Do Companies Have an Obligation to Disclose a Product Defect?

by Dorothy Zegart

Imagine that you have just sold a large stock of goods to a customer. A week has passed since the sale. And now you discover that the goods have a latent fault in them. Should you disclose the fault, even though the purchaser does not know about it? Or should you keep quiet, and avoid the financial losses of recalling the goods?

This ethical problem faces traders and manufacturers often. To what degree should latent defects in goods be disclosed? The problem is heightened when the defect is discovered by the seller after the goods have already been delivered. If the seller discloses the defect, rebates may suffice, but sometimes he will have to refund the total cost of the goods. Either way the seller will suffer loss. If the seller does not disclose the defect he may be faced with lawsuits and even the loss of his credibility and business reputation. Above all, even if the buyer never exercises his right to claim damages, there exists the moral burden on the seller of taking money for potentially imperfect goods. Although the moral issues seem clear cut and simple, newspapers regularly report cases where major corporations do not disclose defects in their goods. Cigarette manufacturers in the US, for example, are currently accused of withholding data showing that nicotine is addictive. Many firms facing this problem hope that none or only a few of their customers will bother to prosecute, or that litigation will take a long time; in both cases they assume that these costs will be lower than the cost of recalling the goods. By and large, latent defects are only admitted under pressure from consumers or from regulatory agencies. It was this dilemma of disclosure which faced Fred Worms at the beginning of his industrial career in England. His firm had completed its first major contract with the Ford Motor Company for the supply of truck mirrors. The novel feature of his truck mirrors, in those far-off post World War II days, was their design. They were basically a round piece of metal held on a swivel arm, on which a circular piece of mirrored glass was held by a rubber ring. The advantage of the design was that damaged mirror glass could easily be replaced.

But after the delivery of the mirrors, the firm discovered that the sulphur in the rubber rings was liable to migration which attacked the silvering on the mirror. The effect was to turn the mirror into a plain piece of glass.

The firm was faced with a simple choice. It could to do nothing and hope for the best (knowing that Ford’s own laboratories which test all new products, had not detected the fault). Or it could disclose the defect. The firm decided to disclose the defect, and thereby suffered a major loss through the return of stock and the replacement of all the defective units sold.

This decision is clearly in accordance with halakha (Jewish Law). The seller is under an obligation to disclose all defects. Even if he was not aware of them at the time of sale, but only became aware of them subsequently; or even if he never discovered them but the defect was discovered by the buyer, the seller is liable to refund the money and the sale may be cancelled. If the buyer does not wish to accept a partial refund or discount, the seller can be forced to annul the sale. Such a sale, a mekach taut in Jewish Law, does not necessarily require fraudulent intent on the part of the seller. Nor is any warranty required. A buyer has an unspoken warranty that the goods he is buying am defect-free.

Note that this contradicts the widely accepted principle of “buyer beware”. Standard economic theory is similarly built on the unrealistic assumption that both the buyer and the seller know all the relevant facts; so the buyer bears full responsibility for the goods which he purchases. But current developments in economic theory presented by G. A. Ackerlof try to capture the reality which the halakha has recognized for centuries. The seller generally knows his goods better than the buyer, and thus bears responsibility for their quality. And fulfilling that responsibility can mean that morality costs money.

Dorothy Zegart was the editor of the Center for Business Ethics and Social Responsibility’s Clear Profit Journal.