June 07, 2011 Articles

Defending Mass Retailer Liability for Foreign-Sourced Goods

By Michelle Cheek

Globalization has redefined the concept of the supply chain by which products are moved from foreign suppliers and manufacturers to domestic customers in search of the best bargain. As globalization accelerates, more supply chain functions are being performed outside the United States to meet consumer demands. This has created legal uncertainty for U.S. retailers who sell products that are often manufactured in countries where quality control may be sacrificed in favor of cheap, efficient production. When products liability suits arise from poor quality control, domestic companies can find themselves in a precarious position when it comes to determining who will bear the loss. While legal claims provide a basis for a retailer to attempt to pass liability on to foreign manufacturers, there are obstacles that can impede a retailer's ability to shift liability and damages to responsible foreign manufacturers.

Significance of the Global Supply Chain
Mass retailer success depends on a continuing ability to provide "everyday low prices." U.S. retailers have increasingly turned to outsourcing and importing to meet consumer demands. In 2009, the United States imported $296.4 billion worth of goods from China, an amount almost triple that imported in 2000. The U.S.-China Bus. Council, US-China Trade Statistics and China's World Trade Statistics, www.uschina.org/statistics/tradetable.html. The growing importance of the global supply chain requires that their suppliers' cost structures and operational efficiency be adaptable to the needs of the retailer. Misha Petrovic & Gary G. Hamilton, "Making Global Markets: Wal-Mart and Its Suppliers," in Wal-Mart: The Face of Twenty-First Century Capitalism 107, 132 (Nelson Lichtenstein ed., 2006). If the retailer is unable to maintain efficiency in its supply chain, the foundation of its business could be threatened. The necessity of controlling the supply chain has become more significant as companies realize that the benefits of globalization can be lost due to inefficient processes and supply chain coordination. PRTM Mgmt. Consultants, Global Supply Chain Trends 2008–2010: Driving Global Supply Chain Flexibility Through Innovation 6 [PDF]. This creates a potential for difficulty, as retailers must balance expansion and globalization with maintaining centralized supply chain planning.

Mass retailers started to emerge as leaders of the consumer supply chain beginning in the 1970s. As the prevalence of mass retailers increased, it became clear (to them and to the marketplace) that they had the power to shape the supplier markets. This resulted in the retailers requiring more of suppliers, such as tagging products before delivery and developing "capabilities for rapid and efficient delivery to the retailer's highly automated distribution centers." Petrovic & Hamilton, supra, at 117. With that added power came the responsibility of ensuring that all parties to the supply chain efficiently and uniformly participate in the process according to the retailer's supply model. A prime example of the mass retail industry's increased control of the supply chain is the change to buying directly from manufacturers rather than through wholesalers, thus eliminating "operational inefficiency in the supply chain." Id. at 134.

The increased focus on product quality has also introduced a greater need for tighter supply chain control. Outsourcing to developing economies may be cost-effective, but such economies often lack regulatory structures or enforcement capabilities to ensure that consumer interests are protected. And, while retailers may exercise strong oversight with primary suppliers, subcontracting can cause defective products to slip through the cracks. One example of such a problem is Mattel's subcontractor's use of lead paint on toys in China. Peter Enderwick, "Quality Assurance and Upgrading in Global Supply Chains: Implications for Management in a Transition Economy," 50 Thunderbird Int'l Bus. Rev. 217, 222 (2008). In that case, even though Mattel maintained tight control of its supply chain, the use of lead paint by a subcontractor outside the normal scope of the chain led to losses in both finances and reputation.

Even though mass retailers can "squeeze" suppliers by reducing profit margins, imposing cost-cutting measures, and forcing outsourcing, to become a vendor for a mass retailer is an opportunity to reach a huge number of global consumers with minimal advertising or promotional costs. Petrovic & Hamilton, supra, at 130. Partner selection of suppliers by mass retailers is arguably based on two main dimensions: (1) the ability of the vendor to offer a low price and (2) operational and technological compatibility with the retailer's business process. The first element requires that the supplier be able to adopt the retailer's business strategy, which includes low profit margins, rapid turnover, and high sales volume. The second element requires that the suppliers be able to use infrastructure to reduce management costs, enhance efficiency, and test potential new products. Some of the components that often play into this analysis are labor costs, flexibility in production, proximity to downstream manufacturers, familiarity with operating environment, capital costs, favorable tax structures, initial start-up time, intellectual property regimes, management complexity, and complexity of the supply chain. Isaac Cheng, "Sourcing Goods from China: The Mass Migration," China Bus. Rev., Sept. 2009.

