Key Words Product Liability Strict Liability

LAW AND ECONOMICSSEMINAR, WT 07/08PRODUCT LIABILITYName: Velik MitrevStudent ID: 176164Field of Study: B. Sc. in Economics and Management, 5th Semester Address: Schifferstraße, 24, Magdeburg, 39106Email: velikmitrev@yahoo.vomAbstract:The aim of this paper is to broaden people’s knowledge about the problems arising from defective products and the way they can be managed. Accordingly, the text will consider a detailed description of the importance of product liability law. Special attention is paid to the forms of product liability: strict liability, negligence and breach of warranty. The content of the paper focuses on the different kinds of defects and the costs generated by product liability. It highlights John Brown’s Model, Judge Hand’s BLP Formula, the relationship between product liability and game theory illustrated by the ‘‘prisoner’s dilemma’’ and the rule ‘‘lex loci delictus.’’Key WordsProduct LiabilityStrict LiabilityNegligenceDefective Products‘‘The common law of products liability and oftorts may experience rapid evolutionary jolts,such as the meteoric rise of strict products liabilityin the 1960’s and 1970’s, but quick growth spurtssuch as this are not the end of the story.’’11 Cupp, R. (2006), p. 19.1. Introduction.‘‘The essence of product liability is the apportionment of the risksinherent in the modern mass production of consumer goods.’’2Products liability is a modern phenomenon. It is the responsibility given to customers by manufactures, sellers and distributors to deliver products free of defects. The law of product liability is often connected with conflicts between consumers and industry. When there is a product liability, it has to be decided who should bear the risk: the manufacturer, the victim or the state? There has to be a correct provision of compensation for accidents caused by defective products and it should include financial support, social security awards and insurance payments.32.Product liability.‘‘Product liability suits are subject to an intrinsic bias that substantially increases the likelihood of unwarranted liability.’’4There is a great expansion of individual product liability lawsuits based on strict liability, negligence, or breach of warranty. Product liability prevails only when it is proven that the injuries are caused by a defective product, whose defect existed at the time of the injury and at the time the product left the manufacture’s control. When liability is not proved, victims have to bear their own losses.52.1Strict liability and negligence.For economists, the analysis of strict liability and negligence is very important. The difference between them is that only the negligence requires proof of unreasonable care, while both require proof of defect. Furthermore, strict liability defers from negligence in the extent to which producers must take account of risks. Product risks are borne by the producers under strict liability; under no liability the risks are borne by consumers.6 According to Geraint Howells from the Faculty of Law in University of Sheffield, five stages can be presented at which liability might be imposed:2 Fairgrieve, D. /Vaque, L. (2005), p. 1.3 See loc. cit., p. 2.4 Krauss, M. (2002), p. 13.5 See Polinsky, A. (2003), p. 115.6 See loc. cit., p. 118.•pre -discovery stage (unknowable risks);•discovery stage;•post-discovery stage - dissemination - minority opinion;•post-discovery stage - dissemination - majority acceptance and•recognition stage.7Negligence would impose liability only at the recognition stage. Under negligence, the manufacturer, responsible for the defective product, is liable only in the case when he did not take the proper amount of care to prevent the injury. However, in the case of contributory negligence, any action made by the victim causing the injury, will make the manufacturer not liable for the injury. In the case of comparative negligence, the consumer injured by a product will be compensated in proportion to the fraction of injury caused.8However, when a consumer is injured, it is very difficult for him to prove that the manufacturer was careless in producing the product. Sometimes, the plaintiff cannot prove negligence because in many cases the only witnesses of the negligence are the defendant manufacturer and the employees working in the manufacturing company. Then strict liability may apply and the plaintiff will be expected to prove only the current condition of the product and its impact on the injury.9One of the characteristics of strict product liability is the judgment of the condition of a product.10 It does not have to be proven negligence. The injured party must only prove that the product was defective. Strict liability is most common in the case of manufacturing products. The manufacturer is responsible for any injuries caused by the defective product, no matter what efforts he has put to prevent the injury. Anybody, who is engaged in manufacturing the product, can be liable for the injury as well. If there is a manufacturing