March 27, 2007

Warranty & the Law:

Some laws that affect warranties go back decades. Others are just a few months old. At the recent WCM Conference, three lawyers provided some perspective on how they see these laws affecting both manufacturers and extended warranty providers who find themselves in court defending against a breach of warranty lawsuit.

Warranty affects so many departments besides the standard triumvirate of quality, manufacturing, and engineering. There's a financial aspect to it, of course. And it affects everything from marketing to advertising, as anyone knows if they paid attention to the commercials aired during the most recent Super Bowl and Academy Awards telecasts.

One department warranties are affecting with increasing frequency is legal. The day's headlines are filled with tales of alleged defects, dissatisfied customers, and denied claims, and if satisfaction is guaranteed but not provided, some of these incidents will result in lawsuits.

At the recent Warranty Chain Management Conference in Tampa, attorneys were sprinkled among the panelists who spoke over the course of the two days. Towards the end of the second day, in fact, there was a whole panel given over to the topic of "Warranty and the Law." Four attorneys were scheduled to speak, but one couldn't attend because of an injury. What follows is a distillation of what the other three had to say.

Paul Wojcicki, a partner in the law firm of Segal McCambridge Singer & Mahoney Ltd., kicked things off with a look at U.S. law regarding consumer product warranty legislation and the recent history of warranty litigation.

"Back in the 1950s, people started complaining that their cars weren't working very well, and that companies weren't standing behind the cars," Wojcicki said.

"Eventually, the complaints made their way to Washington and Congress took heed. In the late 1960s, Congress started looking into the question, and a Presidential Task Force was born. The Federal Trade Commission was asked to do an investigation.

"In 1968, the FTC issued its report," he said. "They found that automobiles were not manufactured to an acceptable quality standard; that manufacturers and dealers were not standing behind the warranty -- were not making repairs as promised; that because of the quality problems, the automobiles required more types of service, more frequent preventative service than was acceptable; and that an increase in private litigation, while it would apply pressure on the industry to provide better cars and improved services, does not represent an efficient or generally satisfactory way to achieve proper performance under the warranty."

In other words, the FTC conceded that litigation wasn't the best way to improve product quality.

"Nonetheless, legislation was proposed," Wojcicki said, in the form of the Automobile Quality Control Act, which he said would have made warranties a statutory requirement, had it become law. "You would have had a set of federal requirements that you would have to comply with if you were an automobile manufacturer."

There are some U.S. states that now mandate minimum warranties, especially for motor vehicles, but so far it hasn't been done at the federal level. It has happened in Europe, however, where two-year warranties are now required for all consumer goods. Wojcicki said he's not sure if it will ever happen in the U.S. "I don't think that you have the kind of consumer outcry now that would justify it," he said.

Trouble Spreads

At the same time that vehicle owners were complaining to lawmakers, household appliances were stirring up their own trouble. And it was similar to what the auto industry was facing: a call for manufacturers and sellers to stand behind their products and take care of their customers. Some manufacturers and retailers were willing to do so, but others were not. And, let's face it, those who did not incur the higher costs of aftermarket repairs and customer service were likely to have higher profits than those who did, at least in the short term.

"It had to be industry-wide to work," he said. And it was perceived to be a multi-industry problem, with no fast or easy solutions. "This wasn't just a couple of voices in the wilderness. This was something that people in various elements of government took notice of, because the consuming public was indeed that upset with what was going on. So the task force sent out a call to action to find ways to bring about this change in customer service and product quality."

They found that some warranties were unclear. Some warranties were downright deceptive, taking away more rights than they granted. Others tried to disclaim the protections of the implied warranties of merchantability and fitness for a particular purpose, as outlined in the Uniform Commercial Code. And then there were the warranties that weren't worth the paper they were written on, because the manufacturers wouldn't fulfill the promises they'd made.

Legislation was proposed to correct these problems. "It was enacted as the Magnuson Moss Act, signed into law on July 4, 1976," Wojcicki said, the 200th anniversary of the signing of the Declaration of Independence.

