Recalls of Chinese goods and litigation concerning defective products erode importers’ profits, threaten market share and damage established brands. Importers of Chinese goods can mitigate these risks by procuring appropriate insurance and by negotiating favourable insurancerelated terms in their contracts with Chinese suppliers.

Overview of Insurance Products Available to Importers

Most sophisticated importers purchase liability insurance with products coverage. Such policies typically cover claims arising out of productrelated damage to third-party property or injuries to consumers. The policies may also cover the costs of defending a product liability lawsuit. Consequently, product liability coverage is essential front-line protection for any importer of Chinese goods.

In light of recent revelations concerning manufacturing defects and quality control issues in China, importers should re-evaluate their existing product liability coverage to assess its scope, the sufficiency of its limits, the effect of defence costs on limits and who has the right to control the importer’s defence and settlement decisions in litigation. Importers should also assess the financial strength of their product liability underwriters and their claims handling reputation, as well as any endorsements or other policy provisions specific to an importer’s business.

Traditional products liability coverage, however, may not offer complete protection. Such policies do not cover product recall and other costs in addition to, or in the absence of, actual or alleged injury to third parties. Product liability coverage will also not apply to the extent that property damage or bodily injury was caused by the sale of products that the importer had recalled or otherwise knew were defective.

Many importers therefore should consider adding product recall coverage to their insurance portfolios. This coverage applies in the event that a product on the market is likely to cause damage or injury to third parties; no actual or alleged damage or injury is required for the policy to respond. Coverage is triggered when an importer incurs costs proactively to prevent injury or damage. Product recall coverage also typically covers the costs of communicating a recall to consumers, replacing unsaleable inventory, and mitigating damage to the corporate brand through public relations and crisis management initiatives.

Product recall policies also may cover lost profits occasioned by the negative publicity and lost sales that often result from a recall. Product recall coverage, however, often comes at a hefty price. Importers should confer with their insurance brokers to discuss pricing and the effect of the recent Chinese products scandal on the breadth of product recall policies on the market.

Because U.S. and European authorities are investigating the importation of defective drugs, toys, foodstuffs and other products from China, certain importers should also consider a form of political risk insurance known as trade disruption insurance. Trade disruption insurance is designed to cover lost revenues should an overseas supplier fold for political reasons or encounter trade restrictions affecting or eliminating supply. Trade disruption policies often also cover the costs of securing a replacement supplier, including retooling costs.

In addition, an importer’s first-party property coverage may be responsive to, for example, the destruction of inventories of defective goods. Firstparty property policies differ in scope and application, but typically cover an importer’s lost income from a covered loss and expenses incurred to restore damaged or destroyed property. Furthermore, if an importer’s management was aware of product defects but negligently failed to act, directors’ and officers’ coverage could be implicated.

Given the breadth of coverages potentially at play and the prospect of costly product recalls, government investigations and litigation, importers should undertake a comprehensive review of their potentially applicable insurance. The increasing costs of product recalls and defending product litigation in the United States and in the EU jurisdictions that now permit class actions and mass tort proceedings warrant such a review as a preventative measure.

Chinese Suppliers’ Liability Insurance

Although most U.S. and European importers likely have at least some insurance potentially responsive to claims arising out of defective Chinese goods, importers also should evaluate whether their Chinese suppliers maintain liability insurance and, if so, whether it is adequate and accessible from the importer’s perspective. An importer faced with a product liability lawsuit, for example, may be entitled to make a claim against a Chinese manufacturer’s liability insurer if that insurer has conferred additional insured or similar status to the importer, or has included in its policy a provision extending coverage to entities contracting with the named insured. An importer must carefully negotiate these terms and ensure their conscientious implementation by the supplier and its insurers.

Market restrictions and cultural norms also may limit an importer’s ability to secure meaningful rights against its Chinese supplier’s insurers. Chinese manufacturing firms have been slow to embrace the concept of, and the need for, product liability insurance. Moreover, the insurance markets in China only recently opened to foreign underwriters. As a result, if a Chinese firm has any product liability insurance, it is likely underwritten by a Chinese insurer or a Chinese subsidiary of a foreign insurer, making it difficult, if not practically impossible, for an importer to enforce any rights it has against the supplier’s insurer. In addition, liability policies issued by Chinese insurers often exclude the equivalent of “serious mistakes”—an exclusion that the insurer likely will contend applies when injury or damage is caused by a manufacturing defect or a quality control problem. Chinese firms are also unlikely to carry sufficient liability limits to protect an importer faced with litigation in the United States or European markets, where damages and defence costs often far exceed Chinese standards.

Insurance-Related Contractual Solutions

These products- and recall-related risks can be mitigated contractually. When negotiating insurance aspects of contracts with Chinese suppliers, importers should do the following:

  • Require their Chinese suppliers to maintain product liability insurance, at the supplier’s expense, with an underwriter and occurrence and aggregate limits acceptable to the importer. Importers should request certificates of insurance confirming compliance with these terms.
  • Request policy endorsements naming the importer as an additional insured or otherwise conferring it rights under the supplier’s liability policies.
  • Obligate the supplier and its liability insurers to notify the importer in writing if any of the supplier’s pertinent insurance policies are cancelled, not renewed or materially changed.
  • Request access to the supplier’s product liability claims history and losses to evaluate its track record and to assess any erosion of its in-force policies’ aggregate limits.
  • Confirm that the supplier has assets in the importer’s domicile and is subject to suit there. For Chinese suppliers that do not meet these criteria—and most will not—importers should require their suppliers to arbitrate any disputes and to agree to do so in the importer’s domicile or a neutral location. Arbitration awards are more readily enforceable in China than foreign judgments.
  • Specify that the supplier’s liability, including any duty to indemnify the importer, is not limited to the extent of its potentially applicable insurance.

In sum, given the risks now widely associated with defective or contaminated Chinese food, drugs, toys and other consumer goods, importers’ risk managers and legal departments should work internally before a problem arises to ensure that their organisations have appropriate insurance coverage and insurance-related contractual protections in place.