Forewarned is forearmed – Dealing with product liability and the increased risks arising from the new EU Product Liability Directive

Product liability poses a significant risk for companies, even today. The new EU Product Liability Directive – currently still a draft - will increase this risk. This article will help you identify the risks and look at what you can do to safeguard against liability.

The central tenet of the Product Liability Act (Produkthaftungsgesetz, ProdHaftG) is found in § 1 (1). According to this provision, manufacturers must provide compensation for a defective product when that product causes the death of or injury to a person or damage to private property. This strict liability rule does not differentiate based on whether or not the manufacturer was responsible for the defect. The possibilities to reduce this liability are few. Manufacturers can only release themselves from this strict liability when one of the circumstances established in the law for the exclusion of liability applies.

Strict liability means product liability is a significant risk for companies. On 28 September 2022, the European Commission released a draft for a new EU product liability directive, which could significantly increase this risk for companies. The new EU directive reflects the increasing number of digital products on the market. Accordingly, the scope is expanded in several ways. For example, the directive clarifies that software is a “product” under European product liability law. Until now, this has been subject to dispute. The scope of liability for personal use has also been expanded. In the future, companies will face product liability risks where they would not have previously. The elimination of both the limits of liability and the excess increases this risk.

You must identify imminent risks and take action to safeguard against them in the best way possible. Any safeguard should have multiple levels: when drafting contracts, you should include appropriate specifications and rights of control, and allocate liability. Careful design and documented production and quality controls are essential. Above all, companies should ensure they are adequately insured and regularly review their insurance coverage, making adjustments where necessary.

Who is the producer under the Product Safety Act?

To assess the risks, it is important to identify the producer under the Product Safety Act. The term “producer” is defined more widely in the Act than one would assume from the way the term is used in everyday language. The manufacturer of the product, but also the manufacturer of any component part built into the product are both considered producers under the Act. In the future, under product safety law, a company will even be liable as a producer if they make “substantial modifications” to a product.

European importers will also be liable as if they were a producer, even if they only put their logo or brand on the imported product (so-called quasi-manufacturer). In this respect, quasi-manufacturers need to consider whether they should put their trademark or brand on a third-party product.

Manufacturers, importers, and quasi-manufacturers should ensure that, where they acquire (part)products from a supplier, their contracts contain appropriate limitations of liability and quality assurance obligations. Where the parties agree to an assumption of costs in the case of liability, the supplier should also be required to provide proof of appropriate insurance.

If numerous parties are liable to pay compensation for the same damage, e.g., manufacturer and importer, they shall have joint and several liability. The injured party can choose to seek damages from the party they prefer and will generally choose the party best placed economically. The party from which the injured party seeks damages can, in turn, demand compensation from the other responsible party(ies). In the case of international supply chains, importers can have difficulty enforcing claims against foreign manufacturers.

A distributor can even be held liable if the manufacturer can’t be identified, or the distributor fails to provide the name of the manufacturer or the manufacturer’s supplier within one month of an incident. In order to be able to provide this information in an emergency, a distributor should maintain a list of the relevant information about the manufacturer or importer. Above all, they should not distribute any products without knowing the identity of the manufacturer.

In the future, in addition to the manufacturer, quasi-manufacturer and importer, the manufacturer’s authorised representative and fulfilment service providers within the meaning of product safety law will be liable for defective products in the same manner as the manufacturer. This means economic actors, which were previously not confronted with such direct or indirect liability, must now also prepare for significant product liability risks. It remains to be seen whether the authorised representative model established under product liability law has a future in its current form if the new rules are adopted.

Definition of product

A product is a moveable that is placed on the market. Medicines expressly fall outside the scope of the directive. If moveables, such as construction materials, are integrated into a building, they will continue to be a product under the directive.

Increasing digitalisation has also impacted product liability law. In the future, European product liability law will not only apply to moveables but will also expressly apply to digital manufacturing files and software. The term software includes artificial intelligence (AI) systems. This change significantly increases the scope of product liability law.

When is a product “defective”?

A product is defective within the meaning of the Product Liability Act when it doesn’t provide the safety an average customer would expect, justifiably considering all circumstances. This will not change in the future, although new aspects, such as cybersecurity, will be added. In contrast to the definition of “defective” under commercial warranty law, the safety aspect is the sole element for a product to be “defective” under product liability law.

The proper legal safety standard for a product depends on the seriousness of the risk, i.e., the likelihood that damage will occur, as well as the expected extent of damage, the status of the legal asset concerned, and the intensity of the damage.

If the product is designed to be used by different groups of users, the safety standard must be based on the weakest user group. The price of the product can also influence safety expectations. However, even cheap products must comply with basic safety.

The product must be safe to use in any manner that can be reasonably expected: this includes the proper use, as well as any predictable or usual incorrect use. For example, children will put toys in their mouths. When conducting product monitoring, manufacturers should therefore watch for any incorrect use of their product. Normally, the manufacturer will not be liable for improper use, where that use is considered reckless in the circumstances.

Whether a product is defective under the Product Liability Act must be assessed on a case-by-case basis and will often only become clear after an expert has prepared a report for the insurer or as part of legal proceedings. In many cases, this will involve independent proceedings for the taking of evidence.

