Magazine article Risk Management

A Smooth Handoff: Challenges in Toll Processing

Magazine article Risk Management

A Smooth Handoff: Challenges in Toll Processing

Article excerpt

As new business relationships develop in many industries, it is becoming increasingly important for risk managers to understand how those relationships affect the safety, commercial and competitive risks facing their employers. Some of the most common and potentially significant new business relationships involve "tolling" or custom manufacturing.

These agreements, which have become commonplace in the chemical, pharmaceutical, agricultural and other industries, often involve a number of different activities. A typical relationship, for example, could be a drug manufacturer that provides raw materials to a toll processor for blending, packaging or other services. The completed pharmaceutical product is then returned to the manufacturer for distribution or other activity.

Recent growth in the use of tolling relationships has been caused by a variety of economic, legal and other factors including the downsizing of major chemical and pharmaceutical manufacturers; product development opportunities presented by these arrangements; a desire to avoid health, safety and environmental risks of onsite product handling; plant capacity limitations; and the unique regulatory expertise of tolling parties.

Some of the biggest users of custom manufacturing services are pharmaceutical companies, which must proceed through extended safety and efficacy trials before their products can be marketed. As one industry commentator noted, "more and more pharmaceutical companies are focusing on what they do best -- researching and developing new drugs -- and leaving the middle part of the process to the custom manufacturers to do what they do best: producing the bulk pharmaceuticals and/or their intermediates."

The advantages of such toll manufacturing arrangements include:

* Savings in equipment modification or installation costs;

* Reductions in the time needed for pilot operations;

* The use of another firm's work force, making the company's own staff available for other projects;

* Space savings;

* Elimination of personnel and equipment obsolescence issues; and

* The potential for actual process-cost savings.

Tolling relationships vary from firm to firm, and often from arrangement to arrangement. In circumstances where the manufacturer provides the toll processor with extensive direction about the production specifications, the term custom manufacturer is generally used instead of toll processor. Whether toll processor, custom manufacturer, contract manufacturer, converter, custom synthesizer, whatever title is used to describe these relationships, they present significant risk management concerns.

Risks of Tolling

The initial source of concern is the highly ambiguous legal relationship between the parties to any tolling agreement. Extensive legal norms apply to traditional business relationships such as buyer-seller, manufacturer-distributor, franchiser-franchisee and similar interactions. Tolling arrangements, however, often do not define the legal status of participants, let alone provide clear rules about the obligations of those parties.

Title to the materials involved is usually retained by the manufacturer; however, almost all other aspects of the relationship are determined by agreement between the parties -- which requires careful contract crafting. With so many major issues to be resolved, these contracts often do not address the key legal and risk management uncertainties inherent in the relationship.

The first question that should be addressed in tolling arrangements is precisely what each party is expected to do. This means determining the products to be supplied to (and the services to be provided by) the toll processor; the risks and obligations associated with the tolling activity must also be understood and clarified. When the relationship depends on the expertise of one of the parties, it is essential that such expertise be provided fully and properly. …

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