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There’s Listeria in your lamb patties; your lighting fixtures catch fire; the paint on your signature line of pricey imported children’s toys is loaded with lead. It’s your worst nightmare – a hugely public product recall.

Every year hundreds of products are recalled, and the number is rising rapidly. Dealing with a major product defect, especially one that could harm your customers, is a major task that every business owner should anticipate.

The basic objectives of any recall are:

  • to locate all defective products as quickly as possible;
  • to remove defective products from the distribution chain and from the possession of consumers;
  • to communicate accurate and understandable information in a timely manner to the public about the product defect, the hazard, and the corrective action;
  • to somehow make the consumer whole, to the extent possible, either through refund, repair or replacement and
  • through all these steps, to somehow minimize the damage to your business.

Recalls are expensive and the mere fact of a defective product will likely do at least some temporary harm to your brand.  A good plan and some good execution may, however, minimize legal risk and damage to reputation. Product recall insurance, coupled with products liability coverage, may go a long way toward covering the out of pocket cost expenses of a recall. In any event, this is certainly not the kind of issue that you want to have to deal with “on the fly.”

Federal Agency Obligations

Most product recalls are actually voluntary recalls, in which a company discovers a safety issue and works to investigate and solve the problem in tandem with a federal agency. In a small number of cases, federal agencies will tell a company that a product needs to be taken off the market, in what is known as an involuntary recall.

If you perform a voluntary recall, you will need to work with the appropriate regulatory body for your industry. The three agencies that cover the majority of products are:

Each has very specific guidelines concerning how and when consumers must be notified of dangerous defects. The appropriate guidelines should be the basis for your recall planning.

The CPSC, for example, requires that manufacturers, importers, distributors and retailers of consumer and other products notify it within 24 hours of the time any of those entities receives information about a serious safety defect. Alternatively, they may have 10 days of the time they begin an investigation of a possible defect. Manufacturers must also report litigation arising out of safety defects. The CPSC can assess civil penalties for failure to comply.

Consumer Lawsuits

Even a well-managed recall will spawn consumer litigation. These come in three basic varieties: product liability suits, arising out of injuries caused by defective products; warranty claims that deal with issues of product quality or performance; and legal action brought under specific consumer protection statutes, such as lemon laws.

These may also appear as class action lawsuits where a large group of plaintiffs has been affected. Companies have been held liable not just for defective products, but for improperly conducted recalls, as well.

In each situation, the consumer still has to demonstrate all elements of the claim, such as the existence of an injury caused by the product. Courts generally do not treat the fact of the recall, by itself, as conclusive, but neither will they permit it to be used as a defense.

Well-represented plaintiffs will sue all of the organizations in the chain of commerce, so that, for example, even if the problem is a manufacturing defect, with which a retailer or distributor had nothing to do; the latter may also face legal liability.

If the defective product is used as a part of some larger product, the prospect also exists for third-party liability. The retailer who sells the vacuum cleaner that was made with defective screws may have a cause of action against the screw manufacturer, just as the unhappy owner of the vacuum cleaner does.

Since litigation is a near certainty, businesses should be mindful of internally created documents and electronic communications concerning the defect or the product. These will not be protected under an attorney-client privilege.

Rather than recalling a poorly functioning product that poses no danger but causes complaints, many companies will offer generous repair and replacement options, without actually admitting a defect. Remember the antenna issues with the Apple iPhone 4?

Public Relations

Clearly a voluntary recall is in a company's best interest. Having a plan may speed a business’s response, and a consumer-centered company culture may help to deal with a natural instinct to bury bad news.

The usual advice is to make the announcement as quickly as possible, to the extent that it can be done in a way that is completely correct and consistent. Nothing is worse than rolling disclosure.

This is the CEO’s job and the CEO should not be reluctant to candidly say that he or she is sorry. That strange circumlocution, “Mistakes were made,” screams litigation posturing and probably does more harm than good.

Getting the product out of the chain of distribution and consumer hands as quickly as possible will also reduce the risk from consumer lawsuits. The CFPC recommends mailing out notices to customers who filled out product warranty or registration cards, and using other databases to find owners of the product, while informing retail stores carrying the product. Notices may be printed in newspapers or magazines, on consumer websites, and usually appear on the company’s website.

There are creative ways to essentially reverse the business’s marketing efforts to target likely geographical and demographic distribution to retrieve as much as the product as possible, but even at that, a return rate of 50 to 75 percent would be considered very good,

The notices should also detail the company’s plan is refund price or replace the item. This is the beginning of the recovery plan for the business, and the focus should be on long-term market implications. Some part of the management team should already be considering how to  re-launch the product to the market. Remember that a successful recall response may ultimately be an opportunity to tell a success story about caring for customers.

Product Recall Insurance

The recall of a product sets in motion a series of events which may involve expenses that could easily bankrupt smaller enterprises. The expenses begin with the cost of pulling the item out of the stream of commerce, disposing of it and replacing it. Add to that the cost of media relations specialists who are often retained  to communicate the details of the recall to the public as well as lawyers and/or government affairs professionals who interact with the relevant government agency.

Product recall insurance reimburses insureds for financial losses they sustain when it is likely that its product may be recalled. The coverage “trigger” under a product recall policy for a food and beverage company, for instance, would be the knowledge that an accidentally or maliciously contaminated product could cause bodily injury were it consumed by the public. Even if the product results in a finding of no liability, the insured is reimbursed for certain financial costs related to the incident.

Generally, organizations can select from three different types of policies, based on the types of products manufactured. Different policies exist for:

  • consumable products, such as food, beverages or pharmaceuticals where coverage could be triggered by an accidental contamination;
  • consumer goods, such as finished household products where coverage could be triggered by knowledge the product is defective; and
  • component parts, non-consumable merchandise where coverage could be triggered by bodily injury, property damage or imminent danger of injury or damage.

Product recall insurance also comes in two parts: one covers the following direct expenses associated with the product recall, including:

  • costs associated with notifying customers,
  • shipping costs,
  • extra warehouse and storage expenses,
  • actual cost to dispose of the products and
  • the cost of extra personnel required to conduct the recall.

The second covers damages suffered by a third party due to a defective product. This covers any legal obligation to pay compensatory damages. Costs include but are not limited to:

  • the recall expenses of any third party for the recall of any product that incorporates your product including the cost to repair or replace such product,
  • business Interruption losses of others resulting from the covered incident,
  • the cost to repair and rehabilitate brand reputation and
  • the additional cost to purchase substitute goods to replace your products.

Both types of coverage are often purchased together. Various other endorsements may be added depending on the nature of your business.

General product liability coverage does not usually cover the costs associated with a product recall, but is still essential for claims brought by consumers.

A product recall may be your business’s worst nightmare. Consumer complaints about a product that is not dangerous but defective nonetheless can also damage your enterprise. These are relatively common situations, however, and management must plan for the possibility. A fast and effective response can reduce the damage of consumer litigation and may ultimately become a story about attention to customer needs that can work to your advantage.

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