval and quality control to something that both the parties can agree upon in a very Clear and obvious way and so what we've done in our agreement. We've baked in what's called product acceptance at each major stage of sampling process

The manufacturer provides samples for the customer to inspect and test. The customer must conduct the necessary testing and inspection 24 hours of receiving the samples and approvals for the samples received within 48 hours. This written type of understanding on the exact allows for both parties to see that this is what quality means. Quality is not an objective standard

Oftentimes, quality is subjective. And as attorneys these types of transactions, we're aware of

Next, we get into warranties. In this case, we have manufacturer warrants that the product shall conform to the agreed specifications, be free from defects in material manufactured in accordance with applicable laws and regulations.

Brand owner warrants that it owns or has rights to the trademarks and product talked about how that might not be the case. Sometimes manufacturer is the one with the product even if we just look at the warranty itself, we look at our We have a very robust warranty here. First of all, where the manufacturer warrants that it will manufacture the products in a good professional and workman-like then we have a specific time period.

the manufacturer cannot offer a warranty for an indefinite, unlimited period of time. So in this case, we have a period of six months, which is the warranty period.

So manufacturer warrants that the products will materially conform to the specifications and quality control standards in the statement of work. And luckily, in our agreement, what the specification and quality control standards on the original sample. we've also limited the exposure of risk for the manufacturer, and we've clarified long this policy lasts for the customer.

If we continue on with our warranties, we also clarifying that the foregoing warranties are in lieu of all other warranties expressed or law implies certain warranties, the warranty of merchantability, the warranty of fitness a particular purpose. in our case, because we're representing a manufacturer, we want to limit the scope of this warranty as much as we can under the applicable laws.

you are permitted in California under the laws that we are subject to when it comes to types of agreements between merchants, we are able to contract for a that allows for a lot of creativity.

that a chat GPT for example is not able to necessarily anticipate. For example, we want to waive certain types of implied warranties and we're able to do that if we express them in contract. But if we don't, we're leaving those on the table and we're leaving our client exposed.

Pankaj Raval (12:17)
Yeah, absolutely.

Sahil (12:18)
And also this is subject to manufacturers warranty of any product is of no effect if the product is not stored or handled appropriately after that way we're protecting manufacturer and we're also clarifying to the brand owner Yes, we're offering a warranty but these need to be handled in a commercially reasonable way the products need to be handled in a commercially reasonable way If we continue on we've included a section related to product recall when you're dealing with

mass production. This is a very important provision that is totally left out of this draft.

In the event of a recall of any product the party shall cooperate in good faith to carry it out all reasonable Corrections and we need to split the risk Manufacturers only responsible for the cost associated with the extent the root cause of the recall is directly and solely attributable to a defect in the manufacturing process We can't have the manufacturer blamed for or liable for acts of the brand that the manufacturer no control over and vice versa, know the manufacturer in this case is

taking ownership over the manufacturing process, but we need to slice two levels of liability. And that's place that we come in is do we limit Now, if we continue on we go into, this is, you've got a one sentence confidentiality provision here.

that each party agrees to maintain the confidentiality of any proprietary or confidential information disclosed during the term of this not to use or disclose such information except as permitted under this agreement. Well, that's broad doesn't really take into account the circumstances that could arise. So for example, in our confidentiality we confidential information, first of all, as all non-public information of a party to the other party.

and that the disclosing party designates as being confidential or which under the circumstances of ought to be treated as confidential, including but not limited formulas, business plans, marketing plans, and product ideas, as well as prototypes, samples, materials, and the like. is a major problem with the chat GPT version of How do we define confidentiality? We need to, yeah.

Pankaj Raval (14:16)
It's a big question. Yeah, you need

to have a definition for confidential information.

Sahil (14:20)
Exactly. If we continue on to term and termination. we have shall commence on the effective date. Either party may terminate X number of days. Termination for cause may occur immediately upon material breach not carried. either party may agreement.

The question then becomes, what do we do if the termination occurs in the middle of production? Are we dealing with the costs of raw materials? How are we dealing IP if the manufacturer has IP, has developed IP and this brand is no longer taking that IP the manufacturer license the IP that they've other

There are a lot of questions here that we need to answer. The effect of termination. So we have a whole section here related to the effect of termination. the IP is handled, how raw materials are leftover packaging components are handled. For example, here we talk about the licenses the termination of this agreement, the rights and licenses granted to manufacture to this agreement, the right to use the IP and manufacture the products will automatically

this case, the brand may be providing the IP, but in the case of the manufacturer providing the IP, we need to contract around a termination is not simply a termination. There are leftover there are leftover rights that need to be addressed.

