Products sold in markets may be recalled due to quality defects, and disputes between manufacturer and seller may arise. By law, seller is allowed to seek certain damages from the manufacturer. But if products that were manufactured in one country but sold in another are recalled due to quality defects, the complexity of transnational disputes may be quite intimidating to a seller attempting to seek damages from an oversea manufacturer.

Manufacturer’s tort liability for “damage other than the defective product itself”

According to Article 41 of China’s Product Quality Law, “Manufacturer shall be held liable for injury to a person or damage other than the defective products itself caused by product defects”. Therefore, in the event of product tort liability caused by product defect, manufacturer is to indemnify “injury to a person or damage other than the defective products to the property caused by product defects”, which in short is “damage other than the defective product itself”, as in contrast to “damage to the defective product itself”.

In accordance with the provisions of Articles 41-43 of the Tort Liability Law and Articles 41-43 of the Product Quality Law, manufacturer shall bear “no-fault” tortious liability, while the seller shall only bear the corresponding tortious liability within the scope of his fault. Where the seller has indemnified the victim when it is the manufacturer that should bear the liability, the seller shall have the right to recover the loss from the manufacturer. In order to ascertain the tortious liability for “damage other than that to the defective product itself” caused by a product defect, the following parameters have to be met: (1) the victim should be a consumer[1]; (2) The tortfeasor should be the manufacturer of the product; (3) the products involved are defective in the sense of Art. 46 of the Product Quality Law; (4) there is damage other than the defective product itself[2]; and (5) there is causality between the defect of the product and damage.

Where the Seller is liable to warranty the quality of the products, according to Art. 40 of the Product Quality Law, the Seller is entitled to recover, from the manufacturer, the loss resulting from and covered by the tortious liability of the manufacturer. Meanwhile, the seller may also claim contractual penalty as agreed in the sales contract or work for hire contract signed with the manufacturer.

Manufacturer’s liability for breach of contract for “damage to the defective product itself”

Seller can seek “damage to the defective product itself” under Contract Law. However, in practice, some foreign corporations use simple purchase orders, emails, or even via telephone calls to establish sales contract or work for hire contract with Chinese vendors. Without a written contract specifying quality requirements of the products and providing liability clauses in the event of breach of contract, if products are recalled overseas due to defects, it would be difficult for foreign corporations/sellers to hold the manufacturer accountable for breach of contract in accordance with the provisions of the Contract Law.

Can seller claim from the manufacturer “damages to the defective product itself” caused by the product recall, based on tort liability or liability for breach of contract?

From the below two cases, it seems that the courts were not entangled with the distinction between the “damage other than the defective product itself” and the “damage to the defective product itself”, but focused more on the “doctrine of recall system” and the “principle of fairness”.

Tort liability of manufacturer

In the case of Guangdong Herbal Medicine Group Co., Ltd. v. Bruschettini S.R.L.[3], the plaintiff Guangdong Herbal, by signing an “Exclusive Distribution Agreement” with an intermediary named Aprontech, became the exclusive importer, promoter, dealer and distributor in mainland China of the “Lantigen B” bacterial antigen product manufactured by Bruschettini, the defendant. The product was later ordered to be recalled due to quality defects and safety hazard by China State Food and Drug Administration (CFDA). Since then, despite the plaintiff informing the defendant of the official recall decision and requesting the defendant to take back the products, the defendant failed to implement any recall plan or measures. The CFDA later issued a “Notice on Mandatory Recall and Rectification” to the defendant, but to no avail. As a result, unsold products and returned products were piled up in the plaintiff's warehouse, and additional costs incurred.

The Supreme People’s Court (SPC) held that though without a sales contract with the defendant, the plaintiff’s request that the defendant shall fulfill the obligation of product recall is well-grounded. The SPC added that the product recall mechanism is designed to protect the legitimate rights and interests of consumers from being impaired by product defects.  The product manufacturer is responsible for the creation of such defects. Therefore, the law obligates the manufacturer to bear the responsibility of product recall. The distributors are only bridge between consumers and manufacturers in the product recall system, and the manufacturer shall be held ultimately responsible for the product recall. The remissness of the defendant in performing its statutory recall obligation is an act of nonfeasance tort, thus the defendant is at fault. The court therefore ruled that the defendant should bear the plaintiff’s losses incurred for warehousing and recalling “Lantigen B” products in the Chinese market and should indemnify the plaintiff's expenses incurred for implementing the recall and for disposal of the inventories.

