THE ABUSE OF WARRANTY LAW
AS A CONTRIBUTING FACTOR
TO CONSUMER PRQBLEMS

's'hesis far the Degree of Ph. D.
MICHEGAN STATE UHWERSITY
MIQKAEL SUESHENE
1973

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thesis entitled
THE ABUSE OF WARRANTY LAW AS A CONTRIBU-
TING FACTOR TO CONSUMER PROBLEMS

presented by
Michael Sunshine

has been accepted towards fulfillment
of the requirements for

Ph.D. degreein A2. Econ.

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Major professor

Date A I 1-3

 

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JAN 1 1 1999

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ABSTRACT

THE ABUSE OF WARRANTY LAW AS A CONTRIBUTING
FACTOR TO CONSUMER PROBLEMS
BY

Michael Sunshine

This study is a formulation of a general theory of
consumer problems with durable products. The argument
assumes the existence of deceptive behavior by sellers.
Following traditional economic theory this behavior is
assumed to exist because such behavior is profitable.

The central task of this study is to determine the features
of the commercial environment which make such behavior
profitable. This study proposes that two sections of the
Uniform Commercial Code, the basic commercial law in 49
states, sets the framework for making deceptive behavior
profitable. These provisions allow the exclusion of
traditional warranties by means of a contract under the
freedom of contract doctrine.

The demonstration of the illusionary nature of the
freedom consumers actually have under this doctrine and
the failure of its presuppositions to exist form the base
of the policy recommendation of this study. The recom—
mendations are that the exclusions of traditional
warranties as allowed in the Uniform Commercial Code not

be allowed in consumer transactions. The study concludes

Michael Sunshine

with a consideration of changes in the law in several
states, proposed Federal legislation and with an analysis

of the likely effects of the implementation of such a

policy.

THE ABUSE OF WARRANTY LAW AS A CONTRIBUTING

FACTOR TO CONSUMER PROBLEMS

By a;

l
a .11' "' ‘

H”‘

Michael Sunshine

A THESIS

Submitted to
Michigan State University
in partial fulfillment of the requirements

for the degree of
DOCTOR OF PHILOSOPHY
Department of Agricultural Economics

1973

©Copyright by
MICHAEL RONALD SUNSHINE

1973

ACKNOWLEDGMENTS

Writing a dissertation is a very frustrating
experience. This thesis exists largely because of
encouragement at critical times from Dr. Hendrik
Zwarensteyn. Professor Zwarensteyn's aid came as a
teacher of business law, a patient force controlling my
tendency to extrapolate and as an author of a very handy
quick reference to law. Dr. Allan Schmid's desire for ties
to the real world required many appropriate changes in my
theoretical conclusions. Dr. James Bonnen made a valiant,
if not fully successful, effort to control my tendency to
use a rather heavy style and to leave out steps in my
reasoning.

This dissertation was written with considerably more
freedom than is usually allowed. My committee did not
require that I agree with them, but rather that I defend
my position. While it is customary for authors to exclude
those who provided aid from responsibility for errors,
such a disclaimer is especially appropriate here. None
of those who aided me in this project are in anything

approaching complete agreement with the conclusions.

ii

TABLE OF CONTENTS

Chapter
INTRODUCTION. . . . . . . . . . . . . . . .
Seriousness of Problem. . . . . . . . . .
Structure of the Problem. . . . . . . . .
Problems of Evaluation. . . . . . . . . .
ONE WARRANTIES. . . . . . . . . . . . . . . . .
Nature of a Consumer Problem. . . . . . .
Expectations and the Uniform Commercial
Code. . . . . . . . . . . . . . . . . . .
a. Implied Warranty . . . . . . . . . .
b. Reasonability. . . . . . . . . . . .
c. Express Warranties . . . . . . . . .
TWO TRADITIONAL WARRANTIES AS A CONSUMER
PROTECTION POLICY . . . . . . . . . . . . .
Contract Law. . . . . . . . . . . . . . .
Competition and Contracts . . . . . . . .
Negotiation of Contracts. . . . . . . . .
Contract Adjustments. . . . . . . . . . .
Automobile Experience . . . . . . . .
Policy Implications of Requiring Effective
Warranties. . . . . . . . . . . . . .
Absolute Liability as a Policy -
Workmen' 5 Compensation. . . . . . . . . .
The Relationship Between Workmen's
Compensation and Consumer Protection. . .
Evaluation of Consumer Protection
Policies. . . . . . . . . . . . . . . . .
THREE TRADITIONAL BUYER PROTECTION AS A PRACTICAL
POLICY FOR PURCHASERS OF DURABLE PRODUCTS .
Expectations. . . . . . . . . . . . . . .
The Solution. . . . . . . . . . . . . . .
Product Variety . . . . . . . . . . . . .
Enforcement . . . . . . . . . . . . . . .
Administrative Agencies . . . . . . . . .
The Ombudsman . . . . . . . . . . . . . .
Judicial Strain . . . . . . . . . . . . .
Product Innovation. . . . . . . . . . . .
The Role of Small Claims Courts . . . . .

iii

Page

GNU-J00

l3
13

18
19
21
27

35

35
38
41
47
48

S7
59
66

67

78

79
81
86
89
92
94
96
99
104

Chapter Page
FOUR RECENT CHANGES IN WARRANTY LAW. . . . . . . 114

Court Action. . . . . . . . . . . . . . 116
Proposed Federal Legislation. . . . . . . 119
State Legislation Passed. . . . . . . . . 120
General Trend . . . . . . . . . . . . . . 124

FIVE THE ECONOMIC SIGNIFICANCE OF REQUIRED
WARRANTIES. . . . . . . . . . . . . . . . . 128

Effects of Workmen's Compensation

Legislation . . . . . . . . . . . . . 129
Effects of Requiring the Traditional
Warranties in Consumer Transactions . . . 135
Voluntary Warranties. . . . . . . . . . . 145
Effect on the Poor. . . . . . . . . . . . 148
Summary . . . . . . . . . . . . . . . . . 149

LIST OF REFERENCES 0 O O O O O O O O O O O O 160

iv

LIST OF TABLES

Table Page
1 U. S. Car Production. . . . . . . . . . . . 50
2 Industrial Fatalities . . . . . . . . . . . 61

INTRODUCTION

"The view has been gaining widespread acceptance
that corporate officials and labor leaders have a
'social responsibility' that goes beyond serving the
interests of their stockholders or their members. . . .
In . . . (a free economy) there is one and only one
social responsibility of business--to use its resources
and engage in activities designed to increase its pro-
fits so long as it stays within the rules of the game,
which is to say, engages in open and free competition,
without deception or fraud. . . . It is the responsi-
bility of the rest of us to establish a framework of
law such that the individual in pursuing his own
interest is, to quote Adam Smith, 'led by an invisible
hand to promote an end which was no part of his
intention. . . . '"

The study which follows analyzes the nature of con-
sumer problems with misrepresented products and proposes
a change in a few of the legal rules which regulate
commerce to yield better performance by manufacturers as
they try to maximize their profits. The present commercial
environment of manufacturers allows the industrial perform-
ance which currently exists. The doctrine of freedom of
contract holds that individuals should be allowed to enter
any agreement which they find mutually satisfactory. This
policy presupposes that individuals can meaningfully
negotiate their agreements.
"The traditional contract is the result of free
bargaining of the parties who are brought together by
the play of the market, and who meet each other on a
footing of approximate economic equality. In such a

society there is no danger that freedom of contract
will be a threat to social order as a whole."

If individuals cannot negotiate their agreements, then a
policy which assumes that they can may lead to very
undesirable results. This study argues that the assumption
of the doctrine of freedom of contract needed to justify
this policy is not generally encountered in the market for
consumer goods, and that the results are often unfortunate.
The current commercial environment is a distortion of the
doctrine of freedom of contract which is used for its
justification. The commercial environment and the
resulting deception of consumers and the production of
goods and services which do not function as a reasonable
consumer would expect are neither necessary nor desirable.
At issue is the incidence, or who will bear the costs, of
losses due to production decisions which lead to unmet
reasonable consumer expectations. The current formulation
of warranty law allows the seller to shift the responsi—
bility for these decisions to the consumer. The changes
proposed in this study would shift the responsibility for
the decisions to the party making the decisions. Under
this situation one would expect, all other things equal,
greater care and concern in decision making. A basic
assumption of this study is that the magnitude and
seriousness of consumer problems are functions of the
operating social policy which determines the party which

will be responsible for losses on unsatisfactory products.

Seriousness of Problem

 

On February 24, 1971, President Nixon in a message
to Congress stated:

"The history of American prosperity is the history
of the American free enterprise system. The system
has provided an economic foundation of awesome propor—
tions and the vast material strength of the nation is
built on that foundation. For the average American,
this strength is reflected in a standard of living
that would have staggered the imagination only a short
while ago. This constantly rising standard of living
benefits both the consumer and the producer.

In today's marketplace, however, the consumer often
finds himself confronted with what seems an impenetrable
complexity in many of our consumer goods, in the
advertising claims that surround them and the means
available to conceal their quality. The result is a
degree of confusion that often confounds the unwary,
and too easily can be made to favor the unscrupulous.
I believe new safeguards are needed, both to protect
the consumer and to reward the responsible business-
man. . . .

Accordingly, I am again submitting proposals
designed to provide such a Buyer's Bill of Rights
by:...

--Proposing a Fair Warranty Disclosure Act which
will provide for clearer warranties, and prohibit the
use of deceptive warranties; . . .3

Structure of the Problem

 

To understand the role of warranties in consumer
protection, the nature of "the typical consumer problem"
must be developed. The failure of a product's performance
to meet the reasonable expectations of a consumer, as will
be developed later, provides such a definition.4 Next, the
existing framework of rules leading to the existing consumer
problems must be determined and examined. The Uniform
Commercial Code (UCC) sets the general rules for the
conduct of commercial transactions.5 The provisions of the

UCC allow for frédom of contract between consumers and

sellers even where in reality no meaningful negotiation
opportunities exist (although such opportunities are
theoretically required for a contract.) Without
negotiation or competition in contractual terms the exercise
of freedom of contract by strong parties against compara-
tively weak parties may yield, and in the past have yielded,
socially dubious results. The UCC covers considerable
ground, but for purposes of this argument only a few
sections involving warranties require consideration.6
The proposed changes, their effects on social
institutions and the economic mechanism by which they
change the manufacturers' behavior (to reduce the number
of consumer problems) conclude the argument. Since this
argument proposes changes which have only recently begun
to occur, the analysis of what will happen is necessarily
speculative. But, the changes proposed are similar to
changes made in laws regulating insurance and industrial
safety:7 Considerations of the changes in behavior which
occurred in these fields as the freedom of contract of the
parties was restricted should provide insights to both the
conditions in which such a change is an effective policy
and the changes such a policy can achieve. The theoretical
discussion on the nature of "freedom of contract" was
developed in discussions of insurance contracts and labor
relations at the turn of the century and during the
depression of the 1930's. The materials considered in

the second chapter, while considered for the insights they

can provide relative to the current problems of consumers,
appeared in these earlier debates involving insurance and
labor relations. The evidence is limited and relies on
analogies, but the direction of behavior change is con-
sistent in all of the cases. This study considers the
effects of legal changes which have and will continue to
occur with such evidence as is available.

Changing the fundamental commercial rule framework
is not the only approach available to society for
resolving the problems consumers face in the market. One
might propose an extensive program of consumer education.8
The task will not be easy; the educational approach
advocate must answer three questions: what is to be taught,
to whom it is to be taught, and how it is to be taught.
These questions cannot be easily, if at all, answered.
There are two hundred million consumers to be taught about
a huge variety of products, at a time when the public does
not seem interested in expanding the educational system.
One may seriously doubt the feasibility of education
resolving consumer problems directly. Further, Ralph,
Nader has pointed out that the emphasis on driver safety
has been promoted by the automobile manufacturers to allow
the industry to preserve its exclusive (at the time) con-
trol over the design of its product.9 Thus it can be
argued that an educational program may (and apparently did
in the case of automobile safety) by shifting resources

and concern from more effective techniques, impede rather

than enhance a program of consumer protection. Another
alternative lies in using administrative agencies, this

complimentary approach is considered below in Chapter Three.

Problems of Evaluation

 

The policy proposal made in this study is
politically conservative. The changes do not call for the
creation of any new organization to supervise the behavior
of anyone. Rather a restoration of the traditional
position of the consumer developed by the courts over
hundreds of years of experience in reaching equitable
dispute settlement between buyers and sellers is sought.
This return to the traditional approach while holding the
consumer responsible for his own carelessness in the market
will place much of the responsibility for consumer problems
on the party which is both mainly responsible for their
existence and capable of their elimination, the manufacturer.
This study demonstrates that one may reasonably expect that
with the return of the traditional rules between buyers and
sellers, the manufacturers will find that honest represen-
tation and the production of goods meeting the consumers'
reasonable expectations are the only means to make a
profit. This change seeks to correct a relatively modern
contrived nonaccountability created by the manufacturers of
consumer products.10

Economic programs which require the allocation of

scarce resources for one use to another are justified in

terms of the trade-off between the net benefits of the

selected program and the lost net benefits of the rejected
alternatives. While obtaining the various figures may
present problems the arithmetic comparison of the costs and
benefits of the justification process is clear.11 When the
proposed change involves a change in the commercial
environment, as in the case of the Sherman Antitrust Act

or the changes in the UCC proposed in this paper, the
evaluation procedure becomes far more speculative. Ideally
the positive and negative effects of the change in the full
economy must be ascertained and evaluated. Experts debate
the magnitude of the benefits which would follow an
expenditure for a kidney machine, but the existence of the
benefits. The mere existence of the effects of a change

in the commercial framework is subject to debate (e.g.,
does antitrust enforcement raise or lower productivity?).12
In general these effects, if agreed upon, will not have a
market value as in the case of economic projects such as
dams or steel mills. Of necessity the conclusion of the
advisability of such a change will depend on the weighting
which must be arbitrarily placed by political means on the
effects that according to those making the analysis believe
will occur. In the case of the policy proposed in this
study the potential effects which are considered in this
study include: 1) the loss of income to those who
currently profit from producing defective goods and who
will not be able to adapt, 2) the effect of this policy on

the cost of goods, particularly as it will effect the poor,

3) the effects of this policy on innovation, and 4) as a
policy ultimately dependent on the judicial system it is
essential to consider the effects of the policy on an
overloaded court system. The combined evaluation of these
effects determines the advisability of adopting and subse-
quently implementing the proposed policy.

The first chapter lays the foundation by considering
the nature of consumer problems, the decision making process
in a free economy and the nature of a society's consumer
protection policy. An analysis of the role contracts play
in society, the assumptions of the doctrine of freedom of
contract, the emergence of standardized contracts, the
sections of the UCC controlling warranties and their
exclusion, and the role of warranties in consumer
protection are considered in the second chapter. Chapter
three begins the evaluation of the trade-offs of this
policy with considerations of the effect of the policy on
the profitable behavior of manufacturers, the strain
caused by the enforcement on the judicial system, and the
effects of the policy on product innovation. A comparison
of this proposal with related pending legislation is made
in the fourth chapter. The fifth chapter returns to the
analysis of the policy considering the economic mechanism
of the policy's operation, the likely extent of the losses
to producers who could not adapt and the effect of this

policy on the poor.

FOOTNOTES

1Milton Friedman, Capitalism and Freedom (Chicago:
University of Chicago Press, 1962), p. 133. This statement,
while not philosophically naieve, is deceptively simple.
The establishment of a framework of law which will yield
the beneficial results is extremely difficult to achieve.
The following study illustrate this point by considering
one such framework which has failed and various adjustment
to this framework of law to improve the performance of the
economy.

 

2Justice Francis in Henningnsen v. Bloomfield
Motors, Inc., 38 N.J. 358.161 A. 2d 69 at 86 (New Jersey,
1960).

3U. S. President. "Consumer Protection," Weekly
Compilation of Presidential Documents, Richard M. Nixon,
March 1, 1971, pp. 288-289. GS 4.114;? These proposed
laws were not enacted.

4This definition is inclusive of virtually all
consumer problems, but the legal changes considered in
this study will have an effect only on durables of a cost
to the consumer, following Federal legislation, of over $5.
Warranty legislation will not eliminate consumer problems
resulting from credit, governmental bureaucracy, or
consumer carelessness.

5The UCC was presented by its authors, the American
Law Institute and the National Conference of Commissioners
on Uniform State Laws in 1952. Seventeen years later it
had been enacted (not always in a uniform manner) in forty—
nine states (all except Louisiana) the District of Columbia
and the Virgin Islands. The UCC was revised in 1958, 1962
and 1966. The 1968 master edition including comments and
citations, but excluding forms, had 1,576 pages.

6During the 92d Congress both the Senate and the
House held hearings on various pieces of legislation which
sought to control warranty abuses. The importance of
warranties to consumers is shown both by the existence of
the hearings themselves and some of the testimony at the
hearings.

". . . if mail received by an organization such as

the Consumer Federation of America is any indication of

9

10

consumer concerns, consumer concern with warranties

looms very large." Edward Berlin, (Cousel, Consumer
Federation of America). U. S. Congress, House, Committee
on Interstate and Foreign Commerce, Consumer Warranty
Protection, Hearings before a subcommittee on Commerce
and Finance of the Committee on Interstate and Foreign
Commerce, House of Representatives, on H.R. 6313, H.R.
6314, H.R. 261, H.R. 4809, H.R. 5037, H.R. 10673 (and
similar and identical bills) 92d Congress, lst Sess.,
1971, p. 274.

". . . The Commission (Federal Trade Commission)
believes that informative, accurate, clear and fairly
written warranties, backed up by warrantors who deliver
what they promise, are essential to our free market
economy, and that legislation to insure these consumer
rights is necessary." Miles W. Kirkpatrick (Chairman,
Federal Trade Commission). U. S. Congress, Senate,
Committee on Commerce, Consumer Products Warranties
and Improvement Act of 1971, Hearin s before the Con-
sumer Subcommittee of the C mm1ttee on Commerce,
Senate, on S. 986, 92d Congress, lst Sess., 1971, p. 33.

". . . The importance of this subject (consumer
warranties) to consumers can hardly be overstated. Not
only do warranties apply to a broad spectrum of con—
sumer products, but in a marketplace where complex and
costly goods are the norm, and repair costs are
skyrocketing, they involve a total investment by
consumers of millions of dollars annually." Virginia
H. Knauer (Special Assistant to the President for
Consumer Affairs). U. 8. Congress, House, Warranty

Hearings, p. 248.

 

 

7Insurance companies learned that juries would
award large judgments to an individual against a powerful
firm. To reduce this risk they prepared contracts which
removed the discretion of a jury to make such a judgment.
Some firms discovered that they could write a contract
which would create false expectations of protection but
which actually made the policies virtually uncollectable.
To correct the injustices of these highly profitable
"insurance contracts" the state (New Hampshire in 1855)
passed statutes and/or formed commissions to determine the
contents of the contract (regardless of its actual con-
tents) which the court would enforce. Three types of
regulation are used: 1) the legislature provides the
exact wording of the policy, 2) an administrative agency
prescribes the exact wording to be used or 3) the legis-
lature provides standards to be administered by an
official who may approve or disapprove submitted policies.
The complexity of insurance has forces the legislature to
give detailed control to administrative agencies which
establish terms for convential policies and give approval
for new style policies sold to consumers. The state policy

11

allows the layman to have his reasonable expectations met.
See Marion W. Benfield, Jr., Social Justice Through Law:
New Approaches in the Law of Contract (Mineola, New York:
Foundation Press, Inc., 1970), pp. 131-140. The
experience with Workmen's Compensation Legislation is
considered in Chapter 5 and Footnote 36 of Chapter 2.

8Education is clearly a sine qua non of consumer
protection. President Nixon in a section on consumer
education in his consumer protection message to Congress
stated:

"Legislative remedies and improved enforcement
procedures are powerful weapons in the fight for
consumer justice. But as important as these are, they
are only as effective as an aware and an informed
public make them. Consumer education is an integral
part of consumer protection. It is vital if the
consumer is to be able to make wise judgments in the
marketplace. To enable him or her to do this will
require a true educational process beginning in
childhood and continuing on." U. S. President, Weekly,
p. 293.

For the nature of such a program see U. S. Presi-
dent, President's Committee on Consumer Interests,
Suggested Guidelines for Consumer Education: Grades K-12
(Washington, D. C.: Government Printing Office, 1970),

Pr 36.8:c76/Ed8. The immensity of the content of such a
program is noted at the end of the introduction, "In
summary, Consumer Education is vital for all young people
because of the competence it can provide in dealing with

our modern marketplace. But, all who are concerned with
education will recognize that Consumer Education is
inherently tied to developing a personal philosophy, finding
satisfaction in daily living, and fulfilling a citizenship
role in a free enterprise system."

9Ralph Nader, Unsafe At AnyiSpeed, (New York:
Pocket Books, 1965), pp. 175-178. This citation refers to
only one form of consumer education—that done by firms.
Nader argues that the automobile industry's efforts in
education did not fundamentally serve to improve education,
but to divert attention from product defects. It is worth
noting that an educational system which teaches consumers
to be wary supports the caveat emptor approach to social
control--the responsibility for a loss rests with the
consumer. This paper argues that placing the responsibility
on the consumer leads to very poor results in the market.

10Ralph Nader and Donald Ross, Action for a Change,
(New York: Grossman Publishers, 1971), p. 4. They use
the term "contrived nonaccountability" for different
behavior, but the term is extremely appropriate to the
problem considered in this paper.

 

 

 

 

 

12

11The potential amount of complexity seems to be
without limit. Cost-benefit analysis includes the deter-
mination of the alternatives and then the listing and
evaluating of the costs and benefits of each. These
figures are then used in a decision criteria (a system of
weighting) for selecting the alternative which will be
used. See M. G. Kendall ed., Cost-Benefit Analysis, (New
York: American Elsevier Publishing Company, Inc., 1971),
for a selection of examples presented at a symposium
organized by the NATO Scientific Affairs Committee.

12"A fundamental question in antitrust is whether
a strong policy against concentrated economic power
groups impedes or is conducive to our goals for
efficiency and technical progress. . . . Since most
small, medium-sized, and larger plants in an industry
generally produce a heterogeneous output that crosses
over a number of industrial classifications, the
problem of ascertaining whether smaller or medium-
sized firms are as efficient (or perhaps more efficient-
MS) as the larger-sized firms is exceedingly complex."
Eugene M. Singer, Antitrust Economics: Selected
Legal Cases and Economic Models, (Englewood Cliffs, N.J.:
Prentice Hall, Inc., 1968), p. 4.

 

 

 

CHAPTER ONE

WARRANTIES

Nature of a Consumer Problem

When working with a problem as general as consumer
protection and consumer dissatisfaction, considerable care
must be given to the foundation to insure that the
resulting structure is stable. The general concepts of a
study, if the study is to have any value, must lead to
policies which result in desirable behavioral changes.
Initially the idea of what is precisely happening when a
consumer consumes must be set.

"The purpose of the product is not what the
engineer explicitly says it is, but what the consumer
implicitly demands that it shall be. Thus the consumer
consumes not things, but expected benefits - not
cosmetics, but the satisfaction of the allurements they
promise; not quarter-inch drills, but quarter—inch
holes; not stock in companies, but capital gains; not
numerically controlled milling machines, but trouble-
free and accurately smooth metal parts; not low-cal
whipped cream, but self rewarding indulgence combined
with sophisticated convenience."

The view that one does not consume products, but rather
flows of services, is not new. A bond is clearly a flow
of income and a house is a flow of housing. This might
appear to be merely a matter of semantics, but the method

of definition makes a difference in consumer products. All

too often there is a difference between a car defined as an

13

14

object with four wheels and a motor (plus any other non-
performance characteristics one might wish to add) and a
car defined as a flow of satisfactory private transporta-
tion services. A car in constant need of repair might meet
the first definition, but would fail to qualify under the
second definition as anything other than something which
looks like a car.

In many situations the use of the physical
descriptions is satisfactory for practical purposes.
Agricultural commodities are bought and sold before they
exist on the base of physical description. For a system
to work in which purchases are made without observation
the consumer must receive the product he expected when
made the purchase. Wholesale markets have various formal
and informal means to insure the level of honesty they
require for their efficient operation (the entire trans-
action can occur by telephone). The situation is
obviously different in the consumer markets.

While in this study the differences between whole—
sale and retail markets can only be treated in passing,
certain characteristics may be noted which illuminate the
problems faced by consumers. A wholesale market is
characterized by high volume, repeat business and low
margins. There are relatively few buyers and sellers and
since they earn their living through their activities in
the market they make an effort to be highly informed. If

a seller delivers a product which is below the standards,

15

the purchaser is unlikely to buy again (repeat business)
and is likely to inform other purchases personally at
meetings and/or in the trade journals about the poor ser—
vice he received. These results are likely to follow even
if the purchaser refuses to accept the product or returns
the product under the formal rules of the market. Under
these conditions it is clearly the situation that honest
representation is the best policy.

The retail market for consumer durables is differ-
ent. Durables, by definition, are supposed to last. They
are sold in a low volume, relatively high margin and little
repeat business (for the same product by the same individual)
market. The seller must create the expectations of services
in the consumer which will lead him to make the purchase.
The actual performance is of secondary importance as
consumers have no effective means of publicizing their
unsatisfactory experiences.

. . . in economic terms, the lack of any practical
consumer remedy can operate as an incentive for
questionable business methods, particularly when one
considers that under modern marketing practices a bad
reputation seldom catches up with the violator, and
that the probability of effective governmental enforce-
ment is generally low."

