As large retailers and other consumer products companies continue to replace research and development with mergers and acquisition activity in order to fuel growth, it is critical that acquirers in this industry perform robust due diligence on the product, brand or company that is the target of a potential acquisition. Failure to do so can prevent an acquirer from having the opportunity to adjust the transaction value or address the potential liability in the transaction documents.

The U.S. Consumer Product Safety Commission (CPSC) has recently taken an aggressive regulatory and enforcement approach with respect to product liability matters, and CPSC recalls and enforcement actions can have significant financial, public relations and litigation consequences to an acquirer. Properly conducting a due diligence review with respect to product quality and compliance with the Consumer Product Safety Act can help an acquirer understand any potential exposure and evaluate the overall quality of an investment and prevent an acquirer from inheriting a significant liability, either in the form of a product recall or a CPSC investigation and, as has become increasingly common, an enforcement action.

Several recent enforcement actions help highlight the need to conduct a proper CPSC due diligence review prior to acquiring a product, brand or company. In February 2018, the CPSC filed an administrative complaint against a global manufacturer of childcare safety equipment, alleging that certain models of its jogging strollers contained defects in their design that presented a substantial product hazard. The strollers that were the focus of the administrative complaint were not only those imported and distributed following a recent acquisition, but also those strollers imported and distributed by the acquired company between 1997 and the closing of the acquisition in December 2011. The administrative complaint seeks, among other things, an order that the manufacturer stop distributing various models of the strollers, notify the public of the defect and offer consumers a remedy that may include a repair, replacement or refund.

Similarly, in June 2016 an American tea company agreed to pay a civil penalty of $3.75 million to settle allegations that the company knowingly failed to report to the CPSC, as required by federal law, that its tea tumblers created an unreasonable risk of serious injury (the company had received numerous complaints about its tea tumblers unexpectedly shattering, exploding or breaking during normal use). While the tea company eventually recalled the tumblers in May 2013, its alleged failure to report this issue to the CPSC occurred prior to its acquisition by a global coffee and beverage company.

Another recent example relates to a consumer goods conglomerate's 2016 acquisition of a U.S. home appliances company and maker of a brand of coffee machines. In June 2016 the coffee machines brand reached a $4.5 million settlement with the CPSC related to allegations that it hid from the CPSC a defect in appliances that let steam build up and possibly shoot hot water toward users. The violations alleged by the CPSC occurred between 2011 and 2012, well before the consumer goods conglomerate acquired the home appliances company.

A multinational toy manufacturer was forced to recall over 9 million toys, including an iconic doll, over fears that the Chinese-made toys contained excessive levels of lead in their paint. The recall cost the manufacturer at least $30 million. In 2016, a Korean electronics manufacturer paid over $5 billion after recalling a smartphone due to its batteries catching fire. The manufacturer now also faces class action suits in three states for other phone versions for failing to adequately warn customers of similar battery hazards. In addition to the financial consequences of a product recall, companies that must recall a product can suffer major reputational damage and loss of brand equity. This is particularly true if competitors' products can easily replace the recalled products.

In order to minimize the risks of inheriting product liability matters in connection with an acquisition, an acquirer should review the target company's claims history with regard to its products. Many companies escalate adverse event incidents for special consideration of safety reporting obligations. Specific inquiry into a target's safety escalation records, including final disposition and communication from consumers, could uncover hidden regulatory and liability exposure. The acquirer should also evaluate the claims history of competitors (if possible), which can show a pattern of product defects and help forecast the likelihood of future claims in the relevant industry. Furthermore, an acquirer should review a comprehensive list of the target's product offerings, a summary of the results of all tests, studies and surveys regarding existing products and products under development, a record of the manufacturing specifications and designs for all products, as well as a list of all product recalls (and the costs involved) incurred by the target. While successfully implementing a thorough due diligence process cannot eliminate all risks inherent in an acquisition, it can minimize the likelihood that an acquirer is found responsible for a consumer products liability issue that arose prior to its acquisition.

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