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ARTICLES AND NEWSLETTERS

FOR IMMEDIATE RELEASE

Reducing Liabilities Associated With Product Warranties

By Gary Ettelman, Esq. & Keith Hochheiser, Esq.

Ettelman & Hochheiser, P.C.
Garden City Center, Suite 401
100 Quentin Roosevelt Boulevard
Garden City, NY 11530
(516) 227-6300 • www.e-hlaw.com

Manufacturers and distributors beware. Every time you sell your product, you automatically enter into a contractual agreement of guarantee and indemnity. Most companies are unaware that they are making these guarantees and assuming the related liabilities. Furthermore, many cannot live up to these terms. Unfortunately, that places you and your business at high risk with potential exposures in the tens of millions of dollars. There are solutions, however, provided by the Uniform Commercial Code (UCC), the U.N. Convention for the International Sale of Goods and other similar laws and treaties. As the old saying goes, “an ounce of prevention is worth a pound of cure.” This is precisely the situation relating to these risks. Companies should take the initiative and presently pay relatively nominal fees in order to apply these solutions before a problem arises, as opposed to paying later in ways and sums that could literally threaten the very existence of the company.

“Laws Governing Product Warranties”

There are three basic tenets to the laws governing product warranties. They are:
• Manufacturers/distributors guarantee the product’s quality and performance,
• They guarantee that the product is fit for its intended purpose, and
• They guarantee that the product does not infringe any Intellectual Property rights of any person or company, worldwide.

That is a pretty tall order given the circumstances of a product sale and the fact that there are many variables that drive how it will perform and be used. For example, consider the circumstances under which a component manufacturer/distributor sells a component. The product is used in a system, where it is affected by the quality and performance of other parts and equipment in that system with which it may or may not be compatible. Still, when selling the component, the manufacturer/distributor makes a warranty at the system level, even though the company has no knowledge of or control over the entire system. Consider also a semiconductor manufacturer whose chip is utilized on a printed circuit board which is installed into sophisticated manufacturing equipment. The manufacturer of the semiconductor can’t be certain that the materials being used at the board level are compatible, let alone at the system level. For the distributor the ramifications are more severe. Even though the distributor had no part in the manufacturing process, the distributor is responsible for parts that fail to perform as warranted. Simply stated, the law is the law and it provides, if you are a “seller of goods” and regularly sell those types of goods, you must stand behind your products.

“Distributors Are At Higher Potential Risk”

It is not unusual for manufacturers to waive their product warranties and limit their exposures during their sales process with the distributor. In this way, the manufacturer makes the unsuspecting distributor solely liable for damages relating to non-conforming products. Often, there is no formal documentation attesting to this reality nor does the manufacturer verbally offer this information. Instead, the distributor becomes the responsible party for the manufacturer’s defects. Interestingly, many distributors are under the misconception that, not only are they not the responsible party, but that they are entitled to reimbursements from the manufacturer should a breach of warranty claim arise and subsequent damages result. When you consider the scope of potential damages (i.e., profits lost, poor customer relations, diminished reputation and therefore loss of future opportunities, and related property damage), it is particularly shocking to know that so many distributors are ill-informed in this area.

“Express Warranties”

Even worse than their lack of awareness is the fact that many manufacturers/distributors unknowingly make inadvertent express warranties. The problem is that once an express warranty is made, it cannot be waived. The company is bound by it unconditionally. Examples of an express warranty can often be found in company brochures and product catalogs which often highlight performance criteria based on optimal conditions that may not exist in ordinary circumstances. Nonetheless, this warranty creates an unqualified obligation whether or not these assumptions are accurate.

Another point of reference: In determining that a product is not performing in a reasonable way (i.e., is non-conforming), the law does not require a plaintiff to prove negligence on the part of the distributor. Therefore, liability is relatively easy to establish.

“A Simple Solution”

Despite the harsh realities of product warranty laws, manufacturers and distributors are not without recourse and means for protecting their interests. There are several basic measures that should be adopted. They pertain to a company’s purchase orders, invoices, brochures and Web site. All of these materials should be developed to contain specific business-friendly terminology, which simultaneously serves to limit implied warranties and cap potential exposures.

To accommodate both a company’s need to market a product effectively without placing it in a precarious position with respect to product liabilities, business-friendly qualifications should be incorporated into all the aforementioned materials. In addition to covering warranty claims, language can also be incorporated to protect manufacturers/distributors from other exposures such as those that can arise from late or cancelled shipments.

Significantly, it is not even necessary to secure a customer signature to obtain the protections of these qualifications. All that is required to realize these protections is that the information be evident on the forms, brochures, etc. Conversely, for those manufacturers and distributors who do not take this precaution, they automatically accept the terms of the exposures implied by the law or even worse, terms incorporated in their customers’ purchase orders which typically impose even greater liabilities.

“Insurance Savings”

Because of the rise in litigation, there are some major product liability insurance carriers who reward manufacturers/distributors who incorporate the proper terminology into their documents. By limiting their implied warranties and potential damages in this way, these manufacturers/distributors can realize a significant reduction in their product liability insurance premiums. Many of our clients are realizing significant insurance savings as a result of implementing these safeguards.

“Precautionary Measures”

Beyond this step of waiving implied warranties, there are other caveats that manufacturers/distributors should follow to avoid hidden liabilities associated with product warranties. They include:

• Do not make unintended warranties.
• Only make express warranties that you can meet.
• Draft a limited warranty, which is not performance based and waives all other warranties and provides for a cap on damages.
• Never state a product to be free from defects (something companies frequently do).
• Distributors, waive all warranties except those provided by the manufacturer.

“Closing Remark”

Manufacturers and distributors facing higher operating costs, eroding profit margins and fiercer competition both domestically and abroad can protect their interests as they relate to product warranties and liabilities. The measures outlined above can be easily implemented with the guidance of counsel well-versed in the UCC, the U.N. Convention for the International Sale of Goods and other applicable laws and treaties. Attorneys experienced in these areas and in representing manufacturers and distributors can conduct an evaluation of your current customer forms, sales and marketing materials, and recommend practical cost effective strategies to waive warranties and limit exposures.

Finally, companies should note that this extremely cost-effective solution not only affords considerable protections against potential liabilities valued in the multi-million dollar range, but also preserves the value of the company in any potential stock or asset sale. Sophisticated investors will conduct thorough due diligence investigations to analyze potential liabilities. In light of the Product Line Exception theory, (now the law in the majority of states), which holds a successor (i.e., purchaser) liable for any damages incurred as a result of a defective product even where the purchaser only acquired the assets of the selling company, avoiding potential product claims is essential. In other words, a company seeking to buy another business, regardless of whether it buys stock or assets, would, under the Product Line Exception, assume the liabilities from past product sales. Savvy buyers will likely look elsewhere or negotiate a substantial decrease in the purchase price, if faced with a company that, having failed to establish the proper protections with respect to product warranties, leaves the buyer wide open for untold potential liabilities. This example further underscores the importance of taking the initiative to reduce potential product warranty liabilities or else, pay the potential short and long-term consequences.

Gary Ettelman and Keith Hochheiser are co-founding partners at Ettelman & Hochheiser, P.C., a national law firm concentrating in corporate and commercial transactions, distribution and licensing agreements, mergers/acquisitions, tax-free reorganizations and related litigation. The firm can be reached at: (516) 227-6300 or www.e-hlaw.com.

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