Pankaj Raval (15:37)
So interesting. Sahil, also I'm thinking, doesn't really address at all how to de-risk this deal, you're the manufacturer, going to ask for payments and milestones, right? Maybe you ask for over every you know, based on milestones or every six weeks or eight weeks based on how, where you are in the process so you never get too far behind. Because one thing we've seen, discussed in the past is that

Sahil (15:43)
right.

Pankaj Raval (15:58)
know, clients can really underwater a lot of money and a lot of money in production, manufacturers fronting a lot of fees for cost of goods and all these other raw materials. then a client just disappears or client, something happens, they change their mind, We've seen it all. And now we have problems or they're just holding back money just because they're trying to strong arm the manufacturer. And, you know, we've seen all these situations and they've become ugly.

So maybe to de-risk that, it's really getting payments at a certain milestones, you're never too far behind or too underwater on some of these deals.

Sahil (16:29)
I think that's exactly right. to our clients, we have the experience to are the potential risk points? What are the potential places where you could lose money, where things can go wrong? And that's something not able to anticipate, or that's not something GPT is able to customize because on its own, it doesn't know what to if you're non-lawyer,

and you're using ChatGPT and you're just typing private label manufacturing are not going to know have a lot of deal with risk and to deal with payments and to deal with might be getting an it's not necessarily the best option.

So we've kind of come to the end of this agreement, but you can see that our and we have responsible when there's a

If the lawsuit is against the brand or the manufacturer, who's paying for that lawsuit? And we have to break out are the where one party pays versus another. We have provisions related to default, default payment have provisions related to authorized disclosures, non-solicitation. These two parties are engaging with each other. if one party

the manufacturer decides it wants to hire person from the brand who's working with them to create this product or vice versa or the either party decides to the other party's IP or this product and take it to a different do we deal with that we have force majeure provisions we have insurance provisions about

These parties need to maintain, customer and manufacturer agree to maintain appropriate insurance cover their respective risk under this agreement. So, we continue on with provisions that we know are necessary. One important provision is related to dispute resolution. the event there's a dispute between manufacturer and customer, in this case, we've drafted a Jams provision for comprehensive arbitration.

both parties, this saves the parties the cost, the expense of going to you know, and then we're talking about governing law. what law do we want to apply in our precedent here? We're using California, but if the company was based in Delaware, we would use there are reasons for

also severability if any of the provision in the agreement is held to be invalid. The whole agreement is not necessarily invalid. Successors and assigns. Let's say brand is buys the brand, a larger company, and this brand had a this manufacturer. the buyer of that brand that brand because of the deal terms they were getting with the that contract

then succeed over to the new are a number of provisions missing here in this Chat GPT agreement, and critical and they can only come from understanding the specific deal we're dealing with, and it comes from understanding the party that we're

Pankaj Raval (19:17)
Sahil, this is a fantastic breakdown exposes some of the challenges with depending on AI if you don't know you're this great maybe outline if you're thinking about entering into negotiations, things you might want to think about. I think given the name of our podcast is Letters of Intent, this could be a great letter of intent, understanding, okay, here are the issues that we need to address. But when it comes to executing a full agreement,

Sahil (19:37)
Right.

Pankaj Raval (19:42)
There's a lot more that clients, it sounds like there's a lot more that clients need to think and you walked us through a lot of important provisions. Another element here that I think I don't want to leave without addressing is the statement of And that is a critical element to these contracts. ChatGPT just says include one, but a statement of work really lays out the details of requirements, descriptions,

Sahil (19:53)
Yes.

Pankaj Raval (20:04)
testing methods, terms. are usually heavily negotiated as well elements of contract. And you know, we've worked with the very big manufacturers for cosmetics. And we're we've spent a lot of time just going back and forth on some of the terms in the statement of work. So sounds like to me someone is their business seriously, whether they're manufacturing

clothes, apparel or cosmetics, skin care. It sounds like they really want a good manufacturing agreement in place will protect them and make sure that they understand deal terms and how they're protected and risks they have these agreements.

Sahil (20:37)
I think that's right. I would encourage all of our clients to use AI and chat GPT because it is part of our world and it is a very powerful tool to get a sense of what are things that may be important. Like you were mentioning when it comes just understating what could be questions that you need to it comes time to drafting a complex agreement that has a lot of money at stake and a lot of risk at

need battle tested and you need some battle tested attorneys who know going to work and what can go wrong.

Pankaj Raval (21:08)
I think that is well put and I think a place to end, Sahil. So you so much for walking us through these contracts. think you did a great job of really breaking down the nuances of these agreements and things for clients to look out for. This is super I know I learned a lot too you go through it. you so much, Sahil. And this is Letters of Intent, a special episode on down contracts you may be needing in your business.

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