That honesty may not be the best (most profitable) policy

is a clear possibility. The concern with consumer

protection leads one to believe that honesty has been
found, by at least some manufacturers and retailers, not

to be the best policy. This study, by considering warranty

law, provides part of the reason why honesty may not be the

16

best policy and what action could be taken to make honesty
the best commercial policy. The honest behavior with which
this study is specifically concerned lies in the efforts

of manufacturers when they create expectations of product
performance in prospective consumers. Honest behavior
would consist of creating only those expectations of
performance in the consumer which the manufacturer knows
the product's actual performance will meet.

In terms of a particular product, a consumer has
two different basic sets of performance expectations.
While it may be impossible to construct a definitive list
of such expectations, if only because expectations are most
clear to consumers only when they are disappointed, a
partial listing of the expectations can be hypothesized.
As an example consider the case in which a consumer pur-
chases an automobile. He has some general expectations as
to automobiles. These might include such considerations
as reliability and personal safety. But a consumer does
not purchase an 'automobile,‘ but rather a particular
automobile. The selection of a particular automobile
follows from other expectations. These expectations might
include extra comfort, fast acceleration and/or good gas
milage. The first set of expectations are those which
concern minimum acceptable performance which one would
expect from any unit of the type and which lead the con-
sumer to the decision to purchase a type of product. The

second set of expectations differentiate the various

17

models on the market and lead the consumer to select one
rather than another unit of the particular product type.
These consumer expectations come from the
promotional activities of manufacturers and retailers.
Consumer disappointments, the consumer problems considered
in this study, occur when the product's actual performance
does not meet the consumers' expectations of performance
as created by the promotional efforts of the manufacturers
and retailers. When the manufacturer and/or retailer
purposefully (and dishonestly) create expectations which
they know the product will not meet, they increase the
sales of their particular units (the more favorable per-
formance expectations created the more attractive the
product) but at the same time this behavior creates
consumer problems. The chronic consumer dissatisfaction
with the automobile industry indicates that this misleading
behavior need not be a short run phenomenon. The tendency
for all firms to exaggerate the capabilities of their
products need not be the result of collusion, but rather
an effort to maintain their competitive positions. The
issues involved in innovation and sales under rules
creating economic incentives for accurate representation
of product capabilities are considered below. Since
consumer expectations are produced in a purposeful manner,
often with the expenditure of considerable sums of money,
and since advertisers exercise great care in determining

in advance the effects of their advertisements, when a

18

consumer has an expectation of performance which is not
met by the performance of the product there exists some
reason for suspecting that the manufacturer and/or retailer

have purposefully mislead the consumer.

Expectations and the Uniform Commercial Code

 

The consumers' expectations might seem to corre-
spond to two different levels of producer performance.
The general level of expectations might correspond to the
typical performance of the industry while the particular
expectations for the selected model would correspond to
the typical performance of the particular firm or division.
This correspondence to actual producer performance is not
the actual situation for two reasons. These performance
standards of the firm and industry are not known by
consumers and could not form the base of consumer decisions.
More importantly, the expectations of consumers come from
the promotional efforts of the firms. The promotional
efforts may create expectations which approximate the
actual performance of the products when the producers
promote in an honest manner. But the expectations created
may be less than the actual performance in a conservative
industry or much greater in a more sensational industry.
There is no necessary direct connection between industry
performance in terms of the product and consumer expecta-
tions since actual performance, through reputation, is

only one of several factors.

19

a. Implied Warranty

The commercial law as embodied by the Uniform
,Commercial Code (UCC) has provisions for each of these
systems of expectations. The general expectations
correspond to the implied warranty of merchantability and
the particular expectations correspond to express
warranties. Section 2-314 sets the standards for the
general consumer expectations.

Sections 2 - 314 - Implied Warranty:
Merchantability; Usage of Trade
(1) Unless excluded or modified (Section 2 - 316),
a warranty that the goods shall be merchantable is
implied in a contract for their sale if the seller is
a merchant with respect to goods of that kind. Under
this section the serving for value of food or drink to
be consumed either on the premises or elsewhere is a
sale.
(2) Goods to be merchantable must be at least such
as
(a) pass without objection in the trade under
the contract description; and
(b) in the case of fungible goods, are of fair
average quality within the description; and
(c) are fit for the ordinary purposes for which
such goods are used; and
(d) run, within the variations permitted by the
agreement, of even kind, quality, and
quantity within each unit and among all
units involved; and
(e) are adequately contained, packaged, and
labeled as the agreement may require; and
(f) conform to the promises of affirmations of
fact made on the container or label if any.
(3) Unless excluded or modified (Section 2 - 316)
other implied warranties may arise from course of
dealing or usage of trade.

Clearly the standard of merchantability is completely
general. This generality is essential because this

warranty arises from the act of sale of a good by a dealer
in the particular good and the definition of merchantability

must apply to all goods sold by dealers.

20

Does this standard, if indeed it is a standard,
provide a manufacturer with meaningful information as to

how to design and construct his product so that it will be

merchantable. To determine if merchantability does provide
behavioral criteria, the term must be considered as it is
used by the courts in their decisions. The editors of the
Uniform Commercial Code in the Master Edition have compiled
under note 9 to section 2 - 314 quotes from decisions which
illustrate their understanding of the term 'merchantable.‘
A selection of these quotes are listed below.

"An 'implied warranty of merchantability' is a
warranty implied by law that goods are reasonably fit
for the general purpose for which they are sold."
Eimco Corp. v. Joseph Lombardi & Sons, 193 Pa. Super 1,
162 A. 2d 263 (1960).

"Warranty of merchantability in sale of goods means
only that the article is reasonably fit for the purpose
for which it is sold and does not imply absolute
perfection." Schipper v. Levitt & Sons, Inc., 44 N.J.
70, 207 A. 2d 314 (1965).

"Implied warranty of merchantability means that
the product is reasonably fit for the purpose intended;
it does not imply absolute perfection; and there is no
duty on the part of the manufacturer to furnish tools
which will not wear out." Jakubowski v. Minnesota
Min. & Mfg., 42 N.J. 177, 199 A. 2d 826 (1964).

"While defendant manufacturer of the automobile was
not necessarily under an obligation to provide a
hardtop model which would be as resistant to roll-over
damages as a four-door sedan, the manufacturer was
required to provide a hardtop automobile which was a
reasonably safe version of such model, and which was
not substantially less safe than other hardtOp models."
Dyson v. Gen. Motors Corp., D. C. Pa. 1969, 293 F.
Supp. 1064 (1969).

”Factors other than those concerned exclusively with
safety of the product may be important in determining
a product's merchantability, and recovery may be allowed
on the basis of breach of implied warranty of

21

merchantability for damage other than personal injury."
Martel v. Duffy-Mott Corp., 15 Mich. App. 67, 166 N.W.
2d 541 (1968).

"Neither the fact that the tractor dealer did all
he could to correct the defects in the tractor, nor
the ultimate liability of the manufacturer for the
defects, relieved the dealer of the obligation imposed
by this section as to the implied warranty of
merchantability." Ford Motor Co3 v. Taylor, __ Tenn.
App. __, 446 S.W. 2d 521 (1969).

Merchantability is clearly not revolutionary. The key
word is 'reasonable.‘ Only if this word has any specifi-
able meaning in a behavioral sense can the standard of

merchantability provide direction for a manufacturer.

b. Reasonability

It is not obvious that the word 'reasonable' has
any content other than describing the behavior of the
courts. The determination of 'reasonable' is a factual
matter and would be determined by a jury or a judge acting
as a jury. Reasonable may be only what the jury decides
in the instant case to be reasonable. If no guide to what
will be decided to be reasonable exists, independent of the
particular court decision, then the manufacturer must guess
at the decisions the courts will make on what would be a
purely random basis (i.e., no guide exists.) Reasonable
is not the only word of doubtful clarity in the law.
Justice Jerome Frank noted,

"Or, on occasion, the guide to a correct legal
conclusion is said to be the 'manifest intention' of
the maker of an instrument. Someone has observed that
whenever a lawyer says that something or other was the

manifest intention of a man, 'manifest' means that the
man never really had such an intention. Lawyers use

22

what the layman describes as 'weasel words,‘ so-called
'safety-valve concepts,‘ such as 'prudent,‘
'negligence,‘ 'freedom of contract,‘ 'good faith,‘
'ought to know,‘ 'due care,‘ 'due process,‘ - terms
with the vaguest meaning - as if these vague words had
a precise and clear definition; they thereby create an
appearance of continuity, uniformity and definiteness
which does not in fact exist." (p. 27) This
uncertainty is not an unmitigated evil. "Much of the
uncertainty of law is not an unfortunate accident: it
is of immense social value." (p. 7) This slack in the
law allows judges to bring in considerations of justice
(also a 'weasel' word).

The word reasonable is defined in Black's Law

 

Dictionary (1951 edition) by a series of synonyms: just,
proper, ordinary, unusual, fit and appropriate to the end
in view, honest, equitable, fair, suitable, moderate and
tolerable. There is clearly some ambiguity in that those
qualities denoted by just are not identical to those of
ordinary. Still there is not a complete lack of content
since words such as careless do not appear on the list. In
the Restatement of the Law of Torts the idea of reason-
ability is considered as follows:

"The words, 'reasonable man' denote a person
exercising those qualities of attention, knowledge,
intelligence and judgment which society requires of its
members for the protection of their own interests and
the interests of others. . . the 'reasonable man' is
a man of reasonable 'prudence.'"5

The definition of 'reasonable' is clearly not denotative

in that it does not list qualities which must be present if
something is to be considered 'reasonable.‘ Neither is the
definition connotative in that it does not attempt even a

partial listing of all reasonable instances. The definition

of 'reasonable' is an intuitive definition - it is believed

23

that reasonable men can agree on what is reasonable.
Clearly this criterium, reasonable, is not salient in that
it is so prominent or conspicuous that by itself it would
provide a comprehensive guide to action for a manufacturer.
To know that a product must be reasonably fit for the
ordinary purposes for which it is used is not to have a
list of qualities that it must meet such as one might find
in commodity grades or Federal Trade Commission orders.

To require all policies to be salient (consisting
of a list of clearly understood minimum characteristics)
might not be desirable. Justice Frank, while discussing
the rescision of contracts based on non-negligent
unilateral mistakes, has noted that such clarity is not
required for commercial activity.

"In short, the 'security of business transactions'
does not require a uniform answer to the question of
when and to what extent the non-negligent use of words
should give use to right in one who has reasonably
relied on them."

"New York, a lively center of commerce, at least
to some ex ent allows relief of such unintended
mistakes."

This case, while dealing with a non—negligent unilateral
mistake is appropriate to show that complete certainty is
not required for commerce. This result is not surprising
since risk and uncertainty are basic characteristics of
business. Commercial security and just results (which may
be difficult to obtain when the rule is salient) must be
balanced. The essential quality is not that the term

'reasonable' be defined so clearly that all who understand

the word use it in an identical manner in all instances

24

(e.g., ‘line' in Euclidean geometry), and that not to use
it in this manner is proof that it is not understood.
Rather, the term must have sufficient common usage so that
while individuals might disagree in particular instances
depending on how they balance the various positions of the
contending parties, the resulting decision while it might
seem incorrect will not seem completely unreasonable.
Unreasonable implies a degree of irrationality and the
lack of qualities found in the 'definition' of reasonable.
Such irrationality is not claimed when one holds that
another is in error.

While the idea of reasonable and therefore
merchantability is not salient, in the sense that they do
not provide a list of conditions which are necessary and/
or sufficient for meeting the requirement, these ideas
are not free of content. While some uncertainty may
continue to exist a manufacturer does have an idea of
whether his product is fit for the ordinary purposes for
which it is used. While the ordinary purposes might be
subject to some interpretation, again some common under-
standing exists. If no common understanding existed as
to the ordinary use of a product the manufacturer would
not know what to produce and offer and the consumer would
not know what to purchase. The existence of products and
markets requires this wide range of common understanding.
The situation is not unlike a normal problem faced by any

producer of goods and services. If the manufacturer is

25

faced by two production processes with cost functions AA
and BB he must choose which to use on the base of expected
output. Function BB allows the production of goods at a
lower cost for quantities between D and E while function AA
allows production at any other quantity level at a lower

cost.
cost/unit

 

 

D c E
quantity

Businessmen work in a world of uncertainty. If their
products must be merchantable they will choose a quality
level even when they are not completely sure of the exact
standard which will be applied in any particular dispute
just as they choose a production process even when they
are not sure of the ultimate output level.

It is possible and indeed it is not unlikely that
a jury might set an unreasonable 'reasonable' standard.
But one may discount both the possibility of this happening
frequently and the significance of when it does happen. A
standard out of line with the demands of the ordinary use
of the product is unlikely to occur because warranties are
an established part of the law with a strong base in

precedent and because the manufacturer will be able to

26

appeal any erratic decisions. Even if an erratic decision
were to occur the effect would not be serious since the
dispute involves only one unit and not the entire produc-
tion of the firm as in a ruling of a regulatory agency.
While the erratic ruling would serve as precedent for
future cases, by itself, if it is clearly erratic, it would
be unlikely to sway other courts. The warranty of
merchantability is a conservative standard that operates
at the margin and is unlikely to put an unfair burden on
a manufacturer who produces goods which are fit for their
ordinary use.
UCC Section 2 - 315 establishes the warranty for
fitness for a particular purpose.
Section 2 - 315 - Implied Warranty: Fitness for a
Particular Purpose
Where the seller at the time of contracting has
reason to know any particular purpose for which the
goods are required and that the buyer is relying on
the seller's skill or judgment to select or furnish
suitable goods, there is unless excluded or modified
under the next section an implied warranty that the
goods shall be fit for such purpose.
This warranty differs from the warranty of merchantability
in that it is not created by the mere act of a sale by a
dealer. This warranty applies only if the buyer acts on
the advice of a seller when the buyer has explained the
particular use for which he wishes to buy a product. This
warranty makes the seller responsible for the advice he

provides a buyer about which product is suitable for a

particular task.

27

c. Express Warranties

Section 2 - 313 establishes warranties on the base
of promotional activities of the manufacturer, including
but not necessarily limited to the written warranties
offered by manufacturers to consumers.

Section 2 - 313 - Express Warranty: By Affirmation,
Promise, Description, Sample

(1) Express warranties by the seller are created
as follows:

(a) Any affirmation of fact or promise made by
the seller to the buyer which relates to
the goods and becomes part of the basis of
the bargain creates an express warranty
that the goods shall conform to the affirma-
tion or promise.

(b) Any description of the goods which is made
part of the basis of the bargain creates
an express warranty that the goods shall
conform to the description.

(c) Any sample or model which is made part of
the basis of the bargain creates an express
warranty that the whole of the goods shall
conform to the sample or model.

(2) It is not necessary to the creation of an
express warranty that the seller use formal words such
as 'warrant' or 'guarantee' or that he have a specific
intention to make a warranty, but an affirmation
merely of the value of the goods or a statement pur-
porting to be merely the seller's opinion or
commendation of the goods does not create a warranty.

While the second part excludes statements considered to be
'puff' from warranties, this provision establishes that
when a seller uses samples and/or claims of fact in selling
the product, the product's performance must correspond to
these samples and/or claims. If the product does not meet
the performance claims of the manufacturer then the
consumer would be able to recover his financial losses
resulting from the purchase. The express warranties take

precedence over the implied warranties if they conflict.

28

If the consumer were to purchase an automobile which
accelerates quickly and is used for racing, the reasonable
standards of gas milage and engine tuning appropriate for
ordinary use would not apply. In a similar manner intracity
electric cars would not be judged on the performance
standards for 'automobiles,‘ but rather on the base of the
factual claims of the manufacturer. The merchantability
standard applies when no express warranty on the particular
quality under consideration is present.

Because the express warranties have precedence over
the implied warranties the manufacturer may produce a
product which fails to meet the standard of merchantability
in certain specified ways. All that is required of such a
manufacturer is that he create accurate express warranties
for these particular qualities of the product which do not
meet the traditional expectations. Such behavior is fairly
common: paper dresses, disposable diapers and intracity
cars. Consider 'paper dresses,‘ this product would have
to meet the standards of merchantability for dresses
(e.g. hold together) except for durability. The intracity
car would have to meet the standards of merchantability
for cars (e.g., reliability) except for speed and range.
If the manufacturer should choose to limit his responsi-
bility for his product's performance under particular
requirements of the merchantability standard he need only
create different consumer expectations by means of actions

leading to express warranties. However by the creation of

29

express warranties under UCC section 2 - 313 the
manufacturer can only alter the warranty of merchantability
in specific areas as he chooses by creating express
warranties different from the standard of merchantability.
He could not completely eliminate the standards of
merchantability by merely excluding it, as such, in the
contract he offers the buyer. He cannot eliminate the
criteria of reasonable performance without establishing
another performance expectation.

These three sections of the UCC would seem to
adequately protect the consumer against misrepresentation
efforts by manufacturers and retailers. By the warranty
of merchantability the consumer can recover his losses if
the unit he purchases is unable to provide the flow of
services one would expect from the products of the
particular type. The warranty of fitness for a particular
purpose establishes the consumer's right to depend on the
advice of a seller of a particular product (and hold him
financially responsible) when the consumer depends on that
advice. The provisions establishing the express warranties
allows the consumer to depend on the descriptions, samples,
affirmations of fact and promises used by the seller when
promoting his product. The prudent consumer would seem
to be virtually fully protected against the dishonest
seller. This protection would apply to unsatisfactory
products which are exceptions to the general run (lemons)

and to those situations in which all units are

30

unsatisfactory due to an error in design. Decisions
involving merchantability are based on the relationship
between reasonable expectations of performance and the
actual performance. Issues of why the performance is
unsatisfactory, such as wrongdoing, are not involved. The
situation is clearer with "lemons" because they are, by
definition, dramatically unsatisfactory. But the source of
both lemons (except in cases of random error) and design
errors are decisions made by the seller (at some stage of
the production process) and it is reasonable that a general
commercial policy such as the UCC would not make a distinc-
tion based on the particular production decision.
One might reasonably wonder why warranties and
warranty problems are so important as shown in the intro-
duction. The reason is that the UCC contains two additional
provisions which allow a manufacturer, at will, to remove
virtually all of the protections given in the warranty
provisions considered above. The option of removing the
buyer protections considered above is established in
Sections 2 - 316 and 2 - 719 of the UCC.
Section 2 - 316 - Exclusion or Modification of
Warranties

(1) Words of conduct relevant to the creation of
an express warranty and words or conduct tending to
negate or limit warranty shall be construed wherever
reasonable as consistent with each other; but subject
to the provisions of this Article on parol or extrinsic
evidence (section 2 - 202) negation or limitation is

inoperative to the extent that such construction is
unreasonable.

(2) Subject to subsection (3), to exclude or modify
the implied warranty of merchantability or any part of
it the language must mention merchantability and in

31

case of a writing must be conspicuous, and to exclude
or modify any implied warranty of fitness the exclusion
must be a writing and conspicuous. Language to exclude
all implied warranties of fitness is sufficient if it
states, for example, that "There are no warranties
which extend beyond the description of the face
hereof."

(3) Notwithstanding subsection (2)

(a) unless the circumstances indicate otherwise,
all implied warranties are excluded by
expressions like 'as is,‘ 'with all faults'
or other language which in common under-
standing calls the buyer's attention to the
exclusion of warranties and makes plain
that there is no implied warranty; and

(b) when the buyer before entering into the
contract has examined the goods or the
sample or model as fully as he desired or
has refused to examine the goods there is
no implied warranty with regard to defects
which an examination ought in the circum-
stances to have revealed to him; and

(c) an implied warranty can also be excluded
or modified by course of dealings or course
of performance or usage of trade.

(4) Remedies for breach of warranty can be limited
in accordance with the provisions of this Article on
liquidation or limitation of damages and on contractual
modification of remedy (Sections 2 - 718 and 2 - 719).

Section 2 - 719 — Contractual Modification of
Limitation of Remedy

(1) Subject to the provisions of subsections (2)
and (3) of this section and of the preceding section
on liquidation and limitation of damages

(a) the agreement may provide for remedies in
addition to or in substitution for those
provided in this Article and may limit or
alter the measure of damages recoverable
under this Article, as by limiting the
buyer's remedies to return of the goods
and repayment of the price or to repair and
replacement of non-conforming goods or
parts; and

(b) resort to a remedy as provided is optional
unless the remedy is expressly agreed to
be exclusive, in which case it is the sole
remedy.

(2) Where circumstances cause an exclusive or
limited remedy to fail of its essential purpose, remedy
may be had as provided in this act.

(3) Consequential damages may be limited or excluded
unless the limitation or exclusion is unconscionable.

32

Limitation of consequential damages for injury to the
person in the case of consumer goods is prima facie
unconscionable but limitation of damages where the
loss is commercial is not.

The key point is (l)(b) of Section 2 - 719. This
allows an express warranty determined solely by the
manufacturer which may be more limited than the traditional
warranties established in the other sections of the UCC
considered above, to be the only remedy available to the
consumer. Under this section the manufacturer may remove
by means of a sentence in an unread (and for most consumers
unreadable) contract any buyer protection of the base of
reasonable expection without creating any alternative
expectation of performance except for those of the limited
remedy allowed by the manufacturer's contract. All con-
sumer expectations of product performance and manufacturer
responsibility after a period of time determined by the
manufacturer can be made irrelevant (except for the
selling of the product) to recovering a financial loss in
the eventuality of unreasonably poor product performance
by the use of these limiting and exclusive express
warranties. Such 'warranties' are extremely common in
consumer contracts. Why the removal of traditional
protection is allowed in basic commercial law, the
economic effects of this removal of traditional protection
and efforts to change this situation are considered in the
rest of this study.

In 1964 Consumer Reports had an article on the

problems with automobile warranties which began with
the following observation: "It is a good idea to call

 

33

to mind now and then the basic characteristic of a
manufacturer's warranty - namely, that it functions
primarily to limit the seller's liability. The

seller says in his warranty that, so far as he is con-
cerned, he agrees to accept a given degree of
responsibility for the good he sells you, but for only
so long. He sets the time. After that, you are on

your own and come what may he will do no more about
it."

FOOTNOTES

1Theodore Levitt (Harvard Business School), Consumer
Reports, March, 1972, p. 134. Quoted with no source from
AdvertisingyAge.

 

2Mary Gardiner Jones and Barry B. Boyer, "Improving the
Quality of Justice in the Marketplace: The Need for Better
Consumer Remedies," Trial, January-February, 1972, p. 361.

3These statements were selected from statements in the
cases selected by the editors of the UCC to illustrate the
meaning of 'merchantability.‘ They appear in the annotated
edition of the UCC under section 2 - 314 note 9, p. 199 of
the 1968 Master Edition and pp. 55-56 of the supplement
for use in 1972.

4Jerome Frank, Law and the Modern Mind, (New York:
Tudor Publishing Company, 1936).

 

5American Law Institute, Restatement of the Law of
Torts, Volume 2, Negligence, (St. Paul, Minnesota:
American Law Institute Publishers, 1934) p. 742.

 

 

6Ricketts v. Pennsylvania R. Co. 153 F. 2d 757 (2nd
cir., 1946). The quotes are at 767 and 765 respectively.

7"The Long Warranties," Consumer Reports, April, 1964,
p. 165.

 

34

CHAPTER TWO
TRADITIONAL WARRANTIES AS A CONSUMER

PROTECTION POLICY

"Accordingly, we hold that under modern marketing
conditions, when a manufacturer puts a new automobile
in the stream of trade and promotes its purchase by
the public, an implied warranty that it is reasonably
suitable for use as such accompanies it into the hands
of the ultimate purchaser." Justice Francis in
Henningsen v. Bloomfield Motors, Inc., 32 N.J. 358,
161 A. 2d 69 at 84 (New Jersey, 1960).

Contract Law

 

The warranties considered above are part of the law

of contracts. To understand the existence of provisions

establishing implied and express warranties, the relation-

ship between these warranties, and the resulting social

problems which have required new laws and hearings, one

must understand the role of contracts in society.

The

the

"A contract is a promise, or set of promises, for
the breach of which the law gives a remedy, or the
performance of which the law in some way recognizes as
a duty."1

contract provides the legal assurances essential for
efficient operation of the market system.

"The predominance of individualism in one sector
of the law of contracts may be explained by the fact
that this part of contract law is the counterpart, if
not the product, of free enterprise capitalism.
Contract, in this point of view, is the legal machinery
appropriate to an economic system that relies on free

35

36

exchange rather than tradition and custom or command

for the distribution of resources."2
The law of contract concerning warranties is particularly
central to the economic system since this law establishes
what must be provided (e.g. reasonable performance) when a
product is sold. It is reasonable to expect that different
formulations of contract law would lead to different
profitable behaviors and therefore to different economic
performances.

The law of contracts is not limited to written
contracts. Those behaviors such as using a sample or model
which create express warranties do not require the exist-
ence of a formal written contract. The critical act which
must occur for the warranty of merchantability to apply is
a sale by a merchant of goods of the type. Just as the
law creates a contract where no written document exists,
the law may also create a contract which differs from the
written contract (some examples are considered in
Chapter Four).

"Even at the risk of oversimplification, the law
of contracts may be divided broadly into two sections
governed by principles that are inconsistent with,
if not diametrically opposed to, each other. At one
pole is a body of institutions and doctrines that are
influenced by volition. At the opposite pole, freedom

of volition is limited, if not suspended, by an ever
expanding system of judicial and legislative control."

