A finished product often consists of various manufacturers’ components. When production and contractual chains are formed, the related dependency risks and error situations become more complicated to manage. Who is responsible and who compensates whom if, for example, a manufacturing defect takes place in the production chain? It is worthwhile considering the division of liability when contracts are being concluded. If’s Product Liability Insurance is a useful tool for covering the risks of a business enterprise.
Case example
Company A manufactures components for industrial equipment suppliers. A sells its components to B which uses them for manufacturing its own products, control devices for production machines. B then sells its own product to C which adds it to an industrial working machine it manufactures.
Company C has sold its working machines to 100 customers in 20 countries. When the machines are taken into use, it is discovered that the control device’s failure protection feature does not work. This causes such substantial risk of bodily injuries and property damage that the machines cannot be used until the necessary repairs have been carried out.
Company C immediately takes measures to repair the machines it has delivered. It contacts all buyers and tells them not to use the machines until the defect has been repaired. Although the repairs are carried out as soon as possible, it takes several weeks from the detection of the defect before all machines have been repaired.
It is discovered that the defect in the machines sold by company C is caused by a manufacturing defect in the component supplied by company A. The largest losses are incurred by company C’s customers, who suffer production losses due to the temporary downtime of the machines. Company C incurs considerable expenses from machine repairs as well as from the measures it takes to warn and instruct its customers. Company C also plans and implements, together with a communications agency, a marketing campaign aimed at ensuring that C’s reputation as a reliable machine supplier does not suffer from the occurrence.
Division of Liability
One of the main principles of contract law is that, as a general rule, the party suffering loss or damage in inter-company relations can turn to its own contracting party only. Thus company C and its customers cannot claim compensation for damages from company A but, instead, must turn to their own contracting parties. Thus, company C’s customers can claim compensation from company C. Company C can claim compensation for its own damages and for any damages it has compensated to its own customers from company B, while company B can claim compensation from company A. The division of liability in each contractual relationship is solved separately on the basis of the contractual terms applying to the said relationship.
If company C has, in its own sales contracts, limited its liability to the repair of defects in the sold products, C’s scope of liability only includes the repair of the machines it has supplied. However, if the contracts contain no limitations of liability, company C is also responsible for the direct and indirect loss or damage caused to the machine users as a result of the defect. For example, losses arising from the interruption of production may be substantial.
In our example, company B’s liability has been limited under the contract concluded between company B and company C to cover direct damage only. In this case, direct damage is considered to include costs arising from repairing the product defect caused by company B in machines manufactured by company C. In practice, this means replacing the defective component manufactured by company A with a faultless one. Thus, company B is liable for the repair costs incurred by company C but not for other expenses, such as those relating to company C’s customer contacts or efforts aimed at securing its customers’ goodwill.
In this example, company A has limited its liability under the sales contract concluded with company B so that it is only responsible for supplying company B with new, faultless components in replacement of defective ones.
It is important to pay attention to the division of liability when concluding contracts
The question of who is ultimately responsible for the various costs and damages arising from a defect depends largely on how the contracting parties have determined their liability within their contracts. Thus, when concluding the contract, particular attention should be paid to the division of liability upon the occurrence of defects.
Through product liability insurance, a company can protect itself against the risk of its product causing bodily injury or property damage to the buyer’s property other than the product itself. If provides various tools for contractual risk identification and management, including contractual risk surveys and training.
Pialiina Karhunen
