Understand the Dramatic Impact of Strict Liability on Your Business

We’re now ready to look at the tort theories of product liabilities, starting first to a strict liability, and then negligence. Remember from our diagram, that we have the three theories of product liability. One of which is a contract theory, and two of which are tort theories. In an earlier module, we mentioned that strict liability is usually applied when somebody is involved in an abnormally dangerous activity. However, in recent years, judges have applied the concept of strict liability to manufacturers and sellers of products. This is the rule of Strict Liability that judges have developed, and as you can see this rule sounds pretty reasonable.

When you start reading it it says, somebody who sells a product in a defective condition, unreasonably dangerous to the user or consumer or to his property, is liable for physical harm caused to the ultimate user or consumer. Now, if you stop right there, that sounds like a very reasonable rule. But, then you get down to part 2A where it says that this liability applies even when the seller has exercised all possible care in preparing and selling the product. In other words, it doesn’t make any difference whether or not you have intentionally injured the consumer. It doesn’t make any difference whether or not you’re negligent or careless.

You are strictly liable when you sell a product in a defective condition that injures the user or consumer. This rule has had a global impact, it was originally developed by judges in California, it then spread across the United States, then spread across Europe, and finally it is spread across Asia. I remember several years ago when I made my very first trip to Japan, I was invited by a group called the Keidanren, which is the Japanese Federation of Businesses, and Japan had just adopted this rule. And, they wanted me to give some lectures on what the rule meant, and how it would impact business in Japan.

This is a statement on adoption of the rule in Korea from the Korea Herald newspaper. With the reality of globalization, no one is immune from the US legal system. Happily, Korea has not developed a compensation culture like the one that causes so much grief for business in the United States. But the fact remains, in a globalized world, companies do not operate in a vacuum. Koreans are beginning to see the impact of their Product Liability Act that came into effect in 2002. It introduced strict liability for manufacturers. So, we have a global impact of the rule. Let’s take another look at this rule, and let me ask you this question.

Let’s say that I hold a garage sale, and you visit the sale, and you purchase a product, let’s say a lawnmower,

and, the lawnmower is defective, and it injures you. So, you sue me, on the basis of this Strict Liability rule. Will you win or lose? Please press pause, look closely at the rule and let me know win or lose. The answer is that you will lose because of part 1A of the rule. This rule applies if the seller is engaged in the business of selling such a product. Now, why would the courts limit liability to businesses? Why shouldn’t it apply to me, selling my lawnmower to you in a garage sale? Think about this for a second, hit pause, and write down your answer. What policy do you think underlies this rule of strict liability?

The answer is that judges, courts limit the rule to business because they view a business as an entity that can spread the risk of loss from one person, the injured party, to a wide group of consumers. This is the way a prominent law professor put it once. Those who are merchants, and especially those in the manufacturing, have the capacity to distribute the losses of the few among the many who purchase the products. It’s not a deep pocket theory. The assumption is that the manufacturer can shift the costs of the accidents to purchasers for use by charging higher prices for the cost of the products.

So, in effect what the lawyers are assuming is the company is not going to bare the loss, the individual who is injured is not going to bare the loss, we’re all going to share in the loss by paying a little bit more for our products. This theory was illustrated by an old ad for insurance, and the ad pictured a courtroom scene. You can tell who the plaintiff is in this case because he’s wearing a cast on his left leg, even though it’s probably been five or six years since the accident. Smiling and shaking hands with his lawyer as the jury foreman reads the verdict in the background, and all the members of the jury are smiling at the plaintiff.

Even the court stenographer is smiling at the plaintiff. The caption for this ad summarizes product liability in a nutshell. The caption reads, the jury smiled when they made the award. They didn’t know it was coming out of their own pockets, but that’s, in a nutshell, the theory of product liability. When somebody is injured we all chip in a little bit to cover the loss. This was illustrated very dramatically a few years ago in a case involving a high school football player. He was playing football, wearing a helmet manufactured by Riddell, and his spinal cord was severed. He brought suit against the manufacturer Riddell, a product liability claim. Now, let me ask you this question.

In a case like this, who, and he recovered $5.3 million, in a case like this, who writes the check for $5.3 million? Hit pause, and write down your answer.

The answer is the insurance company writes the check typically. So in this case, the insurance company wrote the check for 5.3, to the high school football player. Then what does the insurance company do? They call Riddell, and they say, Redell, you’ve been paying us $40,000 a year for your product liability insurance. We’re going to have to bump that up a little bit, to $1.5 million, which is about 10% of Redell’s sales. Who else does the insurance company call? They call the other manufacturers of football helmets. Their hit with these increases in premiums. So, what do you do if you’re Riddell? Well, you increase the price of your football helmets, in this case by about 25%.

So, football teams now have to pay more for their equipment. What do they do? They increase their ticket prices, they increase their advertising prices. So, everybody chips in a few cents toward this award of $5.3 million. Now, that’s the way product liability works in theory, in the theory established by judges, but what happens in practice? Well, in practice companies, manufacturers, retailers, etc don’t always have the ability to increase their prices in a manner that will cover their product liability costs. And, so for instance, in the football manufacturing arena most football manufacturers had to go out of business. They could not afford the cost of product liability.

What else happens is that those companies that remain in business then pass on their cost to you and I as consumers. I had a friend who years ago wanted to buy a football helmet for his son. His son was playing junior high football. And, so he walked into a sporting goods store and noticed a sticker on the helmets that he was looking at and the sticker said that the helmet cost $75 and $25 of that went to cover product liability cost. In other words there was a $25 tax on a $75 helmet.

This is the way that Forbes Magazine put it a few years ago. There’s a hidden tax levied on virtually everything we buy, sell, and use. This tax costs companies, individuals, and local governments at least $80 billion a year, and some estimate as much as $300 billion. What is this tax? It is called tort liability. So, that is a strict liability and in our next segment, we’re going to look at our last theory of liability, which is the tort of negligence as it applies in product liability cases.