3
The sections of the UCC concerning warranties
illustrate the operation of these contradictory principles.

Sections 2-313, 2 - 314 and 2 - 315 create warranties on

the base of the behavior of the parties. If a merchant

37

sells a product by means of a sample, then the courts will
act as if both the implied warranties of merchantability
and the express warranty of conformity to the sample exist.
These warranties have been created by the law and not by
any volition on the part of the parties, they might not
even be aware that these warranties exist. Sections 2 —
316 and 2 - 719 allow one party to remove the warranties
established by the other sections by means of an express
warranty which replaces the other implied and express
warranties. When presenting a warranty which meets the
requirements of sections 2 - 316 and 2 - 719 the more
powerful party (in commercial transactions the more power-
ful party may be either the buyer or sell, but in consumer
transactions it would almost invariably be the seller),
unilaterally sets the conditions of the transaction. In
the case of consumer warranties (this ignores some recent
changes in the law in some jurisdictions which are
considered in Chapter Four) these unread and often unread-
able contracts which greatly limit the buyers' remedies
are given precedence over the traditional protections
created by the law when these documents conflict. When a
limited express warranty is offered in place of all other
implied or express warranties there is clearly a conflict.
There is also the situation in which the state imposes a
contract which comes into effect when a particular act

occurs (e.g., a sale by a merchant) which specifically takes

38

precendence over the contract agreed upon by the parties to

the transaction.

". . . quasi contractual obligations are imposed by
the law for the purpose of bringing about justice
without reference to the intention of the parties . . .
and sometimes in violation of his intentions."

The quasi contract is critically important to meaningful
consumer protection efforts and the changes considered in

Chapter Four are of this form.

Competition and Contracts

The precedence of negotiated terms over traditional
terms follows from some beliefs about how competition can
work to create the most efficient and equiable society.
Both the ideas and their age are shown in the following
quotes from John Stuart Mill who wrote in 1848 that:

"We have observed that, as a general rule, the
business of life is better performed when those who
have an immediate interest in it are left to take their
own course, uncontrolled either by mandate of the law
or by the meddling of any public functionary. The
persons, or some of the persons, who do the work, are
likely to be better judges than the government, of the
means of attaining the particular ends at which they
aim."

"Instead of looking upon competition as the baneful
and antisocial principle it is held to be by the
generality of Socialists, I conceive that, even in the
present state of society and industry, every restric-
tion of it is an evil, and every extension of it, even
if for the time injuriously affecting some class of
laborers, is always an ultimate good."

The behavioral implication of this position is that better
results will occur if those not involved in the transaction,
particularly the government, do not interfere with the

actions of the parties and that competition will resolve

39

any problems. The mechanism by which competition brings
the ideal results in contracts (and their coordinated
economic relations) is simple, in theory. If a producer
offers his product with a poor warranty (e.g., excludes in
an express warranty the traditional implied warranties)
consumers will presumably refuse to accept his offer if
another manufacturer offers an identical product with a
better warranty. In this manner the concerns of the
consumer and the possibilities of production will be com-
bined to yield a contract which by negotiation contains the
joint wisdom of the parties.

The problem with this position lies in the fact
that there is no necessary connection between freedom of
contract and competition. This is shown in the Sherman
Antitrust Act which makes the agreeing to a contract which
restricts competition a misdemeanor.

"Every contract, combination in the form of trust
or otherwise, or conspiracy, in restraint of trade or
commerce among the several States, or with foreign
nations, is declared to be illegal. . . ." Sherman
Antitrust Act (U.S.C. Title 15, paragraph 1.)

This act was passed on July 2, 1890. On August 17, 1937
this paragraph was amended to allow 'fair trade' (a con-
tract between the manufacturer and sellers setting a
minimum retail price) and on July 7, 1955 changing the
penalty for the misdemeanor from $5,000 and/or one year
imprisonment to $50,000 and/or one year imprisonment. The

Sherman Antitrust Act tried to restore competition by

eliminating trusts. The goal, however, was neither the

40

restoration of competition nor any specific performance,
but rather the restoration of the theoretical results of
competition. The theoretical results of competition follow
from meaningful negotiation in the market and are 'fair'
prices and terms. While the general policy, as indicated
by the sections of the UCC considered in this study, is one
of allowing the parties considerable freedom in the terms
of the contract which is to control their particular
transaction, restrictions on the freedom of contract are
not rare. Section 2 - 719, part 3, of the UCC is such a
limitation in that it makes the limitation of consequential
damages for injury to the person prima facie unconscionable
and thus unenforceable. The terms and often the rates in
contracts between consumers and common carriers and
insurance companies are not generally subject to negotia-
tion; nor can a man contract himself into slavery.

Approximately eighty years after the enactment of

the Sherman Act, the California Legislature passed the Song—
Beverly Consumer Warranty Act (considered in Chapter Four)
which in part stated,

"Nothing in this chapter shall effect the right of
the manufacturer, distributor, or retailer to make
express warranties with respect to consumer goods.
However, a manufacturer, distributor, or retailer
making express warranties may not limit, modify or
disclaim the implied warranties guaranteed by this
chapter to the sale of consumer goods."

This provision applies to those express warranties allow-

able under Section 2 - 316 and 2 - 719 which remove the

traditional implied and express warranties. Clearly this

41

is a limitation on the freedom of contract of the parties
to consumer transactions. This corrective legislation
resulted from various abuses of freedom of contract between
manufacturers and sellers of consumer goods and their
customers which led to a situation in which meaningful
negotiation was absent and the joint wisdom of the parties
did not emerge. The reason for this loss, a relatively
recent and probably inevitable effect of mass production
and distribution of goods, provides an important key to

understanding modern consumer problems.

Negotiation of Contracts

 

The idea of negotiating a contract involves two
parties discussing the terms of the transaction. Mass
production assumes a mass market in which the same product
is being sold to many different individuals. The negotia-
tion of contractual terms for each of these sales would be
extremely expensive as well as confusing since different
consumers might have different warranties. The practical
alternatives facing a manufacturer of millions of units
were: 1) not to use any written contract and thus use the
traditional law to distribute the risks between the
parties or 2) write a contract which is offered without
any negotiation, on a 'take it or leave it' basis, to all
consumers as part of the transaction which assigns a
particular distribution of the risks. In either case no

negotiations between the firm and its millions of customers

42

occurs. The complexity of contract law is largely due to
its function of determining the allocation of risks between
the parties. If the manufacturer had chosen not to use a
special contract (option 1) then the general law would have
have applied.

"If we view the law of contract as directed to
strengthening the security of transactions by enabling
men to rely more fully on promises, we see only one
phase of its actual workings. The other phase is the
determination of the rights of the contracting parties
as to the contingencies that they have not foreseen,
and for which they have not provided. In this latter
respect the law of contracts is a way of enforcing some
kind of distributive justice within the legal system.
And technical doctrines of contract may thus be viewed
as a set of rules that will systematize decisions in
this field and thus give lawyers and their clients some
guidance in the problem of anticipating future decisions.
Thus, for instance, if the question arises as to who
should suffer a loss caused by the destruction of goods
in transit, the technical doctrine of when title passes
enables us to deal with the problem more definitely.

In any case, the essential problem of the law of con-
tract is the problem of distribution of risks.”

The presence of written contracts (either signed by the
consumer as in the case of automobiles or enclosed with the
product as in the case of small appliances) indicates that
manufacturers have chosen to write the contract which will
distribute the risks of performance between themselves and
their customers.

These contracts generally serve to limit the rights
of the consumer. The negotiation and joint wisdom which
justifies the state's enforcement of private contracts may
be missing due to grossly unequal bargaining position.

"The weaker party, in need of the goods or services,

is frequently not in a position to shop around for
better terms, either because the author of the standard

43

contract has a monopoly (natural or artificial) or
because all competitors use the same clauses. His
contractual intention is but a subjection more or less
voluntary to terms dictated by the stronger party,
terms whose consequences are often understood only in
a vague way if at all. Thus, standardized contracts
are frequently contracts of adhesion."8
The consumer, in any individual transaction, is clearly
the weaker party. He cannot afford to have a contract
drawn for each of his purchases, but the seller may have a
general (blanks for color, price and other negotiated
items) specialized contract drawn which works to his
advantage since the cost can be spread over the hundreds,
thousands or millions of identical sales. The general law
assuring the consumer of reasonable performance would apply
(UCC warranties of merchantability and fitness for a
purpose) if the seller's contract were not used. The use
of these contracts can be considered an effort by
manufacturers and sellers to relieve themselves from the
responsibility of providing a consumer with a product which
performs in a reasonable manner.

In essence the use of these contracts serves to
separate the expectation of reasonable performance which is
essential to making the sale (if the consumer does not
expect the product to perform he is unlikely to make the
purchase) and responsibility for the actual performance
(beyond the limited express warranty.) Consider the
warranty of one of the most reputable of firms, the

International Business Machines Corporation (office

products division).

44

Warranty; Remedy

The Warranty period for the equipment will be 90
days (one year for electric motors) commencing either
upon the first installation of the equipment or nine
months after its delivery, whichever first occurs. . .

Standard Warranty/Remedy

IBM warrants the equipment to be free from defects
in material and workmanship upon delivery. In the
event of IBM's breach of any warranty, Purchaser's
exclusive remedy shall be that IBM will repair or
replace broken or defective parts and make necessary
equipment adjustments during the warranty period with-
out charge.

NO OTHER WARRANTIES, EXPRESS OR IMPLIED, INCLUDING
THE WARRANTY OF MERCHANTABILITY, SHALL APPLY TO THE
EQUIPMENT (set in upper case in the contract)
IBM has a reputation (consumer expectation) for quality
for which it refuses to assume legal responsibility. The
nature of the contract insofar as achieving (or failing to
achieve) the joint wisdom of the parties is shown by the
conditions concerning breach by the customer.
1. The entire debt shall immediately become due
and payable;

2. IBM, in addition to other remedy, may repossess

the equipment without notice; and

3. The buyer agrees to pay IBM's costs and expenses

of collection and/or repossession, including the
maximum attorney's fee permitted by law, said
fee not to exceed 25% of the amount due here-
under.

One might accept that this contract does separate
expectations from performance, but suppose that competition
between suppliers of office equipment will eliminate the
problem. The question becomes if, in the real world,
competition is operating to eliminate these highly restric-

tive contracts. The holding of Congressional Hearings,

speeches by the President and changes in state laws all

45

strongly indicate that a problem exists which is not self-
correcting. The stability of the problem was illustrated
by testimony in the Congressional Hearings. Senator Moss
felt that the lack of competition followed from a basic
inability of consumers to understand the document.

"Through extensive hearings the committee has
learned that a warranty is a complicated legal document
whose full essence often lies buried in century-old
legal decisions or complicated State codes or commercial
law so that consumer understanding of what a warranty on
a particular product means may not always coincide with
its legal meaning."

Virginia H. Knauer, Special Assistant to the President for
Consumer Affairs, noted that manufacturers exploit this
inability of consumers to understand warranty contracts.

"Recognizing the average consumer's helplessness
where legal documents such as warranties are involved,
suppliers have practically institutionalized warranties
which take away more than they give. And the market-
place has further aggravated the problem by failing,
with some exceptions, to provide meaningful competition
as to warranty terms."

Fairfax Leary, of the Public Interest Research Group of
Virginia, testified that even if consumers did understand
the warranties, without legislation the situation would

not change.

"Much consumer legislation in the Congress and at
the State level seems founded on the concept of
disclosure, usually in the documentation of a sale or
credit transaction. One can, justifiably, doubt that
many consumers read the printed matter on the paper
they sign. It really couldn't do them any good if they
did, since no one at the point of sale has or can get
any authority to change the company's standard form.
The choice is take it or leave it. Nor is comparison
shopping apt to do much good. The form may well have
been supplied by the trade association for all its
members, directly; or indirectly, through a firm
selling legal forms."1

46

Again, the IBM contract is instructive as to the position
of the consumer

"IBM shall not be liable for incidental or conse-
quential damages. This agreement constitutes the entire
contract between the Buyer and IBM with respect to the
equipment, including any parts or equipment furnished
as a replacement, and no representation or statement
nor expressed herein shall be binding on IBM. The
foregoing terms and conditions shall prevail notwith-
standing any variance with the terms and conditions of
any order submitted by the Buyer with respect to the
equipment."

William F. Willier of the National Consumer Law Center,
Boston College Law School summed up the situation.

"The use of warranty disclaimer clauses has become
so universal that manufacturers and sellers of consumer
goods have effectively repealed the law of merchant-
ability." 2

Consumers accept these contracts which separate

expectation from performance because of consumer ignorance
and because of the unequal bargaining strength of the
parties. Solving the problem by educating the consumer is
unlikely to be effective even if the level of education
required were achieved since even lawyers purchase IBM
office equipment, if they want to benefit from IBM's
patents, on the same contractual terms as the layman.13
Consumer education while not directly solving the problem,
might lead to consumer pressures which would lead to
political action restricting the discretionary power of
manufacturers and sellers in the terms of the contracts
they offer consumers. Solving the problem through

equalizing the strength of the parties would require the

restoration of much smaller scale industries in which the

47

buyer and the seller have approximately equal strength.
Clearly such a remedial approach is not a reasonable
alternative. The corrective actions which have been taken
(considered in Chapter Four) have not sought to achieve the
joint wisdom of the parties by means of negotiation between
the parties. Such negotiation would require both a massive
consumer education effort and atomization of firms. Rather
through court decisions and/or legislative action the
"joint wisdom" of the parties is imposed on the individual

parties by governmental decision.

Contract Adjustments

 

The imposition of "joint wisdom" is not new when
meaningful negotiation has become impractical due to
corporate size and the requirements of efficient mass
marketing.

"In recent years (1920-21) the tide has set
strongly in the other direction. Observation of
results has proved that unlimited freedom of contract,
like unlimited freedom in other directions, does not
necessarily lead to public or individual welfare and
that the only ultimate test of proper limitations is
that provided by experience. . . . In the law of
carriers, the Interstate Commerce Acts of the United
States and similar state legislation in regard to
intrastate business, have almost destroyed freedom of
contract between shipper or passenger and carrier.

The rates which the carrier may charge and the facili-
ties which it may furnish are determined by law, not
only irrespective of the will of the parties but in
spite of contrary expressed intention. The contract
of insurance has been similarly defined by legislation.
Standard policies of fire insurance have been fixed by
statute, and policies must be written according to the
terms thus fixed. Other contracts of insurance are
often closely regulated so that the bargain opened to
parties is whether they will insure or not, with whom
they will insure, and for how much; but when these

48

fundamental matters are agreed upon, little more scope

is left for barga1n1ng."1
While the contracts presented consumers allow the profitable
separation of performance from expectation of performance
the need for corrective action can only be shown by obser-
vation of poor results coming from the use of these
contracts.

It is quite possible that manufacturers, although
offering very poor contracts, in effect adequately guarantee
the performance of their products by providing after the
sale service for reasonable consumer claims. This behavior
would be reasonable in that if it were well known consumers
would be more confident (have high performance expectations)
in products produced by that company. Such cooperative
behavior by manufacturers would eliminate much consumer
dissatisfaction. That consumer dissatisfaction is a fact
of the current scene strongly indicates that manufacturers
not only offer these contracts but also use them. The
automobile is both a virtual necessity and an expensive
product. Its central role in American society combined
with an inclination towards lively warranty and expectation
of performance promotion activities has led to Congressio-
nal and Federal Trade Commission (FTC) inquiries into the

warranty practices of the industry.

Automobile Experience

 

From November, 1931, until 1960 the automobile

industry warranted its product for 90 days or 4,000 miles.

49

On September 28, 1960, Ford changed to a one year or
12,000 mile warranty and was followed in one day by American
Motors and three days later by General Motors and
Chrysler.15 In the fall of 1962, Chrysler under a new
president, Lynn Townsend, shifted its advertising account,
doubled the amount spent on advertising between 1963 and
1966, made some styling changes, introduced its new models
before its competitors and offered a five year or 50,000
mile warranty on the power train. This combination of
efforts was quite successful as sales rose by 31% (General
Motors sales increased by 7% and Ford by 3%).16
The quantification of the effects of the warranty
in terms of sales, either total or market share, is
probably not possible. The movements in sales represent
the combined effect of not only the warranty offered, but
also promotional efforts, styling, dealer aggressiveness,
demand for recent models in the used market and other
factors. The best indication of the expected effect of
Chrysler's five-year warranty is the behavior of the
professionals in the industry. General Motors, Ford, and
American Motors not only quickly matched Chrysler, but
offered a slightly better warranty to compensate for the
first exposure gained by Chrysler. The speed with which
the warranty was copied demonstrates the expected
effectiveness, but also makes impossible any statistical
proof since Chrysler only had the monopoly on the warranty

17

for a short period. The effect of the five-year

50

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51

warranty does not appear so much between the firms,
although Chrysler does seem to have a higher market share
after the warranties, but in the total sales of the
industry. That the effect of the warranty should appear

in total sales (automobiles relative to all other goods)
rather than in the sales of the individual firms is
reasonable since there was little difference between the
warranties offered by the various firms, but all of the
warranties would lead to higher consumer expectations for
automobiles (compared to all other goods). These data are
clearly inconclusive. Understanding and predicting automo-
bile (and other products) sales is more of an art than a
science. With all of the modern techniques and a virtually
unlimited budget the group which analyzed the market
situation for the Edsel made a decision which lost Ford a
quarter of a billion dollars.

Initially the warranties represented a bargain
(increased customer confidence in the industry at a small
cost) to the manufacturers. The warranty service costs for
the 1965 models averaged between a low of $41 for Chrysler
(1.6% of its average car price) to $47 for Ford (2.1% of
its average car price.) But the FTC noted in its staff
report, "However, as the new extended warranties take hold,
as customers learn better their rights under the warranties,
as costs of repairs rise, the fulfillment of the terms of
the warranty can and is likely to become an expensive

18

responsibility for the automobile manufacturers." The

52

FTC prediction proved to be correct as the cost more than
doubled a couple of years later and the firms reduced the
extent of their warranties.

Business Week in an article entitled, "Detroit

 

Tries a U-Turn on Warranties" summed up the experiences of
the firms after the FTC study.

"When Chrysler offered its original five-year,
501000 mile warranty [on the drive train - MS]
(1963 cars), the company was the acknowledged leader
in engine and drive component engineering, and
increased warranty costs could be written off against
the marketing advantage that grew out of the warranty.
As a hidden cost-saver, Chrysler retained its 12-month,
12,000-mile warranty (introduced by Ford in 1960
replacing the 90-day, 4,000-mile warranty) on the rest
of the car, while Ford, GM and American Motors esca-
lated to a 24-month, 24,000-mile guarantee. Then when
all four manufacturers went to the same basic, extended
warranty in 1967 - five-years, 50,000-miles on the
drive train, and 24-months, 24,000 miles on the rest
of the car - no manufacturer had an advantage, and,
what is more costs soared. For Ford, the outlay to
dealers for warranties between 1966 and 1967 doubled
to $120 a car for a total hike of $130 million
(similar for other manufacturers) . . . in 1969 alone
Ford paid its U.S. dealers $300 million in warranty
costs. That sum was double Ford's advertising budget
for the year and nearly matched the $325 million that
the company spent in retooling for its 1969 line . . .
To hold costs down, auto companies began pulling back
on their warranties only a year after they all went to
the same extended coverage. On the 1968 models they
introduced restrictions on warranty transfers . . .
On the 1969 models they went further and cut the basic
coverage . . ."19

There are two noteworthy elements in this experience. It
seems clear that the manufacturers were not aware of the
costs consumers had been paying, and continue to pay, to
maintain the drive train and other mechanical parts even
when they follow the manufacturers' maintenance program

(which was required for these warranties to be in effect).

53

One might reasonably conclude that the manufacturers had
not been very interested with the maintenance costs of
their customers. Another interesting element is the
manufacturers' solution to the maintenance problem. Rather
than raising their price and improving their product so
that it could meet their warranty claims (and a consumer's
reasonable expectation of performance) and/or improving
the owner's maintenance program to eliminate product
failures, they chose to shift the risks of operation to the
consumer by limiting their own financial, if not actual,
responsibility for the performance of the product they
design, manufacture and assemble.

The FTC found considerable evidence that the
automobile manufacturers were marginally, if at all,
interested in their products after their sale.

"Despite all disclaimers, sales are still foremost
(they provide the manufacturer's revenue) and service
retains the status of a "necessary evil" in much of
the automobile business. Some evidence of this is:

(a) in one manufacturer's reorganization, service
representatives, who had previously separate but

equal status with sales personnel, were placed under
the regional sales manager; (b) in the training center
of another manufacturer prime consideration is given

to the training of sales rather than service personnel
based on courses given, numbers attending, etc.;

(c) in the manufacturers' regional organizations sales
personnel outnumber and outrank service personnel.

The number of service representatives appears inade—
quate to handle the number of dealers assigned to

them, and these representatives are also assigned
nonservice duties to perform; (d) the accountability

of dealers to manufacturers for sales is much more
strictly enforced than their accountability for
service, as shown by checks on dealers and franchise
cancellations; (e) one manufacturer's system of company-
financed dealers apparently undercut regular dealers'
prices on sales, as a means of forcing new car sales in

54

an area, with unfavorable consequences for service;
and (f) the cancelling of franchises of dealers who
have low new car sales volumes, but who perform a
larger percentage of service work in their
operations."20
These contracts, while extending the express warranty of
the manufacturers, offered the limited express warranty in
place of the traditional implied warranties and any other
express warranty. The emphasis on sales and the subse-
quent solution of returning the risks of design, manufacture
and assembly to the consumer demonstrate the nature of
these contracts. They not only served to separate
expectations from performance, but also to increase the
consumers' expectations. Miles W. Kirkpatrick, chairman
of the FTC, testifying before the House of Representatives'
Hearing summed up the automobile warranty experience.
"After full consideration of the voluminous record
compiled during this investigation, the Commission
concluded that the much heralded and heavily promoted
warranty programs of American automobile manufacturers
during the sixties were, in fact, extremely limited
and had failed to provide the purchases with the
quality and service he rightfully expected."21
If the word 'rightfully' is changed to 'reasonably'
the role of the traditional warranties becomes clear. The
contracts offered to consumers remove the consumer's right
to recover damages if he is sold a defective product.
Justice Francis, in a very important case, Henningson v.
Bloomfield Motors, Inc., in 1960 noted the nature of con-

tracts based on either section 2 - 719 or on the common

law which this section made into statute.

55

"Moreover, the language of this warranty is that
of the uniform warranty of the Automobile Manufacturers
Association, of which Chrysler is a member. . . . The
terms of the warranty are a sad commentary upon the
automobile manufacturers' marketing practices.
Warranties developed in the law in the interest of and
to protect the ordinary consumer who cannot be expected
to have the knowledge or capacity or even the opportunity
to make adequate inspection of mechanical instrumen—
talities, like automobiles, and to decide for himself
whether they are reasonably fit for the designed
purpose . . . . But the ingenuity of the Automobile
Manufacturers Association, by means of its standardized
form, has metamorphosed the wggranty into a device to
limit the maker's liability."

The corrective policy which the automobile experience indi-
cates should occur was stated by Karl Llewellyn, the
principle author of the UCC, many years ago on a different
problem.

"But what [experience in contract law administra-
tion] does not fit [the common-law judge] for is to see
that there is such a distinction; to see that free
contract presupposes free bargain, and that free bar-
gain presupposes free bargaining; and that where
bargaining is absent in fact, the conditions and
clauses to be read into a bargain are not those which

happen to be printed on the unread paper, but are those
a sane man might reasonably expect to find on that

paper.

Faced with the fact that currently freedom of contract
operates without the presuppositions required for the
policy, the contract should not be read as it is printed,
but rather reasonable terms must be imposed on the parties.
By not permitting the exclusion of the traditional
warranties, with their base of reasonable coordination
between manufacturer created expectations in the consumer
and the product's performance, with a limited express

warranty, the consumer will be able to defend himself

56

against misrepresented durable products. Those
manufacturers who do not use express warranties to limit
their responsibility will not be effected by the change.
As is shown in Chapter Four this change can be achieved
in at least three different manners.

The objectionable nature of these contracts can
be shown by a rather simple a priori argument. If the
manufacturer can sell a product without actively and
purposefully creating consumer expectations he has no
intention of meeting, he has no need to restrict the
consumer to the limited remedy of repair or replacement.
If the manufacturer uses these contracts to relieve himself
of responsibility for consumer expectations he created
about the product which he knows will not (in a significant
number of cases) be met, but which must be made in order to
sell the product, society hardly needs the product. It is
hard to imagine a product which consumers need which could
be sold profitably only by means of deception. If the
public does not need products which can only be sold by
deceptive means (with the resulting disappointment of the
buyer) then either the manufacturer does not need the
contract or society does not need his product. In either
case, the contracts are indefensible. It is hard to
imagine how a law which encourages deceptive behavior and
which is supposedly controlled by meaningful negotiation
which does not occur would lead to beneficial results.

Removing the discretion of the seller to remove the

57

traditional buyer protections is not a limitation of free-
dom of contract; freedom of contract does not exist in the

absence of meaningful negotiation and free bargaining.

Policy Implications of Requiring Effective Warranties

 

Requiring absolute liability (not concerned with
negligence) as a policy has its own set of presuppositions
which must be met for this policy to be reasonable.

"The reason for imposing such alliability [irrespec—
tive of the positive contract of the parties . . .
holding] that there is a warranty of quality in case
of sale or contract to sell specific goods, where there
is no promise or affirmation in regard to them upon
the seller is that the circumstances of the bargain
justify the buyer in inferring that the seller by the
very act of offering his goods for sale asserts or
represents that they are merchantable articles of their
kind or are fit for some special purpose, and that the
buyer relies upon this implied assertion or represen-
tation. Such an implication and justifiable reliance
thereon does not exist in every case. The circumstances
which must be considered in deciding the question may
thus be summarized: (1) Was the seller a manufacturer
of the goods, and thus familiar with their construction?
(2) Or, if not a manufacturer, was he a dealer in goods
of that kind and so a competent judge of their quality?
(3) Did the buyer inspect or have an opportunity to
inspect the goods, and was the defect latent so that
it could not be discovered by such inspection?

