Whose liability is it anyway?

Consumers might be surprised to find that manufacturers in the UK have only been liable for injury and damage caused by faulty products since 1987.

The Consumer Protection Act passed that year imposed a general safety duty upon manufacturers, regardless of any fault on the part of producers during the manufacture. After 1987, therefore, any company that made a defective product was held guilty and had to pay compensation unless it could prove it was innocent.

This principle of liability has since been extended to others in the supply chain, including raw material suppliers, importers and own-name branders. Even retailers or distributors can be held liable if they cannot identify the party that caused the defect.

The Act made product liability insurance essential cover for everyone in the supply chain. However, unsafe products still found their way onto the market and, in many cases, manufacturers could not be traced and products contained no identifying manufacturers' marks.

The EU, therefore, decided to improve the safety of products during manufacture and make all parties in the supply chain liable for safety. It decided to unite the existing sector-specific European safety legislation for products such as drugs, toys and electrical equipment, and ensure that all other EU products came under similar legislation. These decisions culminated in the first General Product Safety Directive 1992, enacted as the General Product Safety Regulations 1994.

This regulation provided a definition of a safe product and stated that all products sold or supplied free of charge to consumers must achieve that standard. It also provided a framework for assessing safety, including monitoring and feedback duties on producers and distributors.

Product elements

The definition of a safe product was rather convoluted, referring to: "any product which under ... foreseeable conditions of use ... presents no risk ... minimum risk compatible with the product's use ... consistent with a high level of protection for consumers." In practice, this meant every element of the product - its design, characteristics, packaging and labelling, instructions for usage and disposal - had to be assessed for safety aspects.

This duty was no longer confined to the original manufacturer but to all suppliers in the business supply chain, whether upstream to importers or retailers or downstream to designers or component makers. All parties now had a duty to provide consumers with relevant information and warnings about the safety of products for their reasonably foreseeable period of use.

However, the regulations were confined to new and second-hand goods, supplied commercially to consumers for private use. Professional or business equipment, items used in the workplace or goods sold privately were excluded as were products supplied as part of a service, such as gym equipment.

Other problems also became obvious, such as wide variations in enforcement between the EU member states and a lack of product recall measures to deal with faulty goods.

The EU Commission has, therefore, decided that the original directive needs to be reinforced, clarified and improved. It has rolled up these changes into a new directive, known as the General Product Safety Directive 2001/95, which will come into force from 15 January 2004.

Firstly, the definition of a safe product has been revised to: "Any product which, under normal or reasonably foreseeable conditions of use including duration and, where applicable, putting into service, installation and maintenance requirements, does not present any such risk or only the minimum risks."

Dangerous goods

It also proposes that the term 'products' be expanded to include those supplied as part of a service, such as health treatments, the provision of gas and electricity and in hotels and restaurants. Professional or commercial products likely to be used by consumers will also be covered, even if they were not originally intended for consumers. Furthermore, in an effort to avoid dangerous goods being dumped outside the UK, the regulation rules that any goods deemed dangerous cannot be exported outside the EU.

The most fundamental change is in product recall, however. The regulators can now order a product recall both from suppliers in the chain and end consumers if products have been found to be unsafe. This should stimulate a much greater need for product recall insurance, currently a relatively small market with few players.

Product liability insurers are ideally placed to develop this area, despite the perceived opposition between product liability and recall - recalls promote more awareness, which can lead to further liability claims. A combined recall and liability product could put the emphasis on risk management, preventing unsafe products being manufactured in the first place. This would ideally mean manufacturers avoid both recall and liability issues.

Product recall is likely to be most problematic in countries such as Poland and Hungary, due to join the EU by mid-2004. These territories have previously been reticent in taking action on safety grounds and could face an uphill struggle to meet the standards by 2005.

Raising the general standard of manufacture in the EU should mean there are fewer consumer injuries, less third party damage and reduced financial loss between manufactures, suppliers and retailers. However, financial loss claims will probably increase due to the wider recall requirements.

It is hoped that companies will find it easier to recover their losses against the party ultimately responsible for the defects.

The reporting and notification obligations in the directive are based upon the US model, as they require a report to be made to the regulatory authorities as soon as the product has been ruled unsafe. Information made available to the authorities relating to consumer health and safety will also be made available to the public, with some exceptions for confidentiality.

