China’s new Tort Law expands company liabilities and adds punitive damages for unsafe and defective products.The new PRC Tort Liability Law, which finally passed in December 2009 after four revisions, covers a range of topics that have increasingly captured Chinese and international headlines, including product and medical liability, environmental pollution, motor vehicle accidents, and hazardous work. In fact, several recent safety scandals, such as the 2008 melamine-tainted milk scandal, may have hurried the passage of the law, which was first proposed in 2002 and is slated to take effect July 1, 2010.

Prior to the Tort law, legal rules that addressed and provided for civil remedies in rights infringement cases were spread among several PRC laws, including the General Principles of the Civil Law, the Law on Protection of Consumer Rights and Interests (Consumer Rights Protection Law), the Product Quality Law, and the Food Safety Law. As pressure to provide more effective means of redress through civil courts grew, the need for a unified tort-law framework that clearly defined tort-based causes of action became increasingly urgent. Though the new Tort Law does not supersede tort-related provisions contained in other laws, it consolidates and integrates the basic legal concepts into a single piece of legislation.

Product liability clarified

The apparent expanded protection against defective products and the introduction of punitive damages are key features of the new Tort Law. Their inclusion may in large part be viewed as a response to product scares in recent years. For example, the Sanlu tainted-milk incident—which reportedly left at least six infants dead, roughly 300,000 others suffering from lingering health problems, and a wave of discontent in its wake—prompted government officials and the public to openly demand stronger governmental oversight, harsher punishment for wrongdoers, and swifter, more effective mechanisms to limit the potential harm caused by dangerous products (see the CBR, May-June 2009, Ethical Supply Chain Management).

New liabilities for producers and sellers of defective products

Until the Tort Law takes effect, the Product Quality Law remains the main source of principles to be applied in cases involving defective products. The Product Quality Law recognizes two types of product deficiencies, “flaws” and “defects,” which are subject to different liability rules. The term product “flaws” (xia ci) generally refers to minor non-conformities, such as a product’s failure to function as it should or when a product’s quality does not conform to the standards specified on the product or its packaging. Where product flaws cause injury to the consumer, the seller is liable for compensating the consumer’s losses. If the flaw is the fault of the manufacturer, the seller is entitled to recover its losses from the manufacturer after compensating the consumer. A product contains a “defect” (que xian) if there is an unreasonable danger inherent in the product that threatens the health or safety of persons or property, or if the product does not conform to applicable national or industry health and safety standards. In cases involving product defects that cause personal injury, death, or property damage (other than to the product itself), the Product Quality Law requires the manufacturer to assume compensation obligations.

Though the new Tort Law does not use the term “flaw,” it appears to expand the scope of parties from whom a plaintiff may seek damages in cases where injury is caused by a product defect. Under the new law, a plaintiff may seek damages from either the producer or seller of a product that contains a defect, regardless of who caused the defect. In cases where a seller can show that the product contained a preexisting defect, the seller has the right to seek contribution from the producer, assuming that the producer can be identified. (“Contribution” refers to what the defendant has a right to collect from others who are responsible for the harm caused.) Third parties in the product distribution chain may also be held liable: The Tort Law states that if injury to other persons is caused by defects resulting from third-party transportation or storage services, the producer and seller of the defective product have the right to seek contribution from the responsible third party.

Punitive damages

Punitive damages were generally unavailable under PRC law prior to the passage of the Tort Law. The Consumer Rights Protection and Food Safety laws contain provisions regarding payment of compensation equal to specified multiples of the value paid by the consumer in cases of fraud. The Product Quality Law uses a similar approach when dangerous products are manufactured or sold in violation of applicable national or industry standards, but without any need to establish fraud. Article 47 of the Tort Law, however, provides that where a party knowingly produced or sold defective products that caused injury to life or health, the injured party has the right to claim punitive damages. Unlike previous laws that restricted compensation, recovery of punitive damages is not stated as a fixed multiple of the amount paid for the defective product, nor does the Tort Law place a limit on damages.

