Avoiding a Costly Recall

Tips for U.S. companies doing business with foreign manufacturers

Mattel isn't the first and won't be the last reputable company to face a massive recall. Prudent U.S. businesses that rely on foreign manufacturers are wise to evaluate their processes and policies to ensure that they are doing as much as they can to protect consumers, themselves and their reputations by preventing defective and unsafe products from being sold in the States. The following discussion offers basic strategies to help U.S. companies mitigate the risks involved when contracting with foreign manufacturers.

Conduct Adequate Due Diligence of Foreign Manufacturers

Conduct some level of due diligence on prospective foreign manufacturers. For example, checking a manufacturer's litigation and claims history can reveal potential supply, quality or performance issues and serves as a check on the satisfaction of the manufacturer's other customers.

Similarly, request that the manufacturer provide references (preferably other U.S. customers). Nothing beats speaking directly with other buyers who have done business with the manufacturer. Two potential limitations to this strategy involve: (1) confidentiality issues between the manufacturer and its customers; and (2) avoiding anticompetitive discussions with competitors. Regarding confidentiality, legitimate circumstances may exist preventing a manufacturer from identifying customers as references due to confidentiality clauses in their purchase contracts. In that case, there may be other creative ways to obtain anonymous references or other confirmation of general customer satisfaction. Second, be careful if the references turn out to be your competitors. Conversations with competitors about supply strategies and other competitively sensitive topics can implicate the antitrust laws, so proceed with caution when contacting competitors for references.

Obtain information that demonstrates the manufacturer is adequately experienced in the product area. For example, purchase and test products manufactured for others for quality and safety. Also, research industry and general news for information on the manufacturer and its products. Finally, request information from the manufacturer about its experience and knowledge of U.S. compliance measures.

Finally, investigate the finances and insurance status of the potential manufacturer. The key issue is whether the manufacturer is solvent and has sufficient funds and insurance to cover the consequences of a breach of the purchase contract, including the cost of potential products liability suits, the costs resulting from a product recall or corrective action, and lost profits to you, the buyer, and any distributors and retailers. All too often, U.S. companies who import foreign-made products find out they have no monetary recourse against the foreign manufacturer when issues arise with the products.

Structure Protective Terms and Conditions in the Purchase Contract

If after adequate due diligence, you are prepared to proceed with a supply arrangement, require that the manufacturer sign a purchase contract with terms and conditions designed to protect you from the risks of importing unsafe and non-compliant products. Many companies today rely on routine -- but flimsy -- purchase orders when transacting business with foreign manufacturers. However, plain vanilla purchase orders do little in the way of protecting purchasers when problems occur. This is particularly important when purchasing from a foreign manufacturer over whom U.S. courts or other jurisdiction may be difficult absent specific contractual terms.

A protective purchase agreement should include certain specific terms and conditions. First, include an indemnification clause requiring the manufacturer to indemnify the buyer for any liability, damage or loss from any claims or expenses caused by the manufacturer. This should include any damages, lost profits and other losses sustained by you, the buyer, and distributors and end users from defective or non-compliant products, including recall-related costs.

Second, require that that the manufacturer represent and warrant that the products will meet certain specifications and are otherwise manufactured, labeled, packaged and sold in compliance with all applicable laws and standards. This provision should also allow you to return any products which you reasonably determine to be non-conforming, defective or non-compliant at the manufacturer's expense. Comprehensive representations and warranties typically also include that the products, their manufacturing process, labeling and packaging do not infringe the intellectual property rights of any third party. Finally, seek a warranty from the manufacturer against defects in construction, manufacturing, materials and workmanship for some reasonable period of time.

Third, require that the manufacturer maintain comprehensive general liability insurance, covering personal injury, property damage, products and completed operations, contractual liability, and independent contractors' liability with a reasonably acceptable insurance company naming you as an additional insured and providing for occurrence coverage (as opposed to claims-made coverage). Such an insurance provision will provide an extra level of financial protection should something go wrong.

Fourth, the contract should permit you to conduct on-site inspections of the manufacturing facilities as well as the books and records of the manufacturer related to its performance under the contract. The provision should further require product samples for your inspection at your request before and during the manufacturing process. These two provisions are particularly important to ensure consistent product quality throughout the course of the supply agreement.

Finally, and most important, include a carefully tailored dispute resolution clause, essential to enforcement of the contract. Should you find yourself facing products liability law suits and other problems, you may be without legal recourse or unable to enforce a judgment against the foreign manufacturer absent this type of clause. The dispute resolution clause should specify the choice of law that will apply and the parties' consent to jurisdiction to adjudicate any disputes. The specifics of such a clause will depend upon a number of factors, such as in what country the manufacturer (and its assets) reside and the extent of the manufacturer's contacts in the U.S. In cases where the manufacturer's home country exercises local protectionism and U.S. court jurisdiction would be difficult, many purchasers opt for an international arbitration clause specifying the arbitral institution and venue to administer the arbitration.

Most countries are parties to one or more international conventions on arbitration. For example, China is a signatory to, among other agreements, the New York Convention on the Recognition and Enforcement of Arbitral Awards. Given the difficulty in obtaining jurisdiction over foreign manufacturers, an arbitration clause specifying the place and law for any dispute resolution based upon the arbitral convention to which the manufacturer's home country is a member can be enormously beneficial. While foreign governments do not enforce arbitration awards uniformly, an award secured in a tribunal and venue accepted by the foreign government has a greater chance of enforcement than the alternatives. Given the complexity of these issues, advice from legal experts in international arbitrations regarding the most protective dispute resolution provisions is recommended.

Perform Quality Control Checks at Multiple Points in the Manufacturing Process

Finally, conduct periodic quality control checks of third party manufacturing. Many purchasers simply request a sample at the outset and never inspect further samples throughout the manufacturing process. However, manufacturing processes and product quality can change over time. As costs rise and manufacturers seek to maintain or increase their margins, they often look for ways to cut costs. Thus, it is critically important for purchasers to conduct multiple quality control checks on samples throughout the manufacturing process to ensure consistent quality and safety of the products being manufactured.

In addition, review the books and records of manufacturers periodically, paying particular attention to sub-contracting arrangements, components being used, equipment records, and safety and compliance records. If possible, consider sending quality control personnel or agents to the manufacturing facilities to periodically check the manufacturing process and obtain samples for inspection. Inspectors should check equipment to ensure proper operation and calibration and observe the activities of facility personnel involved in the manufacturing. Facility inspections have the advantage of providing first-hand information on the manufacturing process.

Conclusion

While many U.S. companies have already incorporated some or all of these risk management practices in their dealings with foreign manufacturers, those who have not might be well served to assess their current quality control processes and policies and determine whether there are ways they can further reduce their risks of importing dangerous products. Many of the above mentioned strategies are easy fixes especially in light of the potential costs and risks associated with doing business with foreign manufacturers.

Bridget E. Calhoun is a partner in Crowell & Moring LLP's Washington office practicing antitrust and consumer protection law. She also co-chairs the firm's Product Risk Management practice. Crowell & Moring is an international law firm with more than 350 lawyers representing manufacturing clients in a range of practice areas, often serving as the national coordinating counsel for large-scale litigation matters. www.crowell.com.

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