(4) Apart from opportunity to inspect, were there
circumstances showing that the buyer selected the
goods relying on his own judgment or showing an inten-
tion to take the risk of their quality?"24

These conditions seem to be met in consumer purchases of
mass produced products.

There remain two points which require consideration
at this point. One might suspect that imposing the
traditional warranties would place a difficult additional
burden on the producers. Above it has been shown that the

manufacturers need only meet the reasonable expectations of

58

consumers which the producer may change by clear statements
of likely product performance. But besides the ability to
limit their responsibility by creating special expectations
the firms have often been operating under the traditional
protections when supplying commercial and governmental
accounts. The Assistant Attorney General in charge of the
Antitrust Division of the Justice Department, Robert W.
McLaren stated in his testimony before the Senate Hearings
on warranties that:

"If a contract is negotiated, warranty terms are
likely to be the subject of negotiation. If as
probably happens more frequently (in a commercial
transaction), a transaction is arranged by an exchange
of conflicting purchase orders and acknowledgement
forms, these forms have been carefully drawn by
skilled lawyers so that each is likely to negate the
terms of the other. The ultimate result is that the
parties to the transaction are left with the same
rights and obligations under the Uniform Commercial
Code which they would have hag if both parties had
remained completely silent."

The IBM contract provides that:

"The foregoing terms and conditions shall prevail
notwithstanding any variance with the terms and condi-
tions of any order submitted by the buyer with respect
to the equipment."

A sophisticated large scale buyer would have a similar
clause in his contract with the net result being that both
contracts serve to cancel each other out and any disputes
are settled by the general commercial law. Clearly the
restrictive contracts are not necessary for commerce and
seem to be largely reserved for the individual consumer.

If commerce can continue when industry purchases the same

items as consumers (e.g., automobiles) under the traditional

59

rules (the special contractual terms on the purchase order
and the sales contract cancel each other out), then one
might reasonably expect that commerce would continue if
consumers also purchased products under the traditional

rules.

Absolute Liability As A Policy - Workmen's Compensation

 

Policies are important only if they change
behavior. Basically this study proposes a policy which
removes a contractual approach that allows the seller to
shift financial responsibility for his decisions to the
buyer under the guise of freedom of contract. This policy
would impose an unavoidable liability for performance on
the manufacturer. The oldest governmental social reform
program in the United States, workmen's compensation, is
remarkably similar and gives an indication of how this
consumer protection program might function. The principle
of workmen's compensation (liability of employers without
fault) was first adopted on the Prussian railroads in 1838
and a general compensation bill was passed in Germany in
1884. Britain followed in 1897 and the Federal Government
provided compensation to its employees in 1908. Montana
passed the first state law in 1909 and between 1910 and
1915 thirty states passed this legislation. By 1920 all
but six Southern states had this legislation and in 1948
with passage by Mississippi all the states provided some

system of workmen's compensation.26

60

The legal situation which necessitated workmen's
compensation was that an employer could escape responsi-
bility for accidents of his employees if he could establish
one of three common law defenses: 1) contributory negli-
gence, 2) fellow servant doctrine and/or 3) assumption of
risk. If the manufacturer could show that the worker was
in some way at least partially responsible for his accident
(e.g., careless) or that the accident was caused by another
worker or if the accident was normal for the industry
(e.g., an occupational disease) then the worker could and
would be denied any recovery of his loss. If accidents are
viewed as the result of specific persons' behavior, then
this system is reasonable.

"The nineteenth-century legal system of employers'
liability dervied from the common law of negligence or
tort liability. Implicit was the basic assumption that
occupational injuries were always the result of someone's
fault and that he should bear the costs."

But if accidents are not viewed individually, but rather in
total, it becomes clear that the contributory negligence of
the worker, the negligence of a fellow worker and the risks
of an industry are related to the decisions of the
manufacturer.

"The prevention of occupational accidents and
disease is primarily an engineering problem and as such
is reducible to terms of pecuniary cost. Industrial
safety depends much more upon the construction of
plant and equipment, the choice of materals and pro-

cesses and the safeguarding of machinery than upon the
discipline and training of employees."2

61

Table 2. Industrial Fatalities

Year Coal Mines Iron and Steel Railroads
deaths per deaths per million deaths per ten
million tons hour exposure million train miles
1907 6.78 .7
1908 5.97
1909 5.73
1910 5.62 .5
1911 5.35 .3
1912 4.53 .4
1913 4.89 .4 18.4
1914 4.78 .3 16.5
1915 4.27 .2 10.6
1916 3.77 .3 11.6
1917 4.14 .4 14.5
1918 3.80 .4 17.0
1919 4.18 .4 11.7
1920 3.45 .2 12.7
1921 3.92 .2 7.8
1922 4.15 .2 8.5
1923 3.74 .2 9.0
1924 4.17 .3 6.7
1925 3.85 .2 6.8
Source: U.S. Department of Labor, Bureau of Labor
Statistics, Accidents and Accident Rates, Bulletin
490, August, 1929.
ap. 159
bp. 127
Cp. 172

 

These data, the oldest available, indicate a down-
ward movement in fatalities due to industrial accidents.
Unfortunately in terms of establishing the effectiveness of
workmen's compensation legislation these data are completely
inadequate. It is not possible to determine from these
data if the downward trend observed was in effect before
the enactment of the legislation or if it began as the

legislation began to take effect. One may speculate that

62

the reason the data are not available is that the collection
of data is expensive and no one was interested until the
data were essential for setting insurance rates. The
availability of the data is a function of the concern
which led to the enactment of workmen's compensation
legislation. Faced with a lack of data the researcher
must use the opinions of experts. Before workmen's
compensation legislation the National Safety Council (it-
self formed in the early years of workmen's compensation
legislation enactment - 1912) explains the general apathy
towards industrial safety as due to: 1) common law
defenses which eliminated the manufacturers' responsibility
for most industrial accidents, 2) ignorance of the economic
losses caused by accidents and 3) the idea that accidents
were unavoidable, that they were a price which must be
paid for industrial progress.29
In terms of evidence the absence of the general
accident statistics for the period during which the
legislation was being enacted is probably not too critical
as interpretation would have been very difficult, if not
impossible. Reporting of accidents is doubtlessly a
function of damage recovery possibilities, otherwise where
would the accident be reported and why bother? There is
no necessary and unchanging relationship between the number
of accidents which occur (the condition with which a policy
advocate is concerned) and the number of accidents reported

(the data for program evaluation). Thus workmen's

63

compensation legislation could have effectively reduced
the number of industrial accidents if the number of
reported accidents increased, remained unchanged or
decreased. The removal of workmen's compensation would
probably lead to a decrease in the number of reported
accidents. Also workmen's compensation only directly
effects the first of the three reasons given for the
manufacturers' apathy; a drop in the number of accidents
could occur with a change in either of the other two
beliefs of manufacturers. The connection between these is
shown by the fact that workmen's compensation legislation
would not have produced any behavioral changes in manu-
facturers to reduce the number of accidents unless
manufacturers came to believe that accidents were avoidable
and not a necessary price of industrial progress. Social
policies are inevitably complex and not readily, if at all,
subject to indisputable statistical analysis. The
researcher when faced with a situation in which no
statistical situation would discredit a hypothesis (e.g.,
industrial accidents up, down or unchanged and the
effectiveness of workmen's compensation legislation) and a
choice of several alternative causes must use different
evidence. He must consider what would be rational
behavior for manufacturers under the new rules and the
judgment of those who have studied the situation.

With the removal of their effective common law

defenses the manufacturers would be financially responsible,

64

at least to a limited extent, for accidents in their plants.
Cost functions for a particular production technique would
include in addition to factor costs (e.g., materials and
labor) a cost of accidents. To maximize profits the
manufacturer would have to minimize not only his factor
costs but also his liability for accidents. It is unlikely
that faced with injury claims a manufacturer could continue
to be unaware of the costs of industrial accidents and
maintain the belief that nothing under his control could

be changed which would reduce the likelihood of claims.

The profit maximizing manufacturer would want something
done about these costs. The National Safety Council was
formed as these costs began to occur. The workmen's
compensation legislation destroyed the three conditions
which allowed the manufacturer to remain apathetic to
issues of industrial safety.

"Discovery of the safer way in fact demands close
analysis of the particular processes involved in
relation to the circumstances, product and organization
of the particular plant. The requisite trouble and
expense will not be incurred unless strong inducements
are brought to bear upon the keeper of the purse."30

Workmen's compensation is credited with achieving much of
the gain in industrial safety.

Richard T. Ely, noted in a rather charitable

manner,

"Indirectly [workmen's compensation] promotes

industrial safety by adding pecuniary incentives to
the humanitarian interests of employers."

65

E. H. Downey, writing less than ten years after the enact-
ment of workmen's compensation legislation by the majority
of the states noted,

"Compensation laws have everywhere given a notable
impetus to the safety movement, notwithstanding that
the benefits are pitiably small."32

He further notes that the National Safety Council was
organized AFTER compensation laws had been enacted in

twenty states and that its growth corresponded with the

33

growth of the compensation movement. A later researcher

in industrial accidents credited workmen's compensation
legislation as being the principle force for the improve-
ment in the performance of the manufacturers.

"By making work injuries immediately and
inescapably expensive to employers, workmen's compensa-
tion laws [first passed in Switzerland in 1881, but
developed by Bismark in Germany and passed in 1855 to
reduce the power of a rising socialist party - these
laws remove questions of fault - contributory negli-
gence, fellow servant negligence and the assumption of
risk defenses could no longer be effectively used MS]
have done more to promote [management's] interest in
safety than all other influences put together. As the
worker's knowledge of his rights under these laws
spread, claims increased rapidly in number and the cost
to employers grew to such substantial figures, parti- _
cularly in large, high injury plants, that many of them
initiated extensive programs of hazard elimination.
They usually were very expensive because of the heavy
costs of guarding the machinery, particularly the power
transmission machinery [belts and shafts leading from
a central steam engine MS], but it soon became clear
that the saving of a few deaths or serious permanent
disabilities would pay for a lot of guards. A few
socially minded employers had begun the correction of
obviously serious hazards long before the passage of
workmen's compensation legislation, but the great
majority had done little or nothing."34

66

The Relationship Between‘Workmen's Compensation and

Consumer Protection

 

The workmen's compensation experience demonstrates
that a manufacturer's performance can be improved dramat-
ically if the manufacturer is made responsible for the
losses caused by his poor performance. Since product
performance, like industrial safety, is basically a problem
in engineering one may reason by analogy on the basis of
the experience with workmen's compensation. It seems
likely that holding manufacturers responsible for the
performance of their products (providing the consumer with
means to recover his loss) will lead the manufacturers to
exercise greater care to insure that their products will
function properly. Before proceeding with an analysis of
the implications of a policy of not allowing sellers to
eliminate the traditional implied and express warranties
by means of an unread and unnegotiated clause in a standard
contract, it is worthwhile to consider the beliefs and
conditions which prevented progress in industrial safety
in light of consumer products. The practical freedom from
responsibility of the manufacturer for industrial accidents
by means of common law defenses has been achieved in the
case of consumer products by means of express warranties.
The experience of the automobile manufacturers, sophisti-
cated firms by any criteria, shows that they were not aware
of the consumers' costs of their production decisions. Much

like industrial accidents were formerly, so is sloppy

67

workmanship currently viewed as a necessary cost of mass
production. Just as imposing an absolute liability for
accidents on manufacturers brought increased concern for
industrial safety, so will holding manufacturers unavoid-
ably responsible for the performance of their product
(because they cannot reduce their limited express
warranties as did the automobile manufacturers when faced
with the costs of their decisions) bring greater concern

in product performance.

Evaluation of Consumer Protection Policies

The policy of changing the basic contract law to
preclude exclusion of the traditional implied and express
warranties seeks to reduce consumer disappointments due to
the difference between consumer expectations of performance
and the actual performance. In the light of the diffi-
culties involved in interpreting the automotive sales and
the industrial accident data above, one might consider the
statistical requirements for evaluating this policy. Two
questions are of particular importance: 1) what is the
magnitude of the problem? and 2) is the policy, where it
has been put into effect, reducing the problem? The
fundamental difficulty encountered when seeking to answer
these questions lies in the fact that the problem occurs
as frustration at the disparity between expected and actual
performance. The frustration resulting from this disparity
is a mental state. Research techniques do not currently

permit a direct quantitative measure of frustration. To be

68

sure the problem is not new to economics. Demand theory is
built on the opposite mental state, satisfaction, which
also cannot be directly measured. What must be found is
something which is measurable, behavior and/or events,
which reflects the mental state.

In terms of frustration there are forms of behavior
and events which reflect this mental state: suicide, alco-
hol and drug consumption, crimes of violence, ulcers and
others. Unfortunately the number of these events is not
directly related to consumer frustration with products
since product failures are not the only source of frustra-
tion in a modern society. If this connection could be
made, in a manner which would satisfy a large percentage
of students of the problem (as industrial accidents serve
as a measurable proxy for the unmeasurable level of
industrial safety), it would probably be the most
satisfactory measure of both the size of the problem and
the effectiveness of the solution. Until the development
of a system which allows the separation of the effects of
the various sources of frustration this approach will
remain unusable.

In the case of utility or satisfaction the ordinal
measure is made on the basis of the purchases consumers
actually make. It might be possible to analyze consumer
frustrations of the form relevant to this policy by the
purchases consumers do not make. Unfortunately in terms

of the analysis, purchases of durables are made only on the

69

basis of performance expectations while this policy seeks
to reduce a disparity between actual and expected perform-
ance. Because the products are durable, few subsequent
purchases would be based on the performance of the
previously owned product. Sales of furniture and major
appliances do not lend themselves to analysis of consumer
satisfaction or frustration because the same consumers do
not purchase the same product frequently. Sales to
different consumers are based on expectations rather than
actual performance.

While direct analysis from sales is not possible,
one might argue that an index of brand loyalty would give
an indication of consumer satisfaction. These data would
be far from conclusive. A purchase of a durable depends
on the expectations of performance not only of the selected
brand, but also of all the others available. The appear-
ance of a high level of brand loyalty could result from
either good experience with the currently owned units
and/or an effective promotional effort. A low brand
loyalty situation could follow from poor previous
experience and/or a relatively ineffective promotional
effort. It is very difficult to imagine how one would
interpret an index of brand loyalty. While reputation
based on use rather than promotional effort is a factor in
sales, it is not the only factor (e.g., retail locations,
special sales, and advertising among others). The relative

importance of the factors would vary according to the

70

success of the other factors. Immediately following the
introduction of a new model with considerable advertising,
expectations of performance may be so great as to overcome
previous poor experience with previously owned models. But
as time passed and the excitement wears off past experience
would probably gain in relative importance. While hardly
conclusive the constant and expensive creation of excite-
ment, as in the automobile industry, might lead one to
suspect a poor product performance.

The research problem with sales lies in the number
of factors, and therefore alternative explanations avail-
able to account for any movement. The sales of an
individual brand depend not only on its past performance
and current promotional efforts, but also on these same
factors and price, service, location and other factors for
all of the other available brands. If the industry is
considered as the relevant unit other problems emerge. The
growing demand for some reasonable form of public trans-
portation could be the result of consumer dissatisfaction
with the performance of automobiles. While this demand for
better transportation services is probably largely based on
consumer dissatisfaction with the current structure, the
problem goes beyond mere disappointments with the perform-
ance of automobiles. The demand for public transportation
follows from the nervous strain, pollution, excessive costs
including the expected depreciation, and time required for

primvate transportation. While giving the consumer means

71

to collect his losses if the performance of the automobile
does not meet the expectations of reasonable consumers will
reduce the frustration with automobiles, this policy will
not eliminate all of the frustrations related to private
automobile transportation. To determine the scope of the
problem and the effect of the policy a means of separating
the causes of the frustration leading to the demand for
public transportation would be required. While the industry
analysis eliminates some of the alternative explanations
(e.g., competition between brands) the aggregation combines
many sources of frustration besides a disparity between
product performance and expected performance.

The movement between the cities and the suburbs
also involves frustration. Disappointments in the perform-
ance of automobiles, washing machines, lawn mowers and
other durables characteristic of the suburbs would make
urban life more attractive. Again the product failures
would account for only an unknown part of the frustrations
which would cause a person to move from the suburbs to the
cities and face the ample urban frustrations. A net
movement from or to the cities relative to the suburbs
indicates (perhaps) the greater total frustration, but it
does not indicate the amount or how it should be divided
between the various sources.

If social movements and sales data include too many
alternative explanations besides consumer frustration with

product performance, then it might be possible to use

72

evidence not based on frustration. Rather than working
with manifestations of a mental state, specific behavior
might be considered. Such behavior would include the
production of consumer protection articles (relevant to

the particular policy) in magazines or changes in the size
of consumer protection staff in governmental bodies or
industry. While the connection might not be exact between
these numbers and the amount of consumer frustration in the
population one might suspect that some connection would
exist and could be determined. While a connection probably
exists there is reason to doubt that its form can be
determined. Before consumerism became a public issue there
were relatively few articles and governmental agencies, but
from this one would not conclude that consumer frustration
with products did not exist. At the other extreme there
may be more regulation than problems or the regulation may
create many of the problems - the Interstate Commerce
Commission (ICC) when regulating the railroads may be in
this situation. Again the problem lies in the fact that we
are considering a social behavior which is the function of
several factors. Public action follows not only from the
existence of the problem, but also the awareness of the
problem and if dealing with that particular type of problem
is currently in style. One cannot equate the seriousness
of the problem with the quantity of public response. The

desired information, necessary to analyze the effect of the

73

policy, the magnitude of the problem before the policy
cannot be determined by an analysis of the public's action
and the number of articles.

A very direct measure of consumer dissatisfaction
with products lies in court cases and complaints made by
consumers to consumer protection divisions of governmental
units. Again the problem lies in the fact that the exist—
ence of the problem (the desired information) is only one
factor in many involved in the generation of a court case
or a complaint. If the consumer does not feel that the
courts or governmental agency can do him any good he is
unlikely to complain. The lack of complaints is not
necessarily an indication of a lack of consumer frustration
with product performance. A large number of complaints
may reflect effective handling of a relatively small number
of consumer problems. A numerical examples makes the
situation clearer. If there are actually 1,000 incidents
but only 5% are reported due to a lack of faith in the
institution there are a total of 50 complaints. If there
are actually only 100 incidents, but 75% are reported
because of consumer faith in the institution there will be
50% more complaints where there are 90% fewer incidents.
The actual number is the desired information, but the only
data available would be the number of reported incidents.
Without knowing the reporting rate, which will vary
according to consumer faith, the length of the form to be

filed, the location of offices and doubtlessly many other

74

factors, there is no way of determining the actual number
of incidents from the reported number. The problem is
somewhat more complicated in that the reporting rate will
change as consumers have experience (good or bad) with the
institution and as manufacturers adjust to the institution.
How can a policy be proposed and supported if the
researcher cannot establish by means of social movements,
sales statistics nor complaints, the scope of the problem
nor the effectiveness of the policy? The existence of the
problem can be established by appeals to personal experience
of virtually any adult and probably most children. The
magnitude of the problem will probably remain a matter of
opinion. The policy follows from a logical argument as
does the freedom of contract policy which it seeks to
adjust. Since the argument has been developed in this and
the previous chapter there is no need to repeat it at this
point. Although the difference may be more one of degree
than of kind, in the absence of empirical support the
proponents of a policy must present it for public inspec-
tion. Those who believe that the policy will be
ineffective or counter-productive may present their views.
Hopefully when all of the views are presented and defended
the proper course of action will emerge most of the time.
The lack of firm data is not necessarily bad, this lack
forces attention to questions of behavior which may be more
critical to the effectiveness of a policy than the size of

the existing problem.

FOOTNOTES

1Samuel Williston and George J. Thompson, Selections
From Williston's Treatise on the Law of Contracts, ReviSed
Edition, (New York: Baker, Voorhis & Co., I938), p. 1.
They are quoting from Restatement of Contracts.

 

 

2Friedrick Kessler and Malcom P. Sharp, Contracts:
Cases and Materials, (Englewood Cliffs, New Jersey:
Prentice-Hall, 1953), pp. 2-9, reprinted in Richard D.
Schwartz and Jerome H. Skolnich, Society and the Legal
Order, (New York: Basic Books, Inc., 1970), p. 155.

 

 

3Kessler and Sharp, Ibid.

4Williston and Thompson, Selections, p. 4.

 

5John Stuart Mill, Principles of Political Economy,
Reprints of Economic Classics, (New York: Augustus M.
Kelley, Bookseller, 1965), p. 952 (Book 5, Chapter 11,
Section 7). This book was first published in 1848.

 

6Mill, Principles, p. 793 (Book 4, Chapter 7, Section

 

7).

7Morris R. Cohen, "The Basis of Contract," Harvard Law
Review, XLVI, (February, 1933), p. 584.

 

8Friedrich Kessler, "Contracts of Adhesion - Some
Thoughts About Freedom of Contract," Columbia Law Review,
XLIII, (July, 1943), 632.

 

9Senator Moss, U. S. Congress, Senate Warranty Hearings,
p. l.

 

10Virginia H. Knauer (Special Assistant to the President
for Consumer Affairs), U. S. Congress, House Warranpy

Hearings, p. 248.

11Fairfax Leary (Public Interest Research Group,
Virginia), U. S. Congress, House Warrantngearings, p. 116.

 

 

75

76

12William F. Willier (National Consumer Law Center,
Boston College Law School), U. S. Congress, House Warranty

Hearings, p. 234.

13Large scale buyers may have a general purchase form

which cancels out the restrictive terms - purchases of
single units don't use these contracts.

 

l4Samuel Williston, "Freedom of Contract," Cornell Law

Quarterly, VI, (May, 1921), 374.

 

 

15Federal Trade Commission, Staff Report on Automobile
Warranties, Authorized on July 20, 1965, pp. A1-A3, FT 1.2:
Au8.

 

 

16Federal Trade Commission, Staff Report, pp. 31-33.

 

17Federal Trade Commission, Staff Report, pp. Al-A3.

 

18Federal Trade Commission, Staff Report, pp. 143-145.

 

19"Detroit Tries a U-Turn on Warranties," Business Week:
July 25, 1970, p. 45.

 

20Federal Trade Commission, Staff Report, p. 195.

 

21Miles W. Kirkpatrick, U. 8. Congress, House Warranty

Hearings, p. 194.

22Judge Francis, Henningson v. Bloomfield Motors, Inc.,

161 A 2d 69 (New Jersey, 1960) at 78.

 

23Karl N. Llewellyn, "A Book Review of The Standardi-
zation of Commercial Contracts in English and Continental

Law, by O. Prauznitzji Harvard Law Review, LII (February,
1939), p. 704.

 

 

 

24Samuel Williston, The Law Governing Sales of Goods at

Common Law and Under the Uniform Sales Act, Revised Edition,
(New York: Baker, Voorhes and Co., Inc., 1948iip. 591,
section 231.

 

25Robert W. McLaren, U. S. Congress, Senate Warranty

Hearings, p. 221.

 

77

26Anne Ramsey Somers and Herman Miles Somers, Workmen's

Compensation, (New York: John Wiley and Sons, Inc., 1954),
pp. 29-34.

 

27Somers and Somers, Workmen's Compensation, p. 18.

 

28E. H. Downey, Workmen's Compensation, (New York:

The MacMillan Co., 1924), p. 122.

 

29Somers and Somers, Workmen's Compensation, p. 199.

 

30Downey, Workmen's Compensation, p. 131.

 

lDowney, Workmen's Compensation, p. xxv.

 

32Downey, Workmen's Compensation, p. 132.

 

33Downey, Workmen's Compensation, p. 141 (footnote to

page 132).

 

34Roland P. Blake, Industrial Safety, Third Edition,

(Englewood Cliffs, New Jersey: Prentice-Hall, Inc., 1963),
p. 16.

 

CHAPTER THREE
TRADITIONAL BUYER PROTECTION AS A PRACTICAL POLICY

FOR PURCHASERS OF DURABLE PRODUCTS

Consumer problems, the failure of a product's
performance to meet a consumer's reasonable expectation
of performance, are the result of conscious decisions made
by the management of firms which provide these products.
While one might argue that a poor performance of a parti-
cular product is the result of an oversight or accident,
one cannot reasonably argue that the universal occurrence
of poor performances results from a series of independent
accidents. Clearly the decisions of the manufacturers
leading to unsatisfactory consumer products do not occur
by chance. The extent of the problem considerably narrows
the range of possible explanations since the reason for the
performance must apply to all of the offending manufactuers.
One universal influence on all manufacturers of consumer
goods which could reasonably affect the quality of goods
produced is the set of laws under which the manufacturers
operate. These laws controlling commercial transactions
may create an environment which encourages poor perform-
ance by manufacturers. John R. Commons expressed the

relationship in terms of rules.

