Who’s Responsible for the Misfit Toys? Strategies for Allocating Risk in a Global Economy

by Perkins Coie

In the famous Rankin/Bass holiday special, Rudolph the Red-Nosed Reindeer runs away from home and, during his ensuing adventures, visits the Island of Misfit Toys. The island is filled with poorly designed and unwanted toys but Rudolph, with the timely assistance of Santa Claus, finds new homes for all of the orphaned misfits. 

Unfortunately, not all product sales during the holiday season will end as well.  Far too often, a disappointed customer, or worse, an injured user, will assert claims against the manufacturer or retailer.  In this increasingly global economy, it can be more difficult than ever to make sure that you are properly and fully protected against product-liability risks.  This Wrapping Paper Update provides some tips to ensure that you are protected against those risks.

1. Review your contracts with manufacturers, distributors and other suppliers.  Both upstream
    and downstream contracts can be structured to allocate risk among business partners.

  • Is there an indemnification clause?  You may have agreed to indemnify one of your business partners, or you may be the beneficiary of an indemnification provision.  An indemnification clause passes the risk of a loss from one party to the other.  Indemnification clauses need to be properly drafted and should be reviewed by qualified counsel to ensure that they will be enforceable if and when needed.
  • What about insurance requirements?  While indemnification clauses can provide some protection against product-liability claims, their effectiveness depends upon your ability to enforce the indemnification.  Your business partners may have limited assets to cover a judgment, be protected through corporate structuring, or be unreachable as a result of their home legal system.  In such cases, the protection provided by indemnification can be remarkably meager.  One way to buttress indemnification clauses is to couple them with insurance requirements.  Insurance provisions can require one party to add the other as an additional insured to its insurance.  This gives you a backstop against your partner either disappearing or turning out to be judgment-proof.
  • Does the contract contain any disclaimers or limitations of liability?  In the aftermath of a serious product-liability issue, your business partner may have experienced direct losses, such as recall costs or damages to its reputation.  In such cases, your partner may look to you to make it whole.  But you may be able to head off these claims through well-drafted provisions that limit your liability or exclude consequential damages.
  • What law governs any claims?  The enforceability of the contract’s risk allocation provisions depends upon the law governing the contract.  Your contracts should contain a sensible choice-of-law provision, selecting a jurisdiction that will enforce your mutual expectations.
  • How are disputes handled under the contract?  Depending upon where your business partner is located, traveling to its home and starting a lawsuit there could be difficult or even impossible.  This problem can be addressed through a variety of means.  You can agree in your contracts to mediate any disagreements between your companies’ business leaders.  You can agree to have future disputes settled through binding arbitration.  You can agree to jurisdiction and venue in a specific court.  Regardless of the specific method chosen, the “where” and “how” in your dispute-resolution clauses will affect the ultimate outcome.

2. Ensure that your own insurance coverage is in order and provides the necessary protection
    against product-liability risks.

  • Review your insurance policies to ensure that risks arising from the sale of defective products, as opposed to other types of losses, are fully covered.
  • Check your insurance limits.  Judgments and verdicts continue to increase.  Your insurance coverage limits need to match your exposure, given your company’s size, its scope, and the types of products being sold.  Obtain outside counseling as needed to evaluate the risks facing your business.
  • Examine the geographic and other limits on coverage.  Your policies need to be broad enough to cover all of your business interests.
  • Make sure that you have a voice in defending against claims.  In our experience, companies that participate actively in the defense of claims generally achieve better results than those who leave the matter entirely to their insurers.

3. Examine your internal policies relating to product-liability risks.

  • Review your advertising.  Be careful to avoid creating warranties that the products can’t meet through careless marketing or packaging.
  • Don’t create bad documents.  Companies often make claims worse because their own employees write carelessly.  In today’s world, especially given the ubiquity of email, it is easier than ever for your employees to unintentionally prepare documents that become your opponent’s best evidence.  Employees should be trained on how to avoid this trap.
  • Ensure that your document-retention system is in order.  Documents that are not needed for business, regulatory or other legal reasons should not be retained indefinitely.
  • Be prepared for claims.  You should have internal policies in place that allow you to investigate potential claims, to issue document-freeze instructions and to collect potentially relevant documents.  Plaintiffs who have weak cases may try to strengthen those claims through discovery disputes and, where possible, claims that the defendant has destroyed or altered relevant documents.


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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