A person injured in a bicycle accident sues both the small bicycle manufacturer and Wal-Mart, where the bicycle was purchased. Plaintiff contends that the bicycle was defectively designed and that both defendants are responsible under strict liability theories. Plaintiff also alleges that Wal-Mart's employees were negligent in assembling the bicycle. Discovery soon reveals that there is no basis for the design defect claim, and the claim is dismissed. The litigation continues against Wal-Mart on the negligence claim. After a lengthy and contentious trial, the jury determines that Wal-Mart was not negligent. Wal-Mart then presents a bill for all of its defense costs to the manufacturer. The manufacturer is incredulous. Can it really be responsible for indemnifying Wal-Mart for the costs of mounting a defense to claims that had nothing to do with the manufacturer's conduct?
In Texas it can. That state has adopted the most far-reaching seller's indemnity statute in the country. It requires manufacturers to indemnify sellers for all "loss" incurred a products liability actions, including the defense of non-product claims. While the Texas statute is the most extreme, it is merely part of a trend toward increasing the rights of product sellers through special seller exceptions and indemnity statutes.
This article examines the effect of the new statutes on "mixed cases," in which traditional strict liability claims are joined with claims alleging that the seller was negligent for other conduct. It describes how broad indemnity rights, such as those found in the Texas statute, can distort litigation and provides suggestions for reform.
The Liability of Non-Manufacturing Sellers
The development of strict liability in products cases removed the necessity of proving actual negligence on the part of a manufacturer or other product supplier. Under the new regime, liability was based solely upon the defendant placing a "defective" product into the stream of commerce. Restatement (Second) of Torts § 402A.
This new formulation extended products liabilities for the first time to parties within the chain of distribution, such as wholesalers, distributors and retailers that had not actively participated in the product's formulation. In the leading case, Vandermark v. Ford Motor Co., 391 P.2d 168 (1964), the California Supreme Court justified the extension of strict liability to non-manufacturer entities, reasoning that such parties sometimes play a role in formulating the product's design.
Furthermore, extending strict liability to sellers maximizes consumer protection, provides a viable defendant if the manufacturer is insolvent or beyond the court's jurisdiction, and provides an incentive for product sellers to pressure manufacturers to improve product safety. Id. at 172. The Vandermark rationale proved persuasive and the rule of seller liability was widely adopted in most states. It remains the majority rule today. Restatement (Third) of Torts § 1, Comment e.
While courts were willing to impose liability on non-negligent product sellers rather than leave accident victims uncompensated, they also were concerned that sellers would be left "holding the bag" without recourse against the manufacturer. It seemed unfair to require a non-manufacturing seller to assume the liability for a defect it did not create.
Consequently, courts established a corollary to strict liability - the right of a non-manufacturing seller to receive indemnity from the manufacturer. See generally, Restatement (Third) of Torts: Apportionment of Liability § 22(a)(ii).
In addition to liability that a seller derives merely from being a "conduit" of the product from the manufacturer to the ultimate consumer, sellers may also face legal responsibility for other conduct. The seller may have participated in the design of the product. It may have provided an express warranty regarding the product's safety or performance. Sellers may be responsible where they have negligently failed to pass on product warranties or where they have been negligent in repairing the product or conducting a recall. Sometimes retailers are required to assemble or install a product and these activities can also give rise to negligence claims. For convenience, this article overall refer to such claims as "independent liability."
Of course, manufacturers have not traditionally been required to indemnify sellers for such independent liability claims.
Common law indemnity requires the indemnitee to be free of fault. The assertion of independent liability claims by plaintiffs usually prevented the seller from recovering indemnity in mixed cases, at least until the claim was rejected by the trier of fact. Until then, the seller could not establish that its liability arose solely because it sold the product.
The Defense Cost Problem
While it protects sellers from adverse judgments, common law indemnity does not, in many jurisdictions, allow the seller to recover the substantial expense of defending products litigation. Further, common law indemnity requires establishing that the manufacturer was liable. If the manufacture or seller successfully defended the product, the seller's defense costs were not recoverable. Finally, if the manufacturer settled the plaintiff's claim, the seller was forced to assume the burden of establishing the product defect to recover indemnity.
The defense cost problem is exacerbated by the persistent strategy of suing product sellers even where a viable manufacturing defendant was available. Plaintiffs could often gain tactical advantages such as defeating removal to federal court or obtaining a favorable venue by suing the product seller as well as the manufacturer. While plaintiff's counsel cannot be faulted for pursuing any tactical advantages provided by seller liability, such claims increase the complexity and expense of litigation without offering plaintiffs a great deal of substantive protection.
