March 21, 2006

Warranty Legal Solutions:

So often warranty cost reduction efforts are focused on either the product or the process. But what about the warranty itself? At the WCM Conference, an attorney explained how the right choice of words can limit liability and reduce warranty cost.

Class action lawsuits regarding product defects and the resulting warranty claims are becoming increasingly common. iPod lawsuits seem to sprout like daffodils with each new season. Recalls and product liability litigation are routine in the automotive industry. After all, the genesis of the TREAD Act and all the early warning efforts that followed was basically a series of lawsuits filed by the injured and the families of those killed by allegedly defective tires and SUVs.

Analyses of warranty laws typically look at the rights of consumers and the remedies available to them. However, at the recent Warranty Chain Management Conference, Jonathan Friedman, an attorney with the firm of McKenna Long & Aldridge LLP, closed out day one of the show with an eye-opening presentation on warranty cost reduction. The Atlanta-based lawyer noted that some manufacturers are now trying to cut their warranty costs by reducing the duration of their warranties. He suggests another approach: smarter warranties.

Defense Attorney

Friedman is a defense attorney, with a somewhat noticeable disdain for lawyers who bring those individual and class action lawsuits against manufacturers. In fact, his practice is focused on tort litigation and product liability defense for manufacturers, retailers and distributors.

He said that while reducing the duration of warranties may be the most obvious way to cut costs, the most effective way may be to rewrite warranty policies to eliminate ambiguities and to impose conditions and requirements upon the customer.

"My talk is from 40,000 feet," he said by way of introduction. "It's less about mind-numbing law than it is about common sense suggestions. And the focus is really this: Often overlooked in the warranty cost reduction calculus is the warranty itself."

Friedman said that even though most manufacturers employ legal teams for numerous purposes in numerous departments, they're rarely involved with warranty. "I'm willing to bet that many of those lawyers and many of their companies have not taken to revising their warranties in the last five years," he said.

"By rewriting your warranty to take advantage of recent legal trends -- by drafting a smarter warranty -- you can reduce costs and limit liability," he said. Most of his suggestions had nothing to do with the product. Instead, they concerned improvements in the quality of the language in the warranty's terms and conditions. By being precise and clear about the who, what, when, and where of the warranty, he said a manufacturer can avoid misunderstandings that can lead to lawsuits.

High Legal Costs Already

Friedman said the American legal system is by far "the most expensive and the most contentious in the world." While countries such as Spain, Germany, Belgium, and Italy spend 1.25% to 1.5% of their gross domestic products on tort costs, he said, the U.S. is the only country spending upwards of 2% of GDP on tort costs.

This in turn raises warranty costs and reduces profitability, as companies defend themselves against lawsuits for denied claims and/or product liability issues. This trend is especially relevant to the passenger car industry, and seems to now be spreading to some sectors of the computer and personal electronics industries.

"Critically, there has been an explosion in warranty litigation in the last five years," Friedman said. "In Atlanta alone, as an example, in 2000 we had less than 50 warranty lawsuits filed in the courts. Today there are literally thousands of them."

Friedman said one reason for the increase is the rise of what he called "warranty mills," comprised of specialized claims lawyers who do little besides sue manufacturers, dealers, and retailers over warranty issues. "These warranty mills prey on disgruntled customers," he said, "and benefit from federal fee-shifting provisions," which can force a case-losing defendant to pay the plaintiff's attorney fees. In some ways, they're the manufacturing equivalent of the "ambulance chasers" who look for clients who've been injured.

"These warranty mills can turn a claim involving a $15,000 car into a lawsuit with an estimated value between $70,000 and $100,000, if not more," Friedman said. Warranty cases are very easy to get to a jury, he said. "They're very fact-dependent. The proof requirements are very lean. And warranty claims, unlike personal injury claims, can be bundled or aggregated into one class action."

Encouraging Frivolous Lawsuits?

Another reason for the increasing cost is a direct result of the rise of the warranty mills, Friedman said. After a while, manufacturers who have defended themselves numerous times -- successfully or not -- begin to total up the added costs. And they begin to think that even if they would prevail in court, maybe it might be cheaper to settle out of court before there's a trial. As the warranty mills see this happening, they bring less and less deserving cases against the manufacturer -- some of them downright frivolous.

"The cases are not filed because of their merits," he said. "They're filed because they are a nuisance. And the attorneys hope the manufacturer will settle the case, rather than fight and spend its good money."

One recent case he cited, which he defended, featured a car owner who had burned through three high-performance clutches and a transmission, who was suing the manufacturer for selling him an allegedly defective transmission. But then ten days before the trial, Friedman's law firm finally secured a photo of the vehicle, whose striking red and black paint job combined with flames painted onto the doors and rear quarter panels virtually screamed out "street racing." The case was dismissed, but it still cost the manufacturer $8,000.

Another recent class action case brought against a cereal manufacturer over allegedly unsafe food additives was settled out of court. Plaintiffs' lawyers received $2 million in fees, and plaintiffs each received a free box of cereal. The food additive is still in use.

"The reality is the stakes are very high," Friedman said. "If your industry is targeted or your company is sued in a class action, your legal costs will soar."

Warranty Laws

For American manufacturers, Friedman said, warranty laws come at three levels: international, federal, and state. Those who export to Europe need to be aware of the rules set out in the European Union's Directive 1999/44/EC. Those who sell only within the U.S. need to be aware of the rules set out in the Federal Trade Commission Act, the Magnuson-Moss Warranty Act, and in some cases industry-specific laws such as those covering home construction and air conditioning. Then there are a myriad of state laws, including automotive lemon laws and the Uniform Commercial Code.

