Indirect Effects of Product Liability on a Corporation
FREDERICK B. SONTAG
Unison Industries manufactures ignition systems and other electrical components used primarily on aircraft engines, with applications ranging from Piper Cubs to 747s. It sells $50 million worth of products a year and employs 400 people in two manufacturing locations in the United States. Customers include well-known engine manufacturers such as General Electric and Pratt & Whitney, and almost every airline and corporate aircraft operator worldwide.
Despite the range of Unison's customer base, nowhere is the company's product liability exposure greater than in general aviation. Unison's product liability insurance expense for general aviation is eight times greater per dollar of sales than for all other aviation markets the company services. Of the more than 35 major product liability claims against Unison during the last 12 years, all involved general aviation aircraft. The company has yet to sustain a single product liability claim for a commercial airline or military aviation application.
Unison's experience in general aviation provides an insight into how companies change when they try to cope with product liability. The purpose of this paper is to show the indirect effects of the current product liability environment, as experienced by a small company that supplies parts to an industry with high product liability exposure.
During the 1980s, few U.S. industries fared worse than general aviation. Since 1979, light aircraft production rates have dropped more than 90 percent,
and industry employment has fallen more than 50 percent. Many companies that had been active in general aviation have decided not to invest any further in that market. Industry experts blame this situation on product liability.
Piper Aircraft's experience shows how the high costs of product liability can affect a company. In 1978 Piper produced more than 5,000 airplanes and employed 8,000 people in three manufacturing facilities. Since that time, Piper has gone through several changes in ownership and massive downsizing, finally declaring bankruptcy in July 1991. The cost for defending itself against product liability claims had escalated so dramatically that by 1987 Piper was paying a premium of $30 million for an insurance policy with a deductible of $25 million. At that time, Piper had only $75 million in sales, so it was paying almost 50 percent of its revenues for product liability insurance. The expense was too much to bear.
In 1993 Piper was still operating in bankruptcy under Chapter 11, yet despite its financial condition, it had shipped almost 200 airplanes since July 1991. Because of this demand for Piper's products, attempts have been made to rebuild the company by buying it, moving it, selling off portions of its operations, or getting the liability reduced through the judicial process. Product liability has in one way or another stymied every plan, and it is questionable whether Piper will ever be able to get back on track again.
Trying to cut losses by stopping production does not necessarily relieve the burden of product liability either. Cessna Aircraft stopped making piston-engine airplanes in 1986. Yet in 1993 Cessna still paid $20 million a year for product liability expenses and was being actively sued in approximately 200 lawsuits deriving from its pre-1986 production. The commitment of resources to battle this volume of litigation still has a major effect on Cessna's ability to maneuver in the marketplace.
PRODUCT LIABILITY IMPACTS
One way in which the product liability environment can affect a company is in its product strategies. This is especially true in general aviation. Not only have design improvements been slowed, but many companies, manufacturers of components as well as final products, have left the market entirely. In some cases, the void is not being filled, leaving the customer a more restricted choice in products and services.
The growth of the kit plane industry is a specific product strategy that has resulted from product liability. Rather than sell assembled airplanes, some companies are hedging their product liability exposure by selling
only plans or plans along with a parts kit to be assembled. In 1993 more than 2,000 general aviation airplanes were sold in the form of kits, more than double the production of completely assembled planes. Making the end user also the manufacturer of the plane limits product liability claims for most manufacturing and some design defects. Some designers even offer with the kit an elaborate set of instructions for establishing legally separate corporations for manufacturing, owning, and operating the airplane.
Kit planes have pushed general aviation back into becoming a cottage industry again, essentially reversing the last 150 years of progress made in production techniques for this industry. The jobs and cost advantages of manufacturing complete airplanes in a centralized location have been replaced by the efforts of individuals working in their homes. In terms of safety, which plane would you rather fly—one made at Cessna or one built in someone's garage?