defect that causes harm, the supplier of the product is also liable for the defect, regardless cautiousness of the supplier.11 When a single component of a product is defective, then the producer of the component as well as the producer of7 See Howells, G. (1999), p. 3.8 See Rubin, P. (1999), p. 122-124.9 See Boivin, D. (1995), p. 529.10 See Howells, G. (1999), p. 2.11 See Personal Injury Lawyer, (2005).the product will be liable for the accidents caused by the defective component.12 However, when the firm can prove that all necessary procedures were done according to the dictated standards, then the company will be not liable for the damages caused by its product.13Furthermore, a manufacturer is not liable, when the product was substantially altered after it was produced and the changes of the product were the main reason for the injury. There are products such as drugs and vaccines that cannot be made safe for their ordinary use. In this case, product risks can be reduced by giving consumers complete information concerning the product; regulations also decrease the likelihood of product problems.2.2Product liability costs.Product liability is the driver of a lot of costs. The requirement of negligence causes expenses, delays and consequently, the incentive to sue decreases. For each dollar received by a victim, at least a dollar is incurred in costs. There are other costs like lawyers’ fees and litigation costs.14 When the court decides to impose costs for injury caused by a defective product, then these costs will be included in the price of the product. If the injurer is required to compensate the victim, this will deter him from causing inefficient future harms.3.John Brown’s model.The Model discussed by John Brown in his paper ‘‘Toward an economic theory of liability’’, published in ‘‘The Journal of Legal Studies’’ in 1973, explains the basic liability rules15:12 See Howells, G. (1999), p. 8.13 See Trienekens, J./Beulens, A. (2001), p. 4.14 See Polinsky, A./Shavel, S. (2007), p. 22.15 See Brown, J. (1973), p. 324.Figure 1 from John Brown’s paper ‘‘Toward an economic theory of liability’’, represents the relationship between X, Y and P(X, Y). X and Y are two inputs and P(X, Y) is the output produced by these two inputs. In the case discussed in the paper of John Brown, P(X, Y) is the probability that an accident will not occur. Consequently, the probability that an accident will occur is 1-P(X, Y). It has to be found the least combination of X and Y, that will yield to accident avoidance. If the cost of X is Cx and the cost of Y is Cy then the total cost would be Cx*X+Cy*Y. Let the liability of the manufacturer, who has produced the product, is Lm(X, Y) and Lv(X, Y) the liability of the victim. We assume that16:Lm(X, Y) ≥ 0 and Lv(X, Y) ≥ 0 for all X and Y andLm(X, Y) + Lv(X, Y) = 1 for all X and YThen the amount which will be paid by the manufacturer, in case it will be proven that he is liable for the injury of the victim, will be A*Lm(X, Y), where A is money. Using the model above, Brown explains the liability rules.17 Below are explained five of the liability rules discussed in Brown’s paper:•When the manufacturer is not proven to be liable for the injury, then the victim is liable for his own injury - no liabilityLm(X, Y) = 0 Lv(X, Y) = 1 for all X and Y•When the manufacturer is liable for the injury, then he has to compensate the victim – strict liabilityLm(X, Y) = 1 Lv(X, Y) = 0 for all X and Y•The manufacturer will be liable for the injury only in the case when the plaintiff can prove that the manufacturer was negligent – the negligence rule Let (X*Y*) be a standard of negligence. A manufacturer is negligent in the case when X*>X.16 See loc. cit., p. 245, 327.17 See loc. cit., p. 328.•Strict liability with contributory negligence - the injurer is liable unless the victim is found negligent•The negligence rule with contributory negligence4.Defects.There are three types of product defects that can lead to liability: manufacturing, design defects and defects in warning.4.1Manufacturing defects occurring during the production of the item.There is a manufacturing defect when a product cannot meet its advertised specifications. Such defects are relatively rare and do not lead to high costs. They are independent, which means that when a single unit of a product is defective, the other products will not be defective. The consumer cannot avoid the risk of a manufacturing defect, since they occur in the manufacturing process in the company where the product is produced.184.2Design defects existing before the product is manufactured.There is a design defect, when the producer was able to design a product in a way that would have been safer for the consumers. When there is a design defect, all production units are defective, since all of them have the same design. This leads to higher costs for the company because they cannot sell defective products. Plaintiffs usually claim that it has been possible to produce a product with a better design, while defendants claim not. It