The new law required that entities that choose to issue product warranties must characterize them as either full or limited warranties. The warranty must also describe 1) what is covered, 2) what is not covered, 3) what is the period of coverage, 4) how to obtain coverage, and 5) how the warranty is affected by various state laws. But it does not require that warranties be granted in the first place.

Federal Warranty Law Guidebook

Congress delegated the crafting of the actual rules to the FTC, which has since that time published numerous guides and rulebooks, including "A Businessperson's Guide to Federal Warranty Law," which is available online.

"Consumer product warranty legislation led to consumer product warranty litigation," Wojcicki said. "It provides reasonable access to a courthouse -- to a remedy -- by creating a federal cause of action for breach of essentially state law warranty rights. On the other hand, it also expanded the definition of what a warranty is. Under the UCC there's the concept of an express warranty. Under the Magnuson Moss Act, there's the concept of a written warranty. And the concept of a written warranty encompasses what would be a UCC express warranty, and then expands that definition to include mere promises of what the warranty will do."

Wojcicki explained that the under the UCC, an express warranty must make an affirmation of fact or promise about a product. "I'm going to sell you a pen, and this pen is going to write in blue ink," he said. "That's an affirmation of fact or promise about the goods. If I deliver it to you and it has black ink, then I have breached my warranty."

In contrast, most warranties don't usually make affirmations of fact or promise. Instead, they usually promise that if a product proves to be defective in its materials or workmanship, the manufacturer will repair or replace it. "That promise to take action by a warrantor, as opposed to a promise about the characteristics of the goods, would not necessarily be covered under the UCC," Wojcicki said. "So Congress broadened the coverage by introducing this concept of written warranties."

The Magnuson Moss Act also limited the ability of a written warranty to disclaim coverages available under implied warranties. "If you give a written warranty, you can't disclaim or modify the implied warranty," he said. But Wojcicki also noted that the Act left unclear whether there is in fact an implied warranty between all parties in a transaction. In some states, there must be a direct relationship between the two parties -- I sell to you -- for there to be an implied warranty. But in other states, distributors, manufacturers, and even suppliers can find they're liable for implied warranties that arose through transactions that took place far away from their spot in the supply chain.

Lemon Law

The Act also created its own Lemon Law, at least for products covered by full warranties. "If you give a full warranty and within a reasonable amount of time you don't correct defects in the product covered by the full warranty, you have to replace it," Wojcicki said. "Normally, you're looking at monetary damages, but the Act created this refund and replacement provision."

And it's become something of a cottage industry unto itself. Wojcicki said he typed the phrase "Lemon Law" into Google and came back with 1.8 million hits (we got only 1.42 million, but who's counting?). When he started practicing law in his hometown of Chicago, he said there was only one lawyer doing Lemon Law litigation. Now there are three or four whole firms doing it.

And he said it's not just restricted to cars any more. Lately, he said he sees more cases having to do with hearing aids, kitchen appliances -- you name it. Plaintiff's lawyers like it, he said, because once they have the template for a successful case, they can replicate it endlessly for other clients. "A lot of these guys really have it down to a pretty efficient assembly line kind of process," he suggested.

Finally, the Act included a "fee shift" provision, which required that in cases where the manufacturer-defendant loses a civil lawsuit in court, it must pay not only the cost of the breach of warranty, but also the plaintiff's legal fees. "And I can tell you there is going to be a gross disparity," Wojcicki said, suggesting that in cases where the cost of the breach may be $5,000 or $6,000, the cost of the plaintiff's attorney fees could be $30,000 up to several hundred thousand dollars. The Act sets no relationship or ratio between the two, so conceivably damages could be $10 and attorney's fees could be $10,000.

"So it truly does incentivize people to avoid getting into breach of warranty litigation, and in fact to take some steps to help out consumers that they otherwise might be hesitant to do," he said. This is especially the case in the automotive industry, where he suggested that breach of warranty lawsuits are not that tough to prove.