Relationships with Other Firms
Product liability has affected the ability of companies to acquire, divest, form joint ventures, or license manufacture. In the disposition or reconfiguration of a company or product line with high product liability, one of the major issues is how to handle that liability. While the risk can be indemnified against, there is always an issue of the nature of the indemnification or the strength of the indemnifying party. Even a sale of assets usually does not dispose of product liability. This sometimes leads to canceled deals, as happened in March 1991 when the French firm Aerospatiale withdrew from its proposed acquisition of Piper Aircraft because of inadequate product liability indemnification.
It can also lead to transactions being structured more around coping with product liability than optimizing the future prospects of a business or product line. In the late 1980s Unison was interested in acquiring a small product line with a large product liability problem. Despite a good fit between the new line and Unison's base business, the risk of combining the new business with the company's existing products proved too great to take on. As a result, a transaction was structured whereby the product line would be run in a separate corporate entity and facility that would indemnify the selling party against product liability. The proposed transaction was far from optimum for long-term economic growth of the purchased product line or stability of employment of its workers. It was, however, the only way to cope with the product liability problem. Eventually, the deal fell apart over the issue of indemnification.
Vendor relationships are also affected. Since every company in the manufacturing chain is at risk for product liability, some vendors elect not to sell to companies making high liability products. Beech Aircraft has reported
that it has had to replace more than 100 vendors who dropped them as a customer, all at a very high resubstantiation cost. Other vendors drop out of production completely and cannot be replaced, which forces manufacturers to integrate vertically, often at greater cost. Some key vendors demand to be added to their customer's product liability insurance policy, again at additional cost to the manufacturer.
Another unusual twist to vendor relationships has taken place in general aviation. Since the original equipment manufacturers (OEMs) of airframes, engines, and certain major components must bear the burden of product liability, they usually sell replacement parts at a price high enough to help defray the product liability cost. Some enterprising vendors to these OEM manufacturers, who do not have the same liability burden, have begun to sell their components directly to the end users at prices below those of the OEM producers, thus undercutting their own customers. Since aviation manufacturers cannot easily switch vendors, some OEMs are forced to handle the problem by placing contractual limitations on vendors, putting themselves potentially at risk of an antitrust claim.
Product liability restricts the financing choices of a company. Most lenders are wary of lending to organizations with substantial product liability risk, even though the company may have adequate insurance. To make matters worse, it has been suggested that lenders be held liable for product liability risks of companies in which they invest, much like certain environmental liabilities. Naturally, this causes serious concerns on the part of lenders who are considering financing companies with a high product liability exposure.
Relationship with Regulators
Product liability affects the relationship of a company with regulatory authorities. In 1992 the Federal Aviation Administration (FAA) began to simplify the process by which aircraft aftermarket part manufacturers can have their products certified for repair and service use. Most OEM system manufacturers believe that this new procedure allows aftermarket manufacturers to build parts to a lower quality standard than that to which the OEM is held. These lower quality parts eventually are incorporated into the OEM system by people performing repair and overhaul. While the new FAA procedure potentially provides more parts availability in the marketplace, it also introduces an increased product liability risk for the OEM system supplier. This has resulted in a noticeable strain in the relationship between OEM producers and the major agency that regulates them.
Internal and External Communications
Product liability has had a tremendous impact on both public and internal communications. Since all statements, whether written or oral, can be construed as warranties, marketing documents have to be scrutinized carefully to make sure the words cannot be misinterpreted to take on a meaning not intended by the manufacturer. Most companies require that each major piece of marketing literature be reviewed by a lawyer, and some companies have every written document intended for the public reviewed by an attorney. Service bulletins and warranty statements sometimes read like legal textbooks. This is both costly to the manufacturer and confusing to the consumer, who is faced with complicated product instructions and a plethora of ominous warnings.
