Potential pitfalls for distributors of foreign-manufactured products

A look at product liability law

Under product liability law, manufacturers, distributors, and other entities in the distribution chain can be held strictly liable for injury caused by product defects. In other words, a plaintiff is not required to show that a defendant acted negligently in causing her injury but instead need only show that the injury was caused by a (1) manufacturing defect, (2) design defect, or (3) failure to warn of the potential dangers of using a product.

However, in most jurisdictions, a distributor can push the liability upstream to the manufacturer. If the distributor did not create or contribute to the defect or issue its own warranty, it can escape liability by suing the manufacturer for contribution or indemnity or by taking advantage of an innocent seller statute, if one is available. Innocent seller statutes permit the dismissal of distributors and entities if their liability is based solely on being in the chain of distribution. These statutes typically require the distributor to identify the manufacturer of the product and, depending on the state, establish that the manufacturer is or can be a party to the lawsuit.

Distributors can obtain further protection against product liability lawsuits by inserting protective provisions into their distribution contracts. Some contracts may require the manufacturer to defend and indemnify the distributor against suits arising out of product defects. Others add a requirement that the manufacturer ensure that the distributor be considered an additional insured on the manufacturer’s insurance policy for liability arising out of product defects.

Potential liability for distributors

Based on the protections available to distributors, many companies believe themselves to be fairly well protected against lawsuits arising out of product defects. While this belief is often accurate, such protection can be minimal or nonexistent when the manufacturer and its insurer are located outside of the United States.

In this circumstance, protections can fail for several reasons. First, foreign manufacturers are often not subject to personal jurisdiction in US courts even when their products are sold in the United States. If the court does not have jurisdiction over the manufacturer, an innocent seller statute may not apply and the distributor will not be able to sue the manufacturer for contributor or indemnity, even if the distributor contract specifically states that the manufacturer has a duty to defend and indemnify the distributor against defect claims.

Second, foreign manufacturers are often insured by foreign insurance companies. As with foreign manufacturers, it is difficult to obtain jurisdiction over such insurers. Thus, if the insurer improperly disclaims coverage or mismanages a claim, there is little recourse against the insurer. Finally, policies issued by foreign insurers sometimes include restrictive provisions that are not typically seen in the United States.

Examples of claims against distributors

Below are some examples of issues we have seen in matters involving foreign manufacturers and insurers. Some details, such as the products, have been changed to protect the identities of the parties involved.

• An insured distributed toaster ovens for a foreign manufacturer. In a case involving burn injuries, the manufacturer’s foreign insurer refused a six-figure settlement demand. The case was tried to a multi-million dollar verdict that exhausted the manufacturer’s policy and the distributor’s primary policy. The verdict significantly impaired the limits of the distributor’s excess policy, leaving the insured with reduced protection against other lawsuits. While there is good cause to pursue the manufacturer’s insurer for failure to settle, obtaining jurisdiction over the foreign insurer will be difficult. In addition, recovery may be impeded by a foreign arbitration clause and other restrictive provisions in the manufacturer’s policy.
• A distributor has been sued dozens of times regarding defects in a variety of products. Most of the lawsuits were being defended by the foreign manufacturer’s insurer. After agreeing to settle some of the lawsuits, the foreign insurer abruptly withdrew its defense and reneged on the settlements, leaving the distributor’s insurer to pay the settlements and with limited avenues of recourse against the manufacturer’s insurer.
• A distributor received over a dozen claims for the same or similar allegedly defective product. The claims were successfully tendered to the foreign manufacturer. Subsequently, a “sunset clause” was added to the foreign manufacturer’s renewal. The sunset clause excludes coverage for claims received by the foreign insurer after a specific date, regardless of the date of occurrence. In this case, the sunset clause even applies to claims that were previously tendered and defended by the foreign insurer. For example, in one US lawsuit involving three separate plaintiffs, the foreign insurer hired defense counsel to represent our insured. Due to the sunset clause, the foreign insurer re-evaluated coverage and withdrew the defense of two of those claims because they were received after the sunset clause date.

In short, if an insured distributes products manufactured outside the United States, it may be unable to avoid lawsuits arising out of those products. This possibility should be considered by both underwriters when they are pricing policies issued to distributors and also by claims professionals who are looking for recovery from product manufacturers and their insurers.