Managing Foreign Supply Chains to Avoid Importing Risk

The global economy has caused supply chains to grow in complexity. Often, the manufacturer or distributor of a finished product is located in the United States, while the companies that provide its component parts or assemble the product are abroad. Recently, many medical device manufacturers have been shifting some of their operations overseas to reap the cost benefits associated with doing business abroad. To locate comparatively inexpensive raw ingredients and component parts and to avoid the stringent regulatory requirements imposed on medical devices manufacturers in the United States, some companies are looking to foreign markets.1 However, the perceived advantages of this strategy may be short-lived without proper control over their foreign supply chains. Managing suppliers and preventing supply-chain failures is particularly important for the manufacturers of medical devices because of the potential risk that many products pose to their end-users.

While FDA is the designated official guardian of the public health when it comes to overseeing the development, production, and delivery of medical devices in the United States, its power and resources are relatively limited abroad. Several well-publicized incidents involving contaminated products that entered the U.S. market from abroad—many related to food and other consumer goods—have put the spotlight on foreign suppliers as well as the U.S. companies that do business with them. A study released in May 2009 found that although a substantial number of financial executives recognize global sourcing activities place their companies at greater risk and a solid majority expect global sourcing to increase during the next three years, many feel a lack of control over their supply chain partners’ risk management practices.2

Although the public is clamoring for greater government control over foreign suppliers, there are serious products liability concerns associated with supply-chain failures that cannot be addressed by the current regulatory scheme. Instead, it is up to U.S. companies to step up their efforts to ensure the safety of the products they import to avoid costly products liability litigation. This article examines foreign suppliers—the extent of FDA's control over them and the products liability implications of doing business with them—and suggests several strategies for maintaining greater control over your foreign supply chain.

Limited Product Oversight

By law, FDA is required to inspect domestic manufacturers of Class II and Class III medical devices every two years.3 There is no comparable requirement for the inspection of foreign companies. As a result, only about 10% of registered foreign manufacturers are inspected in a given year, according to the U.S. Government Accountability Office (GAO) in a report dated September 2010.4 The GAO estimated that at that rate, it would take the FDA about 13 years to inspect all such establishments, and that is assuming that no new manufacturers spring up in that time.

Factors Contributing to Low Inspection Rates. The low rate of FDA inspections abroad has been attributed to several factors, including budgetary constraints, language barriers, and hazards and logistical struggles associated with foreign travel. In addition, the GAO determined that FDA relies on inconsistent or unreliable data about foreign companies. Such data can be traced to limitations in FDA's information technology infrastructure, which makes it difficult for the agency to keep track of manufacturers and suppliers located abroad.5 Additionally, it can be challenging for FDA to exercise authority abroad because it faces limits on its ability to require foreign establishments to allow it to inspect their facilities, and FDA is often prevented from conducting unannounced inspections like those to which it subjects domestic establishments.6 In some countries, FDA must first obtain approval from the relevant governmental authority before it may enter a company's facility to perform an inspection.

When a foreign company denies FDA access to a facility, the agency must rely on U.S. import controls as a backstop to allowing the product into the country uninspected.7 This is not much of a backstop, however, as FDA inspects less than 1% of all imports when they arrive at the more than 150 U.S. ports of entry.

Recent incidents involving contaminated products by foreign suppliers have put the spotlight on FDA's track record for foreign inspections. To borrow an example from the world of pharmaceuticals, Baxter International issued a voluntary recall of heparin, an anticoagulant drug, as a result of contamination by a foreign supplier. In January 2008, the Centers for Disease Control and Prevention (CDC) began investigating clusters of patients who reported experiencing serious allergic reactions and severe hypotension after receiving heparin at dialysis centers.

Ultimately, it was determined that the adverse reactions were caused by a contaminant—oversulfated chondroitin sulfate—a man-made chemical compound, which was introduced into the manufacturing process by a supplier located in China. The contaminated heparin was linked to 81 deaths and 785 severe allergic reactions. At a hearing before the House Subcommittee on Oversight and Investigations, FDA was scrutinized for failing to inspect the Chinese facility until after the contamination had occurred. 