A growing focus on quality assurance has forced retailers to reconsider the way in which they choose foreign suppliers. "Importers seek to use the cost savings offered by sourcing from countries like China to expand their markets, but this must be balanced against the need to maintain quality." Enderwick, supra, at 219. Problems with foreign-manufactured essential products draw heavy media attention because such problems have "direct and immediate implications for human health and safety." Id. at 218. Retailers who sell these defective products suffer both financially and in reputation. One strategy to reduce the risks of quality failure is diversification of suppliers. If a retailer has more than one supplier, it can turn to its alternative supplier when quality issues arise. Id. at 221. Retailers can also reduce these risks by increasing the focus on supplier reputation and competence and by reducing the focus on profit margins. This seems to run contrary to mass retailers' business model but could prove to be more financially sound over time. Id. at 222.

The Burden of Liability
The Model Uniform Products Liability Act states that distributors or sellers who did not manufacture a product should not be liable when they received sealed container goods that they do not have the opportunity to inspect for defects. However, this standard does not apply when (1) the manufacturer is not subject to service of process in the court's jurisdiction, (2) a court has declared the manufacturer insolvent, or (3) a judgment is unlikely to be enforceable against the manufacturer. While adoption of this model standard and its exceptions varies by state, the policy rationale—giving consumers a party to recover from when the manufacturer is essentially unavailable—can be the source of the legal gray area that retailers fear.

Jurisdiction
Generally speaking, retailer defendants can use third-party complaints to bring manufacturers of allegedly defective products into suits. A defendant may bring a cross-claim against a codefendant if the claim arises out of the transaction or occurrence that is the subject matter of the original action or of a counterclaim, or if the claim relates to any property that is the subject matter of the original action. The cross-claim may include a claim that the codefendant is or may be liable for all or part of a claim asserted in the action by the plaintiff.

To determine whether a court has statutory long-arm personal jurisdiction over a third-party complaint or cross-claim, the court must look at the applicable state long-arm statute and the constitutional requirements of due process. For there to be  due process, the additional party must meet the requirements set forth in International Shoe Co. v. Washington, 326 U.S. 310, 310 (1945), the well-known two-part inquiry regarding whether the defendant has minimum contacts with the forum state and whether the suit offends "traditional notions of fair play and substantial justice."

When a court must decide whether a cross-claim by a distributor or seller against a manufacturer will go forward, the court applies what is essentially the basic long-arm statute analysis to determine whether jurisdiction is proper. Overall, when looking at the application of long-arm jurisdiction to third-party claims and cross-claims, courts may be willing to assert jurisdiction as long as there is any sort of factual evidence that the nonresident party either intended to do business in the forum state or could have foreseen that the stream of commerce would result in its product entering the forum state. In many instances, courts have allowed personal jurisdiction even with very bare "minimum contacts." However, in cases in which the third-party is not at all connected with the forum state, courts have refused to extend jurisdiction.

Statutory long-arm jurisdiction has successfully been used to address cross-claims and third-party claims in a variety of instances. For example, the Supreme Court of Washington, in Deutsch v. West Coast Machinery Co., specifically stated that the state's "long-arm statute does not discriminate between first and third party actions. A third party plaintiff has the same rights as the primary plaintiff and, under the statute and CR 14(a), may bring in a nonresident who is or may be liable to him for all or part of the primary plaintiff's claim against him." 497 P.2d 1311, 1318 (Wash. 1972). There, the court allowed the defendant, the seller of an allegedly defective metal press, to bring a cross-claim for indemnification against the Japanese manufacturer when it was determined that the manufacturer met the due process requirements for personal jurisdiction.

Courts use a similar, fact-dependant and case-specific analysis when determining whether there is personal jurisdiction over foreign businesses. When courts deny jurisdiction, the facts tend to show that the foreign business did not intentionally design, market, or place the product in the country or specific forum state. Perhaps the best-known case in this realm is Asahi Metal Industry Co. v. Superior Court of California, 480 U.S. 102 (1987). Here the Supreme Court held that the placement of products by a foreign corporation into the stream of commerce alone was not enough to allow the state to extend jurisdiction to that corporation. The Asahi court demanded additional evidence, such as designing the product for the market in the forum state, advertising in the forum state, establishing channels or providing regular advice to customers in the forum state, or marketing the product through a distributor who has agreed to serve as the sales agent in the forum state. Id. at 104.

The California Court of Appeals, in Felix v. Bomoro Kommanditgesellschaft, clarified that the "appropriate test is not knowledge or awareness of the ultimate destination of the product, but whether the manufacturer has purposefully engaged in forum activities so it can reasonably expect to be haled into court there, and, even then, the minimum requirements of 'fair play and substantial justice' may defeat jurisdiction." 241 Cal. Rptr. 670, 676 (Cal. Ct. App. 1987). In that case, the court denied jurisdiction over a German manufacturer when it was not licensed to do business in the forum state, had not solicited any business in the market, and the part it manufactured was incorporated into a finished product that was sold and distributed by a different entity.