is not easy to be determined when a product design is defective. It’s needed a second18 See Rubbin, P. (1999), p. 123.guess for whether an alternative design was possible or not. However, this is very difficult and very costly. The cases that are not normally filed are the most expensive and difficult, consequently there is a great saving for the states from eliminating them.194.3Marketing defects.The last type of defects is associated with the warnings that a producer fails to give regarding the dangerousness of a product. Manufacturers are often found liable for not properly warning the consumers, leading to misuse. A manufacturer is required to warn the consumers of hidden danger that may occur by using the product and he must instruct consumers how to use safely the product. When warnings are properly written, the social costs of injuries and accidents will decrease. Warning also helps consumers to decide which product to buy and from which manufacturer to buy it. This will enable them to reduce their costs of potential accidents.5.Product liability, Prisoner’s Dilemma and Lex Loci Delictus.‘‘A Prisoner’s Dilemma is a predicament in which a number of individuals, acting independently, are each rationally impelled to make choices that, when combined with the other individuals’ equally rational choices, generate a very poor outcome for each individual.’’20 In most typical product liability cases, the usage and the purchase of the product take place near the home of the consumer. Consequently, the product liability suit is initiated by a plaintiff, who has been injured in his home state. However, the majority of products consumed in a state are produced outside the jurisdiction of that state. This is the reason why in USA a product liability Prisoner’s Dilemma cannot be neutralized by industrialization. The Prisoner’s Dilemma comes from the fact that plaintiffs of one state and out-of-state defendants are combatants in a product liability suit. That is why; state legislatures are unlikely to adopt product liability rules in ways favorable to out-of-state interest. However, if each state has an efficient product liability rules, national consumer surplus would be maximized while the cost of doing business between states would be lowered.21The commerce among states would increase and19 See loc. cit., p. 123.20 Krauss, M. (2002), p. 25.21 See loc. cit., p. 25, 27.there will be more out-of-state investments. However, if states apply exploitative rules, this will lead to high increase in production costs and consumer surplus will get lower.22Prisoner’s dilemma as Conceptualized by Justice NeelyNebraska can optimize its reward if it adopts rule exploiting the defendants. If Montana has a neutral rule, Nebraska’s payoff increases from 30 to 45 by adopting an exploiting rule. If Montana uses exploiting rule, Nebraska increases its payoff from -10 to 5. If Montana and Nebraska cooperate by promising to adopt neutral rules, Nebraska’s agents will have incentives to break the agreement. Nebraska will be better to adopt exploiting rule even thought there will be a social loss of 25 if Montana adopts exploitive rule, when compared to the neutral rules of the states. (Total payoff in the upper left box is 30 + 30 = 60, total payoff in the lower left box is 45 + (-10) = 35. L= 60 – 35 = 25, where L is loss.) It is better for Montana to adopt an exploiting rule no matter what rule will be adopted by Nebraska. The expected outcome will be (5, 5), which is worse from each state’s perspective. This is the so called Pareto-inferior position.23The lex loci rule applies the law of the place where the injury occurred to determine the liability.24Let’s look the case, when a customer living in Nebraska wants to travel to Montana to buy a product produced in West Virginia. After the purchase, the customer will return to his state where he will use the product. If the consumer is injured using the product, then courts in Nebraska will apply the product liability law of state Nebraska to determine the liability of the manufacturer for the injury. Courts in other states would also apply the product liability law of state Nebraska, when the injury wasin state Nebraska. Under this rule, the location of the manufacturing facilities plays no role in determining the manufacturer’s liability. The manufacturer will be liable for the injury caused in Nebraska under the product liability law of Nebraska no matter in22 See loc. cit., p. 26.23 See loc. cit., p. 27.24 See loc. cit., p. 31.which state are the facilities of the company. Manufacturers will be not able to price their products differently in different states because of the adverse selection caused by the arbitrage. Out-of-state purchase causes the arbitrage. 