Increasing Efforts Abroad. The volume of imports regulated by FDA has more-than-doubled since 2003.8 The influx of foreign products, as well as incidents similar to the heparin contamination have put increasing pressure on FDA from Congress and the public to ramp up efforts abroad. In response, FDA has focused on increasing the number of foreign inspections it performs.

Additionally, it launched the Beyond Our Borders initiative to increase collaboration with its foreign counterparts and enhance technical cooperation with foreign regulators. The initiative has been described by FDA as the first step toward a larger overhaul of the global import safety system.9

In November 2008, as part of the initiative, FDA deployed staff to China to work directly with importers and foreign regulatory agencies and to conduct inspections. As of July 2010, the date of the GAO’s most recent report, FDA’s plan to further expand its presence overseas had been largely successful. The agency currently has 43 staff members assigned to the overseas offices FDA has also placed investigators in China and India to conduct inspections. One of the main goals of FDA’s newly-established offices abroad has been to develop relationships with foreign stakeholders, as well as the local regulatory agencies and other U.S. federal agencies located overseas. The GAO reported in 2010 that the FDA had made some progress toward this end. However, FDA’s overseas officials have reported that this relationship-building is taking much longer than expected and they continue to face challenges that inhibit the forming of these relationships.  

Concern over Importer Practices. FDA is also addressing import safety by focusing on the U.S. companies that import the products. In early 2009, FDA, in collaboration with several other U.S. regulatory agencies, issued draft guidance for importers. Titled Good Importer Practices, the document recommends procedures that U.S. companies can implement to ensure that they import only those products that comply with applicable U.S. safety and security requirements. For example, to ensure appropriate oversight of imported products, FDA recommends that a domestic company establish a product safety management program. U.S. companies should also develop sufficient knowledge of the regulatory framework that governs the product in its country of production as well as in the United States. The guidance also asks U.S. importers to verify a product's compliance with U.S. requirements throughout the supply chain and product life cycle. 

It is important to note that the scope of the guidance is limited. It purports only to assist U.S. companies with importing products that are compliant with applicable U.S. regulations. This means that U.S. companies must identify other possible exposures, such as potential products liability problems, and implement the necessary safeguards. 

While FDA has made serious strides in its audit and enforcement efforts abroad, the responsibility still lies squarely on U.S. companies to ensure the quality of their foreign suppliers.

Products Liability Exposures

Ultimately, U.S. companies may be held responsible for any products liability claims that arise from goods provided by foreign suppliers. When a product causes injury, all members of the product's supply chain are subject to being named in the lawsuit brought by the plaintiff. As a practical matter, the U.S.-based importer of the finished product—the company that puts its logo on the product's packaging—is most likely to be the first party named in the suit. It is usually the party most readily identifiable by the plaintiff. The plaintiff also may bring component part or ingredient suppliers into the suit, if those parties can be identified. 

However, the legal complications involved in suing a foreign company in a U.S. court may allow a foreign member of the supply chain to escape being sued altogether. It can be difficult for a plaintiff to serve a foreign company with process or provide the foreign company with the required legal notice that it is being sued. Therefore, only the U.S. companies associated with the product may be brought into the suit, even though liability may have originated with a foreign member of the supply chain.

In some states, if a product's manufacturer is not subject to service of process, imputed liability statutes provide that the U.S. company that sells the finished product can be sued for the product's defect. That is the law, even if the U.S. company has no direct responsibility for the defect and it played no role in the design, manufacture, or labeling of the product.6 In short, the U.S. importer of a foreign-made product can stand in the shoes of the foreign supplier, because the supplier cannot be brought into the lawsuit. Because U.S. companies potentially bear the burden of litigation, they may be importing liability along with the products they receive from foreign suppliers. 

While liability can be created as a result of membership in a supply chain, litigation can be spurred by the public attention that is attracted by problems with contaminated products. For example, following the heparin contamination recall and investigation, the plaintiffs' bar sought to drum up business with an advertising campaign for legal services. The campaign was targeted at patients who claimed to have received the contaminated drug. The same is true for the users of other products that have recently been in the news as a result of problems that originated with foreign suppliers. A simple Web search pulls up numerous sites dedicated to locating these potential plaintiffs. Invariably, the sites implore the alleged victims (or their families) to take immediate action against the U.S. companies that imported the tainted products.