78

79

"Stated in language of the operation of working
rules on individual action [Working Rules of Collective
Action] are expressed by the auxiliary verbs of what
the individual can, cannot, must, must not, may or may
not DO. He 'can' or 'cannot' because collective action
will or will not come to his aid. He 'must' or 'must
not' because collective action will compel him. He
'may' because collective action will permit him and
protect him. He 'may not' because collective action
will prevent him."1

Expectations

 

Expectations of performance may be divided into two
classes: 1) those expectations the state will enforce
either directly (e.g., food and drug safety expectations)
or through the courts on the initiative of a consumer
(e.g., breach of contract) and 2) other expectations the
state will not enforce. Those expectations of performance
contained in the valid contract will be enforced by the
state. By limiting the consumer to repair or replacement
of the good for a limited time as permitted in the UCC
(sections 2 - 316 and 2 - 719 in Chapter One, page 30),
the manufacturer need not meet a wide variety of reasonable
consumer expectations. Enforceable expectations are not
necessarily identical with reasonable expectations. A
consumer might reasonably expect that a product will be
well designed and well manufactured. He might reasonably
expect the product's performance to correspond to the
performance claims made by the seller either verbally or
in advertisements. The consumer might reasonably expect
that if the product fails to meet these reasonable expecta-

tions he could receive a refund. With the exercise of the

80

power to exclude the traditional protections of consumers
as permitted by the UCC these reasonable expectations of
consumers were not enforceable in the courts.2

It may be the case that consumers often prefer
inexpensive and poorly made products over expensive and well
produced products. A policy which would preclude the
production of products of low quality might operate against
the interests of some consumers. Requiring the warranty
of merchantability and the express warranties created by
the activities of the seller does not preclude the produc-
tion of inferior products. If the product is presented in
such a manner as to lead the consumer to expect poor
performance (e.g., the durability of paper plates as
compared to china) then the consumer would not reasonably
expect a "well manufactured" product (i.e., he would not
expect china plate performance from paper plates). The
consumer problems considered in this study do not come from
low cost products which are represented as being inferior
(which is to say that the reasonable expectation of average
performance does not exist), but in cases of products which
do not meet the reasonable performance expectations of the
consumer. The price of the inferior product which is
represented as average or superior may be more than, equal,
or less than the average price for goods of the type. But
the problem with these goods is not their price, but rather
the failure of these goods to meet the reasonable perform-

ance expectations of consumers. Purchase decisions are

81

made by considering price and expectations of performance;
when a consumer is disappointed he is surprised not by the
price (which is known), but by the product's performance

or lack of performance. The policy proposed in this study
does not set prices or control advertising, but merely
requires that the product's performance meet whatever
performance expectations the manufacturer chooses to create

in a reasonable consumer.

The Solution

 

As an economic issue consumer problems are a
matter of industrial performance. In terms of legislation
the proper policy issue in the case of consumer protection
consists of the placing of each of the various consumer
expectations into one of two classes. Either the expecta-
tion will be legally and economically enforceable (worth
winning considering costs and awards) or it will be a
legally and/or economically unenforceable expectation.
Legislation may make an expectation enforceable by
disallowing the virtually universally exercised manufactur-
ers' discretionary power to exclude the expectation from
court enforcement by means of the contract.

Requiring the traditional consumer protection of
the common law as an implied condition of sale would have,
with no other change, an important effect on the severity
of those consumer problems resulting from the failure of
the product to meet the reasonable performance expectations

of the buyer. Even if the manufacturers continue making

82

extravagant claims, which the performance of their products
does not meet, the consumer would have gained an important
alternative. If as part of the contract for the good being
sold the seller (by explicit clauses or by implied clauses
which could not be excluded) warrants the good to be
merchantable, then should the good subsequently prove not
to be merchantable the consumer could receive financial
compensation from the manufacturer for his financial loss.
While continuing to suffer the inconveniences and perhaps
psychic losses associated with a poorly performing product
the consumer would no longer suffer the additional
financial loss of the purchase price. The severity of
consumer problems would be reduced. The seller, rather
than the consumer, would be financially responsible for the
special claims he makes and for meeting the standard levels
of performance in his products considered appropriate by
the courts for products of the particular type.

The removal of the discretionary power of the
manufacturers to exclude the traditional consumer protection
of the common law does not place the consumer in a riskless
position. Of course, a consumer who, after purchasing a
product, decides that he does not want a particular product
which corresponds to the claims of the manufacturer and the
general standards for products of the particular type would
have no additional recourse. The proposed strengthening of
the consumers' position will not protect consumers against

sales claims which are not affirmations of fact, but rather

83

"puffing." "Puffing" is a fairly difficult activity to
specify; in the final analysis the courts will decide if
a contested specific claim is an affirmation of a fact
or mere "puffing." As a judicial decision it is sub—
ject to change over time. The prudent manufacturer, to
avoid losses, will stay safely and clearly within "puffing"
if he is going to engage in “puffing" activities. The
consumer would not be protected against flaws that a reason-
able inspection would have revealed. Nor would a consumer
have his unreasonable interpretations of the manufacturer's
claims (including duration of performance) or of a product
of the particular type's performance enforced by the courts.
The consumer is not protected against problems resulting
from his improper use or maintenance of the product.
Basically the proposed change does not protect the consumer
against his own carelessness in the market. It provides
protection only in the areas in which the consumer cannot
exercise care because the complexity of the product
precludes the consumer's making a meaningful determination
of its quality.

The problem of determining the standards to be
used in fixing responsibility for product failures after
they have been used by consumers is not new. In
Henningson v. Bloomfield Motors, Judge Francis considered
the automobile manufacturers' contract condition on this
question.

"The manufacturer agrees to replace defective
parts for 90 days after the sale or until the car has

84

been driven 4,000 miles, whichever is first to occur,
if the part is sent to the factory, transportation
charges prepaid, and if examination discloses to its
satisfaction that the part is defective. It is diffi-
cult to imagine a greater burden on the consumer, or a
less satisfactory remedy. Aside from imposing on the
buyer the trouble of removing and shipping the part,
the maker has sought to retain uncontrolled discretion
to decide the issue of defectiveness. Some courts
have removed much of the force of that reservation by
declaring that the purchaser is not bound by the
manufacturer's decision. . . . In the Mills case
(Mills v. Maxwell Motor Sales Corporation, 181 N.W. 152
(Nebraska, 1920), the court said:

"It would nevertheless be repugnant to every

conception of justice to hold that, if the parts

thus returned for examination were, in point of
fact, so defective as to constitute a breach of
warranty, the appellee's right of action could be
defeated by the appellant's arbitrary refusal to
recognize that fact. Such an interpretation would
substitute the appellant for the courts in passing
upon the question of fact, and would be unreason-

able." Supra, 181 N.W. at 154.

Also suppose, as in this case, a defective part or
parts caused an accident and that the car was so damaged
as to render it impossible to discover the precise part
or parts responsible, although the circumstances clearly
pointed to such fact as the cause of the mishap. Can
it be said that the impossibility of performance
deprived the buyer of the benefits of the warranty?"
161 A. 2d 69 at 78, 79.

The manufacturer can make the first decision as to his
responsibility in light of the buyer's use of the product,
but the buyer may have the issue decided by the courts if
he believes that the manufacturer's decision is unreason-
able. The use of the courts to settle these disputes is
not created by the reintroduction of the traditional
consumer protection of the common law.

The partial elimination of financial loss by the
consumer follows directly from the prOposed changes in the
UCC and does not depend on any change in behavior by the

manufacturers. It is unlikely that the manufacturers will

85

continue their past behavior, which would no longer be
profitable in the face of new and unavoidable responsi-
bility for the performance of their product. With the
traditional protection restored to the consumer, (by the
elimination of the provisions allowing the manufacturer to
restrict the consumers' remedy to the exclusive and highly
limited recourse of repair and replacement) the manufac-
turers would (to avoid paying refunds) have to produce a
product which would meet two sets of performance
expectations. Their products would have to perform as goods
of their type are expected to perform and to perform to the
level of reasonable consumer expectations created by the
manufacturers' specific claims of product performance.
The first group of expectations based on average perform-
ance with products of the general type could not be avoided
by the manufacturer by means of a clause in the contract
(they could, as considered below, be avoided by promotional
activities of the manufacturer.) If sold as a product of
a particular type, the product must meet the traditional
levels of performance. If to do so the manufacturer must
improve his product, then the economic incentives of
remaining in business will require him to improve his
product.

To a large extent the "traditional" expectations
of performance of a product of a particular type are
subject to change by a manufacturer. If a manufacturer

clearly specifies at the time of sale and in his

86

promotional activities that his product performs at a lower
level than consumers would reasonably expect, these lower
standards would be applied to his product. Thus a
manufacturer could produce and sell, without fear of refunds
a "throw away" car provided he clearly promotes it as such
(as in the promotion of paper dresses). A merchantable
product is one that performs to the expectation level of a
reasonable man. Obsolescence is a rather special situa-
tion.3 A consumer would be protected if the product became
obsolete because of poor production decisions (the product
fails to meet the reasonable expectations of products of
the general type) but the consumer would not be protected
against obsolescence resulting from technological improve-
ments or changes in fashion (claims in fashion would

probably be considered 'puff').

Product Variety

 

It is possible that all manufacturers might decide
to produce (and promote as such) a "throw away" car. This
production decision would not be unprofitable because of
breach of contract difficulties, but it might be socially
undesirable for ecology reasons. Ecological considerations
are not a topic of this study, but it is possible to
briefly consider the possibility that this policy would
tend to create ecological problems (wasteful production
due to limited durability of the product). If all

existing manufacturers were to produce a "throw away" car

87

or other short lived substitute for a formerly durable
product, this act would seem to create a profitable market
for a new manufacturer who would produce a product which
would meet the traditional consumer expectations (and
promote it as such). Competition will prevent exclusively
extreme industrial performances either in the direction of
poor quality and low price or high quality and high price.
The mix that will result (and which will be subject to
constant change) will depend on a wide variety of social
actions besides any change in warranty law. As an example
the production of a "throw away" car would be discouraged
by a high 'salvage tax' which would raise the ownership
costs but encouraged by 'socialized medicine' which would
lower the operating costs (assuming that "throw away" cars
would be less substantial and thus their occupants more
prone to physical injury - socialized medicine would reduce
the differential in insurance premiums on medical insurance
between safer and more dangerous cars.) The ecological
result of this or any other policy effecting quality
decisions will be subject to constant change depending on
other policies.

This reintroduction of the traditional warranties
by clarifying the differences in performance between
products should increase the variety of products made
available. Rather than limiting the available choices to
one level (a strict interpretation of what a merchantable

appliance of a particular type might be) as might happen

88

if a agency regulation were used, the reintroduction of the
traditional warranties will lead to meaninful diversity.
The consumer often cannot determine the various differences
in performance between various brands of the same product
and must assume that they are all approximately equal in
performance. As the performance claims become more related
to the actual performance manufacturers will be able to
introduce products which are not merely another brand of
the same general type. The availability of diverse pro-
ducts performing similar functions depends on the ability
of the consumer to differentiate between them. As an
example only very accurate descriptions would allow the
Timken Company to produce 35 types of tapered roller
hearings in 11,000 sizes.4 Honesty and accuracy in
representation increases the variety offered to consumers.5
The act of selling implies the existence of the
standards involved in merchantability.
"In View of the principle that the whole purpose

of the law of warranty is to determine what it is that

the seller has in essence agreed to sell, the policy

is adopted of those cases which refuse, except in

unusual circumstances, to recognize a material deletion

of the seller's obligation. Thus, a contract is

normally a contract for a sale of something describable

and described. . . ."
If the consumer did not have any expectations he would not
know what to buy. The producer would not know what to
manufacture and the retailer would not know what to stock.

While it may not be possible to state precisely the general

expectations of society concerning particular products,

89

reasonably precise expectations must exist and be known for
commercial transactions to occur.

A product's performance may meet the standards for
a product of the particular type and yet a consumer problem
might exist because the product failed to meet the extra
performance expectations created by the manufacturer. The
proposed changes in the UCC would require, to avoid paying
refunds, that if a manufacturer chose to make additional
claims for his product, then the product's performance must
meet a consumer's reasonable interpretation of the claims.
The manufacturer may avoid meeting these consumer expecta-
tions merely by not creating these expectations. The
manufacturer must decide for each consumer expectation he
might create whether the additional income from larger
sales and/or higher price would exceed the cost of creating
the expectation and the costs of improving the product so
that its performance will meet the consumers'reasonable

expectations.

Enforcement

 

Even small policy proposals seldom, if ever, con-
fine their full effects to the problem to which they are
directed.7 Removing the discretionary contractual power of
manufacturers creates, by means of the availability of the
police power of the state, a situation in which the
product's performance must meet a reasonable man's expecta-

tion of its performance. But the shift in economic

90

incentives (profitable patterns of production) leading to a
more satisfactory behavior (honest representation) by the
manufacturer does not follow merely from the act of removing
a few paragraphs from the UCC in the case of consumer
transactions. The manufacturers' behavior changes because
he knows that a deceived consumer can turn to the state and
through the courts or some other institution use the police
power to receive a refund of all or much (depending on the
benefits he received from the product) of his purchase price
resulting from a breach of contract (implied warranty of
merchantability) by the manufacturer.8 In making this
compensation the manufacturer suffers a loss; to remain in
business he will change his behavior to avoid these losses.
But the striking of the paragraphs from the UCC might have
an adverse effect on the dockets of the courts if the
courts were used to enforce the traditional protections of
the consumer. Specifically, the proposed change might
flood the courts with consumer complaints. The effect on
the judicial system might be so damaging as to make this
policy, however beneficial to the consumer, a poor social
action. The danger of flooding the courts could be
eliminated with the use of another institution.

Since the concept of merchantability developed in
the judicial system the enforcement of the policy pr0posed
in this study has been set in the courts. The policy con-
sists of imposing a loss on producers who manufacture

goods which do not meet the reasonable performance

91

expectations of consumers. The agency which imposes these
losses is not predetermined by the policy. Any agency
which could impose the loss efficiently could be used to
implement the policy. The courts are not the only social
institution which could impose a loss on manufacturers for
producing non-merchantable products. The imposition of
losses might be accomplished by administrative agencies
and/or an ombudsman system. In the section below these
non—judicial institutions are considered as possible alter—
natives to the courts for making misleading behavior
privately unprofitable. The consideration is not exhaus-
tive, but rather seeks to illustrate the relative merits

of the available institutions. The use of one of these
institutions does not preclude the use of another and one
might reasonably expect that the several institutions could
function in a complementary manner in aiding consumers.

But with the particular policy under consideration in this
study effective administration depends on the ability of
the injured consumer to make his complaint known and to
receive compensation for the failure of the product to meet
his reasonable expectations. If an institution is not
designed to handle individual problems and order compensa-
tion, then it is not suitable for enforcing this particular
policy. The same institution, while unsatisfactory for
this particular policy, might be suitable for other

important consumer protection policies, e.g., removing

92

unsafe products from the market before they are sold to

consumers .

Administrative Agencies

 

A governmental agency could impose these losses.
Occasionally agencies do impose penalties for poor perform-
ance. However, problems exist in the use of administrative
agencies. Agencies, and courts, have been subject to
influence by the industries they regulate and may perform
badly for the individual consumer.

"Under normal conditions private management is
inevitably the dominant 'organizing' force. When the
industry, after a period of reform, has been stabilized
at a new level, management direction becomes the
primary influence. Paradoxically, this phenomenon may
be reinforced by a vague, broad delegation of adminis-
trative power! Such a delegation is a source of
administrative strength in the initial reform period.
The implied objectives and the climate of opinion give
directing significance to the generalities of the
statute. But when these objectives are realized, the
statutory vagueness may no longer yield a sense of 9
mandate. External forces rush in to fill the vacuum."

The agencies generally prefer to avoid court action for
reasons of efficiency, and settle for cease and desist
orders which apply only to the future and do not aid the
damaged consumer.

"Under the Clayton Act and Trade Commission Act,
all that the Commission's (FTC) order can do is to
direct the respondent to "cease and desist" from the
unfair method or other practice in question, or if the
order concerns Section 7 or 8 of the Clayton Act, to
divest itself of the stock held or rid itself of the
directors chosen contrary to law. The act does not
expressly confer any general power, of the kind
possessed by a court of equity, to compel restitution,
or otherwise to so mold the decree as to do substantial
justice under the circumstances. Of course, no damages
can be awarded, or mandatory order entered. Where,

93

therefore, the unfair act has already accomplished its
purpose, and there is no occasion for repeating it, the
Commission cannot give relief."

This limitation has its effects on consumer
protection:

"Anyone who believes that the provision for injunc-
tive relief is an adequate tool as far as the FTC is
concerned is oblivious to the history of that agency
and its frustrations in trying to accomplish something
in the consumer area. Anyone that practices before
the FTC . . . is familiar with the fact that industry
has little difficulty, and there are numerous cases
substantiating this, in dragging out a cease and desist
proceeding before the Commission for 5, 6, 7 and 8
years without even going to court. And with a very
Clear understanding as to what, at most, will happen
at the end of that period if a violation is determined;
they will be told that they were naughty boys and urged
not to violate the act again. In short, injunctive
relief. Provision for injunctive relief only is the
most single self-defiiting aspect of the FTC's proce-
dures at this time."

If penalized, the effect on the company is quite
limited. These agencies have a rather time consuming
procedure (when compared to a small claims court) which is
reasonable for the considerable amounts of money often under
consideration. But this procedure can make the effort on
the part of a consumer, if feasible at all, more trouble
than the award is worth. In terms of consumer protection,
procedural delay can be fatal. Before the governmental
agency even receives enough complaints to act the company
can gain substantial profits by using a deceptive practice.
Additional profits can occur before the agency finishes its
procedures and appeals and makes its decree. Some companies

have continued with profitable deceptive practices even

after receiving cease and desist orders (at the risk of

94

being found to be in contempt of court). Fundamentally
the difficulty lies in the fact that deceptive practices
are profitable and often privately good business. The
Holland Furnace Company case provides an excellent example
of the limitations of the administrative agency approach

12

under the present rules. Miles W. Kirkpatrick, the

chairman of the FTC, recognizes this problem.

"Moreover, there is no surer means by which the
Commission can perform its role of consumer protection
than by framing its orders so as to insure the those
who have profited wrongfully from proven violations
are denied the fruits of their wrongdoing."

The Ombudsman

 

The problems of controlling administrative agencies
led to the creation of an institution which has the speed
and flexibility needed to control deceptive commercial
behavior. The Swedish Parliament created the office of
Supreme Procurator (Hogste Ombudsmannen) in 1713. Since
that time this office has continued to exercise a general
supervision to insure that laws and regulations were
complied with, and that public servants discharged their
duties properly.14 The legislature recognized that it was
one thing to pass a law and something quite different to
have it carried out as the legislature desired. The
institution of Ombudsman in Sweden was designed to afford
the legislature control at the lower levels and has three
particular qualities: 1) the Ombudsman is an independent
and non-partisan representative of the legislature, usually

provided for in the constitution, who supervises the

95

administration of laws passed by the legislature, 2) he
deals with specific complaints from the public against
administrative injustice and maladministration and 3) he
has the power to investigate, criticize and publicize, but
not to reverse administrative action.15 In the Swedish

form this tool of "administrative remedy" (the heading

for Ombudsman articles in both Reader's Guide to Periodic

 

Literature and Index to Legal Periodicals) is not suitable

 

 

for resolving contractual disagreements between consumers
and manufacturers. This does not mean that the Ombudsman
institutions provides no services to consumers, but rather
that the consumer problems under consideration here are not
the result of maladministration and thus not amenable to
the pure Ombudsman approach.l6

Would a modified Ombudsman approach effectively
aid consumers? A Consumer Ombudsman of some form would
work to insure that the laws are being followed. He is
concerned with the ways in which laws and regulations are
being followed; he is not expected to dispute their
validity.17 The problems consumers face with products do
not follow from goods laws not being properly followed
(the assumption of the Ombudsman approach), but rather from
archaic, socially poor laws followed to the letter.
Basically, under the current contract laws of the UCC, which
are being followed to the letter and size of print (the
exclusion of merchantability must be in large print), the

consumer does not have a legitimate complaint on which an

96

Ombudsman could operate. If the laws were changed as
proposed here, the Ombudsman, when aiding consumers, would
be deciding contract cases which is not an appropriate
activity. He would be performing a quasi judicial function

under a different name.18

Judicial Strain

 

In cases of deceptive practices, the consumer and
seller are in an adversary situation characterized by
considerable bad faith. The decisions required to resolve
these disputes are of a judicial nature. The basic
standards of this policy, that of a reasonable man and
product merchantability, find their meaning in the decisions
of the judicial system. Allowing the consumer to threaten
a seller who has sold him a non-merchantable product, with
a convincing threat of court action is not the same
situation as a massive number of cases brought by
dissatisfied consumers. However attractive having one's
day in court might be in theory, actually going to court
is both expensive and inconvenient. Court action is a last
resort used only if an acceptable resolution of the dispute
cannot be arranged.

The parties will not go to court if the court's
decision can be predicted with certainty.

. . . the litigation process is designed to
provide a framework within which parties with a present,
concrete dispute can put their problem before a court,
clarify and narrow the bounds of the dispute, give the
court the material which it needs to know in order
intelligently to resolve the dispute, and to do all

97

this in a manner which insures, insofar as possible,

that the resolution of the dispute will both appear

and be a just one."
If the law is clear and there are no real disputes as to
issues of fact or issues of law, then there is nothing to
present in litigation--the outcome is certain or certain
enough not to justify the expense of litigation. Thus,
if the product is clearly not merchantable or if the
consumer's expectation of its performance are beyond what
any court would consider reasonable, the parties, on advice
of their lawyers, will settle for what they both know the
winner in court would obtain. The borderline cases will
not go to court because the consumer can only win
compensation of his actual losses which would be fairly
small in a borderline situation. For most consumer
purchases the court must award the consumer a full refund
or the expenses would exceed the settlement. Only when
the parties do not agree if a particular product is
merchantable and when the potential settlement is con-
siderable would a case actually go to court. Cases
involving good faith disagreements as to the merchantability
of a good which would involve enough loss to the consumer
to justify court action would be extremely rare (probably
limited to automobiles and housing), and even these cases
would eliminate future cases by establishing the likely
outcomes of similar cases in the future.20

Since court action lowers the net return to the

winner and increases the net loss of the loser, the courts

98

will be a very unattractive means of settling the dispute.
Many contracts are signed which are later regretted, but
active court enforcement is not required because the
parties know the outcome of a court procedure. In
obtaining the desired performance from the party that would
lose, a high probability of getting a particular court
decision is nearly as effective as actually getting the
decision (as well as more convenient and less expensive
for both parties). When the criteria of performance for
merchantability are established for the special character-
istics of modern products, few if any changes will probably
be needed in the traditional criteria, the contested cases
will be rare. Allowing the consumer the traditional
common law protection should not flood the courts with
cases. Avoiding court action when the outcome can be
reasonably predicted is a necessary and general practice.
"Not only is the existence of ordinary legal
relationships generally unrecognized by the layman;
even when the unexpected happens, and the legal basis
of a relationship is bared, the formal machinery of the
law is seldom involved. It could not, indeed, become
so involved without a revolutionary increase in the
scale of such machinery. In the criminal law, for
instance, it is estimated that only one-seventh of all
felony pfigsecutions in the United States end in jury
trials."
The potential of using the police power of the
state (by means of a court order) if the party will not
"voluntarily" do the action which is sought (e.g., refund

the purchase price of a non-merchantable product) is

critically important. For the policy to reduce consumer

99

dissatisfaction the certainty of loss is essential and can
be achieved effectively by the mere availability of court
action as a reasonable consumer recourse. The actual
imposition of losses on manufacturers by the courts is not
required. The manufacturer will "voluntarily" produce a
merchantable product if he knows the consumer can easily
obtain a refund of the purchase price by going to court

if the product would be found not to be merchantable.
While not precisely known and subject to some change these
standards are those for which the consumer made the
purchase--he must have expected something or the manufac-
turer would not have known what to produce, the seller
what to stock or the purchaser where to look. The
"voluntary" behavior will follow from the potential of
bringing a case and would occur even if no case were ever
brought. The benefits to the consumer of restoring as a
practical alternative his traditional common law protection
do not depend on placing the judicial system under signifi-
cant additional strain. The manufacturers' change in
behavior will become necessary because of the consumers'
potential ability to bring a successful case rather than

on an actual court action.

Product Innovation

 

Introducing a new consumer product is an economic
decision which generally involves considerable risk?2 Under

the policy of restoring traditional consumer protection a

100

manufacturer must for profitable production limit his
claims to those levels of performance his product can
achieve. Generally these claims will be less tantalizing
to consumers than the most enticing claims (limited
slightly by considerations of credibility) of his
advertising agency. Since the manufacturer's presentation
will be less effective under his new legal environment
(all other factors assumed to be unchanged) one might
conclude that he will be able to convince fewer consumers
to buy and try his new product. Presenting a new consumer
good in the market would also be less attractive
financially because to avoid giving refunds the manufac-
turer will have to correct product failings which now
appear only when the product is in general use. Consumers
will no longer have to accept, until the end of the
warranty period, minor repairs and adjustments which do
not really correct basic errors made in production or
design.

If the manufacturer chooses to test his product,
rather than make refunds on unsatisfactory units, then the
manufacturer will spend more on research and testing to
be sure that his product actually will function properly
in the hands of the consumer. From the view of the entire
economy this additional testing by the manufacturer is not
an additional cost. Under the present situation the
consumer performs the testing when he purchases and uses

the product. The changes proposed in the UCC would promote

101

a more economical and reasonable procedure of testing as
the testing will occur by the manufacturer before the
product is mass marketed. This policy shifts more of the
cost of testing from the consumer to the manufacturer. But
to the party deciding whether to introduce a new product
the increased testing will be an additional cost and will
add to the financial risk of the proposed introduction.

It might seem that the manufacturer under his new legal
environment, will find new products both more expensive to
build and design and harder to promote. The proposed
restoration of traditional consumer protections might so
increase the risks of product innovation as to be more
damaging to the consumer than the consumer problems the
policy seeks to control. This conclusion, that restoring
the traditional protection of consumers will seriously
inhibit innovation, follows from only a partial considera-
tion of the risk situation involved in the successful
introduction of a new product. When buying a new product
the consumer also carries some risks in new product intro—
ductions and his situation will also change.

