Opinion: Fake Goods Can Often Carry a High Insurance Risk Factor

This latest Opinion piece by Richard Houseago, Head of Property Risks and Coverage Team at Keoghs, looks at the risks surrounding counterfeit goods for insurers and businesses alike, within the commercial sector.

Richard Houseago KEOGHS LAW

Depending on the source, one can readily find estimates that the counterfeiting of goods now accounts for between 5% and 10% of all global trade. The figures are huge and the reach of the counterfeiters goes far beyond fake watches and handbags. With globalised supply chains, there are no commercial sectors that are unaffected. Counterfeit goods and components are strewn through the automotive, construction, electronics and even the aviation industries.

Occasionally, concern about the wider implications of counterfeit items prompts a serious, co-ordinated response. For example, in the USA in the 1980s, a widespread problem with counterfeit hi-tensile fastenings implicated in construction and engineering failures lead to a 1990 Fastener Quality Act. However, as one specific concern is addressed, another arises.  There are currently problems with supposedly heat-soaked toughened glass and lithium batteries.  These are good examples of products, albeit counterfeit products, that can pose particular product liability issues for legitimate manufacturers who wrongly find themselves implicated after an instance of failure.

fire risk from fake or counterfeit lithium batteries

The risk of a Nickel Sulphide inclusion failure is much greater in the case of toughened glass that has not been correctly heat-soaked during the manufacturing process, while the potential consequences of the shattering of such glass on a high-rise structure are dire. We are all familiar with airline cautions over entirely bona fide lithium batteries but let’s consider for a moment the risks we face from the proliferation of counterfeit batteries.  These are found in all sorts of consumer items and are associated with fires. What is common between these two particular examples is the extent to which the failure, by spontaneous shattering or by bursting into flames, destroys the very product itself; almost certainly complicating the process of establishing what has happened, why and who might properly be answerable for the resulting damage.

In principle, of course, the position might be thought reasonably straightforward for a legitimate manufacturer when first approached by a Claimant seeking to pursue a product liability claim after the failure of a product wrongly purporting to be of that manufacturer’s own brand. Even the strictest regime of product liability would recognise that there was no scope for liability when the answer is that, “It is not my product at all”. Even then however, there has already been imaginative litigation in the USA based on assertions that the manufacturer’s legitimate products should not be so susceptible to counterfeiting in the first place.

FACTBOX: Lithium batteries are relatively fragile and, if damaged, an electrical short can ignite the lithium. This is why airlines ask passengers not to move their seats if they drop their gadget. Lithium batteries can also experience runaway self-heating.

We have not yet seen such in England but manufacturers and importers face claims every day based on the relatively strict liabilities under the Consumer Protection Act 1987. This must become increasingly challenging as counterfeiting continues to become more industrialised and more sophisticated. Consider this, if the US Air Force has in the past failed to identify counterfeit electronics made in China and which came to be fitted to their aircraft, as is the case, then what are the odds of differentiating between the genuine electronics and the counterfeit after they have been involved in a fire without some particular attention being given? 

factory commercial insurance risks and laws uk

Manufacturers, encouraged by their product liability insurers, probably need to adopt more proactive scrutiny of claims as part of an overall regime of brand protection and liability risk mitigation. The problem is such that we should now be encouraging a positive validation of the provenance of the item at issue.  Yet I wonder how common this is. It is not enough to react only to some very obvious anomaly in the physical evidence that might be taken as an obvious sign of a counterfeit. That approach risks counterfeits not only infecting supply chains but also putting an unwarranted burden on product liability insurers. A more questioning approach is needed.

FACTBOX: The manufacture of toughened glass will unavoidably mean some of the resulting glass panes containing small inclusions of Nickel Sulphide. Such panes, if left, are susceptible to shattering because of the differential expansion of those inclusions. Heat soaking at a late stage in the manufacturing process is intended to induce any failures at that stage, so that only glass free of inclusions enters the supply chain.

So what can we do?

  • The starting point is simply to be aware that now, even in supposedly “safe sectors” and even in regard to major projects, not everything is what it may seem. Nobody ought to know their products better than the legitimate manufacturer, so it ought to be encouraged in every significant product liability case for those conducting the defence actually to pose the questions directly: Does this physical evidence appear to be your item? Does the supposed supply history fit? Has there been any associated concerns? This requires lawyers, experts and the insured manufacturer working together and talking openly about the possible incidence of counterfeit goods.
  • It is important to encourage a concentration of experience in claims investigation so that those involved develop an engrained familiarity on a product-by-product basis. This is particularly important for forensic investigators.
  • Keep up to date with any latest information tracking the incidence of counterfeit products. There is good data available for example from US Customs and Border Agency and the International Chamber of Commerce.
  • A good dialogue is needed between manufacturers and their insurers – not one in which any exposure to counterfeiting is ignored;
  • Manufacturers can cut the risk of counterfeiting by, for example, incorporating trace materials or means of identification that a counterfeiter would be unlikely to copy. Rigorous supply chain management ought to assist in a process of retrospective elimination in the event of a claim.

FACTBOX: The Consumer Protection Act 1987 imposes strict liability upon the manufacturers of defective products; with the test of defect being only that the product is not as safe as persons are generally entitled to expect. The consumer must prove the existence of a defect and that the damage was caused by the defect. This may not be a huge burden where, for example, the seat of a fire is obvious from the burn patterns, a piece of electronic equipment sits precisely at the seat of fire and there is no other convincing explanation other than a fault in that equipment.

The problem of counterfeit goods risks getting worse as current trends continue and as products come to market in different ways – notably via the internet.  Manufacturers need to prioritise the issue to protect their business and their customers

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