Month: July 2013

The issue of product liability is a true legal thorn bush. Manufacturers, who fail to understand how liability can impact in bringing a new product to market, are apt to find themselves nicked by the thorns.

There are three ways that a manufacturer can be held liable: strict liability, negligence, or breach of warranty. Strict liability means that a manufacturer is responsible for injuries caused by a product whose defect makes it unreasonably dangerous, despite the fact that they exercised reasonable care in its development.

If a manufacturer is accused of negligence, it means that they did not act with reasonable care in making sure the product was safe. The most important difference between strict liability and negligence is that if a manufacturer is charged with negligence, they will not be held liable if they took reasonable care to look for defects and to avoid them. However, if a manufacturer is charged with strict liability, that fact that an unreasonably dangerous defect exists in the product means that no matter how much care they exercised in its creation, they are still liable.

A breach of warranty is a determination that an assurance or promise about the quality of a product is proven false; that is, the product is defective or not in the condition a reasonable buyer would expect it to be in. The party making the warranty, the manufacturer, is liable to the party to whom the warranty was made, the purchaser. A warranty can be expressed in the description of the product such as describing a piece of clothing as colorfast. An implied warranty means that the buyer can assume certain assurances about the product to be true unless other wise stated. That’s why furniture that is used as a floor model is sold “as is.” There would normally be an implied warranty that the furniture is without nicks or dents. However, by adding the phrase “as is” to the sale tag, it removes the implied warranty.

As a product manufacturer, you also need to be aware of the three different types of defects. The first is the manufacturing defect. This stems from the way a product was made, as opposed to the way it was designed or labeled. An iron that doesn’t get hot enough to take the wrinkles out of cotton clothing is an example of a manufacturing defect.

A design defect is one that is arises from the way a product was designed, rather than the way it was made or labeled. For example, if an auto maker manufactures a vehicle that is so lightweight it’s likely to rollover in a collision, that is an example of a design defect.

A product may also be defective if a manufacturer fails to adequately warn consumers about risks involved in using it that aren’t immediately obvious. The failure to warn defect, as this is called, is the foundation of a number of cases brought against many of the major pharmaceutical companies over the last few years.

Manufacturing defects, design defects, or inadequate warnings are not the only ways a product can be considered defective. A product may be deemed defective if it fails to meet minimum legal standards for a product. However, even if a product does meet minimum legal standards, that does not usually protect a manufacturer from liability.

It’s important to remember that the type of negligence will influence the calculation of damages. In strict liability and breach of warranty cases, damages are limited to compensatory damages. While in negligence suits, the defendant can be awarded both compensatory and punitive damages.

If you are an employer who has received an experience modification rating, it is imperative that you understand how it affects your workers’ compensation premium calculations to make your rating work in your favor.

Workers’ compensation coverage is known as a class rated insurance program. That means that an insurance company gives all employers within a state who fall into a given industry or class the same rate. This is an average rate which doesn’t take into consideration any individual characteristics of the employer. Since policy premiums are affected by the individual factors surrounding the business, carriers need a statistical method of differentiating one business in a given class from another. This is what an experience rating offers.

The experience modification rating is calculated individually for each employer who qualifies. In order to qualify, you would need to pay a premium in excess of $10,000 or a 3-year average premium of $5,000, depending on the state. The modification rating is a value that compares the claim profile of the employer to the claim profile that would be expected of an employer of similar payroll size in the same industry or class code. In this system, 1.00 is average, meaning the frequency and severity of the actual employer’s losses is equal to what the carrier would expect the employer to lose. A rating greater than 1.00 means the employer has experienced worse than expected losses during the rating period, and a rating of less than 1.00 indicates the employer experienced better than expected losses for the rating period.

An employer’s experience modification rating is calculated using claims data from the three most recently completed years. The current calendar year would be excluded because it would not give a full picture of the year’s losses.