"Who on a jury -- and most times, who in a courtroom, including the judge -- hasn't had a bad experience with an automobile at some time in their life?" Wojcicki asked. "Quite frankly, consumers walk in with a leg up in most warranty litigation. And really, the burden is shifted to the manufacturer to show that they did everything they could."

Protecting the Warrantor

To reduce the risk of having to pay hefty settlements every time someone files a lawsuit, Wojcicki suggests that manufacturers choose their battles carefully. But even better, he said manufacturers should try to find ways to settle before even getting to court. Win or lose, the cost of a lawsuit will almost always outstrip whatever profit margin there was in the product at the heart of the case. And then there's always the court of public opinion to consider.

"There are better ways to address situations that through litigation," he said. "Winning in court doesn't necessarily translate into a victory in the consuming public's eyes. And the fact of the matter is, consumers apply different standards than jurors. Consumers vote with their wallets. So you may ultimately win a lawsuit but get bad press because of it. And that can cost you at the cash register."

Wojcicki suggested manufacturers focus more on simply fixing the product, rather than defending against lawsuits. "If you can nip those problems in the bud, and you can handle them directly short of litigation, you've done yourself, the consumer, and your company a good service," he said. "Every warranty complaint -- every recall -- is a brand-building opportunity. You have to also remember that if the customer perceives they have a problem with the product, they do have a problem with the product."

In some RV cases he's seen, customer training and capability seems to be the root of the problem. They might have driven a simple vehicle all their lives, but then they get behind a console that looks like a jetliner and they can't operate it correctly. "And there's an old saying that 'Sometimes, the only problem with the car is the loose nut behind the wheel.'" Yet those problems need to be addressed to protect the brand.

"If you do it the right way, you're going to build that customer relationship. If you do it the wrong way, you're going to destroy it," he said. "Educate them about the product, so they won't have a problem if they know how to use it better." The key is to go above and beyond what is strictly required -- to impress them with your service capability. In the long run, he said, it's less expensive to keep a customer than it is to replace them.

The Deterrence Factor

Jonathan Friedman, an attorney with McKenna Long & Aldridge LLP, said he thought it was equally important for a manufacturer to establish a reputation for itself as a company that won't settle even what they consider to be a frivolous lawsuit simply to avoid the cost of a victory. "We counsel our clients -- manufacturers -- that you have to fight that sort of frivolous litigation," he said, "because if you don't, you're going to see these 'Lemon Law Mills' pop up everywhere. The only way to shut them down is to fight them and not pay them a dime. There is a significant cost in the startup phase to accomplish that. But if you do it, and you do it well, then you end up taking them out of the equation."

Friedman focused the bulk of his comments upon the emerging area of electronic records management, such as which electronic messages are preserved, and how long email is retained.

"There are changes in the law that will revolutionize the way many companies preserve and maintain their documents, particularly electronically stored information," he said.

"And if you haven't already heard about some of these changes, then your company may be in for a surprise when litigation arises."

Friedman said too many companies still discard or delete documents that later turn out to be material to a court proceeding. At the same time, too many companies inadvertently forget to dispose of documents that have little value, except perhaps to an opposition attorney looking for what investigators call "the smoking gun."

And then there are too many companies that store records in a way that makes them difficult to search or retrieve, thereby driving up the cost of complying with legitimate requests. Sometimes, that cost comes in the form of legal penalties imposed by a judge who's become frustrated with an inability or an unwillingness to comply with what Friedman called e-discovery requests.

"In today's litigious society, as we probably all know, litigants are now spending more time in the discovery process -- and the discovery process is the exchange of information between the parties involved in the litigation," he said. And since it's a mandated process, they have no choice but to comply.

New Federal E-Discovery Rules

Friedman said new federal rules came into effect on Dec. 1, 2006 which make it easier for your opponent to request certain electronic records, and more costly for you to comply, especially if you don't have a sophisticated document retention and retrieval system. Certain states such as New Jersey have also adopted similar e-discovery rules, he added.