Managing Potential Supplier Problems

Because U.S. companies can be held responsible for the actions (or inactions) of their foreign suppliers, both from a regulatory and a products liability perspective, it is imperative for them to maintain proper control over their supply chains. Namely, U.S. companies must structure their relationships with suppliers to allow them to keep a close watch on the ingredients, processes, and procedures that are involved in the manufacture of the products they import. 

Improve Supplier Qualification Practices. During the supplier qualification process, many companies fail to perform basic investigations of their potential suppliers to verify their performance records. A U.S. company should begin by reviewing any information available from FDA and the foreign regulatory body with direct authority over the supplier. The GAO determined that the vast majority of the foreign inspections that were performed in recent years were for post-market purposes. The inspections evaluated quality management systems for compliance with good manufacturing practices, adverse-event reporting requirements, and other mandated procedures, or to follow up on specific information that raised questions about particular facilities. If a foreign supplier received such an inspection, the information obtained by FDA can be a valuable part of the due diligence that a U.S. company should request and review prior to doing business with the supplier. 

Regardless of whether FDA has performed an inspection, U.S. companies should conduct their own on-site evaluations of supplier facilities. Particularly for critical parts and components, an on-site inspection can help a U.S. company determine whether the foreign supplier has the necessary infrastructure to meet the specific needs of the job. Information, such as certifications and references, which can come from the supplier directly, may also provide valuable information. Inspections must be conducted early in the relationship, preferably before the U.S. company begins importing the product. 

Expand the Use of Audit Procedures. The draft guidance on Good Importer Practices advises U.S. companies to audit their foreign suppliers. However, the guidance does not impose legal requirements on U.S. companies (and will not impose legal requirements even after the draft guidance is eventually finalized). Rather, the document states that “readers should view [its contents] only as recommendations.” There is no regulatory requirement that U.S. companies audit their foreign suppliers. From a products liability standpoint, audits of foreign suppliers are necessary to ensure that potential liabilities are not created during the manufacturing process. 

U.S. companies should verify with ongoing audits that suppliers continue to meet quality and design specifications. An audit program should be risk based—meaning the extent of the risk associated with the product should determine the audit procedures used to keep tabs on its quality and production. If the potential risk for a product is low, then supplier-conducted surveys (i.e., self-audits) may be appropriate. For higher-risk products, U.S. companies will often use independent third parties to evaluate the risks associated with the product. In some instances, a U.S. company may choose to locate personnel in the foreign supplier's facility to oversee critical operations. 

Verify Supply Chain Integrity and Safety. Too frequently, U.S. companies fail to investigate the length of their supply chains. Instead, they examine only the foreign suppliers that ultimately export the products to them. It is important for U.S. companies to verify that all links in the supply chain (i.e., their second-tier suppliers) are compliant with good manufacturing practices and provide quality products. Following its inspection of the Chinese facility involved in the heparin contamination, FDA issued a warning letter to the facility for its failure to keep tabs on its suppliers, among other violations. In the letter, FDA stated, “Your system for evaluating suppliers of crude heparin material is ineffective to ensure that materials are acceptable for use…Suppliers should be monitored and regularly scrutinized to assure ongoing reliability.”

FDA's findings were consistent with the results of Baxter's own investigation, which determined that the contamination originated not with the Chinese facility that immediately exported the crude heparin to Baxter but with its supplier's supplier somewhere down the supply chain. Given the nature of U.S. products liability law, which holds the U.S. importer responsible for injuries that originate anywhere along the supply chain, it is ultimately the responsibility of the U.S. importer to verify the integrity and safety of all of its suppliers. 