Each claim’s paid and reserved value is listed. Then the frequency of claims is evaluated. An organization with only one large claim will be looked on more favorably than a second one with numerous smaller claims even if both companies’ losses are of equal dollar value. Since the second company is more prone to claims, for any claim over the highest dollar value claim, only a fraction of the amount in excess of that dollar value is used in the calculation. Also, in some states only a percent of the medical only claims are used in the formula. These adjusted claims are compared to the expected losses for the industry class and payroll size of the organization, and an experience modification rating is given to the individual employer. A rating that is less than 1.00 will reduce the company’s premium, while a rating that is greater than 1.00 will increase it.

Obviously, a company will want to find ways to lower their rating. One method a company shouldn’t try is to manipulate class codes when they are obtaining a policy in an effort to get the most payroll into the lowest rated class. This may actually raise the experience modification rating in the long run.

Because the rating is calculated from a comparison of actual losses versus expected losses, allocating payroll to less risky classifications will also put you in line for expected losses that are far lower than what you realistically experience. This increases the likelihood that your actual losses will be greater than expected for the classification, leading to a higher rating in the future. The best way to decrease your rating is to make safety a priority, which will eliminate losses and save you money in the long run.

No recent law has received as much attention as the enactment of the Sarbanes-Oxley Act. Although it was passed in 2002, the financial transparency issues it raises are still being discussed and debated three years later. Every industry has had its problems with interpretation and certainly, construction is no exception. Sarbanes-Oxley has cast a new light on the function of the internal audit department in any publicly held construction firm.

The center of all the controversy is Section 404. It requires companies that file annual reports with the SEC to discuss management’s responsibilities to develop and maintain adequate internal control over the company’s financial reporting process. As if that weren’t enough, the law also requires management to perform a self-assessment of the effectiveness of those internal controls. The process of scrutinizing financial reporting mandates that internal audits go beyond the usual definitions of loss prevention to take a much broader view of the company’s financial health.

This broader vision actually breaks down into a few different areas. The first is recognizing the growing demand for management’s accountability regarding capital stewardship. Internal audits should assume a more proactive role when it comes to providing decision support data. Accurate project scope definitions and cost/effort estimation models that are completed before a contract is finalized, and exemplify a project’s real cost and schedule to complete, will provide management the ability to make an informed decision about whether or not to proceed. Completing a scope definition midway through a project with a change order is an expensive fix for perceived risks that only weaken the firm’s financial state.

Internal audits need to have a watchful eye when it comes to assessing a project’s risk impact on the company’s capital reserves. It is no longer sufficient to assign a standard percentage of the contract’s value to allow for unforeseen events. There needs to be real transparency as to what the perceived risks are and their potential impact on the company’s finances in dollars and cents.

Along with the assessment of risk comes the allocation of risk. One of the biggest hindrances to management’s capital stewardship is inadequate contractual allocation of risk. For example, the firm failing to assign risks to those projects best suited by virtue of their operating margin or the nature of the firm’s expertise. An internal audit is needed to verify the firm’s contractual risks are well within its ability to maintain them without seriously impacting the firm’s capability to complete the project within budget and on time.

While these areas are not really new to internal auditing, the one area of uncharted waters is the company’s potential risks and costs associated with environmental, health, and safety issues. This is the area where Section 404 has made the biggest impact, by requiring increased transparency in reporting these risks.

Any activity the firm undertakes, whether a new project, retooling to become more competitive, or modifying a facility to accept a more diverse range of projects, will have some environmental, health and safety issues attached to it. Ensuring that solid internal controls are in place can minimize the potential impact of these issues. When internal audits consistently monitor these controls, company profitability is protected by reducing environmental, health and safety liabilities.

To that end, internal auditing needs to fully understand the company’s environmental, health and safety policies and how they are integrated with internal controls. Audit teams also need to review compliance documentation. Such documentation includes environmental, health and safety policies, procedures, checklists and training programs. Audit teams need to take a proactive stance by observing the system of controls to see if they work and making recommendations to management about areas that need improvement.