Internal memos and notes are similarly affected. These are usually intended to document meetings and thoughts of employees so that they can be referred to at some future date as a memory refresher. Today, memos and notes need to be drafted carefully, keeping in mind every possible interpretation of their contents. Accountants and engineers have had their words misconstrued and used against them so many times that companies have had to change their document policies. This includes requiring that certain or all documents be reviewed for wording before they are archived, starting courses in memo writing and note taking, establishing elaborate record retention policies that limit what documents are stored and how long they should be kept, and employing special staffs just to enforce these policies. The cost of all this to businesses with high product liability exposure is substantial.
Engineers are some of the most creative people in a company. They need to be open minded and free thinking as they explore the complex technical concepts that eventually lead to the development of new products. However, their ability to design is seriously impaired if they are subject to restrictions in, or unreasonable second guessing of, the way they think and work.
Impacts are first felt in the design stage. Engineers are increasingly being required to "overdesign" products. This entails contemplating every possible alternative design, and carefully documenting why these alternatives were discarded. They must be prepared to explain why a product improvement is not necessarily a correction of a previous design error, become more skilled in the economics of various designs, and envision and design for misuses of products that are far beyond the realm of reasonable use.
What happens to engineers when a product liability suit actually strikes
a company? They become the main targets for plaintiff's attorneys, because a plaintiff's attorney seeking to prove that a product has a flaw in design must locate and document that flaw. Usually that means going directly after the engineers who designed the product. When the lawsuit hits, engineers are overwhelmed with document production requests and interrogatories to answer. Likewise, they are subjected to days, if not weeks, of depositions during which every decision and direction taken in the design of a product is revisited by the plaintiff's attorney looking for an angle on which to build a design defect theory.
These obligations follow an engineer as long as the product he or she designed is in commerce, which could be for decades. In 1992, one of Unison's engineering managers was subpoenaed regarding a product he had worked on 10 years ago. When he arrived at the deposition, the plaintiff's attorney set in front of him a stack of laboratory notebooks, memoranda, and various other written documents generated 10 years ago. Even though this design project was just one of perhaps 50 projects that he worked on during that calendar year, he was subjected to one and a half days of detailed grilling regarding every word of every document associated with that design. And worst of all, the product he was being questioned about was not even one of Unison's. It was a design he had done while working for a previous employer.
No wonder engineers are, in increasing numbers, avoiding companies with high exposure to product liability claims. And how much safer are high liability products when the best engineers refuse to work on them? The net effect of product liability on a company's engineering is a narrower selection of engineers, a higher cost of engineering, a slower product development cycle, and the imposition of bureaucracy in an area where creativity, quick reaction, and bold thinking are the keys for product success.
In companies with high exposure to product liability, manufacturing, too, has been burdened by product liability. Manufacturing processes, particularly changes, must be more carefully documented; more records of manufacturing lot traceability must be kept; and people in production jobs, just like their engineering counterparts, must learn the art of giving depositions. This makes the manufacturing of products more complex and costly.
Product liability has had an effect on personnel policies. People recruited for designing, manufacturing, or marketing high liability products must be screened to a different standard. Companies must also use much
more caution in hiring or firing people. This is particularly true of engineers because of the increasing use of a company's former engineers as expert witnesses against that company. Imagine the impact on a jury when an ex-company engineer testifies against his former employer. Regrettably, too often expert witnesses' former employment matters more than the technical strength of their testimony.
For this reason, some companies have had to create unusually strongly worded employment agreements with engineers. Other companies have had to accept weak performance from engineers they fear would seek work testifying against them. In some cases, engineers have been hired back to companies that terminated them just to prevent them from becoming expert witnesses against their former employer.
The handling of product liability claims and product liability insurance has greatly complicated the operation of many companies. In general aviation, there are approximately five accidents a day. Major manufacturers track every aircraft accident and review it to see if it could generate a product liability claim. Accidents involving serious injury or death are all investigated at the accident site, not only by safety authorities with the FAA or the National Transportation Safety Board, but also by trained accident investigators sent by the major product manufacturers. These activities are coordinated with product liability insurance underwriters. The net result is that massive expense is incurred by manufacturers just in case a product liability claim is filed.
