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RESEARCH AND BRIEFINGS

Third Party Logistics Providers Liability Risks

 


Third Party Logistics Providers ("3PLs") are those entities that arrange shipments, as well as manage and provide advice on transportation and transportation-related services for shippers, freight carriers and other related entities. 3PLs include brokers, freight forwarders, rail transporters, consolidators, shippers and air cargo agents.

The logistics industry is changing rapidly due to the combination of a de-regulated transportation environment, together with 3PLs embracing the internet, e-commerce and other electronic means to provide their logistics services.  These changes significantly impact the liability risks 3PLs face as these risks are often difficult to predict and equally difficult to "contract away".

3PL's also recognize that their customers are changing.  Customers are more sophisticated and demonstrate an unwillingness to share liability risks with 3PLs, thereby leaving 3PLs with exposures that require proper evaluation and insurance coverage.
 
This "white paper" is not intended to be exhaustive of 3PL's liability exposure, but merely representative of current and emerging risk areas. It attempts to identify potential liability risks 3PLs face in providing contract logistics and supply chain management services and measure a 3PL's ability to limit such exposure by contract.

I . Internet Access And Management Claims

3PLs provide significant computer network access and management, and are showing a strong preference in providing internet and extranet access, administration, support and management. 

A.  Representative Liability Concerns. 

A 3PL's failure to properly  maintain and support access and connectivity to its internet and extranet portals creates significant exposure for the 3PL.  Moreover, a 3PL's customer relies on proper security measures being in place.  Even if all of the shipping documentation, contracts, inventory tracking and other information is accurate, a 3PL's failure to maintain and support access and connectivity to this information, as well as ensuring proper security, may create liability.  For example, 3PLs frequently maintain interactive websites allowing their customers to interface with the 3PL on such matters as choosing freight carriers, inquiring about shipments or inventory, and conveying shipping instructions.  Failure of the 3PL to properly manage or support such website activity, connectivity or access (including "slamming"-related access problems), or the security of the website, gives rise to liability exposure to the 3PL when its customer claims a resulting loss or exposure for confidentiality breaches.

B.  Contract/Risk Assessment. 

A 3PL's customer contractually relies on the 3PL to provide secure, trouble-free internet/extranet access and management.  When there are problems, the customer looks to the 3PL on a direct party claim.  If the 3PL has contracted with an internet/extranet provider, the 3PL may have recourse against that service provider (assuming the 3PL was able to negotiate contract terms providing such recourse rights), but the 3PL is still liable to its customer and must ensure that its customer is wholly compensated with no gaps.  The 3PL's customer has no incentive to "contract away" its rights against the 3PL. 

II. Liability Risks For Traditional 3PL Services Provider Over The Internet

Contract logistics and supply chain management services currently offered by 3PLs under more traditional means are also now offered and serviced through static and interactive websites, emails, e-commerce and other internet means.  Use of the internet has created, and will continue to create, additional liability exposure for 3PLs arising from the more traditional contract logistics and supply chain management services provided on the internet.

A.  Representative Liability Concerns. Examples of such internet  exposure include:

1. Shipping, Billing and Claims Documentation.  Shipping documents such as bills of lading, manifests, delivery receipts and air waybills, are quickly becoming electronic and interactive on the internet.  Billing, invoicing and claims handling matters are also now being conducted on-line.  Errors and omissions made in such documentation are transmitted more quickly and, with respect to certain shipping documentation, are transmitted to more entities in the distribution chain than the traditional, non-internet based means of documenting shipments.  Moreover, the traditional checks and balances associated with paper work processes are virtually eliminated in the e-commerce environment (it is the key advantage of e-commerce -- speed and simplicity).  Unfortunately, an input mistake can, in the "press of a button," create immediate liability in this new paperless environment.

2. Contracts/Tariffs.  Contracts between 3PLs and their customers or service providers, including supplements, appendices and tariffs, are becoming more electronic and internet based.  These contracts address legal, practical and operational issues such as rates, routing, carrier practices, classifications, limitations of liability and other relevant cargo and shipping information.  A 3PL's failure to ensure that such information is timely and accurately agreed to, posted, sent and received from, through and on the internet gives rise to liability risks for a 3PL.

