Legal Briefing

Sailing on the seven seas: international product liability perils


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Corporate and commercial | 01 June 2014

Today’s global economy presents both commercial opportunity and legal risk to producers. The vast majority of companies now trade on an international scale with design, manufacturing and distribution spanning the entire globe. However, international trade is not without risk where product liability is concerned. In this article, John Reynolds of Shook, Hardy & Bacon considers some of these risks and ways in which companies may limit exposure.


As products become more and more sophisticated, they commonly contain components produced by different external suppliers, based in multiple jurisdictions. It is not unusual for products to be ‘own branded’, ie to bear the name of a particular company but with key components being manufactured by third parties, over which their company may have little day-to-day supervision or control. In these circumstances, the reputation of a company is vulnerable if the components do not perform as expected. For example, in 2011, the Boeing 787 entered service and attracted positive publicity for its ground-breaking design. However, in January 2013, the entire 787 fleet was grounded following five incidents of electrical problems1, considered to be caused by its main batteries, which power the aircraft systems before the engines are started. The batteries were manufactured by third-party suppliers and found to be at risk of overheating or catching fire due to battery cells short circuiting – a potentially significant safety risk for a passenger carrying aircraft. While the aircraft were grounded, investigations were undertaken. Following a re-design of the battery to reduce the highest charge allowed in each cell and a tightening of quality control which eliminated the identified risk, the US aviation regulator, the Federal Aviation Administration, allowed the aircraft to return to service in April 20132. In addition to its reputation, there was a financial cost to Boeing, as it faced requests to compensate airlines affected by the grounding3. Fortunately, this particular issue did not result in any catastrophic failures; otherwise the legal, financial and reputational issues could have been far more serious.

To limit such risks, manufacturers should look at both legal and practical measures which could be adopted to minimise risks. First, companies should obtain sufficient contractual protection in supply contracts.

CONTRACTUAL PROTECTION

The starting point is to negotiate a supply agreement containing several key clauses, including as those set out below:

Indemnity

Companies should seek an indemnity that suppliers will reimburse the company against all claims made for loss, damage, cost or expense arising out of a failure by the supplier to supply products or components free of defect. Clearly, care should be given as to the scope of such a clause and, in particular, the definition of defect.

Insurance

It is prudent to require suppliers to maintain comprehensive and reputable insurance cover to meet any claims, demands, losses or damages attributable to the components it supplied, including for product liability, personal injury and property damage. Requiring the supplier to periodically provide a certificate of insurance as evidence of compliance is also of benefit. However, the limitations to such a requirement should be recognised as some smaller suppliers may not have the means to purchase adequate insurance.

Quality control

The supplier should agree that it will supply goods that are of satisfactory quality, fit for their intended purpose, are free from defects or faults and shall conform to all specifications provided by the manufacturer. It is often deviations from specifications (particularly in terms of materials used) that cause problems, so such terms are essential.

Succession

As companies often evolve and restructure, it is important that any supply agreement binds the successor entities to the supplier, including where the supply obligations are assigned to other entities.

Supply agreements should also contain clauses for the following:

Dispute resolution

It may be favourable to companies to have a dispute clause that stipulates that any disputes or differences arising between the supplier and the company be resolved by good faith negotiation, or failing resolution, arbitration.

As a private process, arbitration avoids the risk of publicity which court proceedings may generate.

Governing law

A legal system with established precedent giving legal certainty and respecting the company’s contractual rights should be selected, such as English or New York law. It is important to expressly select a governing law, particularly where a supplier is from a country with an under-developed or unpredictable legal system. Otherwise, there is a risk that a system of law which provides an uncertain interpretation or seeks to qualify the manufacturer’s rights may be implied.

The benefit of agreeing a supply contract with such provisions is to allow the manufacturer to invoke contractual terms to ensure that the safety and quality of the finished product is up to standard. It also provides for sufficient remedies without having to commence legal proceedings. In addition to saving costs, this is likely to place less strain on commercial relations. The supplier may, in turn, recover any losses from its insurer. Contractual protection reduces legal risk to companies, especially where overseas suppliers are involved. If the supplier fails to comply with the terms of the agreement, and the manufacturer decides to commence proceedings, the cause of action would be breach of express terms of the supply contract. This is more likely to be effective than if the company was restricted to a cause of action in negligence before the supplier’s local court.

PRACTICAL MANAGEMENT OF THE GLOBAL SUPPLY CHAIN

A global supply chain presents many challenges. If products are manufactured by a third party in a country where the company does not have a presence, it may be difficult to monitor the manufacturing and quality assurance processes. For this reason, some companies decide to send a representative to such countries either on a permanent basis to ensure quality control is implemented and maintained, or on a regular basis to carry out inspections of such processes. In addition to this, strict quality assurance processes should be agreed upon and documented in any event. This will be of benefit both prior to any products being marketed and afterwards, should any allegations as to safety arise.

In addition, the issue of counterfeit products is becoming an increasing 
problem and steps should be taken to prevent such products being marketed in the company’s name. The supply chain should be audited carefully by companies to reduce the risk of unsafe products infiltrating the supply chain at vulnerable points. For instance, manufacturers should identify major freight hubs through which their products are shipped and pinpoint those with less rigorous border controls, such as the United Arab Emirates’ Free Zones. In such circumstances, companies should aim to build relationships with law enforcement agencies and customs authorities, and to educate officers to identify unsafe counterfeit goods mixed into a consignment of genuine goods. Manufacturers should also increase the security of their consignments by improving the sealing, bar coding or fixing indelible identification markings.

Additionally, the performance of the entities which transport the goods should be monitored to ensure that goods are handled in such a way so as not to compromise the integrity of the goods (eg maintaining them at a certain temperature). This reduces the risk of product liability claims by consumers. Again, contractual protection should be in place, with distributors and wholesalers signed to distribution or supply agreements which provide for termination or damages in the event of breach.

A further international issue, sometimes overlooked, is for companies to ensure that the translations of their instructions for use and warnings are consistent and mean the same thing, irrespective of the language. Sometimes a simple straight translation may not be adequate because of the nuances in meanings resulting from different languages.

Finally, companies will want to reduce the risks presented by selling goods overseas where they have less control. First, they should undertake due diligence to identify suitable retailers and once assured, enter into distribution agreements which protect how the company’s product is marketed and how any issues regarding safety are dealt with. Companies should ensure that distributors are aware of both statutory and contractual obligations to report any complaints about the products to them within a specified period of time and to provide assistance should product related action be required, such as recall. Furthermore, the manufacturer should carefully identify entities to carry out warranty work to repair faulty products, or set up maintenance support in that country. This is an important consideration, because if products are recalled, the manufacturer requires assurances that they can be repaired properly to stop further safety risks to consumers.

In conclusion, while the global economy presents product liability risks to manufacturers, these may be managed and reduced by tightening quality control and obtaining comprehensive protection against suppliers. Companies which take such steps will face fewer product liability claims and establish a stronger brand reputation, contributing to the company’s success.

Notes

  1. BBC, 13 March 2013, ‘Dreamliner: The modern aircraft plagued by problems’, 
http://www.bbc.co.uk/news/business-21060541.
  2. It is interesting to note that although ‘Boeing redesigned the battery system, the precise cause of the problem was never conclusively proved’ (BBC, 14 January 2014) ‘Boeing 787 aircraft grounded after battery problem in Japan’ http://www.bbc.co.uk/news/business-25737515.
  3. Reuters, 20 March 2013: ‘Boeing faces pressure for cash compensation over 787’ http://www.reuters.com/article/2013/03/20/us-boeing-dreamliner-ana-compensation-idUSBRE92J0X120130320.