256.Product liability directive.The main purpose of the Product liability Directive is to protect EU consumers from damages caused by a defective product or service. It covers any defective product manufactured or imported into the European Union that causes damages to consumers. Factors that can make the product defective can be: the presentation of the product, the time the product is put into consideration as well as whether the product is being put into reasonable use from the side of the consumers.26When there is an injury caused by a defective product, the victim has three years for compensation, while the manufacturer’s liability expires after ten years from the date on which the product was placed on the market.27 There are three types of damage payments: pecuniary damages, no pecuniary damages and punitive damages.28Pecuniary damages compensate consumers for money loses. No pecuniary damages compensate individuals for non-monetary losses. Example of no pecuniary damage payment is for pain and suffering. When there is a punitive damage, the goal is not only to compensate the victim, but also to punish the party responsible for the injury.Damage payments are seen like insurance. The manufacturer will increase the price of a product; the consumer will pay the higher price and will be compensated if he is injured by the defective product. However, individuals do not buy insurance against pain because injuries reduce the marginal utility of the victims. This can be easily seen by the shape of the utility function of an individual.7.Examples of product liability.Smoking can cause disease, suffering, and even death. Cigarette smoking and exposure to secondhand smoke kills 440,000 Americans each year. The annual number of deaths due to cigarette smoking is much higher than the total annual number of deaths due to25 See loc. cit., p.31-35.26 See Delaney, H./Zande, R. (2001), p. 1-3.27 See loc. Cit., p. 5.28 See Rubbin, (1999), p. 124-125.alcohol consumption, drug use, automobile accidents, fires, suicides, and AIDS.29On May 2007, Richard Schwarz, personal representative of his wife Michelle Schwarz, was awarded compensatory damages of $ 168,514.22 and punitive damages of $ 150 million against the defendant Philip Morris Incorporated. Michelle Schwarz died at the age of 53 on July 13, 1999.30 The plaintiff stated that Michelle Schwarz’s death was a result from lung cancer, caused by cigarettes manufactured by Philip Morris Incorporated. It was stated that the cigarettes used by Michelle Schwarz were defective and dangerous. The plaintiff stated that Philip Morris is negligent for selling light cigarettes as a safer cigarette and as an alternative to cessation and for the intentionally misrepresentations of its tobacco products. On February 20, 2007, the Supreme Court decided Philip Morris to pay $32 million to the plaintiff. 31The McDonald’s Coffee Case.32A 79-year-old woman ordered a cup of coffee from McDonalds. When she attempted to open the lid, the coffee spilled. The coffee was 135-140 degrees Fahrenheit causing third degree burns. The decision of the jury was that the coffee was a defective product. The victim was awarded $200 000 in compensatory damages and $2 700 000 in punitive damages. Later, the punitive damage was reduced to $480 000 and the compensatory damage by 20% (the jury had decided that the victim had 20% fault and McDonalds 80%).The Ford Pinto Case33 – How much costs a human life?In 1968, Ford Ponto was produced on an accelerated schedule. A defective fuel system design caused the explosion of the car. This led to the death of Lily Gray. The family of Lily Gray was awarded $560 000. Ford had a new design, the use of which would have decreased the likelihood of Ford Pinto to explode. This new design would have cost only $11 per produced car and would have saved 180 Ford Pinto’s drivers. According to Ford’s analysis, the monetary cost of changing the design would have been $137 million versus the social benefits of $49.5 million price on the deaths and car damages.29 See Kessler, (2006), p. 219, 220.30See The Court of Appeals of the State of Oregon, (2006).31 See Dreier, W. /Thompson, K. (2007).32 See Inman Flynn Biesterfeld & Brentlinger.33 See Leggett, C. (1999).Consequently, because of the high costs, Ford decided to use the previous more dangerous model. This decision was explained by Judge Hand’s BLP formula.Judge Hand represented the theory of negligence as an algebraic equation, the BLP formula:Burden/Injury BLP ProbabilityCost of accident if it did occurIf B<PL, then the person is found to be negligent and liable for the damages. B is the burden of a precaution, the accident avoidance cost. L is the cost of the accident if it occurred. PL is the expected liability of the discounted accident cost. A company must take precaution in the case when the expected harm exceeds the cost to take the precaution.34 Let us consider the example of the company producing soda in cans and bottles illustrated in ‘‘An introduction to law and economics’’ in chapter 14th by A. Mitchell Polinsky. If the company produces soda in bottles, the cost per unit will be $1.00. The chances of an injury will be 1/10 000. If the product is manufactured using cans, the cost per unit produced will be $1.03 and the likelihood of an injury will be 1/200 000. If the company uses