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Private Labeled Products – Opportunity is Not Without Risk

NAW Legal Advisory - July 2007

According to the recent Facing the Forces of Change® – Lead the Way in the Supply Chain, published by the NAW Institute for Distribution Excellence (www.naw.org), a key future trend will be wholesaler-distributors marketing their own private label products, i.e., products manufactured for the wholesaler-distributor under contract for sale under the wholesaler-distributor’s brand name.

Private labeling may be an attractive business strategy for a host of reasons. However, this business opportunity has some legal and financial risks, particularly for the U.S. wholesaler-distributor who sources product from overseas for resale in the U.S.

Product Liability Exposure

In the United States, any seller of a product (not just the manufacturer) is liable for losses, injury or damage caused by a defective product under the doctrine of strict tort liability. The injured party may file a suit against the wholesaler-distributor and it is not necessary to also sue the product manufacturer. The fact that a wholesaler-distributor did not create the defect, or did not participate in the design or production of the product, or did not author the product instructions or warnings, is no defense. This is true if the wholesaler-distributor is selling a private label product, or if the product bears the manufacturer’s own brand name.

Normally, a wholesaler-distributor in a U.S. product liability suit will bring the manufacturer of the defective product into the case as a defendant if the plaintiff has not already done so and claim indemnity from the manufacturer as the faulty party. This may not always be successful, especially when the product is made by a foreign supplier. If the foreign supplier does not have a legal presence in the U.S. (e.g., a U.S. subsidiary, a U.S. plant, offices, etc.), or has not agreed by contract to be subject to the jurisdiction of the U.S. courts, the wholesaler-distributor cannot obtain jurisdiction over the foreign supplier in the U.S. courts. The wholesaler-distributor may still claim indemnify from the foreign supplier, but will have to do so in a distant, overseas court system.

Intellectual Property Rights

The seller of a private label product also faces greater exposure to claims that the product infringes upon another’s patent rights, trademarks or other intellectual property rights. As with product liability exposure, when the product is sourced from a foreign supplier beyond the reach of the U.S. courts, the seller may be ultimately responsible for damages caused by an intellectual property rights infringement. In all instances, a wholesaler-distributor should exercise due diligence to assure that its private-labeled products will not infringe U.S. patents or the IP rights of others.

Quality Control

For a private-labeler building brand value, it is critical to select a foreign supplier who will produce defect-free products that meet specifications and applicable U.S. legal and regulatory requirements. Field monitoring of the products produced is necessary to assure continued compliance and to detect product irregularities or unauthorized changes to the product’s design or specifications, or the raw materials used in production. Independent testing in the U.S. of randomly selected product samples should be considered.

Product Recall Responsibility

Federal law grants broad authority to the U.S. Consumer Product Safety Commission (CPSC) to order the recall of a defective consumer product that presents a substantial risk of injury to the public. A consumer product is broadly defined as any product offered for sale to a consumer for use in or around a household, residence, school, in recreation or otherwise. Articles that are primarily intended for use in commercial and industrial settings may nevertheless be considered a consumer product, so many items sold by a wholesaler-distributor can fall within CPSC’s jurisdiction.

The law authorizes the CPSC to order the manufacturer or any wholesaler-distributor or other seller of the product to give public notice of the defect and also give specific notice to every person to whom the product was delivered or sold. In addition to notification, the CPSC may order the manufacturer or any seller of the product to either: (1) repair the defect in the product; (2) replace the product with an equivalent product free of defects; or (3) refund an amount up to the purchase price of the product. Federal law places similar responsibilities on importers of motor vehicle parts and equipment.

In most cases it is the manufacturer that bears the responsibility and expense of a product recall. However, in cases where the manufacturer is thinly capitalized, out of business, in bankruptcy or is located in a foreign country (thus beyond CPSC’s jurisdiction), the US-based wholesaler-distributor may be the party that bears the recall expenses. The financial burden to wholesaler-distributor can be substantial.

The wholesaler-distributor can minimize this liability exposure by exercising due diligence when selecting a supplier, especially a foreign supplier, to assure that the company has insured against this risk, has recognized its recall responsibility in the supply contract, and is able to fulfill its responsibility if required. It is also prudent for the wholesaler-distributor to consider buying product recall insurance coverage as part of the firm’s general liability policy.

Conclusion

The foregoing concerns apply with equal force to a U.S.-based importer of a product, as well as a wholesaler-distributor selling a foreign-made product whether on a private label basis or under the foreign supplier’s brand name. Some precautions to mitigate these risks are discussed below.

Insurance. The wholesaler-distributor should obtain product liability insurance to cover the products it sells. Product recall insurance is also worth considering though coverage can be costly and coverage limits low. With respect to a foreign supplier, it is prudent to deal with a company that has its own adequate product liability insurance coverage that includes claims occurring in the U.S.

The wholesaler-distributor may ask the manufacturer to supply a “certificate of insurance,” which is a document issued by the manufacturer’s insurance company and which describes the extent of coverage and the policy term. A wholesaler-distributor may also ask to be added as an additional insured on the manufacturer’s product liability policy, although this is no substitute for the wholesaler-distributor having its own coverage.

Indemnification. As part of the supply contract with a foreign supplier, include a term whereby the supplier consents to the jurisdiction of the U.S. courts in the event a claim involving one of its products is filed here. The agreement should also contain an indemnity provision whereby the foreign supplier agrees to indemnify the wholesaler-distributor against any loss, damage or injury caused by a defective product.

This will also allow the wholesaler-distributor to bring the foreign supplier into a suit and enforce its indemnity rights. However, contractual indemnity is only as valuable as the manufacturer’s ability to pay, so it is no substitute for assuring that the foreign supplier has its own product liability insurance coverage for the U.S.