Generally, a distinction is made between the following three categories of defects:

• Production defect:
  The product differs from the standard specifications for the product series. The manufacturer will almost always be liable for production defects. They will even be liable for “outliers” which are very unlikely to occur due to elaborate quality control measures. In any case, full control of all products supplied, with careful documentation, can be enough in some cases to prove there was no production defect when the product was placed on the market.
• Construction defect:
  In the case of a construction defect, the question is whether, when the product was placed on the market, an alternative construction would have prevented the damage from occurring. From a construction perspective, therefore, the generally accepted rules of technology should be determined, observed, and documented. Where necessary, any construction changes in later series should also be assessed to limit the identified product risk or implement new technology standards. Generally, a cost/use analysis can be conducted as part of this assessment.
• Instruction defect:
  An instruction defect occurs when the consumer is not or not sufficiently informed about the method of use and related dangers. This requires an analysis of the potential hazards of a product. The manufacturer should therefore provide clear and appropriate instructions for use. In some cases, it may be necessary to place warnings (pictograms) on the product. Product packaging should also be carefully planned as the manufacturer can be liable for any misuse of the packaging. The same applies to advertisements about the product.

Where serious risks are later discovered, manufacturers must subsequently warn users about the product risks in an appropriate manner.

In any case, manufacturers are generally not required to provide warnings when the product is clearly or generally known to be dangerous, such as alcohol, tobacco, and sweets (for the risk of diabetes), unless specific laws require such warnings. The tendency in the US legal system to provide warnings for everything has so far had little influence on the European liability system.

Time of assessment

At present, the decisive point in time for the evaluation of whether the safety expectations were fulfilled is when the product was placed on the market. A product placed on the market without defects will not subsequently be defective. However, new safety standards can establish additional information and recall obligations.

In the future, placing on the market will not be the only decisive time. The manufacturer will also be liable when they can control the product after it has been placed on the market (e.g., through software updates).

Easing the burden of proof for injured parties

Generally, injured parties must prove the defect, the damage, and the causal link. They will benefit from an easing of the burden of proof: for example, prima facie evidence of the typical course of events, including life experience, will be deemed to be true. In the future, the burden of proof for injured parties will be further eased. The necessary causal link between the product defect and the damage will be assumed in favour of the injured party where the damage arose because of an “obvious malfunction of the product under normal conditions of use.” In addition, companies will be forced to provide the injured party with copies of any evidence (e.g., construction documents, documented findings from product monitoring) the company has in their possession which the other party needs to establish their claim. If the manufacturer fails to (completely) comply with this requirement, they could lose a lawsuit because the defective nature of the product will then be assumed under statute. A “disclosure of documents” inspired by the Anglo-American model, would be an innovation for German civil procedure law.

Exculpatory evidence

• The manufacturer must prove all circumstances that could exclude their liability. The Product Liability Act provides various scenarios in which a manufacturer would not be liable, despite the defect, if they can prove the relevant facts: the manufacturer did not manufacture or distribute the product for sale to make money or within the framework of professional activity.
• The manufacturer, importer or quasi-manufacturer did not willingly put the product into circulation; instead, an unauthorised third party did so.
• The product is only defective because of an unforeseen change to the established state-of-the-art technology after the product was placed on the market.
• The defect was not yet recognisable, despite the state-of-the-art science and technology when the product was put in circulation.
• The product is only defective because it was produced in accordance with mandatory legal requirements.
• If a supplier supplied a defective component and the defect only occurred during the production of the end product, the supplier of the component part shall not be liable for the damage.

These already very narrow exclusions of liability will be even narrower in the future. For example, the fact a defect is not recognisable when the product is placed in circulation will no longer exclude manufacturer liability if a software or security update could have remedied the defect. The tech industry will not be the only industry that will have to consider whether it can afford to cease security updates for older products after just a few years.

Extent of liability and insurance

The damages companies must pay in product liability cases can quickly run to several tens of millions of euros. If a product causes injury to numerous individuals, the maximum total amount of damages is EUR 85 million. There is no maximum limit for property damage, but the injured party must pay up to EUR 500 in excess. Under the new EU directive, national legislators may no longer establish maximum limits for damages or self-participation for injured parties.

The obligation to indemnify cannot be contractually excluded or limited in advance. A waiver or limitation of the obligation to indemnify can only be agreed upon with the injured party after the damage has occurred.

Claims under the Product Liability Act become time-barred three years after the injured party should have become aware of the damage, the defect in the product, and the identity of the party liable to pay damages. The claim expires ten years after the product which caused the damage was put into circulation unless measures that stop the limitation period were introduced.

Overall, despite all precautions, there is still a high long-term risk of claims under product liability law, especially for dangerous products. Such claims can even threaten the continued existence of the company. This risk will be even greater in the future. It is therefore vital your contracts shield you as much as possible from these risks. In addition, you must closely monitor both production and the products sold and carefully document all control measures. Even with the best preventative measures in place, it is not always possible to avoid product liability. Sufficient insurance against this risk is, therefore, essential. Every company that could be liable should therefore regularly assess whether the insured sum and the subject of its product or business liability insurance correspond to the existing product liability risks. As soon as you become aware of a possible liability case, you should inform the insurer or the insurance agent and agree on the next steps. It also makes sense to obtain legal advice at this early stage – insurers will often bear these costs with their approval - as this prevents mistakes which are difficult to rectify or cannot be rectified later.

Dr André Depping
Katharina Pöhls