Kenneth Ross is a former partner and now Of Counsel to Bowman and Brooke LLP. For over 40 years, Ken has provided legal and practical advice to manufacturers and other product sellers in all areas of product safety, regulatory and corporate compliance, and product liability prevention, including contracts, design, warnings and instructions, risk assessment, document management, safety management, recalls and dealing with the CPSC. Ken has also served as an expert witness in litigation involving recalls and recall adequacy for over 20 years. He can be reached at 952-210-2212 or firstname.lastname@example.org. Other articles by Ken can be accessed at www.productliabilityprevention.com.
The supply chain for many products can be complex, especially for products that include component parts comprised of many subcomponents. On the manufacturing side, the relevant parties are retailers, dealers, distributors, OEMs and Tier 1, 2, 3, 4, etc. suppliers. All of these relationships are governed by implied or express contracts.
Every entity that buys or sells a component, raw material, finished product or service needs to consider the risks it is willing to assume and what obligations and risks it wants to impose on the seller or buyer. This is particularly important when it comes to recalls since these can be very expensive and result in very adverse situations in the future. It is important for all parties to understand the contracts that might govern their responsibilities and liability as they can have a significant impact on all entities.
A buyer and seller in the same transaction have a somewhat adverse relationship and there may not be a meeting of the minds as to their duties and obligations. It is hard enough for courts to interpret clear contracts which both sides have agreed to. But, when there is a “battle of the forms” where both parties have terms and conditions that conflict with each other and arguably no clear agreement, it is very difficult to know whose contract clearly governs the purchase. Courts also have a difficult time.
Therefore, the surest way to understand the deal is to have both parties sign the contract. Unfortunately, this is not realistic for many companies and probably happens infrequently. Either one entity issues a purchase order and the seller just agrees to it, or the seller sends their terms and conditions and the buyer agrees to it by paying the invoice.
Before a manufacturer produces its product, it buys raw materials, component parts and maybe subassemblies, typically from entities outside their company. Each of these purchases is governed by some kind of contract.
When a manufacturer buys raw materials, component parts and services from suppliers, it wants the strongest warranty from the seller and few exclusions, limitations and disclaimers. It wants the supplier to warrant that the product meets specifications and all applicable laws and regulations, to agree to repair or replace any defective or non-compliant product, and to agree to pay for all costs of recalling or repairing the product, including labor if that is required.
The manufacturer also wants to protect itself from a supplier who sells them a component that is defective and causes harm to the ultimate user or requires them to recall the product. One way to do this is to include an indemnification clause in the purchase order where the supplier agrees to indemnify the manufacturer for all product liability costs and consequential damages to the extent that defects in the components caused the injury, damage or loss.
For example, if I am an OEM and buy components, I would want to be protected in case a defective component requires me or someone else down the chain to recall the product. And I would want the supplier to pay for all recall costs, including any administrative costs for implementing the recall. Unfortunately, most suppliers would balk at such a requirement. Or, they might agree to it on the assumption that the OEM would never try to get them to pay for it or they can blame someone else if a recall occurs because of a defect.
In some industries, OEMs are big and powerful, and they require their Tier 1 suppliers to agree to pay for all recall costs. Then the Tier 2 and lower suppliers most likely will not agree to be responsible for all costs if their component is defective and causes a recall. The result is that the Tier 1 supplier might be responsible for the recall even if the recall was caused by the Tier 2 or lower supplier’s component. While this sounds unfair, it makes sense given that the maker of a low-cost component part can’t make enough of a profit to potentially be responsible for the full cost of a recall.
So, if you are a Tier 1 supplier in such a situation, what do you do? You can try to buy recall insurance, but that coverage can be expensive and somewhat limited. And the insurance company may take into account that you are responsible for problems you didn’t cause when pricing a policy. You can also seek out a Tier 2 or lower supplier that will agree to pay for all recall costs. But that may raise the price of the component significantly, and, if a problem occurs, the supplier may not have the financial ability to meet its obligations.
A better approach is to identify the few “safety critical parts” that go into your product (this should be done during a typical risk assessment) and consider taking additional measures to ensure that these critical components have been designed correctly, meet specifications, and work correctly in the product into which it is installed. Minimizing the risk of a recall is the best way to protect the OEM and all suppliers.
So, when the manufacturer and supplier negotiate the purchase of components or a finished product, they need to evaluate their own potential liability and what is a fair apportionment between the parties. The parties may not agree, but at least they will understand who is responsible for various occurrences and they can take appropriate preventive measures to reduce the risk to an acceptable level.
Too often, recall management has a low priority within a company. It’s put in its own box, locked away, only to be applied, or even discussed, when a product must be pulled off the market. We want to change that.
The Expert Solutions Spotlight is our way of sharing perspectives from our strategic partners – lawyers, insurers and risk managers and crisis communications experts across industries – on product safety issues that have potential to influence a company’s view on recalls and crisis management. In some cases, the connection is obvious but the perspective is new. In others, we will raise questions that you may have never considered in the context of recall management. That’s our intent.
i Protect your intellectual property including the unique design features and/or physical appearance of the product, register your brand name and trademark, and be diligent about IP protection.
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