Given that the Tort Law has not yet taken effect and that China does not follow case precedent, it will be particularly important to monitor legislative and judicial developments, especially PRC Supreme People’s Court Judicial Interpretations. Of particular concern are guidelines for punitive damage awards and whether—for purposes of granting punitive damages—constructive knowledge can be imputed to a manufacturer or seller based on press reports, searchable information available on the Internet, or other public sources.

Mandatory product recalls in private tort actions?

Before the introduction of the Tort Law, product recall rules and regulations were generally confined to industry- or sector-specific enactments such as the Food Safety Law and the Administrative Measures on Defective Auto-Product Recalls. The Food Safety Law requires recalls when the product in question fails to meet food-safety standards—for example, when it exceeds permissible limits on pathogenic microorganisms or fails to meet requirements on the types, scope of use, and amount of food additives.

Unlike these previous rules and regulations, the Tort Law is phrased in an open-ended fashion and therefore applies to a wide range of products. Under article 45, injured parties have the right to require the producer or seller to eliminate the danger or remove impediments where defects in the product endanger the safety of persons or property. The wording of article 45 also suggests that any party whose rights have been infringed—regardless of the injury actually sustained—may demand that a manufacturer or seller eliminate the hazard. The plaintiff could therefore ask the court to mandate a product recall that is much more expensive than the compensation payable to the plaintiff. Even if courts, without further judicial guidance, are reluctant to order product recalls instead of less expensive remedies such as safety warnings, the threat of punitive damages under Article 47 may provide sufficient motivation to recall defective products.

What companies can do

Provisions in the Tort Law that relate to product liability will likely benefit consumers. They will also likely increase the costs of conducting business, especially for multinational companies, which tend to be scrutinized more closely when a product defect is identified. By clarifying that an injured party may seek damages from either the producer or seller of a defective product, the Tort Law makes it more important than ever for companies to not only maintain effective quality-control systems, but also ensure that upstream and downstream business partners have equally effective systems in place. At the most basic level, manufacturers should aim to establish an effective quality-control system and a product-recall plan. These measures should enable manufacturers to identify potential issues before they become liabilities and take appropriate preemptive action when necessary.

Though the PRC Contract Law generally permits contracting parties to allocate risk among themselves, mandatory provisions in laws and administrative regulations invalidate contract provisions that violate those mandatory provisions. Thus, general liability waivers may offer inadequate protection if they are at odds with mandatory provisions of the Tort Law. Companies should therefore revisit their contract-based waivers and liability-shifting mechanisms. Companies may find it prudent to incorporate into their contracts provisions on emergency recall measures and information management processes that allow for open communication channels with all parties in the product distribution chain. Companies, particularly those that may not have product liability insurance, should pay special attention to their insurance coverage, which may need to be expanded to protect against new liabilities under the Tort Law.

More details on the way

The Tort Law is a significant step forward for China’s product liability legal framework in that it clearly articulates basic legal concepts that would be considered fundamental in mature legal jurisdictions, such as the United states, but which may be poorly understood by PRC courts. Among these are rules that govern punitive damages and product recalls. In addition, propelled by great changes and tensions in Chinese society brought about by rapid economic development, the Tort Law may reflect a significant expansion of the scope of individual rights protected under PRC law. But the effectiveness of the law will remain subject to the realities of access to the courts, procedural rights, and implementation of remedies through the PRC legal system, which remains a work in progress. Key tests for the new law and the integrity of the courts include cases in which private individuals without financial resources or government connections take action against powerful state-owned enterprises or in which a large award could bankrupt a defendant company that is a significant employer.

Given the general nature of the Tort Law and the breadth of issues that it covers, China will likely issue further guidance to fill in the details and guide calculations of damages awards before the law takes effect July 1. Meanwhile, companies active in the China market should implement effective quality-control systems, develop product-recall plans, review their current contracts and relationships with business partners, and revisit insurance policies and other risk-management measures.

[author]Peter Neumann is shareholder at Greenberg Traurig, LLP in Shanghai. Calvin Ding is associate in Greenberg Traurig’s Shanghai and Houston, Texas, offices.[/author]

Posted by Peter Neumann and Calvin Ding