The SPC made it clear that when it comes to a product that needs to be recalled due to product defects, the manufacturer should ultimately bear the recall responsibility. Therefore, the manufacturer is obligated to repurchase the recalled defective products building up in the seller’s inventory and reimburse the seller other reasonable expenses. If the manufacturer is remiss in fulfilling its recall obligations and causes the seller to bear additional losses, it shall pay the damages according to Art. 46 of the Tort Liability Law.

Contractual breach of manufacturer

In the case of Japon Elektronik Teknoloji Ticaret Limited Sirketi v. Qingdao Hisense Trading Company [4](“Japon”), the plaintiff Japon ordered a batch of telephones from the defendant after verbal communication and meetings at the defendant's premises. In view of the defendant's business scale and reputation, the plaintiff only made verbal agreement with the defendant on the time and settlement method of the advance payment, without signing a written contract. The plaintiff wired a total of US$ 145,000 to the defendant. After receiving the payment, the defendant delivered 900 phones to the plaintiff through a third party. Before shipment, the plaintiff’s product passed the test run by a third-party testing agency based in the United States (Bay Area Compliance Laboratories Corp.). However, the same batch of products entering the Turkish market failed the test there and were ordered by the Turkish telecommunications authority to be recalled, causing economic losses to the plaintiff. In fact, the technical standards advocated by Hisense are not the same as those adopted by Turkish authority.

Qingdao Intermediate Court held that: 1) the fact that no written contract had been signed by the plaintiff and the defendant does not prevent their relationship to be bound by a verbal sales agreement; 2) a contract for the international sale of goods generally includes the technical standards and quality requirements of both the exporting country and the importing country of the product, based on which, the parties may agree on internationally accepted product standards and technical requirements or make special agreements. In absence of specific quality requirements in the contract and internationally acknowledged standards for the litigious products, though the recall decision made by the authorities of the importing countries does not suffice to prove that the litigious products were substandard, both parties are liable for the recall of the products and the damages caused therefrom. The defendant, as the manufacturer of the recalled products attributes objectively to its mandatory recall in Turkey, because the product produced by the defendant objectively caused the fact that the relevant Turkish authorities determined that it had a quality defect and ordered the recall. The court found, however, that the plaintiff failed to pay necessary caution until consumer complaints prompted mandatory recall, precluding the defendant, in its capacity of manufacturer, from being part of risk assessment and other pre-recall procedures. Therefore, the plaintiff was ordered to bear 40% of the damages, and the defendant 60%.

In practice, the seller may argue that the manufacturer breached the obligation of warranty against defects as prescribed in the sales contract or the quality warranty obligation as prescribed in work for hire contract. In case that the liability rests with both parties in the recall of products, the may take into account the fact that 1) the substandard products delivered by the manufacturer lead to the failure of realizing contractual objectives and 2) the work delivered by the contractor is substandard, which constitutes breach of contract in both sales contract and work for hire contract.

Comments:

Recall of defective products may lead to two types of damages, namely “damage other than the defective product itself” and “damage to the defective product itself” and may bring twofold liabilities to manufacturer of the recalled products, i.e., tort liability and liability for breach of contract. The seller of OEM/imported products usually assumes the obligation to recall the products in case of product defects. Though it is possible to recover the losses caused by product recall partially or in entirety from the manufacturer through judicial proceeding, based on either of the liabilities, it is advisable to draw up a written agreement with explicit provisions on product quality requirements and liability clauses in case of breach of contract to manage legal risks. In practice, prior to the execution of a voluntary recall or a government-directed recall, the seller should promptly notify the manufacturer of the recall, urge the manufacturer to cooperate or implement the recall in writing, and retain the evidence in case it needs to seek damages from the manufacturer in the future.

Contributed by: Cindy Shuqi ZHEN, Yuqing ZHUANG