Distribution agreements help with product liability claims

Direct and indirect sales

Typically businesses either choose to sell their products directly to customers or indirectly through distributors.

The critical difference between the two channels is that in the former, the business enters into a sales contract directly with its own customer. In the latter, the supplier sells the product to the distributor and the distributor in turn enters into its own sales contract with the end customer. There is no privity of contract between the supplier and the distributor’s end customer, so we know that the end customer must rely on a tort remedy to get at the business for a product liability claim.

Pros and cons

The direct sales channel is often preferred by suppliers for financial reasons. In a direct sale, the supplier holds on to the entire margin. When products are sold through distribution, the distributor buys at a discount and typically marks the item up.

A sales strategy based on direct sales, however, may not be the most prudent choice since distribution sales can help insulate the supplier against certain product liability claims.

For sales made through distribution, the supplier’s sole exposure is either to be sued by the end customer in tort or to be sued by the distributor itself in tort or contract. Ideally, in-house counsel will have anticipated these exposures and put measures in place to defend itself against both possibilities.

Breach of contract

In-house counsel should ensure that distribution agreements contain a clause stating that products are sold to the distributor subject to the supplier’s standard product warranty, including disclaimers. The clause should state that if the distributor offers a different warranty, it does so at its own risk and assumes all liabilities that arise. 

A defence often used by suppliers is that it is not liable for product liability damages where the non-conformance or other condition giving rise to the claim could have been avoided by either the distributor or the end customer inspecting the product. For example, where the product is one component of a product, it is often reasonable to expect the end customer will perform in-system tests after the component has been incorporated. Supplier warranties should contain disclaimers in the event of failure to perform in-system tests and incompatibility with third-party products and equipment. 

In the case of certain apparent defects that could have been discovered by the naked eye, it could be argued that the distributor had a duty to inspect the product before shipping it to its end customer.

Another strategy might be to require that distributors obtain a written declaration or certification from the end customer that componentswill be tested on arrival, and before they are incorporated into product or simply resold. 

Product warranties should contain disclaimers against modification or misuse. Suppliers should insist that distributors disclaim against both possibilities. To prove modification, the defendant must prove the original design, how the product has been changed (for example, removal of safety guards or the installation of nonstandard parts) and that the change caused the plaintiff’s injuries. Product misuse is either foreseeable or unforeseeable. Product misuse that is foreseeable (such as a mobile phone battery exploding after ordinary use) may not provide a manufacturer any defence, but unforeseeable misuse (such as using a gas propane tank as a hammer) may exonerate the manufacturer from liability.

Labelling, manuals and assumption of risk

For both tort and breach of contract claims, proper labelling and the use of carefully worded instruction manuals can go a long way toward de-risking a supplier’s business. In-house counsel should proactively enquire how products are labelled — does the distributor or the end customer add tits own labels? Does the distributor provide its own manual? Are products shipped to the end customer along with the supplier’s manual? To prove assumption of the risk or contributory negligence, the defendant must prove that the plaintiff knew of the hazard that ultimately injured him and confronted the hazard knowingly. Manuals and labelling will help guard against product liability claims. It is not enough that in-house counsel should draft its standard sales terms and review product manuals — enquiries should be made about how products are ultimately labelled and packaged when they arrive in the end customer’s hands.

Fitness warranty

A breach of warranty of fitness for a particular purpose does not require the plaintiff to prove that the defendant’s product was defective. Instead, the plaintiff must prove that it informed the defendant of its particular needs from the product, that the defendant promised to meet those requirements and that the defendant’s product failed to meet the plaintiff’s specifications. This, of course, is much harder to prove where sales occur through a distributor and there is no contact between the end customer and the supplier. In-house counsel may consider highlighting this important detail to the product group concerned and recommend there be limited contact between the supplier and the end customer.  Where such contact does occur and reassurances are provided by the supplier that the product is fit for a particular purpose, not otherwise represented by the supplier, liability could be found.

Product specifications

An important strategy in limiting a supplier’s risk is to ensure that product specifications are carefully reviewed by product line managers — the quality and assurance department as well as legal staff. Are the specifications consistent with the supplier’s product warranty? Are there appropriate disclaimers regarding fitness for a particular purpose? Has the end customer been put on proper notice regarding to what extent products have or have not been tested against certain parameters? Are product specifications shipped with the product to the end customer? Are they modified by the distributor and, if so, to what extent? 

Notices

Where product warranties are based on contract (i.e., sale to a distributor), the supplier can require the distributor to do certain things to obtain a remedy. For example, the distributor could be required to make a claim within a specific time after the injury or damage and give notice of such claim in writing, or the supplier could require that the distributor provide a sample of the allegedly defective or non-conforming product unaltered, within a certain time frame, for testing and root cause analysis.  Distribution agreements should include audit rights, giving the supplier the right to audit the distributor’s records and business locations.

Due diligence on the distributor

In-house counsel should also be part of the decision loop when distributors are selected. Prospective distributors should be pressed to provide evidence they have proper insurance, are financially sound and hence can indemnify your client, and litigation searches should be performed to determine whether the distributor has a litigation history. Demonstrating due diligence can provide a defence to certain product liability claims, even for certain strict liability claims.