3. Posting of Carrier, Inventory, Tracking and Other Information.  3PLs are posting significant amounts of information on the internet such as carrier, inventory, metrics and tracking information in their continuing efforts to provide timely and pertinent information to their customers.  Similar to shipping documentation and contracts, the failure by a 3PL to ensure that such information is timely and accurately posted, sent and received from, through and on the internet give rise to liability risks for the 3PL.  3PLs that are negligent in locating, tracking and securing status checks on their customers' freight can also be held responsible for those customers' resulting damage claims.  For example, if such negligent tracking causes the 3PL's customer to lose its customer, the 3PL may have liability exposure for such lost business.

B.  Contract/Risk Assessment.  3PLs' customers have rarely shared in the liability risks associated with the traditional 3PL services provided and are no more likely to share in such risks now given the greater liability exposure to 3PLs in conducting these services on-line.

III. LOGISTICS MANAGEMENT CLAIMS

The range and variety of contract logistics management services provided by 3PLs are extensive. In providing such broad and wide-ranging management services, 3PLs face liability exposure for their negligence and breach of contract.  See, Office Max v. Ryder (U.S.D.C. Akron, Ohio) ($21 million contract dispute against 3PL; $75 million countersuit by 3PL); See, Menlo v. Office Max, No. C-95-1890-SBA (1995 California) (dispute as to who was to develop and/or fund sophisticated software related to the contract services and charges).

A.  Representative Liability Concerns.

1. Transportation Management.  3PLs often take responsibility for preparing a shipment for transport and are liable when preparations such as incorrect packaging or mislabeling are negligently performed. In managing their customer's transportation requirements and needs, 3PLs are required to ensure that the correct transportation rates are charged and paid.  See, Office Max, supra.  3PLs can be liable for their negligence in failing to ensure that the rate actually charged by the freight carrier was the correct and agreed upon rate.  Moreover, 3PLs may be liable when they fail to identify all rules sand classifications related to the freight, such as limitations of liability, so that all liability risks are known and can be properly assessed.  The current deregulated transportation industry places an even greater burden on 3PLs to determine limitations of liability such as released rates (i.e. published limits affecting cargo claim value) and Himalayan clauses (which can limit liability in certain intermodal situations), see, Sony Chemicals Europe, B.V. v. M/V INGRITA, 1997 AMC 755 (D.Md. 1996).

2. Load Management. Sometimes 3PLs are responsible for the correct load management of shipments.  If 3PLs fail to properly manage the load of shipments, they are liable for their negligence.  Common examples of negligent load management are when the 3PL fails to properly inform the carrier of relevant shipment details such as the nature (e.g. refrigerated), size, or value of the shipment, when the 3PL makes mistakes in routing, loading, dispatching, COD or other instructions, and when the 3PL fails to process and fulfill special transportation requests.  See, Office Max, supra; Byrton Dairy Products, Inc. v. Harborside Refrigerated Services, Inc., 991 F.Supp. 977 (N.D.ILL.1997) (3PL may be liable for spoilage).

3. Administrative Services Management. 3PLs perform administrative services such as paying freight bills.  3PLs face liability when their negligence in failing to timely or accurately, see, Office Max, supra, pay freight bills results in the assessment of late payment penalties or loss of discounts on shipments.  Moreover, such late payment penalty situations frequently allow for the recovery of attorney fees by the carrier, an expensive additional monetary exposure for 3PLs. 

4. Claims Management. 3PLs often act as intermediaries in resolving and processing cargo loss and damage claims.  In such capacity, 3PLs face liability exposure to their customer for negligence in failing to timely and appropriately file the necessary proof of claim.  In most transportation modes there are specific rules as to what constitutes a valid proof of claim and when the claim must be filed. See, Warsaw Convention, Article 26(2) (air); 46 U.S.C. 1303(6) (Ocean); 49 U.S.C. 11706 (e)(rail); and 49 U.S.C. 14706 (e)(motor carrier).

5. Supply Chain and Coordinated Management. 3PLs are often responsible for developing and preparing studies and analyses that are used to implement an effective supply chain and coordinated management plan for their customers. The process is complex and affects many aspects of logistics.  It is understandable that mistakes are made that result in alleged damages or losses by the 3PL's customer.  If the 3PL's analysis fails, for example, to adequately assess trailer drop-off security issues or incorrectly assumes that one mode is cheaper than another mode of transportation in one step of its analysis, or improperly relocates a warehouse and the customer is damaged due to the 3PL's improper analysis, the 3PL could be liable for such damages.  See, also, Office Max, supra (alleged failure to prepare a comprehensive supply chain analysis).  