The Sellers Strike Back
Consequently, sellers have urged statutory reform on two different fronts. In many states they have procured passage of seller-protection statutes. These statutes vary greatly in form. Some exempt non-manufacturing sellers from strict liability unless the manufacturer is insolvent or beyond the court's jurisdiction. Other legislation, such as that adopted in Minnesota, uses a certification system whereby a seller can obtain a conditional dismissal from the products liability action if it certifies the correct identity of the manufacturer. See M.S.A. §544.41. Some apply only to cases involving products that reach the seller in a sealed container, see Tenn. Code Ann. §28-29-106(a), while others provide a broad ruling of non-liability except where the seller has engaged in certain conduct beyond selling the product that renders it liable to the plaintiff, see Tex. Civ. Prac. & Rem. Code §82.003. Regardless of the specific form, the intent of such legislation is to make non-manufacturing sellers "defendants of last resort." So long as a viable manufacturing defendant remains available to the plaintiff, the seller should not be sued.
All seller protection statutes preserve an injured person's right to pursue the seller for independent liability claims. Some contain express exceptions to seller immunity. Others apply only to strict liability claims by their own terms.
The seller protection statutes have a double-edged effect on indemnity. To some extent they discourage plaintiffs from naming non-manufacturing sellers, thereby eliminating potential indemnity claims. On the other hand, a plaintiff determined to bring a seller into the suit for tactical reasons must bring the case within the exceptions to the applicable seller's protection statute. Most of these exceptions involve allegations of independent liability. Thus, the effect of the seller protection statutes may be to increase the number of "mixed cases," even if the total number of cases against sellers declines.
The indemnity rights of sellers have been enhanced as well. Some states, most notably Texas and Arizona, have passed statutes that broadened indemnity rights to permit recovery of defense expenses even when the product is exonerated. The Texas statute is the most extreme. It requires a manufacturer to indemnify the seller for all costs associated with products liability litigation, including claims that the seller was independently liable.
Texas Indemnity: The Manufacturer as Accidental Insurer
As part of the Products Liability Act of 1993, Texas adopted Section 82.002 of the Civil Practice & Remedies Code. The statute requires a manufacturer to indemnify and hold harmless seller against all "loss" arising from a products liability action except that loss caused by the seller's negligence or other conduct for which it is independently liable. The term "loss" encompasses not only the damages awarded to the plaintiff, but also court costs, attorney fees and other reasonable expenses. §82.002(b). The statute specifically provides that the duty to indemnify applies without regard to the manner in which the action is concluded. Thus, the obligation to indemnify the seller remains, even if the product is found not to be defective or the case is settled. §82.002(e).
Texas courts have grappled with the application of the indemnity obligation to mixed cases. Intermediate appellate courts held that the term "products liability action" included only the part of the case involving claims that the product was defective. It did not include independent liability claims. Thus, the seller could recover attorney fees and costs associated with defending the products claim, but not those clauses associated with defending allegations of the seller's negligence. Hurst v. American Racing Equipment, Inc., 981 S.W.2d 458, 463 (Tex. App. - Texarkana 1998, no pet.); E.I. Du Pont de Nemours & Co. v. Bee Agric. Co., 24 S.W.3d 522, 524 (Tex. App. - Corpus Christi 2000, pet pending).
The Texas Supreme Court disapproved these opinions in Meritor Automotive, Inc. v. Ruan Leasing Co., 44 S.W.3d 86 (Tex. 2001). In that case, a truck driver was injured as he attempted to open the hood of his truck. He alleged both negligent design of the truck and negligent maintenance of the vehicle by the truck's owner, a leasing company. The plaintiff's claim was ultimately settled, but a dispute remained regarding the truck owner's right to indemnity from the manufacturers.
The Texas Supreme Court construed the statute broadly, requiring the manufacturer to pay for the defense of the seller's negligence claim. It held that the term "products liability action" encompassed the entire lawsuit in which a products liability claim was made, including the claims not directly related to product defects. The obligation to indemnify the seller arose from the products liability allegations in the plaintiff's pleading. The independent liability exception to indemnity, however, required an actual finding of liability by the fact finder. Id. at 90.
Whether the Texas Supreme Court has correctly construed the language of the statute is debatable, but the result of its holding is clearly extraordinary. The Texas system converts the manufacturer into a partial liability insurer. It must pay for a seller's defense even for claims that relate entirely to the seller's own operations and that are unrelated to any alleged defective condition of the product.
The central assumption seems to be that, in a mixed case, the focus is always on the product claim and that independent liability claims are a mere sideshow. But this is not invariably true. Consider the facts of Ely v. General Motors Corp., 927 S.W.2d 774 (Tex. App. - Texarkana 1996, writ denied), a case that arose before the adoption of the indemnity statute. In Ely, an employee of a car dealership was test-driving a Cadillac after performing warranty service on the vehicle. While traveling at an excessive rate of speed, he lost control of the car and struck and killed a man working in his yard. The family of the victim sued the dealership, asserting that it was responsible for its employee's negligence. They also sued General Motors, principally on the theory that the dealership was GM's agent. The family did, however, include a single products liability count - the contention that the vehicle was defective because it was capable of exceeding the legal speed limit.
