Manufacturing Supply Agreements: Specifications, Acceptance Criteria and Handling Non-Conforming Products

Hello, I'm Noriaki Asato, Representative Attorney at LegalAgent.

A manufacturing supply agreement is a contract that, even in corporate legal practice, requires checking product specifications and contract terms together. Looking only at the wording of the contract, it may appear to be an ordinary sales agreement or service agreement, but in reality there are items to check ranging from product specifications and inspection procedures to quality assurance and the handling of intellectual property rights.

When reviewing this type of contract from the standpoint of the customer placing the order, what matters is aligning in advance the definition of the specifications, meaning "what is to be made," and the acceptance criteria, meaning "what condition counts as passing." If this foundation is left vague and only the damages and late delivery clauses are built up heavily, the result is a contract that cannot be put to practical use on the ground when defects arise after delivery.

Even in AI-assisted contract review, manufacturing supply agreements are an area where it is difficult to complete the work by checking the contract itself alone. Problems that can arise on the manufacturing floor can be examined by comparing the contract against on-site materials such as specifications, drawings, inspection standards and mold registers.

Identifying the Specifications and Agreeing on Change Management

The first point to assess in a manufacturing supply agreement is how clearly the products to be supplied and their specifications are identified. Check whether the product name, dimensions, materials, performance, inspection methods and so on are objectively agreed in the contract or its appendices. Even if the contract itself states that "specifications shall be as set out in a separate specification document," if the name and version number of the document agreed by both parties cannot be identified, trouble may arise later. That said, the specifications need not be physically attached to the contract; they can also be incorporated into the contract by clearly referring to a specific document agreed by both parties.

It is also important to set an order of precedence in case of inconsistencies among the specifications, drawings, quality assurance standards and so on. Unless you decide which prevails when the specifications in an individual purchase order differ from the basic drawings, and which becomes the final standard when the drawings are revised after a prototype sample has been approved, it becomes difficult to determine product non-conformity after delivery.

At the same time, pin down the procedures for specification changes and design changes after mass production begins. If the supplier can change materials, manufacturing processes or subcontractors at its sole discretion, unexpected variation in product quality may result. For major changes, consider requiring prior notice and consent, submission of prototype samples and approval to move to mass production.

Sample Approval and Allocation of Responsibility for Non-Conforming Products

Approval of samples before mass production tends to give rise to differences in understanding between the customer and the supplier. This is because interpretations diverge on whether approving a sample means only that the appearance and operation were checked, or that the internal materials and manufacturing processes were also approved, and whether quality equivalent to the sample is guaranteed for all mass-produced products.

Suppliers sometimes argue that "since the customer approved the sample, the customer should bear responsibility for the mass-produced products delivered as well." From the customer's perspective, however, the sample is merely a limited check at the prototype stage, and the customer may take the view that responsibility for maintaining the same quality in the mass production process lies with the supplier.

Therefore, contracts sometimes expressly state that sample approval is merely a preliminary check for moving to mass production and does not release the supplier from its quality assurance responsibility or contractual non-conformity liability. For changes in material lots and process changes as well, decide the scope subject to prior reporting or approval depending on the impact on quality.

The same care is essential in the acceptance procedure. A clause under which the supplier is released from all contractual non-conformity if the customer raises no objection within the acceptance period after delivery may impose a heavy burden on the customer. For hidden non-conformities that cannot be discovered in ordinary incoming inspection, defects that continuously occur throughout a mass production lot, and safety defects that first come to light after use by end users, a framework must be set under which the supplier is responsible for addressing them for a certain period even after acceptance.

Investigating Non-Conforming Products and Allocating Costs

Some defects are not resolved by replacement or repair. Investigate the impact on the same lot and products already shipped, and confirm whether the cause lies in design, manufacturing or materials. Set out in the contract the supplier's cooperation in investigating the cause, the isolation of lots and the procedures for preventing recurrence.

As for costs, confirm who bears not only the cost of remanufacturing but also the costs of inspection, travel and alternative procurement. Also consider separately how to handle cases where the cause was the customer's design instructions or specified materials. If the Act on Ensuring Proper Transactions with Small and Medium-sized Entrustees (the Torihiki Tekiseika Act) applies, attention must also be paid to the prohibitions on changes, redoing work and the like discussed below.