If relative to producing and introducing a new
product nothing changed with the reintroduction of the
consumers' common law protection except that the
effectiveness of promotion was lowered and development
costs increased, then product innovation for the consumer
market might be severely limited. But the manufacturer

does not carry all of the risks involved in the introduction

102

of a new product. When the new product enters the market,
the consumer must decide (under conditions of considerable
uncertainty as to the product's performance) if he is
interested in the product the manufacturer has brought to
the market with a set of performance claims. If he is
interested he must decide if he will try the product
immediately, or if he will wait until others have tried

the product and until the problems associated with a new
product have been eliminated. By removing the financial
loss of the consumers in the eventuality of a new product
performing poorly relative to reasonable expectations of
its performance, trying new products soon after their
introduction will be made more attractive to the consumer.23
The use of money-back guarantees (on low price items)
indicates that manufacturers believe that consumers are
hesitant to bear the financial risks of poor product
performance. However, much of the appeal to the manufact-
urer of a money-back guarantee is that it inspires consumer
confidence (expectations of performance) at a low cost
since many consumers will not exercise their right to a
refund on a low priced item.

While the reintroduction of the traditional consumer
protection will limit the creativity of the manufacturer's
claims it will also create consumer confidence in the
claims which the manufacturer does make. The manufacturer
will continue to make claims in order to induce consumers

to purchase his product; the difference is that for

103

profitable sales the product must meet a reasonable man's
interpretation of these claims. Advertising new products
currently serves to introduce a new product and to overcome
consumer skepticism. While a manufacturer will continue to
buy advertising to introduce his product and present his
performance claims he will not have to spend great sums of
money merely to overcome consumer skepticism. The consumer
knows that the producer will suffer any losses resulting
from the product's failure to meet reasonable performance
expectations. Total advertising expenditures for the
introduction of a new product should fall. Consumer
acceptance of new products will increase since consumers
would no longer have to fear a total loss on a new product,
which will make introducing new products of merit more
attractive. New products, introduced with the most
promising claims the product can meet, would have a stronger
demand which would allow the manufacturer to recover his
greater costs in insuring the actual performance of his
product. While the actual outcome will depend on the
particular product it is quite possible that the reduced
promotional expenses and increased consumer demand (greater
volume in the initial production runs) for new products
MIGHT more than compensate for the increased testing
expenses (increased for the manufacturer - decreased for

the economy as a whole) to yield lower consumer prices.

104

The Role of Small Claims Courts

 

A remaining issue lies in the effectiveness of the
policy within a given institutional framework. Since this
policy depends on the potential use of the courts, the
conditions of actual use are critical. If the actual use
of the courts is costly and inconvenient the consumer could
only use (and threaten to use) the courts when his loss was
considerable. As a practical matter the courts would not
be available to compensate a consumer for losses of
relatively small amounts of money and the manufacturer could
safely and profitably ignore the threat of court action on
a significant scale. If the court action is available to
the consumer at a low cost and minimally inconvenient form,
the threat of a potential action is very real for a moderate
performance failure of a product. Under the low cost
situation the manufacturer would have to exercise consider-
able care to insure that his products' performance meet
the traditional expectations of products of the particular
type and a reasonable man's interpretation of the manu-
facturer's special claims. The goal of restoring the
consumers' traditional protections is not the change in
wording of the UCC; the goal consists in changing the
manufacturers' decision making environment so that he will
be encouraged to exercise greater care and concern for his
product's performance. This policy would be most effective

under a low cost court system.

105

Since contract cases are appropriate for small
claims courts the reintroduction of the traditional buyer
protection will be very dramatic where these courts
operate.24 For a small expenditure and a minimum amount of
time the consumer can use the police power of the state to
receive compensation for his losses on purchases of products
which are not merchantable. The manufacturer will have no
practical alternative but to make the product merchantable
(or lose money by making refunds). The ready availability
of low cost court action will leave the manufacturer who
desires to remain in business no choice but to produce a
merchantable product (at least the vast majority of the
units must be merchantable) which meets his claims. The
small claims court will provide the potential court action
needed to bring the desired industrial performance (more
care and concern) in the production of both minor and major
appliances.

The simplicity of the question (is a particular
performance of a product less than a reasonable man would
expect from a product of the type and the special claims of
the manufacturers?) allows practical recourse to the regular
judicial system in cases involving losses greater than the
maximum allowed in small claims proceedings. In cases
involving larger sums of money the traditional protections
and care, with their larger costs to the parties and society,
of the regular courts are appropriate. While a consumer

suffering a major loss would have to threaten the use of a

106

fairly expensive procedure the costs would remain moderate
to the loss because of the relative simplicity of the
merchantability question.25 Breach of contract of an
implied or explicit warranty of merchantability is a much
simpler (less expensive) case to win than fraud which
requires the showing of intent or other tort cases which

require a demonstration of wrongdoing.26

For major losses
the traditional court system would provide the essential
potential of court action if the consumer can sue success-
fully under contract law rather than tort law. If the
traditional common low protections were to be reinstated
for consumers by the removal of the discretionary
contractual power of manufacturers the courts are capable

in their present form of providing the potential of court

action.

FOOTNOTES

1John R. Commons, Institutional Economics: Its Place

in Political Economy, (Madison: University of Wisconsin
Press, 1959), p. 71 (Chapter 2 [2-2-4]). The original
copyright is 1934. The UCC is an important part of the set
of working rules of commercial transactions which indicate
what firms can, must or may do or make without fear of
collective action.

 

 

2In Black's Law Dictionary (1968) "Reasonable" is
defined by a series of synonyms: just, proper, ordinary,
usual, fit and appropriate to the end in view, honest,
equitable, fair, suitable, moderate and tolerable. Absolute
certainty as to what will be found to be reasonable is not
necessary or possible.

 

3"Obsolescence occurs with or without 'planning.‘ With
respect to things, obsolescence occurs under three condi-
tions. It occurs when a product literally deteriorates to
the point at which it can no longer fulfill its functions-
bearings burn out, fabrics tear, pipes rust . . . replace-
ment is required. This is obsolescence due to functional
failure. Obsolescence also occurs when some new product
arrives on the scene to perform these functions more
effectively than the old product could. This is
obsolescence due to substantive technological advance. . . .
But obsolescence also occurs when the needs of the consumer
change, when the function to be performed by the product
are themselves altered." Alvin Toffler, Future Shock,
(New York: Bantam Books, Inc., 1970). p. 68 (Chapter 4-
Temporary Needs).

 

4"Bearings: Roller, Split," Thomas Register of American

 

Manufacturers, Volume 1, (New York: Thomas Publishing Co.,
1972), p. 432.

 

5It is worth noting that this industrial diversity
developed under contractual conditions a consumer would
face if disclaimers of implied warranties were not allowed.

6American Law Institute and the National Conference of
Commissioners on Uniform State Laws, "Official Comment 4,

107

108

UCC, Section 2 - 313, 'Express Warranties by Affirmation,
Promise, Description, Sample,'" Uniform Laws Annotated,
Uniform Commercial Code, Master Edition, Vol. 1, (St. Paul,
Minnesota: West Publishing Co., 1968), p. 173.

 

7"Rules never generate behavior exactly appropriate to
the contingencies from which they are derived, and the
discrepancy grows worse if the contingencies change while
the rules remain inviolate." B. F. Skinner, Beyond Freedom
and Dignity, (New York: KnOpf, 1971), p. 172.

 

8The profitability (award exceeding the party's cost of
litigation) to the party is central to the exercise of a
legal right. The class action increases the potential
award considerably, but does not change the questions
subject to litigation (except if the class is a legitimate
class) nor the cost of litigation. Therefore class actions
by raising the profitability of litigation might lead to
an exercise of a legal right which an individual could not
profitably use. But in cases, such as the warranty provi-
sions of the UCC, where the party's difficulties follow
from the substance of the law rather than the procedures
of the judicial system, class actions will not provide a
means of obtaining justice.

9Louis L. Jaffe, Judicial Control of Administrative
Action, (Boston: Little, Brown and Company, 1965), p. 13.

 

10Gerald C. Henderson, The Federal Trade Commission, A

Study in Administrative Law and Procedure, (New York:
Agathon Press, Inc., 1968), p. 71.

 

llEdward Berlin (Counsel for The Consumer Federation of

America), U. S. Congress, HouSe Warranty Hearings, p. 278.

 

len May 4, 1954 the FTC filed a complaint against the

Holland Furnace Company. The complaint alleged that the
company engaged in practices which were to the prejudice
and injury of the public and competitors of the company,
and constituted unfair acts and practices in commerce and
unfair methods of competition in commerce within the intent
and meaning of the Federal Trade Commission Act. The
company, on September 15, asked for a temporary restraining
order to stop the FTC from holding any hearings until

1) its appeals to the FTC were disposed of, 2) motions
before the examiner were disposed of, 3) any subsequent
appeal from those rulings were disposed of and 4) it might
make an offer of settlement or proposal of adjustment.

The FTC pointed out that the company's appeals pending at
that time included a motion for suspension and referral, a

109

motion for a preliminary hearing, and an application for
stay of proceedings-~among other motions. The court ruled
that the FTC could hold the hearings as schedule. (See
Trade Cases, 1954, Commerce Clearing House, Inc. 67,859).
On July 7, 1958 the FTC issued a cease and desist order for
the following activities:

1. Representing, directly or indirectly, that any of its
employees are inspectors or are employees or repre-
sentatives of governmental agencies, or of gas or
utility companies.

2. Representing, contrary to fact, that its salesmen
or servicemen are heating engineers.

3. Representing that any furnace manufactured by a
competitor is defective or not repairable or that
the continued use of such furnace will result in
asphyxiation, carbon monoxide poisoning, fires, or
other damage, or for any other reason, when such is
not a fact.

4. Tearing down or dismantling any furnace without the
permission of the owner.

5. Representing that a furnace which has been dismantled
cannot be reassembled and used without danger of
asphyxiation, gas poisoning, fires, or for any other
reason, when such is not a fact.

6. Requiring the owner of any furnace which has been
dismantled by respondent's employees to sign a
release absolving the respondent of liability for
its employees' negligence, or of any other liability,
before reassembling said furnace.

7. Refusing to immediately reassemble, at the request
of the owner, any furnace which has been dismantled
by respondent's employees.

8. Misrepresenting in any manner the condition of any
furnace which has been dismantled by respondent's
employees.

On August 5, 1959 the company was ordered by the
court to obey and comply with this order. (See Trade Cases
1965, 71,360) Holland petitioned the Supreme Court of the
United States for a writ of certiorari which was denied.

In 1961 Holland appealed the cease and desist order on the
grounds that it had not had a fair hearing (the hearing
lasted for 88 days during which over 5,200 pages were
collected). This complaint was found to be without merit.
The order was made permanent on November 7, 1961. (See
Trade Cases, 1961, 70,132) On January 27, 1965, the FTC
petitioned to bring a criminal contempt proceeding because
the company "knowingly, willfully and intentionally"
violated and disobeyed the August 5, 1959 court order. The
company, its president and two sales managers were found
guilty of contempt. (See Trade Cases, 1965, 71,360) Only
the most optimistic could consider this eleven year per-
formance effective consumer protection.

 

 

 

 

110

13U. S. Congress, House Warranty_Hearing§, p. 198.

 

l4Sten Rudholm, "The Chancellor of Justice," in

Donald C. Rowat, ed., The Ombudsman, Citizen's Defender,
Second Edition, (Toronto: University of Toronto Press,
1968), p. 17.

 

15Rowat, The Ombudsman, p. xxiv.

 

16The Swedish Ombudsman can aid the consumer with his

problems when the government supplies the good or service.
While these services are important and increasing, this
study is concerned with goods and services supplied in the
free market.

17John F. Smyth, "The European Commission of Human
Rights," in Rowat, The Ombudsman, p. 166.

 

18One could, of course, give the Consumer Ombudsman

judicial powers and still use the Ombudsman title. This
procedure would seem to be both unnecessary (why not call
him a consumer judge?) and confusing (what would
'ombudsman' signify?).

19Harold Shepherd and Byron D. Sher, Law in Society,

An Introduction to Freedom of Contract, (Brooklyn: The
Foundation Press, Inc., 1960i: P. 9.

 

20Different judicial systems would determine different
minimal levels of money in dispute to justify the action.
For many cases the dispute must be at least $10,000 for a
trial in the Federal Courts. The cost of legal representa-
tion ($40 per hour, minimum, in Lansing, Michigan) requires
that the sum be substantial for a trial in a regular state
court. A small claims court (considered below) with its
minimal costs would allow smaller claims to be profitably
considered.

21H. Laurence Ross, Settled Out of Court, The Social

Process of Insurance Claims Adjustment, (Chicago: Aldine
Publishing Company, 1970), p. 4.

 

 

22". . . You must now spend far more to launch a
product than you did a few years ago--and stand ready to
lose more. Of the roughly 100,000 soap, food, snacks and
other products that will bomb in supermarkets during the
l9705--out of a total of 120,000 introductions-—the
advertising expenses alone will add up to an estimated

111

$5 billion for those being test marketed and $7 billion or
$8 billion for those introduced nationally. . . . New
product (all products) failure rates now run as high as
80%, and the waste in research and development has been
estimated at 70% or more." "New Products: The Push is on
Marketing," Business Week, March 4, 1972, pp. 72-73.

 

23"Why is it. . . that over the last 10 years, in spite
of growing sophistication in marketing and research, no
perceptible improvement has been made in the success ratio
of new products? Have we, in fact, reached a new—product
saturation level where consumers have turned off because
of the number of me-too entries tried year after year?
Are consumers no longer gratified by fresher breath, a
richer coffee, a whiter wash, but searching for different
values? Have government regulations and consumerism
actually destroyed the marketing leverage we previously
enjoyed and blocked our ability to recognize what consumers
really want in the new-product area?" "New Products: The
Push in on Marketing," Business Week, p. 77. The article
continues and concludes that with the loss of 'marketing
leverage' (which in the use here can only mean deceptive
advertising) it is now more important to create new pro-
ducts with meaningful product differences. In other words
it is in the manufacturers' interest to honestly represent
an improved product. This behavior would be reinforced by
the liability changes proposed in this paper.

 

24Every state except Colorado, Indiana and Nebraska has

some kind of small claims court. For a description of these
courts (in a table) and an analysis of their performance
see: "Buyer vs. Seller in Small Claims Court," Consumer
Reports, October, 1971, pp. 624-629. The Consumer Report
study found, "With all their limitations, the small claims
courts in our study were the best general means we've yet
discovered for breaking the impasse between consumers and
sellers." (p. 627) Their suggestions for change included:
1. "Every state should establish a system of small
claims courts where proceedings are informal and
strict rules of evidence are not required. . .
2. The maximum size of suits admissable as small claims
should be $1,000. . .
3. Neither plaintiffs nor defendants should be permitted
4

 

to have attorneys in small claims courts. . .
. The use of small claims courts as debt-collection
egencies must be curtailed. . .

5. The use of small claims courts as a place of redress
should be promoted by agencies serving the poor, by
bar associations, and by the court itself.

6. The courts should be brought to the people. Small
claims courts should ride circuit, going regularly
into the poor neighborhoods and sitting nights and

112

Saturdays for the benefit of working people. While
justice may be blind, it is not lame, and the
distance to the courthouse is often unbridgeable by
the poor.

The small claims court procedure in Michigan is
found in Public and Local Acts: Michigan Session of 1968
(Lansing, Michigan: Legislative Service Bureau, 1968),
pp. 231-234. The small claims court procedures are part
of a law designed to revise the organization of the
district courts in Michigan.

Each district court is to have a small claims
division with the judges of the district court serving as
judges in the small claims divisions (600.8401). These
courts shall be confined to cases for the recovery of money
when the amount does not exceed $300 (600.8402). The
action is begun by an affidavit filed with the clerk or
deputy clerk of the district court. The form of the affi-
davit was to be written by the Supreme Court of Michigan.
A copy of the affidavit is served by certified mail along
with instructions to bring any materials necessary for the
defense (600,8404). The date for appearance is to be
between 15 and 30 days from the date of the notice
(600.8406). "No attorney at law, except in his own behalf,
collection agency or agent or employees thereof or person
other than the plaintiff and defendant . . . shall take
part in the filing, prosecution or defense of litigation
in the small claims division. Corporations may be repre-
sented by a full-time employee who is not an attorney at
law. Plaintiff or defendant may demand and remove the
case to the district court. The judge will inform both
parties of this right prior to trial and also inform the
parties of all rights waived if they choose to remain in
the small claims division." (600.8404). The rights waived
include right to counsel, right to trial by jury and any
right to appeal (600.8412). The court to be used is that
of where the cause of the action arose or the county in
which the defendant is established or resides (600.8420).
A fee of $5.00 is charged for filing the affidavit and a
fee of $1.00 is charged for each copy which is to be mailed
to a defendant by the clerk (600.8420). The prevailing
party in any action receives the costs of the action (600.
8421). Actions of fraud, libel and slander and actions
against the state or any other governmental agency are not
permissible in a small claims procedure (600.8424). "In
hearings before the small claims division witnesses shall
be sworn. The judge shall conduct the trial in an informal
manner so as to do substantive justice between the parties
according to the rules of substantive law but shall not be
bound by the statuatory provisions or rules or practice,
procedure, pleading or evidence, except provisions relating
to privileged communications, the sole object of such
trials is to dispense expeditious justice between the

 

113

parties. There shall be no jury nor shall a verbatim
record of such proceedings be made." (600.8411).

25". . . If the buyer is compeled to contest the
question of negligence (tort law rather than contract law)
with the seller, he will find it very difficult to recover.
In the nature of the case the evidence will be chiefly in
the control of the seller, and the expense of even
endeavoring to make out a case of this sort will be
prohibitive in cases involving small amounts. Moreover,
if the buyer cannot recover from the seller (dealer or
manufacturer) he cannot recover from anyone for the
defective character of the goods which he has bought. The
wrong done by the sale of defective materials to the
manufacturer who later sold the goods cannot form the basis
of action by the ultimate buyer. Consequently, the real
wrongdoer who has caused the ultimate injury escapes. On
the other hand, if the manufacturer is held to an absolute
liability irrespective of negligence, it will unquestionably
increase the degree of care which he will use, and if in
any case he is compelled to pay damages for breach of
warranty where the real cause of the defect was inferior
material which he himself innocently purchased, he will
have a remedy over against the persons who sold him this
inferior material, and his damages will include whatever
he himself has had to pay for breach of warranty. Thus
the loss will be borne ultimately by the person who would
be responsible." Williston, The Law Governing Sales of
Goods, p. 620 (Section 237a).

 

26Tort means wrongdoing. The elements which must be

proven to win a tort case in fraud are:
"1. misrepresentation or concealment of a material
fact.
2. intentionally made (with knowledge of the
falsity)
3. with intent to deceive.
4. reliance by the other party.
5. resulting in loss or injury."
Hendrik Zwarensteyn, Introduction to Business Law, Revised
Edition, (East Lansing, Michigan: Michigan State Univer-
51ty, 1963), p. 99.

 

CHAPTER FOUR

RECENT CHANGES IN WARRANTY LAW

The thrust of this study has been that consumer
problems have developed because manufacturers have been
able to escape from financial responsibility for their poor
production decisions.1 This immunity has resulted from
the abuse of the doctrine of freedom of contract to
justify the exclusion of the traditional warranty of
merchantability and the express warranties which would be
created by their behavior. This abuse of the freedom of
contract in consumer transactions has recently led to
limited corrective action by some states, Congress and the
courts. This section will consider four of these moves.
The analysis of these changes will consider only their
effect on freedom of contract and the traditional implied
and express warranties.

At the Congressional hearings on bills involving
restrictions of the freedom of contract to exclude the
warranty of merchantability there was testimony to the
effect that such an action would not be in the best
interest of consumers. Richard W. McLaren (Assistant
Attorney General, Antitrust Division, Department of

Justice) testified in favor of the approach used in the

114

115

Administration's bill which was not reported out of the
Senate committee:

"We believe that consumers are best served when
they have available a wide range of choices between
competing consumer products and competing warranties
and guarantees given in connection with these products.
We believe that consumers have a right to be well and
fully informed as to the nature of that choice.
Generally, so long as the consumer is informed of and
adequately understands whatever warranties or services
are offered, a supplier should be free to offer
consumer products with no warranties, with comprehen-
sive warranties or with warranties limited in
substantive content and duration."2

In other words, there should be no limit on the freedom of
contract of manufacturers so long as the consumer is aware
of what he is being offered. The issue of the likely
extent of competition in consumer warranties has been
considered in Chapter Three and is considered again in
Chapter Five, at this point it is sufficient to note that
other testimony at these Congressional hearings held that
competition in warranty terms was virtually non-existent.
The Senate committee did not agree with Mr. McLaren and
reported out a bill (considered below) which restricted
the manufacturers' freedom of contract.

Another argument presented at the hearings held
that the use of disclaimers of implied warranties was
proper and should not be restricted by the government.
Alan Weber (counsel for the Gas Appliance Manufacturers
Association, Inc.) testified:

"Traditionally manufacturers have disclaimed all

implied warranties in their express warranties. This

device is used primarily to disclaim responsibility
and obligations over which they have no control

116

(e.g., air conditioning systems assembled by an

independent contractor with components of several

manufacturers)."3
While the word 'traditionally' may be a poor choice, this
argument illustrates a basic problem, fixing of responsi-
bility. If the manufacturer is not responsible because
the contractor assembled the individual parts and if the
contractor is not responsible because he didn't manufacture
the defective part, then what is the position of the
consumer? The consumer, the one party who has no
responsibility for the failure, pays for the repair work.
The approach in warranty reform has been to hold the
manufacturer responsible. This procedure is not as unfair
as it might seem since: 1) the manufacturer can refuse to
sell to an incompetent contractor (and can determine
competence as well as the consumer) and 2) the manufacturer
could recover his loses for warranty service from a
contractor whose incompetence caused the failure. The
Senate Committee did not feel that the consumer would be
protected by maintaining the manufacturers' freedom of

contract.

Court Action

 

Berg v. Stromme (Wash., 484 P. 2d 380 [1971])

This case, decided by the Supreme Court of
Washington on April 22, 1971, greatly limits the effect of
standardized contracts in its jurisdiction. Dr. Berg
purchased a Pontiac which he claimed had so many things

wrong that he felt justified in rescinding the deal.

117

Seeking damages for the depreciated value of the automobile,
costs of repairs and time lost Dr. Berg sued the dealer
(Stromme) who had sold him the automobile. At the close

of Dr. Berg's case the superior court (trial court) on
Stromme's motion ordered a dismissal with prejudice on two
grounds: 1) that the article had been purchased by trade
name and that sale was, therefore, without warranty (the
buyer did not depend on the seller's advice) and 2) Berg
had signed a disclaimer of warranty.4 The court of appeals
affirmed, with one judge dissenting (they affirmed only on
the grounds of the written waiver of warranty), the

supreme court granted review and reversed the court of
appeals and the superior court. The decision has a distinct
tone of anger.

"The issue, as we see it, is whether the buyer,
despite the printed disclaimer of warranty, was
entitled under the circumstances and conditions of the
purchase, to receive delivery from the dealer of a new
automobile that would operate with reasonable
efficiency, safety and comfort. Evidence of the
seller's representations were relevant to this issue,
however, because it shows that the purchase resulted
from negotiations, item by item, as to the color, size,
weight, horsepower and body style of the vehicle and
the kinds of optional extra equipment to be put on it,
such as power brakes, power steering, tilt-steering
wheel, soft—ray glass, power-operated rear window,
power seat, air conditioning, super-lift shocks - and
a host of other times of extra equipment not included
in the standard price of the car of that size, type
and model.

"The printed documents constituting the written
agreement between the parties and the execution of
them in writing will show, we think, why printed
disclaimers of warranty in the purchase of new automo-
biles are now regarded with increasing disfavor by the
courts. . . . Although competent parties may make any
lawful contract they choose, there exists a strong
presumption that the buyer, in negotiating the purchase

118

of a brand new car from a dealer, after discussing
and agreeing upon all of the details as to its style,
type, price, equipment, accessories and condition of
delivery, would not in the same agreement negate and
undo his bargain by disclaiming the right to a car of
merchantable quality. Merchantable quality in a new
car means a car that is reasonably safe, trouble free
and dependable . . . and that it is reasonablyssuited
for the purpose for which it was manufactured" (at
381, 382).

”The purported disclaimers of warranty in the
conditional sale contract form and the waiver of
warranty in the purchase order form highlight the
absurdity of a rule of law which elevates these bland
and substantially meaningless terms and conditions
above the individually and expressly negotiated terms
and conditions, and gives them controlling effect over
specifically agreed upon items and conditions of the
contract. To adhere to such a rule means that the law
presumes that the buyer of a brand new automobile
intends to nullify in general all of the things for
which he has specifically bargained and will pay. We
would presume the buyer does just the opposite" (at
385).

This decision allows the parties full freedom of contract
in that it does not invalidate any particular type of
contractual condition, per se.

"Parties to an agreement may make any contract that
comports with general law and if 'a seller positively
and expressly refuses to give any warranty, and the
contract is not induced by fraud, no warranty of any
kind can be implied by law.‘ Jones v. Mallon . . .

101 P 2d 332 . . . But to come within these principles,
the burden is upon the dealer to show with particular-
ity just what the buyer is waiving, that is, which
particular defects or conditions the purchaser of a
brand new automobile explicitly waives.