The trial court granted summary judgment in GM's favor on all claims, including the products liability allegation, and the court of appeals affirmed. The negligence case against the dealership proceeded. Under traditional principles the case is easy to determine. Since the products claims were rejected, the seller has no right to indemnity. Under the Texas indemnification statute, however, GM would retain the obligation to provide a defense to the dealership for claims that it negligently hired, retained, or trained the employee, even though such allegations had nothing to do with the product defect.
How the Texas Indemnity Scheme Distorts Products Litigation
The Texas system is objectionable on a number of grounds.
- First, it is doctrinally unsound. The remedy of indemnity is derived from equitable principles of restitution and is based on the concept of relative responsibility. Indemnity permits a relatively less responsible party to recover from a more responsible party, where it has discharged the more responsible party's liability to a third person. As one court described the moral basis for indemnity:
"all should be responsible for their own derelictions and, therefore, wrongdoers should be liable to persons who are required to pay damages that the wrongdoer should have paid. Winter v. Smith, 914 S.W.2d 527, 541 (Tenn. App. 1995).
The Texas scheme stands equity jurisprudence on its head. It is not based on any greater relative responsibility on the manufacturer's part. Where the product is not found defective, there is no difference in the degree of responsibility of the parties. Both manufacturer and seller are free of liability to the plaintiff. To saddle one party with the other party's costs and expenses is arbitrary. Indeed, requiring the manufacturer to assume the defense of the seller is contrary to traditional indemnity principles, because the seller - not the manufacturer - is in the best position to regulate its own conduct and thereby minimize the risk of loss.
- Second, making the manufacturer defend independent liability claims against the seller creates an unfair burden. Unlike a traditional liability insurer, the manufacturer has little or no ability to control its risk. In many instances, it may not even be able to select the ultimate sellers of its product. Certainly, it is in no position to control the business operations or seller. It cannot select counsel or direct the seller's strategy in defending the case. An insured under a liability policy has a duty to cooperate with the insurer in its own defense. A seller has no similar duty to the manufacturer. Needless to say, the manufacturer collects no premium for providing the coverage. In the past, requiring indemnity of the independent negligence claims may have had some economic justification. The manufacturer could be viewed as having superior ability to spread the cost of litigation expenses through insurance or by raising prices. Increasingly, however, sales functions are handled by large, well-capitalized entities. The largest retailers, such as Wal-Mart, enjoy substantial market power and, indeed, dwarf the size of all but the largest manufacturers.
- Third, in many mixed cases, the seller and manufacturer have a serious conflict of interest. The best defense to the product defect allegation may be to argue that the injury was caused by the seller's conduct. The seller's best defense to misconduct allegations may be to contend that the fault lies with some inherent characteristic of the product. The Texas indemnity approach requires the manufacturer to pay for a defense that may well result in establishing or increasing its own liability.
- Finally, the Texas system skews the interests of the parties with respect to settlement. Because another party may be responsible for paying for its defense costs, the seller has less incentive to settle the case. It is gambling with house money. The manufacturer, by contrast, is forced to calculate the potential expenses of defending the seller into the settlement value of the case. This factor enhances the manufacturer's legal vulnerability for reasons completely unrelated to the safety of the product. Again, however, the burden of settling a mixed case is shifted to the manufacturer for reasons unrelated to its own conduct or ability to control the situation.
Going Forward by Going Back: The Case for the Common Law
The costs imposed on the legal system by the Texas innovations are not justified, especially when a superior option is available - a return to the common law rule. This approach requires each party to bear its own defense costs, consistent with the American Rule that each party is responsible for its own expenses. Alyeska Pipeline Service Co. v. Wilderness Society, 421 U.S. 240 (1975). Although there are numerous fee-shifting statutes allowing a prevailing party to recover attorney fees, see Buckhannon Board and Care Home, Inc. v. West Virginia Dept. of Health and Human Services, 532 U.S. 598 (2001), there is no precedent for requiring a prevailing party to another party's attorney fees.
Leaving each party to pay its own costs recognizes that neither seller nor manufacturer is more responsible than the other when the product is not found to be defective. Plus, the expense associated with defending against claims that ultimately fail is part of the cost of doing business for every industry. There is no equitable reason why product sellers alone should be allowed to shift those costs to other innocent parties.
