How Placing Increased Duties on U.S. Importers And Providing U.S. Government Assistance Can Stem the Rising Tide of Product Liability Lawsuits Based on China-Made Goods

Just a year away from the Beijing Olympics, China is suffering a major public relations melt-down. For products ranging from poisoned pet food to contaminated children's toys, the "Made in China" label is quickly becoming more a warning of high risk than a mark of low cost. In fact, according to recent Congressional testimony by Nancy Nord, the Acting Chairman of the Consumer Product Safety Commission, China-made products constitute the large majority of imported consumer product recalls.

The market share for imported consumer products of Chinese origin has nearly tripled over the last decade, and growth shows no signs of slowing. As a result, the product liability situation has become critical for retailers, distributors, and their suppliers. Some commentators even have ominously predicted that the number one export from China may become lawsuits.

This column will consider possible remedies for the situation.

Why Are Chinese Imports Disproportionately Unsafe?

Let's begin with the root of the problem: Why are Chinese imports so likely to be unsafe?

A Chinese proverb, "The mountains are high and the Emperor is far away," astutely sums up one contributing factor: the difficulty governmental entities confront when attempting to enforce regulations or provide oversight of industries. Regulators must oversee 23 provinces (including Taiwan), five autonomous regions, four municipalities, and two Special Administrative Regions (Hong Kong, and Macau--now the largest gambling destination on earth). In so doing, they face significant language barriers; the Mandarin of the North is as different from the Cantonese of the South as English is from French.

In many respects, then, it makes no sense to expect that Beijing could simply wave a magic wand--as many recent U.S. delegations to China have seemed to suggest--over the vast expanse of the Chinese manufacturing landscape, and thereby bring the teeming millions into compliance with U.S. safety regulations.

Moreover, even if such heavy-handed regulation were possible, it would wreak havoc with the various and sundry industries and undoubtedly increase cost - yet without providing much assurance of safety.

Finally, heavy regulation, enforcement and oversight are the exact opposite of what has allowed China to become the mammoth manufacturing haven it now is. After all, decentralization, not centralization, is what has brought China out of an agrarian, peasant-based economy and into a capitalist system.

The Role of U.S. Importers: Should They Be Doing More?

The real solution here may lie not with the Chinese government, but with U.S. importers. After all, the vast majority of Chinese-made products that make it into U.S. stores do not come directly from China, but through U.S. importers.

The importers contract with China-based manufacturers on either OEM (Original Equipment Manufacturer) or ODM (Original Design Manufacturer) bases. In other words, China-based manufacturers simply make what their U.S. importers want them to, or are willing to buy from them.

While U.S. importers are not involved in the actual manufacturing of product, they nevertheless have the opportunity to inspect product as it moves through the supply chain, as well as to work directly with their suppliers on design, manufacturing and quality control issues.

Accordingly, any initiative to improve the safety of imported products, to be effective, should focus primarily on the role of U.S. importers.

Importers Have Strong Incentives to Ensure Products Are Safe

When a company sells its product to a retailer, it generally is required to provide proof of product liability insurance and to indemnify the retailer against any and all injuries that may result from the sale of the company's product. It thus assumes the risk if the product proves defective or dangerous.

Meanwhile, none of this risk can typically be passed on by the company to a China-based manufacturer. Typically, such manufacturers lack insurance and are unwilling to enter into an indemnification agreement. Moreover, even if such an agreement existed, enforcing it against a Chinese company would be virtually impossible.

In sum, U.S. importers generally take all the risk and are virtually assured to be the defendant named in any product liability suits involving products or components they distribute. Thus, U.S. importers face strong incentives to ensure their products are safe. One way they can do so is by choosing the right Chinese supplier. As the Internet has grown, it has become easy -- through such portals as Alibaba.com --for even the smallest U.S. importer to find a Chinese supplier, instantly accessible by email.

But with that ease, has come perhaps too much anonymity. Many of the companies listed on such websites are not actual factories, but trading companies. These companies--once the only means through which a U.S. company could gain access to China's manufacturers--merely find the factories (or even other trading companies) from which to provide the required product to their U.S. Customers. Therefore, the separation between the U.S. importer and the actual factory manufacturing a given product often can be several layers deep.

Accordingly, it is important for U.S. importers to verify exactly with whom they are dealing. Laudably, more U.S. companies have set up offices in China in recent years for the express purpose of sourcing and developing close relationships with their overseas vendors.

For smaller companies, however, such operations may not be feasible. In such situations, retaining third-party auditors and investigators based in China is a possible option. Certainly, at least annual trips to China by company representatives to visit the supplier's factories would be the minimum of due diligence requires.

Our Ideal Number One Export to China: A Culture of Compliance

If lawsuits are becoming the major import from China, then compliance and ethics programs should become our major export to China. Championed by several NGOs as well as by the U.S. Sentencing Commission and The Department of Justice, compliance programs essentially are designed to prevent and to detect violations of laws, regulations, and company policies, and -- where violations occur -- to remedy them in a timely, effective manner.

In addition to auditing and monitoring overseas factories, a U.S. importer could reduce liability exposure by assisting a factory in developing and maintaining such a program internally.

And here, perhaps, is where the U.S. Government could be most effective. With literally hundreds of major manufacturing trade shows going on year-round throughout China, the U.S. could direct local consulates to hold seminars or other informational sessions in conjunction with these shows, in order to educate China-based manufacturers on compliance. Such seminars could go a long way in assisting U.S. importers in developing a culture of compliance among their vendors.

The Interagency Working Group on Import Safety

In response to the current outcry over the safety of imported products, the President recently created the cabinet-level Interagency Working Group on Import Safety. The Working Group is tasked with developing recommendations to promote the safety of imported products within 60 days. A tall order for such a large issue, but in light of the above, here are some suggestions for the Working Group:

First, U.S. importers should have as part of their purchasing and sourcing departments written Quality Assurance procedures for products once they reach their U.S. facilities, as well as procedures and processes for qualifying potential vendors.

Second, U.S. importers should be encouraged to verify and monitor their overseas vendors either through representative offices in China of trusted employees, or by retaining independent auditors and investigators with offices in China.

Third, the U.S. government should develop educational programs through local consulates that would coincide with major manufacturing fairs, in order to educate manufacturers on relevant U.S. laws and regulations pertaining to the products they manufacture.

Fourth, the product liability insurance industry should consider offering incentives in the form of premium discounts for U.S. importers that either undertake establishing compliance programs that include auditing and monitoring their foreign suppliers, or otherwise can prove that their suppliers have a robust compliance and ethics program.

Fifth, and finally, the product liability insurance industry should also begin working with its Chinese counterpart to educate and offer product liability insurance for China-based manufacturers.

In sum, while the current economic glory China is experiencing after decades of reform has become tarnished by product liability issues, we cannot look to China alone for solutions. Encouraging U.S. importers to work more closely with their China-based manufacturers to ensure that they better understand our laws and regulations and have the means to comply, will go a long way toward keeping consumers safe and China trade prosperous.