"Thus, in the sale of a brand new automobile,
there does exist an implied warranty of fitness . . .
The parties may agree to do more or to do less, but
unless there is proof of explicit departure from this
norm, the presumption is that the dealer intended to
deliver and the buyer intended to receive a reasonably
safe, efficient and comfortable brand new car.

"These principles do not, we think represent a
drastic departure from, but rather an adaptation of the
prevailing trends in the law of torts to the law of
contracts . . . this court adopted the rule of strict
liability against the manufacturer - not the dealer -

119

in accordance with modern views . . . Strict
liability - liability without proof of negligence -

in torts has been applied to the retail dealer despite
disclaimers of warranty with greater and impressive
frequency . . .

". . . Waivers of such warranties, being disfavored
in law, are ineffectual unless explicitly negotiated
between buyer and seller and set forth with parti-
cularity showing the particular qualities and
characteristics of fitness which are being waived"

(at 386).

In essence this decision makes disclaimers of
warranties in standardized contracts unenforceable in the
State of Washington. If the seller can convince the buyer
knowingly to purchase an item which may only appear to be
what he desires to purchase (not merchantable), then he
may do so. 'As is' sales are permissible under the
decision, but not if the 'as is' (or other disclaimer of

warranties) is lost in a mass of fine print and not fully

understood by the buyer.

Prgposed Federal Legislation

 

Magnuson-Moss Act 5.986 (92d Congress, lst Session)

Going beyond Berg v. Stromme the Senate passed
on November 8, 1971 (no warranty bill passed the House
during the 92d Congress) the Magnuson-Moss Act. This act
provides in Section 108 entitled Limitations on Disclaimer
of Implied Warranties:

"(a) There shall be no express disclaimer of
implied warranties to a purchase if any warranty in
writing or service contract in writing of a consumer
product is made by a supplier to a purchaser.

(b) For purposes of this title, implied

warranties may be limited only as to duration and only
to the duration of a warranty in writing of reasonable

120

duration, if such limitation is conscionable and is set
forth in clear and unmistakable language and prominently
displayed on the face of the warranty."
While according to Berg v. Stromme it was possible (although
fairly unlikely in the case of purchasers of new products)
for the manufacturer to openly negotiate with the consumer
and exclude the implied warranty of merchantability, under
the Magnuson-Moss Act such complete exclusions would not
be possible. But the manufacturer would be free to limit
the duration of the implied warranties provided such a
limitation were conscionable.6 The burden of proof of the
duration not being conscionable would seem to lie with the
consumer. As a practical matter the manufacturer would
continue to be free to limit warranties to a year or less
even though the consumer might reasonably expect the item
to last much longer.7 Considerations of what would be a
conscionable limitation of warranty duration, when the
consumer is aware of this argument, may require too great
a level of sophistication to be of value to consumers

when protecting themselves.

State Legislation Passed
1) Uniform Commercial Code 2 - 316A

Maryland and Massachusetts have removed the
manufacturers' discretion to exclude implied warranties
and much of their discretion to limit their express
warranties in the area of consumer warranties by passing

2 - 316A which is an amendment to the UCC of these states.

\.
\.

The

121

"The provisions of section 2 - 316 shall not apply
to sales to consumers as defined by section 9 - 109
(Maryland), services or both. Any language, oral or
written, used by a seller of consumer goods and ser-
vices, which attempts to exclude or modify any implied
warranties of merchantability and fitness for a
particular purpose or to exclude or modify the con-
sumer's remedies for breach of those warranties, shall
be unenforceable, provided however, that the seller
may recover from the manufacturer any damages resulting
from breach of the above described warranty.

"Any language, oral or written, used by a
manufacturer of consumer goods, which attempts to limit
or modify a consumer's remedies for breach of the
manufacturer's express warranties, shall be unenforce-
able, unless the manufacturer provides reasonable and
expeditious means of performing the warranty
obligation."

Massachusetts law:

The provisions of section 2 - 316 shall not apply
to sales of consumer goods, services or both. Any
language, oral or written, used by a seller or manu-
facturer of consumer goods and services, which attempts
to exclude or modify any implied warranties of
merchantability and fitness for a particular purpose or
to exclude or modify the consumer's remedies for breach
of those warranties, shall be unenforceable.

Any language, oral or written, used by a
manufacturer of consumer goods, which attempts to limit
or modify a consumer's remedies for breach of such
manufacturer's express warranties, shall be unenforce-
able, unless such manufacturer maintains facilities
within the commonwealth sufficient to provide reason-
able and expsditious performance of the warranty
obligations.

In this form the manufacturer cannot limit the duration of

the implied warranties to a duration he finds convenient.

Thus in a dispute a consumer, after using the product for

90-days or one year, need only prove that the performance

of the good has not been to the level of reasonable man

would expect to recover his loss (the depreciated value

of the good). He would not have to prove the unconscion-

(fl/

ability of the limitation of the duration as well as the

122

unreasonable performance of the product as would have been
the case with the proposed Federal legislation. The
relationship between clarity and litigation is well
illustrated by these laws. The annotated codes for use

in 1972 listing these laws include no cases or law journal

articles which were based on these laws.

2) Song-Beverly Consumer Warranty Act (California Civil
Code 1790)

This California act went into effect on March 1,

10

1971. Unlike the approach in Maryland and Massachusetts

this law is not an additional paragraph to the UCC, but
rather a different law which when a conflict between it
and the UCC occurs the Song-Beverly Consumer Warranty Act
prevails. Section 1790.3 Law Governing; reference to
Commercial Code:

"The provisions of this chapter shall not affect
the rights and obligations of parties determined by
reference to the Commercial Code except that, where
the provisions of the Commercial Code conflict with
the rights guaranteed to buyers of consumer goods
under the provisions of this chapter, the provisions
of this chapter, the provisions of this chapter shall
prevail."

This act removes the freedom of contract of the parties to
consumer transactions.

"Any waiver by the buyer of consumer goods of the
provisions of this chapter, except as expressly
provided in this chapter, shall be deemed contrary
to public policy and shall be unenforceable and void"
(1790.1).1

This law further provided that express warranties may not

be used to exclude the implied warranties.

123

"Nothing in this chapter shall affect the right of
the manufacturer, distributor, or retailer to make
express warranties with respect to consumer goods.
However, a manufacturer, distributor, or retailer
making express warranties may not limit, modify, or
disclaim the implied warranties (merchantability and
fitness for a particular purpose) guaranteed by this
chapter to the sale of consumer goods (1793)."

The effect of the bill was limited by the amendment
of 1971 which went into effect on January 1, 1972. This
amendment among other changes added Part C to Section 1791.1.

"As used in this chapter:

(a) "Implied warranty of merchantability" or
"implied warranty that goods are merchantable" means
that the consumer goods meet each of the following

(1) Pass without objection in the trade under
the contract description.

(2) Are fit for the ordinary purposes for which
such goods are used.

(3) Are adequately contained, packaged, and
labeled.

(4) Conform to the promises or affirmations of
fact made on the container or label.

(b) "Implied warranty of fitness" means that when
the retailer, distributor, or manufacturer has reason
to know any particular purpose for which the consumer
goods are required, and further, that the buyer is
relying on the skill and judgment of the seller to
select and furnish suitable goods, then there is an
implied warranty that the goods shall be fit for such
purpose.

(c) The duration of the implied warranty of
merchantability and where present the implied warranty
of fitness shall be co-extensive in duration with an
express warranty which accompanies the consumer goods,
provided the duration of the express warranty is
reasonable; but in no event shall such implied warranty
have a duration of less than 60 days nor more than
one-year following the sale of new consumer goods to
a retail buyer. Where no duration for an express
warranty is started with respect to consumer goods, or
parts thereof, the duration of the implied warranty
shall be the maximum period prescribed above.

(d)...

It is important to note that this change which limits the

duration of the implied warranties was not the result of

124

poor experience with the Song-Beverly Act. The amendment
took effect only ten-months after the original act went
into effect - obviously there was not enough time to learn
the effects from practical experience of enforcing implied
warranties after more than one year. This change continues
protection for consumers who purchase products which fail
within the express warranty period or one year, whichever
is less. But the 1971 amendment removes protection from
consumers who are unfortunate enough to purchase a poorly
designed or built product which fails after the express

warranty period or one-year, whichever is less.

General Trend

 

Whether in the form of no time limit as in the
Berg v. Stromme decision and the UCC section 2 - 316A of
Maryland and Massachusetts or with a limit on duration as
in the Magnuson-Moss Act and the amended Song-Beverly
Consumer Warranty Act consumers are no longer losing the
implied warranties of merchantabllity and fitness for a
purpose by means of one-sided standardized contracts.
Warranty legislation at the state level is becoming
common. Approximately forty bills (twenty states) were
pending in late 1971 or introduced for the 1972 season.12
The legislation in Maryland and Massachusetts and to a
limited extent, California, adequately meets the policy
proposed in this study for the implied warranties of

merchantability and fitness for a particular purpose.

125

However, this legislation fails to provide the consumer
with adequate protection against the failure of products
to meet the express warranties created by sellers in the
act of selling. While these states allow a consumer to
recover his losses if a product fails to function in the
general purpose for which such products are purchased, the
consumer has no contractual recourse if his unit fails to
meet the special claims and/or samples used when the
product was sold if the manufacturer excluded any but his
limited express warranty in the standard contract. The
restoration of the implied warranty of merchantability is
an important step in allowing the consumer to protect
himself against misrepresented products, but it is not a
full restoration of the traditional rights of buyers. As
a result of this legislation contracts eliminating the
implied warranties are becoming relatively rare. The
next chapter considers the economic effects on consumers

of this change in the commercial law framework.

FOOTNOTES

1This is not, of course, completely correct. Certain
problems of consumers are not related to warranty diffi-
culties as considered in footnote 3 of the Introduction.
Also if a firm produces an unsatisfactory product,
eventually its reputation will suffer and the firm might
have to terminate its operation. This process can be very
slow, wasteful and this penalty for poor performance does
not provide any relief for consumers who have suffered
losses with the poorly made products.

2U. S. Congress, Senate Warranty Hearings, p. 223.

 

3U. S. Congress, Senate Warranty Hearings, p. 173.

 

4A leaning towards one side of a cause for some reason
other than a conviction of its justice. Blacks Law
Dictionary, 5th Ed. Rev., p. 1343.

 

 

5"i.e. a serviceable automobile capable of transporting
a driver and passengers with reasonable efficience,
comfort and security upon the roads and highways of the
state." at 383

6"Conscionable" does not appear as a legal term in
Black's Law Dictionary, Bouvier's Law Dictionary, nor in
Words and Phrases - however "Conscience“ appears in Words
and Phrases where it is considered synonymous with "good
faith.“

 

 

7The Federal Government provides asset depreciation
ranges for use in computing income taxes. These could
serve as an estimate of the useful life a consumer could
expect from a product.

Item Lower Limit Upper Limit
(Yrs.) (Yrs.)
Typewriters 8 12
Automobiles 2.5 3.5
Restaurant Equipment 8 12
Dwellings 45
Pool Tables 8 12

126

127

See Department of the Treasury, Internal Revenue Service,
Depreciation, Amortization and Depletion, (Washington:

U. S. Government Printing Office, 1972), Publication 532
(2-72), T22.44/2:534/4, pp. 20-22. The government and the
consumer both expect products to function in a satisfactory
manner for periods much longer than the 30-days or one year
periods during which the manufacturer will guarantee his
production decisions.

8Maryland, Annotated Code of the Public General Laws of
Maryland, (Charlottesville, Va.: The Michir Company, 1972)
Article 95B, went into effect July 1, 1972.

9Massachusetts, Annotated Code of Massachusetts,
(Charlottesville, Va.: The Michir Company, 1970), Article
101B - added by 1970, 880, approved September 1, 1970
effective 90 days thereafter.

 

loCalifornia, West's Annotated California Codes, Civil
Code, (St. Paul, Minn.: West Publishing Co., 1973).

11". . . a sale 'as is' or 'with all faults' means that
the manufacturer, distributor, and retailor disclaim all
implied warranties that would otherwise attach to the sale
of consumer goods under the provisions of this chapter
(1791.3). This exclusion is not effective 'unless a
conspicuous writing is attached to the goods which clearly
informs the buyer, prior to sale, in simple and concise
language of each of the following:

(1) The goods are being sold on an 'as is' or 'with all
faults' basis.

(2) The entire risk as to the quality and performance
of the good is with the buyer.

(3) Should the goods prove defective following their
purchase, the buyer and not the manufacturer, distributor,
or retailer assumes the entire cost of all necessary
servicing or repair." (1792.4).

12George P. Lamb (Association of Home Appliance
Manufacturers), U. S. Congress, House Warranty Hearings,
p. 317 and 'Statement of National Automobile Dealers
Association', U. S. Congress, House Warranty Hearings,
p. 463.

 

CHAPTER FIVE
THE ECONOMIC SIGNIFICANCE OF
REQUIRED WARRANTIES

". . . Even if there is no negligence, however,

public policy demands that responsibility be fixed
wherever it will most effectively reduce the hazards

to life and health in defective products that reach the
market. It is evident that the manufacturer can antici-
pate some hazards and guard against the recurrence of
others, as the public cannot. Those who suffer injury
from defective products are unprepared to meet its
consequences. The cost of an injury and the loss of
time or health may be an overwhelming misfortune to

the person injured, and a needless one, for the risk

of injury can be insured by the manufacturer and dis—
tributed among the public as a cost of doing business."
Justice Traynor in "Escola v. Coca Cola Bottling Co.

of Fresno", 24 Cal. 2d 453, 150 P 2d 436 at 440-441,
(Cal., 1944).

The return to the traditional relationships between
buyers and sellers proposed in this paper will require
thousands, if not millions, of decision makers of firms
producing consumer goods to determine which, if any;
changes in production and promotion activities, they will
make to adjust to the changed commercial environment
(i.e., strengthened rights of consumers). These decisions
involving promotion and production adjustments require the
experience and judgment of experts working in the firms.
Those outside the firms who pr0pose the changes are limited
to considering the general trends by which firms will

adjust to the changed environment. Since adjustments to

128

129

changing conditions are largely the result of trial and
error testing, these adjustments are subject to only the
most general type of prediction by even the experts of the
firms. Those outside of the particular industry (and for
many decisions those inside the firm as well) will not be
able to predict the specific changes, such as changing from
22 gauge metal to 20 gauge.1 But it is possible to deter-
mine the decision structure facing the firm when required
to provide consumers with the warranties of merchantability

and fitness for a purpose.

Effects of Workmen's Compensation Legislation

 

Fortunately the workmen's compensation experience
provides an example of a similar change in the law (a
shift in risk from a weaker party to a stronger party who
has the power to control the rate of loss) which allows an
analysis based on actual adjustments rather than specula-
tion of changes in the future.2 The decision structure
facing a manufacturer who has been required to assume
responsibility for the on the job injuries of his
employees is similar to the decision structure he would
face if made responsible for the financial injuries of his
customers when he sells a faulty product. With the develop-
ment of workmen's compensation legislation the employers'
legal position was changed. No longer was he virtually
immune (by means of acceptable common law defenses based

on contributory negligence, fellow servant rule of

130

negligence or assuming the risks of the job) but rather
he had nearly absolute liability (fault was not considered

3 To avoid

when these defenses were no longer effective).
payments to compensate employees for industrial accidents
he had to make a number of choices.

The most basic of these choices was whether he
should remain in business or whether he should stop; but
this decision is misleading. The decision as to how or
whether to adjust is made at the microeconomic level of the
firm; the justification of the shift in responsibility lies
in the effect on the entire economy - a macroeconomic
situation. If one firm stops operating (a microeconomic
change) due to the new legislation, but, rather than
closing down and holding idle the fixed resources the firm
formerly used, the firm sells the business to another firm
which continues to utilize the fixed resources, then, in a
macroeconomic sinse there has been no change. Since the
past fifty years have been a period of generally rising
production, this legislation, while it caused many changes
at the microeconomic level, did not seem to seriously limit
the productive capacity of the economy. An analysis of
the microeconomic decisions of the firms in adjusting to
workmen's compensation legislation is considered in some
detail since it provides a good example of what may be
expected as firms adjust to stricter warranty provisions.4

The adjustments to the macroeconomic policy of

workmen's compensation legislation occurred at the

131

microeconomic level of the firm. Living with the imposition
of considerably increased liability required several
decisions. The firm which decides to remain in business or
to take over another business must determine whether it
costs will be lower if the firm continues with the present
practices and pays compensation for the injuries which will
result, or whether it should change its current practices
and spend resources on safety programs to reduce the cost
of injuries. If the reduction in payments (directly by
the firm or indirectly by insurance premiums) is greater
than the interest on the cost of the safety program, then
instituting the safety program is a profitable activity for
the firm. 'Safety program' like 'improving quality' is an
abbreviation for a whole series of complex firm decisions.
A firm does not have a choice of 'safety programs,‘ each
with its known costs and benefits to be taken from a shelf.
Rather each firm must study its particular hazards and
adapt techniques which have proven to be of value in other
situations to its particular conditions and perhaps develop
new safety techniques designed for its particular situation.
If a firm should decide to lower the costs of its
unavoidable liability for employees' safety by means of
improved conditions in its factory (or lower warranty
costs by improving quality) the firm must decide
specifically which activities it will use. Safety programs
can include as component parts better lighting, less noise,

non-slip floors, air conditioning, dust control, posters,

132

shorter working hours, automation of hazardous operations,
shielding, speeches by the company's president on the
importance of safety, direct drive tools rather than belts
and shafts, and dress regulations among other possible
specific changes. Each of these 'specific' programs are
subject to some adjustments: noise may be reduced consid-
erably or hardly at all, lighting may be improved for the
entire factory or merely in certain work areas. The degree
of change is determined (in theory) by improving the
situation until the interest payments on the cost of the
improvement exceed the decrease in payments to employees
for injuries over the same time period. The choice
problem is complicated further by the interdependence of
these specific approaches. Depending on the particular
situation in the factory a combination of specific changes
may be more or less effective in lowering the costs of the
firm's payments for industrial accidents than the sum of
the individual programs.

An advocate of workmen's compensation legislation
could have listed the various improvements which firms
could make to reduce the number and seriousness of
industrial accidents and he could have predicted that if
the legislation were adopted, firms would incorporate
these techniques in their operations to lower their direct
payments and/or insurance premiums. The estimates of the
firms before the program will be high because they will be

based on the currently available means, but the actual cost

133

will be based on the lowest cost combination of these
means and others to be developed and because they might
have designed their estimates to demonstrate the impract-
ability of the scheme. The advocate of the general policy
could, as shown below, demonstrate that by changing the
incidence of the cost of industrial accidents from the
employee to the employer, that the total of the expendi-
tures for compensation for industrial accidents and their
prevention (cost of the safety programs) would be less than
the losses due to injuries and the cost of prevention
before the passage of the legislation. This conclusion is
true both at the microeconomic (if one includes both the
firm and its employees in the same unit) and the macro-
economic level.5
Assuming that the worker receives only his actual
loss in compensation for an accident, the only change
resulting from the legislation is that the employer rather
than the employee suffers the losses of industrial accidents.
To reduce his payments the employer can make his factory a
safer place to work. Since the reduction in payments (the
amount of loss due to industrial accidents) exceeds the
costs of the safety program, the sum of losses due to
industrial accidents plus the costs of the safety programs
is less after the institution of workmen's compensation
than the losses due to industrial accidents would have been
without the legislation. The employer may feel that the

legislation has created losses since he had to make payments

134

(direct or insurance) only after the legislation became
effective. But in terms of the microeconomic unit of the
firm and its employees the legislation does not create
losses. The losses are created by the conditions in the
factory;.workmen's compensation legislation merely changes
the location of the financial responsibility for the losses.
The laws have the effect of lowering total losses because
the party which must carry the responsibility for the losses
has and will exercise profitable options which reduce the
number and seriousness of industrial accidents.

The reduction of loss for the entire society is
the macroeconomic result of the imposition of liability
on the firms for the safety of their employees. By shift-
ing the losses of poor performance to the party capable
of changing the performance an incentive of greater profit
is created for a better performance. This is true for the
individual firm and for the entire economy. A reduction in
economic loss for a society will follow if two conditions
are met: 1) the policy shifts an existing loss and does
not create a previously non-existent loss (e.g., making
the payment a penalty rather than compensation) and
2) the loss is shifted to a party capable of profitably
taking action to reduce the loss. Both of these conditions
were met in the workmen's compensation example and both,
as will be shown, of these conditions are met in the trend
in warranty changes. A reduction in total cost while

beneficial, is not sufficient to justify a program. The

135

effect of increased responsibility for performance on

. . . 6
innovation must also be con31dered.

Effects of Requiring the Traditional Warranties in Consumer

 

Transactions

 

The consumer protection program of requiring
manufacturers to warrant the performance of their products
in a meaningful manner (merchantability and fitness for a
purpose), like workmen's compensation legislation, shifts
rather than creates losses. The losses, poor performance
of consumer products, are created in the production
decisions of the manufacturers. As the financial responsi-
bility for product performance by means of required
warranties of merchantability and fitness for a purpose is
placed upon manufacturers of consumer goods they are faced
with the necessity of making several decisions. For each
product the manufacturer must decide if its continued
production under the new rules will be or could be made
profitable. Considering the decisions selected by the
editors of the Master Edition of the UCC to exemplify
their understanding of the standard of merchantability
(see above - Chapter 1, p. 20) the standard of merchant-
ability is clearly conservative. Few, if any, products
currently available in the market are so difficult to
manufacture that manufacturers would find them impossible
to build, at a commercial price, to a level of performance

that would meet the expectations of a reasonable man. The

136

passing of these few products from the market which can now
be sold only by means of deceptive advertising creating
unmet expectations would likely be mourned by few. Produc-
ers of products which function as a reasonable consumer
would expect could continue profitably with their current
production practices.

The nature of the criteria of merchantability are
critical to both the number of products which will be
commercially possible and the protection this policy will
provide consumers. If the standard were placed quite low
the number of changes required of manufacturers would be
minimal and the protection of consumers would likewise be
minimal. At the other extreme, if any product not incor-
porating the highest possible standards was not considered
to be merchantable, then manufacturers would be greatly
limited and consumers would not be able to purchase
moderately priced products. Clearly such a policy would
not benefit consumers. When a policy is based on a stan-
dard of reasonability specific predictions of future
decisions is not possible, but two lines of reasoning lead
one to doubt that the actual policy of requiring the
warranty of merchantability will operate at or near either
extreme.

First, the more important judicial references to
the standards of merchantability, as listed in the Master
Edition of the UCC clearly lie in the center. Courts in

the past, and there seems to be no reason to expect a

137

radical change in the future, have considered that
merchantability only requires that the product be able to
moderately perform the function for which a reasonable
consumer would purchase the produce; a superior performance
is not required. Secondly the conservative nature of the
standard is also shown in the relationship between implied
and express warranties. One might compare a Chevrolet with
a Rolls Royce to determine the relevant standards for an
'automobile.‘ The Rolls Royce purchaser spends several
times as much as the Chevrolet purchaser because he has
been led to believe that the Rolls Royce is a superior car.
This difference in expectations is based on the promotional
activities of the manufacturer and dealers. Much of this
difference in performance expectations is based on express
warranties (e.g., hand polished paint, leather seats, and

a car so quiet that the clock is the loudest sound), and a
reputation for quality which has been carefully nurtured.
The difference in expectations is not based on the qualities
covered by the warranty of merchantability (does it work

as an automobile). In terms of the implied warranties the
standards would be very similar for a Rolls Royce and a
Chevrolet. The dissatisfied Rolls Royce owner might be
upset because the car did not meet the express warranties
or the puff claims of Rolls Royce promotion, although the
performance would be considered satisfactory in a Chevrolet.
The purchasers' expectations of performance differ because

of different express warranties having been created (and

138

often disclaimed) and different puff statements. If
Chevrolet promotion claimed that as a fact a Chevrolet
would perform like a Rolls Royce, then the standards would
be identical and would include the Rolls Royce express
warranties created by the actions of the sellers of Rolls
Royce automobiles.

The basic economic effects of imposing an
additional liability on manufacturers for the performance
of their product is, if poor products are being produced,
to create an additional cost to the current method of
production and thus to create an incentive to improve the
product's performance. The cost of providing the required
warranty service (the repair costs would otherwise be paid
by the purchaser) is related to several qualities of the
product. The manufacturer may reduce his warranty expenses
by making his product differently: more performance test-
ing, building in repairability, using heavier materials,
more care in design, improved inspection techniques and/or
other techniques to improve the reliability and performance
of the product. Alternatively he could reduce the claims
made for his product. In either case the products' perform-
will correspond more closely to the consumers' expectations.
These changes will tend to increase the price of the product
(which has been improved) to the consumer and it might seem
that this policy would harm the poor.7 But the total cost
of the product (sale and maintenance) is the economically

important cost. The effect of this policy on the 'total

139

cost' is considered below. The particular decision as to
which means to use to improve the performance so as to lower
warranty costs belongs to the manufacturer as he would be
responsible for the results under a system requiring
meaningful warranties.

Production decisions both before and after any
legislative action will be made in an effort to maximize
profits. Determining the optimum combination of warranty
payments and product improvements occurs when the manu-
facturer improves the product until the cost of improving
the product exceeds the reduction in warranty costs correc—
ted for changes in the price of the product and the number
sold. With greater certainty of product performance
consumers should have a greater demand for the improved
product. The individual manufacturer should be able to
sell the same quantity at a higher price, or a larger
number at the old price or more likely a somewhat greater
quantity at a somewhat increased price.8 The complexity of
the decisions both in production and pricing requires that
the manufacturers have considerable discretion in choosing
how they adapt to their increased liability for their
products' performance due to the required warranties in
order that society obtain reasonable rather than arbitrary
results. To reduce his losses the manufacturer may either
terminate production of a particular product or reduce his
responsibility by clearly limiting his claims of perform-

ance for his products. The particular alternative chosen

140

by the manufacturer will depend on if he believes a profit
can be made from a product which is accurately represented
to consumers. The action taken will vary between different
manufacturers within industries.