Indemnification for product defense costs should be allowed only in cases where the product has been found to be defective. In such cases, only the products-related defense costs should be indemnified. While apportionment of costs may post some evidentiary difficulties, they are not unique. Courts are often faced with having to apportion attorney's fees between claims for which recovery of such fees is available from claims for which no recovery is unavailable. See e.g., The Traditional Cat Ass'n. v. Gilbreath, 340 F.3d 829 (9th Cir. 2003).
The Collusion Problem
The mixed case presents another potential problem. A seller facing serious independent liability claims has a strong incentive to "steer" the plaintiff's case toward "conduit" claims for which the seller has indemnity. The plaintiff may be content to litigate product claims against a seller's lackluster defense, take an assignment of the indemnity claim from the seller, and proceed against the manufacturer on that claim.
The stratagems described in Casa Ford, Inc. v. Ford Motor Co., 951 S.W.2d 86 (Tex.App.—Texarkana 1997, no pet.) illustrate the possibilities for gamesmanship. The plaintiffs sued an automobile dealership, contending that it had misrepresented the condition of the used car they had purchased, had breached warranties, and had negligently marketed the vehicle. Plaintiffs also pleaded strict liability, contending that the vehicle was defective at the time it was sold. They did not sue the vehicle manufacturer. Shortly before trial, plaintiff and the dealership reached an agreement. The dealership admitted that the vehicle's restraint system was defective and unreasonably dangerous and that it proximately caused plaintiff's injury. In return, plaintiff dismissed all independent liability claims against it. At the subsequent trial, the dealership was found liable for over $8 million dollars.
The dealership then sued the manufacturer for indemnity. Ford contended, and the trial court found, that the dealership's negligence caused the accident and granted summary judgment for the manufacturer. The court of appeals reversed the summary judgment, holding that the dealership's negligence was not relevant to the indemnity issue. Because the underlying judgment was based solely upon strict liability, Ford was not permitted to explore other bases of the seller's responsibility, even where the circumstances strongly suggested that the seller had "rolled over" on the conduit claim to avoid independent liability.
Combining the Casa Ford rule with the Texas indemnity statute is potentially devastating. The statute permits the manufacturer to state its indemnity obligation only if the seller is found to be independently liable. Yet, the preclusion to the principles of the Restatement, as applied in Casa Ford, prevents the manufacturer from establishing that very fact.
While it did not use the term, Casa Ford applied the common-law "vouching-in" procedure. This procedure is a rule of issue preclusion designed to encourage indemnitors to assume the defense of indemnitees. It generally requires that an indemnitee provide notice of the claim to the indemnitor and invite the indemnitor to assume the defense. If the indemnitor refuses to do so, it is bound by any common fact determinations that are made in the lawsuit against the indemnitee. See Restatement Judgments §57. A form of vouching-in has been codified in the Uniform Commercial Code for application to breach of warranty cases. See U.C.C. § 2.607.
The vouching-in system is designed to protect indemnitors from collusive arrangements. Under the Restatement of Judgments formulation there is no issue preclusion where there is a "conflict of interest" between the indemnitor and the indemnitee. Section 57 defines "conflict of interest" as a situation in which the injured person's claim against the indemnitee is such that it could be sustained by different grounds, one of which is within the scope of the indemnitor's obligation to indemnify and another which is not. Restatement (Second) of Judgment § 57(3).
Casa Ford failed to recognize that an inherent conflict of interest exists whenever the seller is confronted with independent liability as well as conduit claims. Because it has an incentive to avoid the independent liability claims, common law vouching-in procedures should not apply to estop the manufacturer from contesting the existence and extent of products liability when the seller also faces independent liability claims. Where, as in Casa Ford, the independent liability claims disappear from the case, the court should consider whether a settlement has, in fact, occurred. If so, the court should apply the rule that only a settlement that discharges the indemnitor's liability entitles the indemnitee to recover indemnity.
Conclusion
While the seller protection statutes were, by and large, enacted with laudable objectives, their practical effect has been to make seller liability more complex and less equitable than under common law. The Texas Supreme Court's interpretation and application of that state's seller protection law offers a dramatic example of how seller "protection" can be leveraged beyond the equities, so far as to place manufactures in the position of insurer for any and all claims against the seller, even those having little or nothing to do with the product.
Manufacturers distributing in states with aggressive seller production statutes such as Texas have little present recourse. The statutes generally apply notwithstanding any contractual provisions. Consequently, it is not possible to "contract around" the statute. Except in those cases where there is clear indication of independent liability on the part of the seller, the manufacturer would be better served by assuming the defense early in the litigation. The loss of a questionable independent liability defense may be a small price to pay to avoid the potential for collusion.
*article courtesy of S. Vance Wittie, special counsel to Sedgwick, Detert, Moran & Arnold LLP. Mr. Wittie can be contacted at vance.wittie@sdma.com.