If a product liability lawsuit is actually filed, a company must have its resources properly organized to manage the claim. In many companies, this is done by the corporate legal department, while in others, cases may be coordinated by a risk management department. Unison's experience has shown that while the legal strategy is important to the direction of the suit, the element that can win or lose a claim is the strength of the technical arguments. There have been many cases in which the plaintiff's technical arguments have no merit.
For this reason, defense of a product liability claim at Unison is led by the company's attorney and someone with a strong, broad engineering background. After a thorough review of the facts of the case, potential causes are evaluated. Once the suit is filed, it is possible to learn the plaintiff's theory for the accident, although sometimes this takes a very long time. With the plaintiff's theory on the table, technical information to rebut the theory is gathered. A variety of mechanisms—lab analyses, accident recreations, employment of expert witnesses, and design reviews—are employed, both to refute the allegations and to propose other theories
for the accident. The downside of putting engineers more directly in control of litigation is the tremendous drain on their time and the additional expense it entails. However, using this method, Unison's product liability costs have been held to a fraction of those of other companies with similar products.
As has been described, product liability costs entail more than insurance premiums and litigation defense. Product liability affects a company's product strategy; relationships with other firms; financing; communications policies; engineering, manufacturing, and personnel policies; and organizational structure. All these extra indirect costs have to be paid somehow, usually in the form of product price increases. Moreover, the bureaucratic burden imposed by product liability reduces a company's ability to react in the marketplace. This puts American companies at a competitive disadvantage relative to their foreign counterparts.
Some argue that American law applies equally to foreign companies doing business here as it does to U.S.-based companies. However, this argument falls apart when one considers what has happened in many markets once dominated by Americans. Once again consider general aviation.
Twenty years ago, American companies such as Cessna, Beech, and Piper were preeminent in general aviation. Today those companies have seen their businesses decimated by high product liability costs. Yet despite current market conditions, foreign manufacturers are taking a closer look at the U.S. general aviation market. One reason is that while a foreign plane manufacturer will have the same liability as a U.S. manufacturer for every new plane it sells, foreign manufacturers have little or no existing product base in America. Since product liability costs are proportional to the existing base of product sold, the foreign manufacturer's product liability cost is lower than that of its American competitors. As a result, a foreign manufacturer can sell its new planes cheaper. Even if a lawsuit is brought against a company based in a foreign country, conducting depositions, obtaining documents, and collecting damages is much more difficult than it is for a U.S.-based company.
REFORMS ARE NECESSARY
This situation is not what the crafters of product liability law intended. Product liability law was created to improve product safety and compensate victims of unsafe products. It was not meant to penalize conscientious companies that provide products and services vital to the U.S. economy.
Over the past two decades, product liability law exponents can point to
only a handful of cases in which products were made safer as a result of product liability litigation or the fear of it. With these few safety successes has come a flood of examples of companies and products being damaged by the system. Moreover, only a small portion of the total amount expended in a lawsuit—15 percent according to some sources—is actually getting to the victims of unsafe products. The rest is paid for attorneys and other litigation costs.
Many have come to the conclusion that the system does not work as intended. It is too expensive, too complicated, and it is jeopardizing American competitiveness. As a result, serious efforts have been made to change product liability law. In 1993 these efforts included reforms that would establish a statute of repose for general aviation aircraft. The irony of not having a statute of repose is that it unfairly penalizes the most quality-conscious manufacturers, since their products have a longer life in the market. This proposal, and others like it, contain elements of common sense that seem so absent in the current product liability system.
General aviation is one U.S. industry whose demise can be traced almost solely to the product liability burden it bears. The same insidious effects of product liability are being felt in varying degrees by manufacturers in other industries. Perhaps it is time to ask the question: What U.S. industries are we willing to sacrifice to our product liability system?