Importers should assess their insurance programs and negotiate insurance-related provisions in their contracts with Chinese suppliers.

Recalls of Chinese-made products have proliferated this year, eroding importers’ profits, threatening their market share and damaging brands. Mattel, for example, recently announced that its recalls of popular children’s toys and a ban on its imports into Brazil may affect its holiday sales. Other recently recalled Chinese products include 24 toys, defective tires, toothpaste containing poisonous diethylene glycol, contaminated pet food, AC adapters posing a burn hazard and electric scooters with defective handle bars. In the United States, the plaintiffs’ bar has begun to capitalize on this “made in China” scandal and the attendant publicity by suing importers. U.S. Congress and several federal agencies have begun investigations.

Faced with these risks and potential liability, importers of Chinese goods should proactively assess the scope of their insurance programs and carefully negotiate insurance-related provisions in their contracts with Chinese suppliers. This article identifies insurance issues that importers should consider and steps that they can take to protect themselves in the current business and legal climate.

Overview of Insurance Products Available to Importers

Most importers purchase liability insurance with products coverage. Such policies typically cover claims arising out of product-related damage to third-party property or injuries to consumers and 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 defense costs on limits, and who has the right to control the importer’s defense and settlement decisions in litigation. Importers also should assess the financial strength of their product liability underwriter and its claims handling reputation, as well as any endorsements or other policy provisions specific to the importer’s business.

But liability policies with products coverage do 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 also will not apply to the extent that property damage or bodily injury was caused by sales 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. Unlike product liability coverage, product recall policies apply 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. Thus, product recall coverage is triggered where an importer incurs costs proactively to prevent injury or damage. It also typically covers the costs of communicating a recall to consumers, of replacing unsaleable products and of mitigating damage to the corporate brand through public relations and crisis management initiatives. These costs can be devastating. The unfortunate case of Foreign Tire Sales is a case in point. FTS, a family-owned tire import business, was forced to recall 450,000 defective Chinese-made tires at a projected cost of $90 million. In addition, product recall policies 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 Chinese products scandal on the breadth of product recall policies currently on the market.

Because the U.S. Congress and several U.S. government agencies are investigating the importation of defective drugs, toys, foodstuffs and other products from China, certain importers also should 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 this era of just-in-time manufacturing processes, trade disruptions can have significant consequences.

Chinese Suppliers’ Liability Insurance

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 in the United States, for example, may be entitled to make a claim against a Chinese manufacturer’s liability insurer if that insurer has conferred additional insured status to the importer or has included in its policy a provision extending coverage to entities contracting with the named insured. Although such rights can offer an importer protection in addition to its own insurance, an importer must carefully negotiate these terms and ensure their conscientious implementation by the supplier and its affected insurers.

Market restrictions and cultural norms 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 to the extent that injury or damage is caused by a manufacturing defect or quality control problem. Chinese firms also likely carry insufficient liability limits to protect an importer faced with litigation in the United States or other western markets.

Contractual Solutions

These recall-related risks can be mitigated contractually. When negotiating 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 confer it rights under the supplier’s liability polices
  • Obligate the supplier and its liability insurers to notify the importer in writing if any of the supplier’s pertinent insurance contracts 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 or in a neutral domicile. Arbitration awards are more readily enforceable in China than are 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

These terms are a starting point for insurance-related negotiations with Chinese suppliers. They are subject to pricing and other business considerations, of course, and should be tailored to the contracting parties’ circumstances.