The changes in warranty law merely require
manufacturers to warrant the performance of their product
to the expectation level of a reasonable man (in the final
analysis if the parties cannot reach agreement, a judicial
decision). If they take definite action to reduce the
consumers' expectation of performance they will reduce
their warranty costs.

In terms of the entire range of consumer products
only general expectations of changes can be formulated
that would follow if the policy were enacted. It would
be unlikely that manufacturers will accept the costs of a
warranty program under the new policy without making
efforts to reduce costs. These adjustments to bring the
performance of the product to the level of expectations of
a reasonable consumer would be of the form of more accurate
advertising, improving the capabilities of the product and
increasing the reliability of the product by means of
increased testing, better design, greater care in produc-
tion, and/or reducing advertising claims. All of these
efforts would reduce total losses (currently repair or
replacement costs to the consumer or warranty costs to the
manufacturer) more than such efforts would cost. Any

change (which works as planned) the manufacturer were to

141

make to reduce his warranty costs (which the consumer
currently pays when the product is repaired or discarded)
would reduce the losses suffered as a result of poor
product performance by the microeconomic unit of the
manufacturer plus his customer. Since these savings can
be summed (the program does not lead to waste at another
level) this policy will lead to an improved use of
resources.

The effect on profits of imposing meaningful
warranty obligations on manufacturers will vary according
to their current production and promotion activities and
the effect of the change in policy on mass production and
innovation.9 Some products, particularly new products,
might experience a large increase in demand with an improve-
ment in consumer confidence and the manufacturers of such
products would enjoy a considerable increase in profits.
Consumers are hesitant to purchase new products because of
the risks of 'bugs' and doubts as to whether the product
will actually perform as the manufacturers claim. This
policy shifts these risks from the buyer to the seller.
Therefore, new products will be more attractive to consumers
with the return of the traditional warranties. This
increased attractiveness of new products will be reflected
in increased demand and probably increased profits for
manufacturers of new products who have worked out the

10

'bugs' and made realistic claims. But the introduction

of new products will remain a very risky enterprise. The

142

lure of greater profits leads firms into the introduction
of new products both before and after any change in the
responsibility of the manufacturer to his customer. By
increasing consumer acceptance of new products this policy
should reduce the risks of innovation and lead to the

11 In general this policy

introduction of more products.
of requiring a meaningful warranty should lead to a moder-
ate increase in profits for those manufacturers producing

a product whose performance is well enough known to be
warranted. The cost of a commodity is the sum of the
original cost and the operating costs (including repair).
This policy shifts the repair costs from operating costs to
original costs when an effective warranty is required. If
the manufacturer takes any action to reduce his warranty
costs then that part of the original costs which pays for
the warranty (and the costs of improving the product) will
presumably (otherwise the manufacturer is raising rather
than lowering total cost which is unlikely) be less than
the repair costs the consumer would otherwise be paying.
While the original cost, which will include a charge for
the product improvements and the warranty protection, will
be somewhat greater than previously, the total cost which

includes the reduction in the repair expenses to be paid

by the consumer will be less than previously.

 

_—.——d

b - - - -

 

b-- B

L——c

 

 

143

The total cost of a product is AD.
The production costs (including profit) is
CD. AB represents the operating costs of
the product including repairs due to nor-
mal wear and tear. Repair costs due to
poor production decisions are represented
by BC (the magnitude is unknown to the
consumer).

At the present time the consumer pays
CD to acquire the product and then BC to
correct for poor production decisions -
his total expenditure (ignoring operating
expenses) is BD. The implied warranties
would shift BC from the consumer to the
producer and thus the purchase price
would become BD rather than CD. It might
not seem to make any difference if the
consumer pays BD in two steps or if the
same amount is paid when the product is
purchased - but this is incorrect. If
the manufacturer can improve his product
(increase CD) and in so doing reduce the
costs due to his poor production decisions
(decrease BC) by a greater amount he will
be able to offer his product at a lower
total cost (BD will be less) to consumers
at the same profit per unit. The lower
price should increase sales and profits.
Under the present rules manufacturers
find it profitable to reduce CD even if
BC increases a greater amount increasing
total cost to the consumer. While the
cost to the consumer will possibly remain
BD, under the proposed policy the manu-
facturer has a profit incentive to
improve his product which is not operating
under the present rules.

This policy does not add expenses to the total

producer-consumer unit. The servicing units required by

the producer for providing warranty service already exist

and are currently supported by the consumer of products

requiring repairs.

While some manufacturers will probably

create their own repair service (Sunbeam Appliances

currently use this approach) at the present time on the

base of current practice it appears that the use of

144

franchised 'independent' repair stations is most economical.
Under this policy the manufacturers' improvements to avoid
the costs of warranty service would include design for
repairability which would allow faster and better repair
by the service industry at a lower cost.12 With a lower
total price (assuming the same amount for profit per unit)
the manufacturer should be able to sell more units for a
greater total profit. This policy by lowering the total
cost of consumer goods, rather than damaging the manufact-
urer, will increase the profits of the producers of
consumer goods.

Producers of products which cannot be sold
profitably if their performance must be warranted would
suffer under the proposed policy. They would naturally
oppose the policy, but not on the grounds that it will
make producing unsatisfactory products unprofitable.
Consumer oriented legislation is generally attacked as
imposing governmental bureaucracy on the efficient
workings of the market which has yielded the vast array
of goods the consumer now has at his disposal. A similar
argument, clearly inappropriate, will probably be applied
to this policy. While there may be dire predictions of
substantial damage if this policy is enacted, very few
producers will not be able to adapt to the new rules when
their choice becomes either to produce a merchantable

product or not to produce a product at all.13

145

VoluntaryyWarranties

If this result of increased profits or the
manufacturer of satisfactory products is accepted, an
explanation is required to explain the fact that firms which
seek to maximize profits have not voluntarily offered
meaningful warranties. One can only automatically conclude
that what is true for the industry (increased profitability)
is true for the individual firm at the risk of committing
the fallacy of composition.14 Comprehending the situation
facing the individual firm, rather than the industry as a
whole, is critical to understanding individual voluntary
action. If a manufacturer were unilaterally to adopt a
policy of offering a meaningful warranty, the sales price
of his product would be higher (the total cost to the
consumer including sales price and repair costs would be
unchanged or lower) than the sales price of the products
of competing firms.

If the consumers' consideration of price when
making their purchase decisions rests entirely (or largely)
on the base of the sale price of the product which is
known and ignores repair costs (due to a lack of interest
and/or information) then the higher price required for the
additional warranty protection will shift consumers to
other brands. Shifting away from an improved brand which
sells for more, but has a lower total cost works against
the consumer. The unprofitability to the individual

manufacturer of improving his product probably helps the

146

poor who would be most likely to make the shift (to the
inferior product which would be selling without the
warranty protection). If at the other extreme consumers
were to base their purchase decisions on the total cost
(this possibility assumes that the consumers know the cost
of the repairs that will be required) the additional charge
for the warranty protection would have no effect, and the
changes made by the manufacturer to reduce his warranty
costs, if passed to the consumer, would result in a less
expensive and more attractive product. The feasibility
of offering meaningful warranties on a voluntary basis
depends on the information consumers use for making
decisions. Since an effective educational program would
be essential for a unilateral improvement in quality by a
manufacturer to be profitable, such a move is unlikely to
occur.15 Unfortunately the same conditions (consumer
consideration of only part of the cost and the need for
education) which limit a unilateral improvement in quality
favor a unilateral decrease in quality. A decline in the
quality of consumer goods is a common complaint of consumer
groups. Unilateral voluntary improvements in quality
rarely occur because the conditions for their profitability
rarely exist.

Consumers do not all buy a product on the basis of
total cost of sale price. Some consumers probably buy on
the basis of the monthly payment and others on a carefully

constructed and reasonably accurate prediction of the total

147

cost. It is not possible to determine directly where most
consumers lie on this range of buying strategies.l6 But
the sellers tend to aim their efforts at a middle position
as they stress both the price and some 'guarantee' of
performance to reduce the consumer's expectation of total
Operating costs. The manufacturer cannot recognize this
diversity of approaches by consumers and make a different

17 Rather, he must determine the

offer to each consumer.
one offer which will yield the largest profit. The
manufacturer can make different offers to different types
of consumers by means of a service contract. The
manufacturer could sell a product with a minimal warranty
to appeal to those consumers most interested in a low
sale price, and then offer a service contract at an
additional charge to those concerned with total cost.18
Only if all customers purchase the service contract will
the manufacturer have as much incentive to improve his
product as he would with required warranties of merchant-
ability and fitness for a purpose. Consumers have addi-
tional freedom when given the choice to buy the warranty
protection in the form of a service contract. But service
contracts and warranties are not substitutes except in the
area of keeping the product working. The chief weakness

of service contracts compared to required warranties for
the consumer is that the consumer cannot return the product

for a refund if the performance of the product should fail

to meet the expectations of a reasonable man. If the

148

manufacturer refused to perform his duties properly on a
service contract, he would breach the service contract
rather than the sales contract as would be the case if the
same duty were required by a warranty in the sales
contract. The service contract, by adding another contract
in addition to the sales contract, serves to isolate the
manufacturer from responsibility for promotional claims

and poor production decisions which lead to poor product
performance, but not to a total breakdown of the product.
The sales contract is basic to consumer protection and is

unchanged by an additional service contract.

Effect on the Poor

 

One might argue that the requiring of implied
warranties this policy will raise the price of products and
thus be burdensome to the poorer households. The sale
price alone is a particularly unsatisfactory guide to
purchases for the poor. The total cost (sale price and
repair costs) are particularly important when one has
limited funds to allocate and the poor will benefit from
the lowered total cost which would follow from this policy.
Few things are less valuable and more frustrating than an
appliance which is broken and cannot be repaired because
of a lack of money.19 The poor do not benefit from the
availability of defective products.20 The poor more than
the affluent need the protection of the warranties of

merchantability and fitness for a purpose in which the

149

sale price will include a large charge for the warranty
protection. The poor are the group least able to pay the
costs of working out the bugs in a new product. The major
benefit of this policy for the poor might lie in the avail-
ability of used products with a better life expectancy than
those now available because of the production decisions
made in response to the required warranties of merchant-
ability and fitness for a purpose. Requiring the implied
warranties by encouraging honest representation of products
(with a subsequent improvement in quality) will not be

detrimental to the poor.

Summary

There is a tendency in consumer protection dis-
cussions to view the problem as a confrontation of consumers
and sellers. This study does not propose that sellers make
large profits by purposefully misleading consumers. The
position of this study is that such practices are bad
business leading to reduced profits. Misleading the
consumer, while profitable in the short—run for some
individual firms, is unlikely to be a profitable long-run
strategy for an individual firm or an industry. Consumer
confidence is an important factor in sales when the
consumer is free to choose between a wide variety of
products and brands. The lower profitability of misleading
consumers follows from the substantial expenditures which
must be made in advertising to create consumer confidence

in any claim. Prices might be lower and/or profits greater

150

if these expenditures could be reduced for the manufacturer
who has a product which meets his claims and which can be
sold on its merits. But consumer skepticism must be

reduced by more then new claims. The policy proposed in
this study, by actually making sellers responsible for

their claims, can reduce consumer skepticism. Reputable
sellers will recognize that this policy is both pro-consumer
and pro-seller. This policy will improve consumer satis-
faction and will raise the profit levels of firms which
supply the consumer with improved products.

While the change to accurate representation is a
profitable change, it is not a change which an individual
firm could profitably make. It is very likely that
consumers would not believe the claims of the manufacturer
that he would stand behind his product even if he actually
intended to do so. This change, if it is to be profitable,
depends on a change in the attitude of consumers. A well
publicized change in the law could successfully change the
attitudes of consumers as well as their legal position.

The lack of individual firms making the change to a
meaningful guarantee of their product does not prove that
such a change if made in the economy as a whole would
lower profits, but rather that given the level of consumer
skepticism such a change would be unprofitable for an
individual firm.

In the case of any change in general law designed

to alter the environment of complex decisions of countless

151

individuals those proposing the change while perhaps unable
to make specific predictions should be able to indicate
the general directions of change the public could expect.
The change removing the contrived nonaccountability
achieved by the purposeful abuse of the "freedom of
contract" by manufacturers will require them to be directly
concerned because they will bear the costs of failure with
the performance of their products. This change in
commercial law encourages (by making higher profits occur
if the manufacturer operates with greater care and concern
with his product) certain desirable activities (accurate
advertising and the production of merchantable products)
and makes the socially dubious activity of creating unmet
expectations pointless due to a loss in profit. Since
with the warranty protection the product will be sold in
terms of its total cost rather than merely on sale price
not including repairs, the manufacturers will be concerned
with lowering the total costs of a commodity rather than
merely the sale price. To increase their profits they
will exercise greater concern and care in designing
materials, and construction. Deceptive advertising
leading consumers to underestimate repair costs will not
occur since the product will be sold with the repair costs
largely prepaid. Requiring warranties of merchantability
and fitness for a purpose will create incentives leading
to voluntary decisions by manufacturers which will result

in improved products and more accurate advertising. To

152

return to Milton Friedman, "It is the responsibility of

the rest of us to establish a framework of law such that
the individual in pursuing his own interest is, to quote
Adam Smith again, "led by an indivisible hand to promote

an end which was no part of his intention."

FOOTNOTES

The decision will depend on several factors. Assume
a quality distribution of this form.
Those units between A and B would be
lemons and clearly non-merchantable.
Those between B and C would be poor, but
subject to some dispute - on these units
the consumer could get a partial refund.
Those beyond C would be of merchantable
quality. The average quality level, D,

 

quality would be merchantable. Faced with the
necessity of making complete refunds F}
for the units between A and B and 7
partial refunds for those units .0
between B and C the manufacturer “HNB

would make some attempts to reduce ‘
the number of units in these groups.

The manufacturer could improve the
inspection techniques which should

make the product more standardized —

 

 

 

 

while the average quality is un- A C I)
changed, more units are at the ar
average level and fewer units are q“ lty

at the A to B and B to C levels. It is also possible that
the manufacturer will improve the
materials used or the design em-

%, ployed. In this case the distribution
might remain unchanged, but the
average quality will be improved and
fewer units will be in the A to B or
B to C range. The average quality
has improved from D to E. The mix
that companies will actually use
. . . between more inspection, better
A C D E materials and improved design will

quafity vary according to their relative
effectiveness and cost. Most firm
will probably reduce the number of unprofitable units (those
between A and C) by using all of these methods.

units

 

 

2There is a difference in the need for protection
against losing future income through an industrial accident
and making an unfortunate purchase. This difference in
need might account for the much earlier adjustment to the
special qualitites of an industrial economy of workmen's

153

154

compensation as compared to consumer protection. The
mechanism of operation, rather than the reasons for the
relative development are of interest in this study.

3Lawrence M. Friedman and Jack Ladinsky, "Social Change

and the Law of Industrial Accident," Columbia Law Review,
LXVII, (January, 1967) p. 50.

 

4It would be possible that while workmen's compensation
did not seem to seriously disturb production, the requiring
of the traditional consumer warranties would upset and
severely limit production. The best evidence against any
such hypothetical problems is that some firms have been
operating very successfully for several years without
using disclaimers. Also the industries have not been
arguing that any such production problems would result from
making disclaimers of implied and express warranties
unenforceable. Their arguments have been that disclosure
of terms would be a better approach than governmental
restrictions on the terms which courts will enforce.

5This argument is a slight variation on basic produc-
tion economics. If the producer has only one way to do a
job, method X, then the job will have a particular cost C.
If the producer is given a choice of means to do the job,
methods X, Y, 2, then the cost will be no more than C. If
methods Y and Z are more expensive than method X, then the
new options will not be used. In the same manner if
method X is some current production procedure with its
resulting accidents and method Y is a different production
procedure with more expenditures on safety and a reduction
is losses due to accidents, then the cost to the employer
will not be greater than that of method X if the employer
may choose between methods X and Y. Workmen's compensation
shifted the employee's loss to the employer making the
proper unit of analysis in the determination of the
benefits of safety programs the employer-employee unit,
rather than just the employer. If the program gives only
compensation, then it does not create losses in society;
it merely shifts financial responsibility.

6As another example consider the case of the Santa
Barbara, California oil slick in January 1969. The Federal
Government to eliminate such negligence in the future
imposed 'absolute liability without cause.‘ "'Absolute
liability without cause' was acceptable because it was
fair. If all competitors abide by a regulation, then an
individual competitor can live with it." This policy
shifted the private cost from being not more than $100,000
work of lost oil to the several millions of dollars damage
(the matter is still being settled) other individuals and

155

communities suffered. Under the new rules the oil men
realized that their safety performance was not adequate.
See Walter Hickel, Who Owns America, (New York: Paperback
Library, 1971), pp. 93-94, (Chapter 4, section 2).

 

7It might be that the poor have a short time horizon
(high time rate of discount) and thus desire a lower price
now rather than a better performance in the future. Thus
the imposing of implied warranties in a meaningful way
which result in an increased price (sale) may be damaging
the poor. This is a function not only of the time rate of
discount, but also of the likely increase in price and the
increased protection for consumers. Since the implied
warranties cannot be excluded in several jurisdictions at
the present time and prices have not risen considerably in
these areas (that would have been well publicized!) this
change in the remainer of the country seems unlikely to
damage the poor by significantly raising the prices of
goods. Also the poor often pay the highest prices and
their complaints about quality indicate that they do not
buy products with little concern for future performance.
Not knowing how efficiently to purchase products is not
equivalent to not caring how the products perform. See
David Caplovitz, The Poor Pay More: Consumer Practices of
Low-Income Families, (New York: The Free Press, 1967).

 

 

8The conclusions for the industry are uncertain because
of conflicting effects. Profits would increase as the
demand for the product increased since a better product is
more attractive compared to all other products than a
poorly made product. But an improvement in quality may
lead to less demand (fewer units replaced) with the result
of over-capacity developing in the industry. The new
effect of these two forces depends on the particular
product and its market.

9This policy should have no effect on mass production,
which is using division of labor to achieve greater
efficiency. In order to insure the performance of the
product the manufacturer may engage in more testing and
inspection, but these activities are consistent with mass
production. Mass production depends on mass distribution.
Requiring manufactures to limit their claims to the actual
capabilities of their products might limit the enchanting
power of the resulting ads to create demand to such an
extent that mass distribution would not be possible. There
are several reasons to doubt that such a drop in demand
will occur. First, most of the enchanting effects of ads
(e.g., the beautiful woman next to the car) are pure puff
and therefore not limited by this policy - under this
policy the consumer would be assured that his reasonable
expectations would be met. Second, all ads will be under

156

the same rules and an ad which is less enticing may be just
as effective if all of the other ads are also less enticing.
Third, consumers are going to spend their income - the
volume lost in one area will be made up in another. Most
important, any drop in volume will be compensated for by
closing the least efficient plants (a process which is
constantly occurring), not by a return to the handicraft
methods of the past. There is no feasible alternative to
mass production in a modern economy.

10If the costs of testing are excessive leading to a

retail price which is too high for profitable production —
the failure of the product is not the result of the required
implied warranty of merchantability which required the
testing. Excessive testing is the result of uncertainty
with the performance of the product. If it is expensive to
determine if the product will function as promised, then

it seems likely that the owning of the products would be
expensive if the testing were not done. The poor cannot
afford to purchase products with uncertain performance
characteristics. Offering the poor the opportunity to buy
poorly designed and poorly manufactured products, by
relieving the manufacturer of financial responsibility for
the performance of his products seems to be of dubious
social value.

11These warranties should create confidence in product
performance in a manner similar to the effect of 'brand
names' (when the consumer has had good experience with the
product). The consumer will expect products to work (and
will be protected if they fail to work). In creating well
founded confidence (and substituting to a large extent for
brand names) this policy would make market entry easier for
new firms and thus stimulate competition and perhaps lower
prices.

12As a general effect of this policy an improvement in

the quality of products would result. However, it might
be preferable for products to be impermanent. This con-
clusion requires that three conditions be met: 1) that
advancing technology lower the cost of manufacture much
more than repair which remains as a handicraft, 2) that
product innovation comes at such a rate that consumer will
not want a well-made more expensive product because they
will be exchanging it for the new products to come, and

3) that the flow of new type products will restrict the
investment consumers will want to make in any existing
product, so that they will be able to spend more on the
new products. See Toffler, Future Shock, pp. 56-57.

In terms of durable consumer products one may question if
any of these conditions are met now or likely to be met in
the future. "Repairability is subject to much of the same

 

157

technology as manufacture. The lack of interest in
repairability follows from the limits of voluntary action
by manufacturers to improve their product (considered
below in the text) rather than any necessary difference
between manufacturing and repairing. The second condition
may be exactly backwards; if the consumer plans to change
products he will be interested in the resale value which
will be higher if the second owner expects good performance
from the product. The case of the using of impermanent
products because they are less expensive is doubtful since
if the consumer is going to use the product for any length
of time the policy is this argument leads to a more
permanent, but less expensive (total cost) product.
Toffler's description is accurate in situations of rapid
turnover with no concern for resale which is true in
women's fashions, but it does not apply to consumer
durables where fashion is not a major consideration. Even
in clothing fashions there are indications that the youth
may not be as susceptible. See Charles A. Reich, The
Greening of America, (New York: Bantam Books, 1970TT

p. 344 (Chapter II).

13The elimination of these products might be valuable

to society in other ways. Ecological considerations would
seem to require that the production of poorly made products
which waste resources (frequent replacement) be restricted.
Those concerned with maximizing satisfaction would also
favor economic restrictions on the production of products
which are almost certain to disappoint the consumer. These
are certainly grounds for objecting to the production of
non-merchantable goods by allowing the use of disclaimers
for the warranty of merchantability and fitness for a
purpose. However, the justification used in this study is
that the shift to not allowing disclaimers of implied
warranties is consistent with the principles of high levels
of knowledge and freedom of contract in market transactions.
These principles are essential for maintaining a satis-
factory free market and avoiding governmental controls.

14The fallacy of composition is to conclude that what
is true for the part is also true for the whole or to
conclude that what is true for the whole is true for the
part. Thus an industry (the whole) may have an increased
gross profit, but each firm (the part) may have reduced
profits if more firms have entered the industry.

15It is very difficult for a consumer to determine if,

on the average, product A with a lower price and more
restricted warranty is a better purchase than product B
with a higher price and more inclusive warranty. The
essential datum is average repair cost and this is not

158

available nor can it be calculated by studying the product
before making a purchase.

l6Consumers buy particular brands on the base of

considerations other than price. A major purpose of
advertising is to create different expectations of perform—
ance (e.g., status, convenience or economy) which may or
may not be accurate. The policy proposed in this paper will
make the manufacturer responsible for meeting reasonable
interpretation of his claims which should lead to a reduc-
tion in brand differentiation (one merchantable washing
machine will be very similar to another) and an increase in
the importance of price. Therefore this policy will tend
to limit consumer considerations in purchasing to expecta-
tions, price and total cost.

17While the elimination of disclaimers of implied and
express warranties reduces the variety in contracts which
may be offered consumers, this removal of disclaimers does
not limit the variety of products (as long as they function
as described) which may be profitably offered. By increas-
ing the consumers' knowledge of likely performance this
change in commercial law should lead to greater product
diversity. Consumers will no longer discount performance
claims (since the manufacturers will be responsible for
meeting their promises) and thus the consumers will not
consider all the products of a type to be basically identi-
cal. Buyer knowledge is the required base for significant
product differentiation.

18Service contracts would seem to provide the consumer
with an estimate of the repair costs he is likely to face.
But they may serve, when the consumer is aware of them, to
mislead him into underestimating repair costs. The repair
industry is a very high fixed cost industry - most of the
expenses, equipment and labor, must be paid even if there
is no work. The firm could profitably offer a service
contract for slightly more than the cost of the parts if
this low price led other consumers to purchase the product
without a service contract. Those consumers who did not
purchase the contract would pay the full price for service
which is largely a charge to cover the fixed costs. The
service contract may be a promotional effort to increase
sales of the units and to thus make more efficient use of
the repair services which are largely fixed in size
regardless of the demand for the services.

The best datum for determining if service contracts
have this misleading effect, average repair costs, is not
available to the consumer and probably even the manufactur-
ers often have only a vague idea. Profitability by
departments in high fixed cost industries is subject to

159

considerable change by means of bookkeeping manipulations
(is the overhead charged to service contract customers or
to regular customers or to both and in what proportion?)
Thus profitability figures alone on service contract
operations would not provide the information required to
test the accuracy of this suggestion. While an interesting
idea, using service contract rates to mislead consumers is
peripheral to the changes in commercial law considered in
this study.

19It is unlikely that the poor would knowingly

purchase a seriously defective product which they knew was
quickly going to fail merely because it is a few percent
less expensive. The time rate of discount required to
make such a purchase rational is unreasonably high. Buyer
naivete is a more reasonable explanation for the purchase
of poorly made products by the poor and this naivete is
consistent with complaints on the quality of the product.

20It is possible, but unlikely, that the poor might
benefit from having poorly made products available. This
is true if they could repair them at a lower cost than the
manufacturer could either repair them or build them so
that the products would be merchantable. As a general
policy, the poor would probably benefit more from the
availability of well built and designed used products than
from poorly built new products. The used products would
probably be both less expensive and more functional.

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.‘l @153

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