"They are very significant," Friedman said. "They are going to impact every business across the board, in the warranty industry and every other industry. And they have already changed the way lawyers approach and prepare for litigation."

The concept of e-discovery goes all the way back to the 1970s, Friedman said, but until rather recently neither courts nor lawyers had a very good grip on the issues. "They didn't understand the architecture nor the software, and they didn't know what should be produced and what shouldn't be produced," he said. And it really only came into play rarely, especially in breach of warranty litigation.

"But those days are now long gone," he said. E-discovery is now becoming routine, and the inadvertent or willful destruction of documents to prevent their discovery by opposing counsel has already resulted in hundreds of potentially crippling fines, he added. In fact, the duty to begin preserving relevant documents, or at least to shut off systems that routinely dispose of old documents, now begins not when a lawsuit is actually filed, but when it becomes reasonable to anticipate that one will be filed.

This can be triggered in some cases by a mere complaint, or perhaps a warranty claim, he suggested. And employees need to be trained to inform certain key people when certain thresholds are crossed, for instance when a customer threatens a call center agent with a lawsuit.

High Cost of Compliance?

The cost of compliance will be very high, Friedman predicted. Just a single laptop could potentially hold millions of documents or messages. Servers could hold even more. And then there's voicemail and archives and even deleted files that still leave behind a trace of their contents. For word processing documents, there are the various drafts and revisions to consider. Even "metadata" attributes such as who actually created a letter and how long it took can be extracted from the file if someone knows where to look.

"Your opponent can now demand the production of these types of e-data," Friedman stated. "And he can actually specify the format in which he wants it. He may want it in the native format with the metadata intact. Or he may want you to find a way to print that out and show you the metadata."

The new rules also require that within 30 days of the filing of a lawsuit, that the parties sit down and discuss the types of e-discovery that each has, whether they are preserving it, and whether it is in an accessible format. In the old days, the discovery process moved along at a glacial pace. So this is also a major change.

The cost of non-compliance can also be high. The destruction or loss of relevant information in legal terms is called spoliation, and as Friedman said, this can result in multi-million-dollar fines. In some cases, the judge might tell the jury that the information that was destroyed would have adversely affected the destroyer's case.

"That's a critical instruction to the jury, because you're basically instructing the jury that there's something wrong, and that you likely should be finding against the person who destroyed that information," he said. Potentially, the judge could even bypass that step and award the verdict to the other side. And that could have nothing to do with the merits of the case.

Friedman said the key to preventing such outcomes is to institute a comprehensive record retention policy that includes digital as well as physical records. "If it's properly designed, it hopefully will help prevent the possibility of sanctions," Friedman said. "But it's also a roadmap for your opponent." Therefore, once the opposing counsel knows what is retained, they will begin asking for it. If it isn't there, then they'll want to know why not.

Different documents should be kept for different periods of time. For warranties and extended warranties, Friedman said the absolute minimum period for retention will be the length of the warranty period. So that means all repair records and correspondence with a customer needs to be retained at least until the warranty expires. Then there's the statute of limitations on breach of warranty lawsuits, which can vary from state to state. Friedman suggested an additional four years as a hypothetical rule of thumb. So if the warranty is one year, he suggests keeping the relevant records for five years.

And then there's the whole process of providing an e-discovery response. Different people in different departments need to get together to catalog what they have on laptops, servers, and backup tapes, because those formats will be subject to e-discovery. Some data may be on legacy systems from which it cannot be easily extracted. Other data may be preserved in an inaccessible form except in the case of a disaster. Thankfully, Friedman said access to data in an inaccessible format is rarely granted, and when it is, there's usually some provision for the opposing side to pay for the attempt to retrieve it.

"There are two important things you have to remember," Friedman concluded. "One is that Spartan records management is the key, and that preparation, beginning now, is essential."