EU directive

Clearly, such powers are only important if they can be implemented and executed. To this end, the EU directive envisages the increased use of the RAPEX system in the EU. This involves national authorities reporting products of serious risk to the commission, which in turn notifies the enforcement agencies in the network. To date, it has not been used extensively (184 notifications in four years) but it is apparent that, considering the systems on which it is based, the Directive is moving the EU towards a closely linked, centrally controlled product safety authority.

The Consumer Product Safety Commission is the US agency responsible for regulating more than 15,000 consumer products. In 2002, it initiated and obtained more than 950 voluntary actions or corrective actions, involving 55 million product units. Various other US agencies have stiff reporting requirements, not least the Food and Drug Administration, which frequently demands seven-figure fines for breaches of reporting rules.

Australia has onerous reporting requirements, mandatory recall powers and one of the highest incidences of recall in the world. In Australia, recalls can be enforced where the product will, or may, cause injury and can carry penalties of up to A$1.1m (£439,000).

UK risk managers currently face a £5000 fine and/or three months' imprisonment if they fall foul of product safety liability laws and this is likely to be considerably increased when the Directive is enacted. They will, therefore, have personal as well as business reasons for reviewing contracts and standard operating procedures with suppliers. They will also have to establish recall and safety warning procedures, perhaps accompanied by simulated training and testing.

Brokers should bear in mind that product recall cover will now become essential cover for commercial clients and should encourage clients to respond to the directive early. Up-to-date advice combined with extensive knowledge of the client's business will allow potential risks to be identified and cover arranged prior to 15 January.

Part of a service

The main risks will centre round products supplied as part of a service, products intended for use by professionals and goods manufactured in former Eastern-bloc countries. Brokers should continuously assess the levels of cover, however, as the cost of recall may increase as information is shared across other regulatory territories worldwide. Companies might also like to consider taking out cover against brand loss of profit.

Brokers must actively encourage underwriters to enter this market, which is currently woefully short of players. They can do this through presenting client risk management plans that are progressive, compliant and simulation tested.

Poorer clients that pay little attention to manufacturing standards will suffer the greatest interest from regulators and be more susceptible to enforced recall. Unprepared for the task, they will incur the highest costs and claims and, being inadequately insured, will probably go into liquidation. All in all, the new directive is big news for any EU manufacturer.

RISK MANAGEMENT ACTION PLAN

- Prepare document retention policies to ensure compliance with legal, regulatory and commercial requirements

- Review supply and distribution contracts with particular emphasis on indemnity and insurance provisions

- Obtain on-going legal advice on regulations and legislation, including in relation to other sector-specific European safety legislation

- Ensure that recall and crisis plans are robust, up to date and fully address national and cross-border regulatory issues

- Review insurance coverage for recall, liability and brand protection

BROKER ACTION PLAN

- Examine the activities, advise on directive requirements and secure placement of recall cover for businesses that:

- supply or allow use of products as part of a service rendered;

- loan work tools or professional equipment - migrating services;

- sell second-hand goods;

- issue sub-standard or seconds goods outside the EU;

- manufacture in accession countries

- Reassess levels of cover for enhanced costs of recall procedures

- Develop combined product recall and liability policies

- Promote risk management that eliminates unsafe products being placed on the market

KEY POINTS FOR THE FUTURE OF LIABILITY

- The requirement that all consumer products placed on the market must be safe will be based on a new European standard

- Provisions apply to products covered under specific sectoral directives where they are silent on safety provisions specified in the new directive, for example, notification and recall obligations

- Products now include those supplied in the context of providing a service, for example, hotel and restaurant services, health treatments, the provision of gas and electricity

- Inclusion of professional or commercial products used by consumers or likely to be used by consumers under reasonably foreseeable conditions, even if not intended for them - migrating products

- Safety will be assessed to include usage, putting into service, installation and maintenance requirements

- A duty on producers and distributors to notify authorities if they know or ought to know of a dangerous product in the stream of commerce

- RAPEX will now be used to notify all serious risks, to gain early warning of all voluntary measures

- Producers now have to be in a position to recall products from consumers, not just from the distribution chain

- Distributors will have a duty to keep and provide traceability documentation

- If unsafe, regulators can order products to be recalled or removed from the distribution chain and from end consumers.