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Various aspects in transferring manufacturing rights to a foreign company in products funded by...

 the Israeli Chief Scientist by Rona Ginat

Israeli companies that hold in their possession knowledge and technology developed with the funding of the Israeli Chief Scientist often encounter difficulties manufacturing in Israel a product developed by them and often turn to foreign companies to transfer the manufacturing or the manufacturing rights to a foreign company. Sometimes, this cooperation also includes distribution and marketing services for the products. 

Pursuant to the Encouragement of the Industrial Development and Research Law (The "R&D Law"), the transfer of the rights of a company to another country that is funded by the Israeli Chief Scientist is subject to the Chief Scientist's approval. This approval is necessary to protect two fundamental interests of the R&D Law: To ensure that all knowledge developed with the funding of the Chief Scientist and that the manufacturing will both remain in Israel, and in order to encourage the local employment market.

Nevertheless, the Chief Scientist acknowledges the need for these types of collaborations and therefore subject to certain conditions, allows them. Some of these conditions are financial (such as the increased rate of royalties that companies must pay the Chief Scientist for the sales of their product) and others are instructions intended to verify that the contractual communication between the companies shall not harm any protected interests of the Chief Scientist.

This article will be focusing on a contractual tool that is customarily used in this type of cooperation agreements and that the Chief Scientist views it as a means to protect, among other things, his own interests. This tool is the trust agreement.

Naturally, in cooperation agreements for manufacturing and maintenance, each party must protect several important interests. An Israeli company must verify that all Intellectual Property rights in its products and the development thereof remain in its exclusive possession and it must avoid a situation in which a foreign company can make forbidden use of any exposed information. Furthermore, according to the R&D Law, an Israeli Company must avoid a situation in which the cooperation between the parties shall be an illegal transfer of information - which can be considered a legal felony according to the R&D Law.

A Foreign company that undertakes to manufacture a product and to also, in many cases, distribute it, is interested in avoiding a situation where it would not be able to change or restore the product as the result of an Israeli company being unable to meet its contractual obligations. For example, in a case where an Israeli Company becomes Insolvent - Since the Intellectual Property rights relating to a product belong exclusively to the Israeli company, while the foreign company only owns manufacturing rights, the latter can easily find itself facing an impossible situation where it is unable to continue manufacturing the product and is unable to meet its obligation to supply the product to third parties.

As the result of the need to protect the aforementioned interests, a mechanism of trust agreement, which is attached to the primary agreement between the companies, was developed over the past few years. The trust agreement establishes the responsibilities of a third party who is appointed as trustee of all the knowledge and information that ensures the rights to continue the manufacture and support of the product (the "Materials"). The trustee's role is to put the parties' agreements into practice and to release the Materials to the foreign company, if necessary, in accordance with the specific and predefined conditions of the trust agreement.

In 2007, and in order to suit itself to this foregoing practice, the Chief Scientist published a list of principals needed for his approval of such trust agreements. These principals were intended to protect the owners of the knowledge that is funded by the Chief Scientist. It is important to emphasize that although these principals are not considered to be an Israeli Law or regulation, the parties are obligated to obtain the Chief Scientist's approval on their agreements. Without this approval, the cooperation between the Israeli company and the foreign one can be considered a breach of the R&D Law.

The following principals must be met in order to obtain the Chief Scientist's approval: The trust agreement must establish that the release of the Materials to the foreign company does not include the transfer of any Intellectual Property rights and that all Intellectual Property rights belong exclusively to the Israeli company.

  • The foreign company's right to use the Materials, if released by the trustee, is limited to fulfilling the predefined needs written in the trust agreement. Pursuant to the Chief Scientist's principles, these needs must be limited to manufacturing (where a transaction for the manufacture and supply of products is involved) or for the support and maintenance services of the product. If the foreign company is interested in receiving the Materials in other scenarios, then the parties must include these scenarios in the trust agreement and obtain a written specific approval from the Chief Scientist thereto, in advance.
  • The trust agreement must include a clause stating that in the event of releasing the Materials to the foreign company by the trustee, such a release shall be made only for a temporary and predefined period.
  • The trustee must be an Israeli civilian; the trust agreement must be governed by the Laws of the State of Israel and set that the competent courts of Israel shall have sole and exclusive jurisdiction over any disputes arising from it. Since a Governing Law and Jurisdiction clause stating otherwise can be included in the primary agreement, i.e. the cooperation agreement, it must be clarified in the trust agreement that the Governing Law and Jurisdiction clause written in the trust agreement supersedes any contradictory instructions written in the cooperation agreement, in that matter.
  • The trust agreement must define a reasonable timeframe that only upon its lapse the trustee will be entitled to release the Materials.
  • The trust agreement must establish that the trustee and the Israeli company shall report to the Chief Scientist upon its activation. In addition, any material change in the agreement after the signing thereof, such as the replacement of a trustee or a change of substantial conditions in the agreement, is subject to the prior approval of the Chief Scientist. 
  • The Chief Scientist aims to protect the Israeli company's rights in cases of a request for its dissolution or for the appointment of a receiver thereto. As long as there is no interruption in the supply of the products or in the support and maintenance services, the filing of a request for the company's dissolution or for the appointment of a receiver thereto does not constitute a sufficient cause for the activation of the trust agreement and the release of the materials. This applies also in cases where an Israeli third party purchased the company or took the Israeli company's obligations upon itself.

To expedite the approval procedure, the Chief Scientist is usually satisfied with a legal opinion from the company's attorney stating that the trust agreement meets the principles stated above.

The Israeli Chief Scientist acknowledges the Israeli companies' need to integrate into the global world. This is especially true for Israeli companies that are actually a part of global corporations. The need for cooperation is particularly recognizable in such companies and the Israeli Chief Scientist has identified that negative incentives might be created when foreign companies try to cooperate with R&D centers in Israel that are partially funded by the Chief Scientist. Therefore, disregarding a few exceptions, the Chief Scientist enables the transfer of manufacturing from Israel to other countries.

Notwithstanding the above, it should be noted that the Chief Scientist's approval is subject not only to the limitations specified above but also, in the majority of cases, to the increased rate of royalties that an Israeli company must pay the Chief Scientist for the purchase of its products (usually between 3.5% to 4.5%) and to the increase of the total sum that the company must pay the Chief Scientist (increase between 120% - 300%).

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