To build automobiles in the early 20th century, Henry Ford built the largest integrated manufacturing plant the world had ever seen. Indeed, he eventually purchased iron mines in Minnesota and rubber plantations in Brazil so that he could control all of the inputs that went into his cars.

That world no longer exists. In recent years, the manufacturing process has become more fragmented. Different companies specialize in the manufacture of component parts that can be used in a wide variety of products. Manufacturers outsource the production of components to many different manufacturers and suppliers. Sometimes, those suppliers are on the other side of the globe. Dozens of different companies may manufacture the components required to manufacture a single product.

Lengthy and complex supply chains complicate the defense of product liability lawsuits. If a defective product causes personal injury or property damage, the company that sold the finally-assembled product may have had no role in the design or manufacture of the component that failed. But that is not a defense to a product liability lawsuit brought by an injured end user. The company that puts together and sells the completed product is liable as the “manufacturer” of the product even if it did not design or build the component that caused the failure.

A manufacturer can take steps to protect itself against product liability lawsuits resulting from defective components supplied by others. And component suppliers can take steps to protect themselves against the losses that can result from being wrongly involved in lawsuits against the final product manufacturer.

 

How Can A Manufacturer Protect Itself?

Imagine a hypothetical manufacturer of washing machines. The manufacturer purchases the electric motors for the washing machines from another party. Years after a consumer purchases the washing machine, the motor overheats and starts a fire, damaging the consumer’s house. Under general product liability principles, the manufacturer of the washing machine can be held responsible for a defect in the electric motor that caused the fire even when the manufacturer had no role in the design or manufacture of the motor. It sold a defective product. How can a manufacturer in such a situation protect itself against product liability claims caused by defective component parts?

The first step is to “know your supplier.” Is the supplier financially stable? Is the supplier insured against product liability losses? Does the supplier have a history of being sued on product liability claims? These are important questions because of the sometimes extremely “tail” of product liability claims. An injury-producing accident can occur many years after the manufacture and retail sale of the product. Therefore, a manufacturer could face a claim for a product that was manufactured and sold years prior to the accident. A manufacturer should learn enough about a potential supplier of key components to make a judgment about whether that supplier is likely to be around years in the future and able to respond if a claim arises.

For more critical supply relationships, a manufacturer should consider requesting to be included as an “additional insured” on the component supplier’s product liability insurance policy. If the manufacturer is an additional insured on the supplier’s policy, that insurance company would defend and indemnify the manufacturer even if the supplier has gone out of business or has financial difficulties. For important supply relationships involving critical components that potentially are a source of product liability claims, manufacturers should strongly consider such an arrangement.

A manufacturer can seek protection in the law of warranty. Absent contractual disclaimers, the law in most states generally will provide that the seller of a product warrants to the buyer that the product is “merchantable.” A merchantable product is “fit for the ordinary purposes for which such goods are used.” In addition, the parties can create a warranty by express agreement. The manufacturer’s purchase order should include language stating that the component parts to be supplied are free from defects and reasonably suited for their intended use. If the component parts are to be put to a specialized or unique use, the supply agreement or purchase order should provide that the components are suited for that specific use. Such a warranty will provide the manufacturer with a legal basis to hold the component parts supplier responsible for a defect in the part that causes a personal injury or damages property.

A manufacturer should be alert to the possibility that the supplier may try to overcome the warranty contained in a purchase order by including language in a written order confirmation that provides that the goods are sold without warranty. A purchaser of component parts should be able to insist on a warranty. A manufacturer should be able to expect that a creditable supplier will want to stand behind its product. Do you really want to do business with a supplier that will not provide any warranty of fitness for the component parts it supplies?

The manufacturer should also be alert to language in a purchase order confirmation that limits the damages that can be recovered from a component parts supplier. A prohibition on the recovery of “consequential damages” may seem innocuous, but it could prevent a manufacturer from suing a component parts supplier to recover the loss resulting from a product liability lawsuit.

An alternative way for a manufacturer to obtain protection is to negotiate an indemnification agreement with the parts supplier. In such indemnification agreement, the supplier would agree to shoulder any liability or costs that might be inflicted on the manufacturer as a consequence of a defect in the component part. Such indemnification should include the manufacturer’s defense costs. In addition, the indemnification agreement might require that the component supplier assume the burden of defending a lawsuit against the manufacturer if a claim that the component was defective is the sole basis of the claim against the manufacturer.

Overseas component suppliers can create challenges for a manufacturer facing a product liability claim. The injured consumer may have no stomach for going to the trouble and expense of serving a lawsuit on a foreign company. The foreign component supplier may not be subject to the personal jurisdiction of the court in which the product liability claim is brought. In a purchase order or supply agreement, the manufacturer should ask that the foreign supplier consent to the jurisdiction of courts in the United States, perhaps the courts in the location where the manufacturer is located. Or the consent could be to arbitration in the United States. Such a consent eases the burden on the manufacturer when attempting to hold the component supplier responsible for its product.

A manufacturer should maintain records that will allow it, many years later, to determine the terms of sale for component parts. Years after the purchase of a component part, a manufacturer may need to prove what warranty it received for that part or what representations were made about its suitability for the intended use. Sound document management can be an important element to defending a product liability case.

 

How Can a Component Supplier Protect Itself?

Long and complex supply chains also create risk for component suppliers. Imagine a hypothetical manufacturer of a chemical compound or an electric circuit that might have a thousand different uses. If the product containing that component causes a personal injury or damages property, the injured consumer might sue all of the component suppliers, alleging that each contributed to the failure of the product. Perhaps the manufacturer of the final product is insolvent and the component supplier is the only deep pocket that could possibly pay the damages that the consumer is looking for. What could such a component supplier do to protect itself against such claims?

Just as a manufacturer should know its supplier, a supplier also should know the manufacturer. How is the manufacturer using the component? Is the component truly suited for that intended use? Does the manufacturer have the engineering sophistication to properly use the component? Such knowledge can help a supplier avoid risky relationships.

A component supplier should make sure that the manufacturer that purchases the component is fully informed about the properties of the component, its proper uses, the limitations on its use and the possible risks of its use.

The law of most states recognizes a “learned intermediary” or “sophisticated user” defense. If the component manufacturer informs the manufacturer about how to properly use the component and its potential risks, the component supplier has a defense against a consumer’s product liability claim. If the manufacturer does not properly use the component or fails to pass along the warnings to the ultimate consumer, that failure is the responsibility of the manufacturer, not the component part supplier.

The component supplier should maintain documentation about the information it provides to the manufacturer. As is noted above, product liability claims have a long tail. Years after selling the component, a component supplier might need to re-create what information and warnings it supplied to the manufacturer about its component. The supplier may also need to recreate the terms of sale to establish any limitations on warranties or indemnification agreement.

Indemnification language in the purchase order acknowledgment or a supply agreement can also protect the component supplier. The component supplier should ask that the manufacturer indemnify and defend the component supplier for claims arising out of the conduct of the manufacturer. If the manufacturer does not follow the component supplier’s instructions or warnings and the product fails, or the accident resulted from a design choice of the manufacturer, the manufacturer should indemnify or defend the component supplier for product liability claims.

As in many areas of the law, a little forethought combined with proper contract drafting can go a long way to controlling the product liability risk presented by complex supply chains.