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“Product Warranties Warrant Risk Management Strategies”

by Gary Ettelman, Esq. and Keith Hochheiser, Esq.
Partners Ettelman & Hochheiser, P.C.

One of the most neglected areas in many manufacturers’ and distributors’ risk management plans is that of their product warranties. More often than not, businesses are being held hostage by product warranties they don’t even realize they’re making. Unfortunately for many businesses, their first knowledge that they have this inherent problem arises in one of two scenarios – either when slapped with a multi-million dollar lawsuit based upon a product failure or when attempting to sell their business, an astute purchaser conducting its due diligence review determines that the company has not protected itself against such claims and the deal is either lost or the purchase price is dramatically reduced as a result. To avoid and reduce potential liabilities associated with errant product warranties, manufacturers and distributors need to arm themselves with knowledge of related laws and avail themselves of effective legal strategies.

“Laws Governing Product Warranties”

There are various laws and treaties which place certain obligations on manufacturers and distributors regarding their product warranties. Among them are the Uniform Commercial Code and the U.N. Convention for the International Sale of Goods. What these and other related legislation have in common are certain core principles. They presume that manufacturers and distributors guaranty their products’ quality and performance. In addition, they hold that manufacturers and distributors guaranty that their products are suitable for their intended purposes. Finally, under these laws, manufacturers and distributors guaranty that their products do not infringe the intellectual property rights of others; whether an individual or another business, domestically-situated or anywhere in the world.

One may believe that these obligations are not too difficult to meet. However, if you consider the infinite range of factors which come into play in any product’s application, you realize that satisfying these guarantees is virtually impossible. A closer look at the cycle of a component upon leaving a distributor’s warehouse illustrates this point.

Consider the case of a distributor of semi-conductors (computer chips). It sells a semi-conductor to a customer that incorporates the chip into a circuit board, which in turn is sold to a manufacturer of engines, who next incorporates the circuit board into an engine that is then sold to an automobile manufacturer and installed in a shiny new car. Keep in mind that the semi-conductor distributor did not manufacture the computer chip, did not install it in the circuit board and therefore had no control over or knowledge of the production of the circuit board (or the engine or automobile). Nevertheless, if there is a failure even at the system level (i.e. the engine fails) the distributor of the computer chip may be held liable despite the fact the manufacturer of the circuit board may have used products and processes that were incompatible with the computer chip. Draconian? Perhaps, but the law provides that a seller of goods has to stand behind the goods it sells.

“Liabilities and Damages”

While warranty laws and regulations make demands on manufacturers and distributors, they also offer certain protections. That is, of course, assuming companies know how to protect themselves against liabilities and damages. Manufacturers are generally better at protecting their interests than distributors. In fact, many distributors are easy prey to manufacturers that systematically make their distributors the sole party liable for damages stemming from “non-conforming” products (i.e., products which fail to live up to their guarantees). Often this happens below the radar, with the unknowing distributor becoming responsible for manufacturers’ defects. What makes this particularly disconcerting is that if you were to randomly canvas ten distributors, the majority probably believe that not only is the manufacturer responsible for their product defects and any resulting damages, but that they (the distributor) are entitled to reimbursements from the manufacturers for breaching the terms of the warranty. Think about their shock when they learn that they are responsible, not to mention the havoc a warranty claim can have on the distributor’s reputation, customer relations and future revenues.

“Watch Out For Those Express Warranties”

In addition to not recognizing their liabilities, both distributors and manufacturers routinely make what are known as “express warranties.” These are the claims highlighting a product’s performance features, which are often found in product sales sheets, brochures, direct mailers, advertisements, Web sites, etc. Here again, many companies don’t even realize that they are making a claim about a product which will be subject to other factors and conditions for which they have absolutely no control. Under warranty law, however, this is not a defense. Once an express warranty is made, the manufacturer/distributor has an obligation to meet the warranty, which cannot be withdrawn. Additionally, under the law, a plaintiff in a product warranty suit does not have to prove negligence on the part of the manufacturer/distributor in order to win a favorable judgment, just that the warranty was made and breached, which makes liability relatively easy to establish.

“Risk Management Strategies”

It’s not all doom and gloom for manufacturers and distributors. There are several very effective and economical risk management strategies, which can be employed to reduce liabilities associated with product warranties. They are easy to implement with the guidance of counsel experienced in product warranty laws.

Specifically, the protections lie in the proper drafting of various company documents such as purchase orders, invoices, product catalogs and brochures, as well as Web site content. By incorporating certain language and avoiding the use of other language, companies can limit implied warranties and contain related liabilities for breaches of warranty. The line to walk is a fine one, which advances a company’s marketing objectives related to its products, while concurrently managing its risks regarding product performance. The key is to utilize business-friendly language which strikes this balance. This language should serve both to afford product warranty protections, as well as address risks relating to delayed or cancelled shipments. It should follow these basic rules:
• Beware of unintended warranties
• Only make express warranties that you can meet
• When drafting a limited warranty, make sure it is not performance based, that it waives all other warranties, that it limits remedies available in the event of a breach and that it provides a cap for damages
• Never claim that a product is free from defects

There is one additional caveat for distributors to follow. It is:
• Waive all warranties except those provided by the manufacturer

In using properly drafted documents with business-friendly terminology and built-in risk management, manufacturers and distributors do not have to obtain their customers’ signatures in order to gain the protections afforded by qualifying language. The language merely needs to be incorporated within the various documents and marketing tools.

Recognizing the utility and financial value of properly drafted documents, several insurance carriers covering product liability are offering their policy holders a reduction in their premiums as an enticement for implementing documentation which reduces their exposure to liability. Many of our clients have realized significant insurance savings since taking these steps to minimize their exposures. In view of rising insurance costs across all areas, companies should appreciate this as another reason to take action. On the other hand, the penalty for failing to incorporate the right product warranty language into their documents consists of the imposition of even greater liabilities based upon the more stringent terms of their customers’ purchase orders.

“The Long Arm of the Warranty Law”

Product warranty law and its ramifications can reverberate in many areas of a manufacturer’s and distributor’s business. Product liability litigation does not reflect well on a business, often imposing negative repercussions on its image and market position, as well as its cash flow. On a broader note, not having the proper protections in place can jeopardize a business’ future opportunities. For example, in a pending merger/acquisition a sophisticated purchaser will review the seller’s documentation to determine if appropriate protections have been incorporated. If not, a pending deal will either be lost, or the purchase price of the business will be reduced. This is because of the Product Line Exception , which provides that a successor in interest (purchaser) will be liable for defectively manufactured products of its predecessor regardless of whether the purchaser acquired the stock or the assets of the seller. You can see, therefore, why a company might change its plans to acquire a business when the business failed to institute protections against breach of warranty claims and related damages.

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

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