Other case law demonstrates that foreign manufacturers may likely be just as subject to long-arm jurisdiction as domestic entities if it is foreseeable that their product will enter the forum market, even if placement in that market is not done directly by the foreign business. The Washington Court of Appeals, in Omstead v. Brader Heaters, Inc., suggested three guidelines for determining whether the due process requirement is satisfied:

(1) If a foreign manufacturer places his products in international trade, either directly or through use of intermediaries, it must be foreseeable that the product is destined to be placed in the broad stream of commerce in the United States, or sent to the forum state. . . . (2) The court should consider the extent of multistate business engaged in by the foreign manufacturer in this country, either directly or through intermediaries, and the benefits it receives. The court should then balance this against the extent or lack of multistate activity engaged in by the plaintiff. . . . (3) The court should balance the relative convenience and burdens placed upon both the plaintiff and the defendant by reason of litigating the cause of action in this state.

487 P.2d 234, 242 (Wash. Ct. App. 1971).

The court stated that foreseeability was the most important factor, and only when the other factors strongly weighed against jurisdiction should it be denied. Id. This application was based heavily on a consumer protection policy argument, and the court recognized that "[i]n many cases the foreign manufacturer is the only person liable or financially responsible." Id. at 243.

A relevant trend in state long-arm statutes was the emergence of "single-act statutes," which allow for long-arm "jurisdiction over nonresidents on the basis of an isolated act done or transaction engaged in by the nondomicilliary within the state of the forum, such as transacting of 'any' business, or the making or performance of a contract, or the commission of a tort." E.H. Schopler, "Products Liability: In Personam Jurisdiction over Nonresident Manufacturer or Seller under 'Long Arm' Statutes," 19 A.L.R. 3d 13, 21 (1968). The Supreme Court has not ruled on whether a single tort is a sufficient basis of personal jurisdiction as a matter of due process but did hold in McGee v. International Life Insurance Co., that state jurisdiction over a foreign business was allowable based on the fact that the corporation had made a single insurance contract with a resident of the forum state. 355 U.S. 220 (1957). In McGee the court referred approvingly to Smyth v. Twin State Improvement Corp., 80 A.2d 664 (Vt. 1951), in which the court "up[held] a statute which predicated jurisdiction upon the commission by a foreign corporation of a single tort within the state." Id. at 32. This suggests that the Supreme Court may approve of such statutes in the future.

Once a court finds that it has jurisdiction over a foreign manufacturer, a retailer may invoke tort law or, if available, make contractual or common-law indemnity claims. While tort and common-law indemnification claims will vary by jurisdiction, contractual indemnity relies on the same principles found in general contract law.

In cases in which an express contractual indemnity provision between a seller and manufacturer was at issue, courts have generally ruled in favor of indemnifying the seller. In the article "Products Liability: Seller's Right to Indemnity from Manufacturer," Debra T. Landis provides an overview of the case law reflecting this trend. 79 A.L.R. 4th 278 (1990). In Knab v. Alden's Irving Park, Inc., the Illinois appellate court held that the trial court had erred when it directed a verdict in favor of the manufacturer of pants that burst into flames in the retailer's third-party action against the manufacturer. 199 N.E.2d 815 (Ill. App. Ct. 1964). The court based this decision in part on the existence of a provision in the sales agreement in which the manufacturer agreed to indemnify the retailer from any loss or damages arising out of litigation relating to the manufacture, sale, use, or consumption of the merchandise. Id. at 824.

In Oklahoma, an appellate court came to a similar decision in Kelly-Springfield Tire Co. v. Mobil Oil Corp. when it held that the manufacturer of a tire that exploded had indemnified the buyer and reseller purchaser from every claim. 551 P.2d 671 (Okla. Civ. App. 1976). The court looked to the language of the indemnity agreement, which stated, "Kelly will save Mobil and DeYong harmless from every claim or injury, including attorneys' fees, which may arise or be asserted, based upon a claim of injury, claimed to have been caused by or attributable to defective workmanship or material." Id. at 673–74. Kelly argued that proof of negligence on its part was required to enforce the indemnity agreement, but the court rejected that argument because the language in the agreement was unambiguous and did not refer to negligence as a prerequisite to indemnity.

Because basic principles of contract law apply when dealing with contractual indemnity agreements, care must be taken in drafting them as well as reviewing them for enforcement, to ensure that rights are created and protected consistent with the intent of the parties. Public policy favors contractual allocation of responsibility, which promotes the goal of making the injured party whole and encourages the manufacturers who control production to provide quality products.

Recommendations
Although various legal theories support indemnity for innocent retailers, U.S. retailers will be the ones to pay the price if foreign members of their supply chain are rendered unreachable or uncollectible. Retailers can protect themselves best by, first, keeping a tight reign over quality control of their foreign suppliers to minimize the risk of defective products. Second, retailers must contract wisely in consideration of the obstacles they will face in successfully bringing foreign manufacturers into liability suits and then enforcing judgment against them.

Keywords: litigation, products liability, foreign-sourced goods, globalization


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