Friday, September 9, 2011

Disposing Excess and Obsolete Material From a Contracts Perspective

Many companies consider selling or bartering excess or obsolete material to reduce the inventory levels and free up cash. Sounds like a great idea, but it isn’t without potential problems and risks that you should be aware of if you consider it.

First, you should always consider the potential product liability risk that is inherent in the product or with different potential uses of the product. Since you are functioning as a seller that puts you in the sales chain where you can be potentially liable under product liability claims if there is personal injury or property damage caused by the product.

Second, unless you specifically control how it can be used and where it can be used the subsequently use of the product could increase the potential risk and magnitude of the liability. You know how you used the item and the design tolerances that you had. You don’t know how the item purchased will be used or what their design tolerances will be. You purchased the item for use in a specific application. You don’t know what application it will be used in and there are many applications that can be much higher risk. For example if you sell the item to a broker and the broker sells it into a medical products company that makes life support systems, your potential risk is dramatically increased.

Third, you always need to read the terms and conditions and specifications that you purchased the item under.Those will identify whether you can pass thru any of the commitments you received from the supplier. They may also have included restrictions on use that would void any commitment to you if the product were used in one of those restricted uses. Many times suppliers do not allow you to pass anything thru to your customers or may prohibit the resale of the items.

To put the issues into perspective consider the following scenario. The Supplier you purchased from specifically prohibits use in certain applications in their terms to you. You sell the product to a Broker. The Broker sells it into one of those uses. The product fails and individuals are injured. The injured party will sue everyone that was involved in the process.
They sue the party that used it to make the product for high risk use, they sue the broker,they sue you, and they sue the original supplier. The company that made the high risk product is small with little assets. The broker has minimal assets. Your company and the Supplier's company have substantial assets. So paying the claim comes down to you or the original supplier.But you breached your agreement with the Supplier because you either resold it when you weren't allowed to or you allowed it to be resold into a restricted use. This means that you lose the contract protections you had from the Supplier for product liability, and you will be responsible to them for damages they sustain because of your breach of the agreement.Those damages will include those third party liability claims.

Fourth, you need to decide the sales terms that you will sell to the purchaser under. Most of the time since the supplier won’t allow you to pass any of their commitments thru and you won’t want to be assuming risk or liability on those sales. That means the sales will be done as-is, without any warranties or indemnities. That will provide protection against claims from purchaser claims, but it does not protect you against third party product liability claims. Those can’t be disclaimed in most jurisdictions. Since you are now functioning as the seller rather than the buyer you also need to manage all the issues a sales function traditionally deals with such as receivables, refunds for damaged or defective product shipped.

Fifth, I would never sell off any excess item that was proprietary to your company. All that could do is potentially provide a third party with what they may need to compete with you in servicing or repairing your product that used the item.

The alternative to all of this and this is the first step I would recommend is always try to sell it back to the original supplier even if it’s at a significant discount. If the Supplier has demand for the product they won't want you dumping a large quantity of excess on the market as it could depress their sales. You might also get more than if you tried to sell the excess. Buyers will pay a higher price to purchase it because the supplier will offer the full terms. Suppliers will also be happier because they can control who it’s sold to and where it will be used to manage their potential product liability.

Before I would head too far down the road on selling excess material I would talk to your lawyer and get their input and the sales terms they recommend for those sales. What they will want to understand is the trade-off that needs to be made between getting the proceeds of the sale versus assuming the potential additional risks from the sale.There will be some items that may be easily resold that have minimum risk and there will be other items that can be common across many industries where use in those other industries would be high risk. Electronic components is one of those areas where that clearly is a concern.