Distributors selling private-labeled goods manufactured offshore have been closely watching the product recalls this summer by U.S. companies like the Mattel Toy Co.

Private-labeled goods have been profitable lines for some distributors. But if their agreements with overseas suppliers don't protect them from possible liabilities, those distributors could be leaving themselves open to damaging and expensive litigation, experts say.

Many private-labeled products are being produced offshore, mainly in China, where manufacturing costs are much lower than in the United States—the obvious appeal for American companies.

But businesses have to be cautious about falling in love too much with those dollar signs to the point of overlooking other, potentially litigious, concerns, says Allen Ray, principal of Allen Ray Associates, a Texas-based consulting company.

“For some reason, when someone goes offshore, the business sense seems to focus on cost and not [liability] protection,” Ray says. “We hear stories of sloppy agreements that don't protect anybody. And [distributors] are dealing with people who don't have financial assets here in the U.S. that can be subject to the [U.S.] legal system.”

This can be especially risky for small or medium-sized companies that are privately held, he says.

“There's a huge temptation to look at that significant reduction in cost,” Ray cautions. “And with the majority of distributors being privately owned and family owned, they could take a [liability] hit that could cripple them for life.”

Distributors that are selling private-labeled products imported from overseas need to focus on the overall picture and potential worst-case scenarios—not just financial savings.

“If you think you're going to find a quick buck, you really have to stop and think through the entire process and have a strategy,” adds David Gordon, principal of the Channel Marketing Group, a Raleigh, N.C. -based consulting firm. “If you're going to put your company at risk, or you're crafting a major strategy—and private labeling can be a major strategy—you have to dot your I's and cross your T's.”

Lessons can be learned from the mistakes of many companies, but Gordon cites Mattel's unique product line as carrying more weight with mainstream consumers and media than would most other items.

“Mattel is the straw that broke the camel's back,” Gordon says, referring to the unique combination of a toy being both well known and having an emotional factor—children.

“The lead paint is something that has high-visibility, high-consequence value,” he says. “Enough lead paint and you've got major issues.”

Though Gordon says lessons can be drawn from Mattel's difficulties, he adds that many of the products private labeled for the electrical industry, for example, carry far less emotional impact.

“[With] non-current producing products—if the products are effectively benign, as far as their consequential aspects, and they meet minimum quality standards—the issues won't be overly significant,” he explains.

He emphasizes due diligence and attention to detail. But he also says overseas goods have been used in the electrical industry for some time, with few, if any, negative consequences.

“I find it hard to believe everything coming out of China is going to be tainted when, in the electrical industry for example, 60 percent of the product comes in from overseas,” he says. “Are we going to say that all those products made by name-brand manufacturers are not quality?”

Larry Goode is president of RT/Dygert International, which imports O-rings and other elastomer seals manufactured in China. Since 2005, he has also been involved in American Supply in Asia, a domestic LLC joint venture between RT/Dygert and Patton Industrial Products.

Goode stresses the need for due diligence literally on a daily basis when using a foreign supplier—and a level of due diligence that is often complicated and more detailed than in the United States.

“Due diligence says you are checking, you are visiting, you are auditing, you are inspecting,” Goode says. “You are writing [specific] standards and communicating on a daily basis. I wouldn't call those 'best practices.' I'd call them standard practices. My company has daily correspondence [with China] on any number of issues. A lot of that daily correspondence relates to quality issues, customer service and quotes. We try to address those issues before they can become painful.”

Goode and his company also have longstanding relationships—some as long as two decades—with many of their overseas vendors.

“That way, we know the many levels of their organization—so we're not just dealing with 'the boss.' We deal with the quality manager or people down the line closer to where any problem might originate,” Goode explains.

Goode and his colleagues visit China annually, if not more frequently, to do on-site audits verifying that the agreed-to systems are in place. They can also get a feel for what changes, if any, might be needed. He has confidence in his methods but admits that no system is perfect.

“We also do a very stringent incoming inspection process where we look at dimensional and physical properties of our products to make sure they are made to the original standards that we established,” he says. “And even then, it looks like Mattel was probably doing the same thing, but it seemed like that wasn't enough.”

As of early September, Mattel had recalled nearly 10 million Chinese-made toys from the United States. In addition to the lead paint, some toys were found to contain small magnets that could break off and potentially be swallowed by small children.

The toy recall was the latest in a series of recalls of Chinese-manufactured goods this year that have included pet food, laptop batteries and contact lens solution.

“Any distributor at this stage that is sourcing product from China has probably lost a little sleep,” Goode admits.

Distributors should not let their being “only” small or medium sized give them a sense of “why worry” as far as repercussions, legal or otherwise. Goode adds that even though his product line may not be as well known as the Barbie Doll, he still has to be on guard.

“I supply a component that's far down on the food chain,” he explains. “But frankly, if my O-ring fails and there's a worker sitting over a high-tension electrical [wire] whose life is at stake, my name could be on the nightly news if a severe enough tragedy as that took place.”

The causes and reasons for the recent recalls vary. One contributing factor is the enormous size of the supply chain in China. Many times, once you get past the primary supplier, that supply chain can take a number of twists and turns.

This can potentially impact any company, even if it is not large or as well known as a Mattel.

Grace Parke Fremlin, partner in the Washington-based law firm Steptoe & Johnson, cautions that not enough attention and diligence is paid to the entire supply chain in China once things get past that primary supplier.

This was part of the problem that Mattel faced in China, where sub-contractors used lead paint rather than the paint that had been approved by Mattel.

“Most of the recalls occurred not with the direct supplier to Mattel, but with a sub-contractor or a materials supplier,” Fremlin says. “In most cases, not enough attention is being paid to the entire supply chain, past that first supplier.”

Fremlin is a member of her firm's International Department and an authority in cross-border contracts and litigation. In some companies, she says, there is a lack of consistent contact between the sales department and the legal department—communication that is essential when doing business overseas.

“There has to be more talk between the business people in U.S. companies and their general counsels,” Fremlin says. “Legal counsel needs to understand they must be more involved in the purchasing, and the purchasing departments need to understand that legal needs to be more involved in handling this.”

Fremlin also recommends more thorough and consistent record keeping when looking to China. Some companies have been known to use only a purchase order, rather than a more formal legal agreement, when dealing with China—a risky approach, she says.

Paying attention to detail—every detail—is the message distributors should be heeding, experts say, especially if they engage in private labeling.

“If [details] aren't being followed assiduously, then you as a distributor are at risk of creating a potential news item that you don't want to be a part of,” Goode says.