Supplier Risk and Downstream Liability
In the insurance business, the term “deep pockets” is tossed around more frequently than an antipasto salad. In my opinion, the term “downstream liability” is a better way to describe how risk costs can flow to a party irrespective of the degree of fault.
Downstream liability risks are the risks of inheriting liability from the more culpable party. Laws, which vary by state, can sometimes increase these risks, and quite often, downstream liability flows from suppliers and vendors.
Vicarious and Downstream Liability Contrasted
Vicarious liability is a legal doctrine that, in some instances, makes a party responsible for the actions or inaction of a culpable party based only on the relationship between those parties. In other words, the “duty of care” is imputed to a third party precisely because of their relationship to the culpable party. Employee-employer and child-parent are common examples of special relationships that can yield vicarious liability.
Sources of Downstream Liability
- Product Defects. Defects in a vendor’s product that impact the safety of the subsequent service or product delivered can often result in liability being assigned and/or apportioned. For example, a manufacturer of medical devices produced scopes with a design flaw that made them highly susceptible to bacterial contamination. While the device manufacturer was responsible for much of the settlements, many hospitals that used the “scopes” during surgical procedures were also subject to significant costs and settlements.
- Catastrophes and Disasters. Highly publicized events that result in multiple injuries or deaths can lead to lawyers placing focus upon how to find enough assets to adequately compensate victims of the tragedy, regardless of the respective degrees of negligence. An example of this would be the Station Nightclub fire in Rhode Island (2003), which injured or killed more than 200 people. In this case, there were 65 defendants involved with the $176 million settlement. The nightclub, headlining band and others responsible for the pyrotechnics that started the fire paid a very small fraction of the settlement. Beverage distributors, TV and radio stations, and the manufacturers and installers of the foam that enhanced acoustics shouldered the majority of the settlement dollars.
- Environmental/Pollution Legal Liability. There are numerous claims where vendor work has led to substantial liability for property/business owners. Many of these instances involve indoor air quality issues arising from construction activity and defects, as well as HVAC installation and maintenance. In one of the more extreme examples, the deaths of three young cancer patients within a month of each other at a hospital in Tampa, Fla. were alleged to have resulted from toxic mold released from dust generated during a construction project.
There are many other downstream exposures, which might not involve bodily injury, but can result in unforeseen third-party related costs. Timely examples include: vendors that misuse client data; downstream reputational risk; and staffing agency exposures.
The risks associated with suppliers and vendors can result in significant, unanticipated costs. Risk management programs should include identification and analysis of exposures that could lead to downstream liability costs. These risks can be mitigated, but it is essential to go well beyond supplier audits and certificates of insurance.