Product Liability, Recalls and Mold Management

In a manufacturing supply agreement, the allocation of responsibility when an accident or recall occurs due to a product defect determines the initial response. The Product Liability Act imposes liability for damages on manufacturers and others when a defect in a product causes harm to a person's life or body or to other property. If the damage is limited to the delivered product itself, the Act does not apply, and contractual claims such as contractual non-conformity liability are considered instead. In addition, when the customer sells the product under its own brand, the customer itself may be deemed a "manufacturer, etc." under the Product Liability Act if the statutory requirements are met. However the parties allocate responsibility between themselves, the statutory right of an injured third party to claim damages cannot be excluded by contract.

For this reason, it is essential in practice for the contract to oblige the supplier, when an accident caused by a manufacturing defect or mislabeling occurs, to cooperate in identifying the cause, suspending shipments and making insurance claims. As for the allocation of recall costs, a wide range of expenditures is involved, such as the cost of recall notices, freight and fees for commissioning investigations from outside experts, so do not stop at general wording such as "shall compensate for damages"; clarify in advance the scope of costs covered. However, where the customer specified the design drawings and specifications in detail, check the possibility that the customer is also partly responsible, and a realistic design is one that separates responsibility by cause, such as manufacturing-related, design-related and storage-related.

At the same time, sort out the rights in molds and jigs produced at the customer's expense. Beyond providing that ownership belongs to the customer, include in the contract the supplier's obligation to store them properly at its factory, the prohibition on unauthorized modification, the prohibition on use for other purposes and the obligation to return them upon termination of the contract. The customer cannot acquire the supplier's existing intellectual property rights, but it must secure a license arrangement allowing it to use that IP smoothly to the extent necessary to sell and maintain the contracted products. Provisions such as a prohibition on sales to third parties and certificates of disposal for remaining stock are also essential to prevent products manufactured for the customer or surplus products from leaking to third parties without authorization.

Prohibited Acts Under the Torihiki Tekiseika Act and Using Practical Materials

When considering manufacturing outsourcing or manufacturing supply transactions, you cannot skip examining whether the transaction is subject to the Act on Ensuring Proper Transactions with Small and Medium-sized Entrustees, the so-called Torihiki Tekiseika Act. The Subcontract Act (Act against Delay in Payment of Subcontract Proceeds, Etc. to Subcontractors) was amended, and the Torihiki Tekiseika Act has been in force since January 1, 2026. Whether the Act applies is determined in light of the content of the transaction and the thresholds for the stated capital or number of employees of both parties. Proceed with the check taking into account the explanations of the scope of application published by the Japan Fair Trade Commission and the Small and Medium Enterprise Agency.

From the customer's standpoint, it is tempting to set terms favorable to oneself, but in transactions to which the Torihiki Tekiseika Act applies, acts such as having the entrustee change the order or redo work without bearing the cost, even though the entrustee is not at fault, are prohibited. The issue of statutory violation for prohibited acts and the civil validity of the contract provisions themselves should be considered separately, but transaction terms that impose excessive burdens on the entrustee should be avoided both from a compliance standpoint and for the stability of the supply chain.

When asking an attorney to review such a manufacturing supply agreement, the accuracy of the review improves if you prepare not only the contract provisions but also on-site materials such as the following:

• Specifications
• Drawings
• Quality assurance standards
• Inspection standards
• Sample approval documents
• Purchase orders
• Quotations
• Manufacturing process charts
• Process change rules
• Insurance policies
• Mold registers
• Information on subcontractors
• Sample accident reports
• Recall procedures

In LegalAgent's legal outsourcing, building on an initial organization of issues by AI, our attorneys conduct the review by comprehensively considering the product's technical specifications, quality assurance standards and related laws, including the Torihiki Tekiseika Act. By clearly separating the revision comments to present to the counterparty from the matters to be discussed with your own purchasing and quality assurance departments, we support contract management that is useful for your actual business.

We assist with contract reviews for manufacturing outsourcing and supply transactions and with compliance with the Torihiki Tekiseika Act through the following service:

• Legal Outsourcing