cans, this will cause an additional cost of $0.03 per unit produced, but it will decrease the accidents losses by $0.08.35 In this case, according to the Judge Hand’s BLP formula, the company has to produce soda in cans.8.Conclusion.In our daily lives, we use different products. We used them as it is directed on the label of the product, assuming right away that the products are reliable and safe. However, each year thousands of people are injured or even die because of dangerously defective products. According to The Consumer Product Safety Commission, over 22 million injuries are related to defective products each year. Injuries, property damage and deaths caused by defective products, costs the USA more than $700 billion each year.36Product liability is a field of the law which has evolved through the years. Today, there are a lot of product liability rules which are used to determine who is liable: the34 See loc. cit.35 See Polinsky, A. (2003), p. 113, 114.36 See The Consumer Product Safety Commission USA.producer, the consumer or the state. However, when all of the effects of product liability rules are taken into account, it is clear that no one rule is the best in each respect. What liability rule should be used depends always on the product liability case and on the relative importance of the competing consideration in the particular case.3737 See Polinsky, A. (2003), p. 123.List of ReferencesBoivin, D. (1995): Strict products liability (revisited): in Osgoode Hall Law Journal, Volume 33, No. 3, Osgoode Hall Law School York University, Canada, p. 529. Brown, J: (1973): Toward an Economic Theory of Liability, The Journal of Legal Studies 1973, The University of Chicago Law School, 245, 324, 327, 328. Consumer Product Safety Commission (2007): CPSC Overview:/about/about.html, 02.11.2007.Cupp, R. (2006): Believing in products liability: Reflections on Daubert, doctrinal evolution, and David Owen’s ‘‘product liability law’’, The Berkeley Electronic Press (bepress), Pepperdine University School of Law, p. 19.Delaney, H. /Zande, R. (2001): A Guide to the EU Directive Concerning Liability for Defective Products (Product Liability Directive): U.S. Department of Commerce, National Institute of Standards and Technology, /Standards/Global/upload/product-liability-guide-824.pdf,20.11.2007, 1-3, 5.Dreier, W. /Thompson, K. (2007): Recent Court Rulings affect Punitive Damages: New Jersey Lawyer, (reprinted 14.05.2007), Volume 6, No. 20.Fairgrieve, D. /Vaque, L. (2005): Product liability in comparative perspective: Product liability and overlapping interests, 1st published 2005, Cambridge U niversityPress: New York, USA, 1, 2.Howells, G. (1999): The Millennium Bug and Product Liability, The Journal of Information, Law and Technology (JILT), University of Warwick – WarwickLaw School, United Kingdom,/fac/soc/law/elj/jilt/1999_2/howells/#fn1,04.12.2007, 2, 3, 8.Inman Flynn Biesterfeld & Brentlinger: Colorado Products Liability Law: Explaining the McDonald's Coffee Case:/2000/Aug/1/130741.html, 02.11.2007.Kessler, G. (2006): Civil Action No. 99-2496 (GK):/litigation/cases/DOJ/20060817KESSLEROPINIONAME NDED.pdf, 20.11.2007, 219, 220.Krauss, M. (2002): Product liability and game theory: One more trip to the choice-of- law well, working paper No. 02-09, Arlington, VA: George Mason UniversitySchool of Law, USA, 25- 27, 31-35.Leggett, C. (1999): The Ford Pinto Case: The Valuation of Life as it applies to the Negligence-efficiency Agreement: Wake Forest University,/~palmitar/Law&Valuation/Papers/1999/Leggett-pinto.html,20.11.2007.Personal Injury Lawyer: Strict Product Liability Law:/productliability.cfm, 20.11.2007.Polinsky, A. (2003): An introduction to law and economics: Product liability, 3rd Edition, Aspen Publishers, New York, USA, 113-115, 118, 123.Polinsky, A./Shavel, S. (2007): American Law & Economics Association Annual Meetings: The Uneasy Case for Product Liability, Berkley Electronic Press,/cgi/viewcontent.cgi?article=2216&context=alea,20.11.2007, p. 22.Rubin, P. (1999): Courts and the Tort-Contract Boundary in Product Liability, in Buckley, F.: The Fall and Rise of Freedom of Contract: Duke University Press1999, USA, 122-125The Court of Appeals of the State of Oregon, (2006),/litigation/cases/supportdocs/schwarz_v_pm_en_banc_5-17-06.htm, 20.11.2007.Trienekens, J. /Beulens, A. (2001): The implications of EU food safety legislation and consumer demands on supply chain information systems: Netherlands,/conferences/2001Conference/Papers/Area%20IV/Trienekens_Jacques.PDF 20.11.2007, p. 4.Table of ContentsAbstract (iii)Key Words (iii)1. Introduction (1)2. Product liability (1)2.1 Strict liability and negligence (1)3. John Brown’s model (3)4. Defects (5)4.1 Manufacturing defects occurring during the production of the item (5)4.2 Design defects existing before the product is manufactured (5)4.3 Marketing defects (6)5. Product liability, Prisoner’s Dilemma and Lex Loci Delictus (6)6. Product liability directive (8)7. Examples of product liability (8)8. Conclusion (10)List of References (12)。