Most times manufacturers see these laws as imposing rules and restrictions on them, but Friedman said they also can be used to impose rules and restrictions on their customers.

One big question is whether the item in question is a consumer product or not. Friedman said warranties for consumer products are more tightly regulated than warranties for commercial products. For instance, the terms of the Magnuson-Moss Warranty Act as well as the EU directive apply only to products that are normally used for personal, family, or household purposes.

However, it's not always obvious whether a product is commercial or consumer. Friedman cited conflicting U.S. court cases that found that a small plane either was, or was not, a consumer product. One court looked at the actual use of the product in the case at hand, while another looked at whether such use of the product was common.

If the item is a consumer product, the law allows the manufacturer to specify terms such as the identity of the parties to whom the warranty is extended, what is covered, what is not, the duration of the product warranty and any implied warranties, how the beginning of the warranty period is determined, how it ends, and the procedures to be followed when warranty service is necessary. And then there are some mandatory "boilerplate" phrases that must be included to inform the consumer that there are additional rights and responsibilities that vary from state to state.

Poorly Written Warranties

In general, Friedman said, many of the warranties he sees are poorly written. Some don't even specify whether they are "full" or "limited" warranties. Others don't include the mandatory phrases. Some are silent on the question of whether the warranty applies to just the first owner, or whether it can be transferred to subsequent owners.

"The fact is that poorly-drafted warranties increase claims rates and spew dissatisfaction," Friedman said. "Smart warranties, on the other hand, reduce costs and limit liability."

One example Friedman cited came from a paintball gun manufacturer. Though he blacked out the name of the manufacturer in his WCM presentation, he didn't cover up any of the terms and conditions. While the language was clear in regards to the product warranty's duration being one year, it was unclear about numerous other aspects. For instance, it did not specify whether the warranty was "full" or "limited." It also didn't specify whether the warranty applied to just the gun, or to the targets, the face masks, the propellant tanks, and the ammunition too. Instead, the language simply referred to "this product."

The terms and conditions said the warranty would last for one year from the date it was purchased by the initial owner. But then it wasn't clear whether that meant the initial owner could transfer the warranty to a subsequent owner within that first year. And while it set the duration of the express warranty at one year, it did not set a limit for the duration of any implied warranties, such as the implied warranty of merchantability or the implied warranty of fitness for a particular purpose.

"This is only going to encourage a plaintiff's attorney to assert claim for deceptive trade practices, and seek treble damages," he said. The poorly worded and missing language also might encourage a plaintiff to seek consequential damages for their aggravation, for their hotel costs, and numerous other costs. "There is no way to prevent that because this warranty doesn't disclaim that," he noted. "You're inviting claims."

Require Mandatory Arbitration

One way Friedman suggested for manufacturers of commercial products to discourage denied claims from turning into lawsuits was to insist on mandatory arbitration. As an alternative to litigation, it is faster, more informal, and most importantly, less costly. Claims are evaluated by a neutral referee, and decisions are binding on both parties (though sometimes they can be appealed). He said courts have split on whether warranty terms and conditions for consumer product can call for mandatory arbitration, but the national trend is favoring the idea that they can.

Another alternative, if mandatory arbitration is not feasible in a given jurisdiction, is to insist on what Friedman called Informal Dispute Resolution. "IDR does not prevent litigation," he said. "Rather it simply provides the parties with a neutral body to hear a dispute, with the hope that it's going to be resolved quietly." If that doesn't happen, a lawsuit is still an option.

Manufacturers also might look for language that gives them what Friedman called an "opportunity to cure." Basically, this requires the consumer to notify the manufacturer that a defect has not been repaired to their satisfaction before they can file suit. This gives the manufacturer another opportunity to repair or replace the product. The absence of such an opportunity, if clearly required in the warranty's terms and conditions, would prevent the consumer from trying to enforce the warranty through a lawsuit.

While some courts have found that bringing the broken product back to an authorized service center fulfills this requirement, others have found in favor of manufacturers who specified in clear language that they alone -- and not just their authorized service providers -- must be directly notified. This allows the manufacturer to supplement prior efforts by their authorized service providers -- to basically have one more chance to do the right thing. And it requires the plaintiff's attorney to give the manufacturer that last chance, before they can file a lawsuit. If they don't, case dismissed.

Warranty Registrations Required?

Friedman said that manufacturers can even cut down on the number of claims by attacking the validity of the warranty itself. But this can have an adverse effect on customer satisfaction and brand loyalty. For instance, in the case of a limited warranty, the manufacturer can include language that specifies that the consumer must return the warranty registration card within a specified period. If these trigger conditions are clearly stated and are not followed, courts have already ruled that there's no warranty.

To us, it would seem that this piece of advice, if followed, would cause plenty of controversy for the manufacturer and/or dealer. First of all, there is the very real problem of personal information being sold. Some consumers suspect the manufacturer wants to know their annual income and what they read so that information can be sold to direct marketers. And second, exclusionary language that appears to be arbitrary might lead a consumer to believe the manufacturer is simply looking for ways to get out of paying otherwise valid claims.

In the furniture industry, we note, many of the stain warranties are basically worthless, because of all the exclusionary language. One service plan requires the consumer to report a stain within five days. On the sixth day, the warranty is invalid. Another requires consumers to report each stain individually. Call in two stains at once, and the warranty is invalid.

Some furniture warranties don't cover tears in the seams. Others don't cover food stains or pet stains. One might legitimately wonder exactly what they do cover, if anything. After a while, consumer advocates and columnists catch on to the pattern, and what results are headlines such as "Stainsafe is to customer service what mad cows are to cheeseburgers," which appeared in the Orlando Sentinel last summer. Wonder how many policies they're selling now?

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