Federal vs. State Regulations

Brian Casey, a partner in the firm of Lord Bissell & Brook LLP, said he tells his insurance clients to keep their email for 180 days. "It's somewhat all over the board," he said, "but as a general rule, my personal view is 180 days. We have some clients that are doing 90, and a couple that are doing 60. But that's very aggressive. You have to look at your business. And really what we're saying is there are emails that you do not want to keep."

In his presentation, Casey said there are also privacy and security aspects to warranty law, especially since the advent of the Internet.

Businesses must be extra careful how they contact customers, what data they gather about customers, and how they safeguard that data from being disclosed to others.

And then since September 11, there have been new laws passed that grant government access to some data that was previously private.

"The bottom line is, in terms of security and privacy, that the stakes are very high from a business perspective, because it can be a real easy reason for customers to walk away from your business," he said. "Spyware and spam are still problems. States get on the bandwagon, start passing laws, and perhaps a federal solution will come." There are even federal laws that empower the FTC to coordinate enforcement actions and information sharing with foreign governments.

Similarly, Casey said, the extended warranty business may soon find itself swept up in the debate between federal and state regulators regarding the insurance industry. Right now, insurance regulations are set at the state level, but some in Congress have called for a more active federal role, especially after all the recent hurricanes. And then, he said, there are those in the insurance industry that would prefer the consistency of one set of federal rules as opposed to those of the 50 different states.

"I'm basically a corporate and regulatory lawyer in the insurance and financial services space, and warranty and extended service contracts are some of the niches I'm involved in," Casey said. So he's always on the lookout for emerging issues that will have an impact on his clients, especially in the online realm. "For those of us that have clients in the financial services industry, the privacy and security area is in your top ten issues list. But these days, privacy and security is almost like a separate practice."

One case he mentioned came about when an insurance company objected to a Web search engine's use of sponsored links. When, for instance a person searched for "GEICO," sections of the screen might display advertisements for competitors. The insurance company asserted that this was an infringement of its trademark, but a district court ruled that users were unlikely to confuse the search results with the advertisements.

Another problem he said he thinks will become more prominent is the whole issue of what's called click fraud. If an advertiser pays a publisher by the click, a rival company's employees or perhaps a disgruntled customer could run up the advertiser's costs simply by making repetitive click on the ad. "There's a case in Arkansas now," he said, which seems to be moving towards settlement, though the plaintiff still has some objections to the terms.

Can Spam Be Canned?

In terms of anti-spam law, there hasn't been a lot of change in the past two years, Casey said. The current federal law mandates that those who send spam must give the recipient the opportunity to opt out of further correspondence. But it doesn't actually ban the initial correspondence. And it doesn't pre-empt the various state laws that overlap and/or contradict portions of the federal law.

In fact, Casey said he sees another legal cottage industry beginning to grow around state anti-spam laws. "I can tell you there are these 'professional plaintiffs' out there that just sit there and wait for spam," he said. "We have gotten two nasty spam suits for a couple of insurance clients." One simply rented some lists on an assurance from the provider that all the addressees were opt-in. That turned out to not be the case. In another case still taking place in California, the client has already spent $300,000 defending itself.

"We think we're right on the merits, but at some point from an economic perspective you just have to throw in the towel," Casey said. But there are also possible fines to consider, so one must be careful about admitting liability. Fortunately, he said, state insurance regulators have so far shown no inclination to begin enforcing federal anti-spam laws. "They have enough to do these days," he said.

Companies can do a lot to protect themselves, Casey said, first by using some common sense when it comes to who they deal with and what content they send out. Common sense also goes a long way when it comes to other aspects of security and privacy. More than anything, what a company needs to do is write down its policies and procedures in detail, and then make sure they're followed.

"You have to train employees," Casey said. "You need written policies and procedures. And you have to test your system from time to time." In addition, companies must also make sure their contractors and suppliers are following the same procedures. "So you need to address your contracts."

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