Shifting Risk Back to the Supplier. One of the most important things a U.S. company can do before it does business with a foreign supplier is to negotiate and enter into a contractual agreement. The very act of negotiating the contract is important to ensuring that both parties—the U.S. company and the foreign supplier—understand the requirements and specifications of the job. Among other things, the contract should name the party that will be responsible for recalls and other post-market activities, the insurance requirements for each party, and the quality requirements that the supplier must meet. Also important is the type of notification (i.e., when and how) the supplier will provide to the U.S. company any change to its manufacturing processes or component parts or ingredients. 

A U.S. company may include a cooperation clause in the contracts, which requires the foreign supplier to cooperate with any investigations conducted by the U.S. company or FDA. Finally, it is important to include an indemnification agreement in the contract, which may enable a U.S. company to shift risk back to the foreign supplier. A foreign supplier that agrees to indemnify a U.S. company becomes contractually liable for any damages that arise from the products it supplies.

How the parties structure their agreement depends on the unique facts involved, which underscores the need for parties to seek legal assistance when negotiating these agreements. In particular, U.S. companies should seek legal assistance from attorneys who are experienced in drafting contracts between multinational parties since agreements may involve foreign laws. As noted previously, it can be challenging to bring a lawsuit against a foreign company. An experienced attorney can help a U.S. company draft a contract that can be enforced successfully in a U.S. court. Sometimes, a foreign supplier's connections to the United States can be surprising. Depending on what preexisting relationships a foreign supplier has with other U.S. companies, it may be easier than it first appears to negotiate and enforce a contract with a foreign supplier. Regardless, laying out each party’s duties and responsibilities ahead of time is always the best practice, because it ensures that each party understands the expectations of the relationship.

Conclusion

A U.S. company should not wait for FDA to enhance its authority abroad before it begins to exert greater control over its foreign suppliers. The products liability threats that lurk in supply chains are reason enough for U.S. companies to step up their oversight efforts. In general, a U.S. company must seek greater transparency in its relationships with suppliers. That can be done through enhanced supplier qualification and audit procedures that cover the length of the supply chain and contracts with its suppliers. The products liability costs associated with supply-chain failures justify making these oversight activities a top priority for U.S. companies.

1 Fuerst Ittleman, PL: “Medical Device Manufacturers Seek Quick Approval Overseas” (February 2011).

2 FM Global and Harris Interactive Inc.: “Physical Risks to the Supply Chain: The View from Finance” (May 2009).

3 See 21 U.S.C. § 360(h), (i)(3).

4 Government Accountability Office, Report to the Committee on Oversight and Government Reform, House of Representatives: “FDA Overseas Offices have Taken Steps to Help Ensure Import Safety, but More Long-Term Planning is Needed” (September 30, 2010).

5 According to the 2010 GAO Report to the Committee on Oversight and Government Reform, “Overseas Offices Have Taken Steps to Help Ensure Import Safety, but More Long-Term Planning is Needed,” the algorithm used by customs brokers to assign the manufacturer identification number does not provide for a number that is reliably reproduced or inherently unique. Consequently, FDA officials have acknowledged that multiple records may be created for a single establishment, resulting in an inflated and overall inaccurate count of foreign manufacturers.

6 GAO: “FDA Faces Challenges Overseeing the Foreign Drug Manufacturing Supply Chain,” Testimony before the Committee on Health, Education, Labor, and Pensions, U.S. Senate (September 14, 2011).

7 A von Eschenbach (FDA commissioner), testimony before the Committee on Energy and Commerce, Subcommittee on Oversight and Investigations, House of Representatives (November 1, 2007). 

8 FDA: “FDA Beyond Our Borders,” FDA Consumer Health Information (December 9, 2008). 

9 E Zalud and C Taft: “Tracking Foreign Manufacturers to Obviate Liability,” in For the Defense (December 2008). 

This article was adapted from an article originally authored by Sara Dyson and published on August 1, 2009, for Medical Device and Diagnostic Industry, available at www.mddionline.com. This article is not intended as legal advice and does not constitute legal advice. It does not create an attorney/client relationship and is intended to provide only general, educational, non-specific legal information. It is not intended to cover all the issues related to the topic discussed. 

Sara E. Dyson is Vice President of Underwriting Operations and Risk Management for Medmarc Insurance Group.