6. Record Retention and Management.  3PLs face liability exposure regarding their record retention and management of their customers' goods.  3PLs are asked to maintain, retain and retrieve their records on customer's goods for various purposes including payment information, inventory and shipment information, and other product or shipment information relevant to their customer's requests.  Failing to properly manage such records, including the inability to provide the records upon demand, places the 3PL in a liability situation with its customer.  An example of negligent record management occurs when a 3PL's records are deficient or cannot be located to determine whether warehoused goods were maintained in the proper storage conditions (e.g., proper temperature controls).  Other examples include lost checks and money orders, lost receipts and paperwork critical to billings and credits for customer accounts, and lost bills of lading causing uncertainty in warehouse inventory.

7. Facilities and Warehouse Management.  3PLs are often responsible for managing their customer's facilities and warehouses and, as a result, face liability exposure for negligent management of those facilities and warehouses, including hiring incompetent laborers.  One particularly sensitive facility and warehouse management problem involves security for high value goods such as electronics and computers.  Greater cargo security measures are being decreed by manufacturers and others in the packaging, transportation and storage of such high value goods.  The failure of 3PLs to ensure that proper security measures are in force and maintained in storing such goods creates liability exposure for 3PLs.

8. Management of Contract Services.  Disputes arise as to the contract interpretation of the 3PL's services being provided.  For example, a significant dispute arose between a 3PL and its customer over who was to develop and/or fund sophisticated software related to the contract services and related charges. See, Menlo v. Office Max, No. C-95-1890-SBA (1995 California),

B.  Contract/Risk Assessment.  Although a 3PL may be able, in certain circumstances, to contractually limit its liability for certain negligent acts in performing its services, the majority of a 3PL's liability risk is likely to remain. This risk will need to be managed through loss control procedures or risk transfer mechanisms (i.e.: insurance).  The OfficeMax cases are prime examples of the overwhelming financial risk 3PLs take in providing contract logistics management services.

IV. CopyRight, Trademark And Confidentiality Claims

3PLs are often in the possession of confidential or protected information concerning a shipper or a carrier and that information is frequently protected by statute or by contract.  3PLs can be liable for their disclosure of such confidential and protected information even if they were not negligent.

A.  Representative Liability Concerns.  Information on the internet is obtained from many sources and the use of information on the internet has given rise to significant copyright, trademark and other unauthorized use and infringement claims.  A 3PL's failure to heed such potential claims in posting or using, for example, tariffs, classifications, carrier lists, service marks and other potentially infringing material creates liability exposure for the 3PL.  Moreover, because 3PLs have significant access to a shipper's operations in performing logistic services, contracts between a shipper and a 3PL frequently contain a confidentiality clause restricting the disclosure of the shipper's information.  3PLs face significant liability exposure for the disclosure of such information, especially on the internet.  See, Universal City Studios, Inc. v. Reimerdes, 82 F.Supp.2d 211 (S.D.N.Y.2000); OBH, Inc. v. Spotlight Magazine, Inc., 86 F.Supp.2d 176 (W.D.N.Y.2000).

B.  Contract/Risk Assessment.  It is very difficult for a 3PL to contractually eliminate, or even limit, its liability for improperly disclosing or using its customer's confidential or protected information.  A 3PL's customer expects its confidential and protected information to be treated as such, and is therefore, unlikely to have any reason to agree to contractually limit the 3PL's liability for damages to the customer resulting from the 3PL's wrongful disclosure.

V.  Libel, Slander And Other Defamation Or Disparagement Claims

3PLs are establishing a significant internet presence and are posting more information on the internet that risks being identified as defamatory or disparaging.

A.  Representative Liability Concerns.  An example of information that a 3PL posts on the internet is a 3PL's identification of service providers available for use by the 3PL's customers.  On occasion, 3PLs comment on the service providers.  In doing so, 3PL's face liability exposure for remarks made about such service providers that are defamatory or disparaging. See, Agora, Inc. v. Axxess, Inc., 90 F.Supp.2d 697 (D.M.D.2000); Nicosia v. De Rooy, 72 F.Supp.2d 1093 (N.D.C.A.1999).

B.  Contract/Risk Assessment.  It is very difficult for a 3PL to contractually eliminate or even limit its liability for defamatory or disparaging remarks.  Defamatory or disparaging information posted on the internet by a 3PL could give rise to any number of different entities (ranging from suppliers to carriers to the 3PL's customer) making a defamation claim against the 3PL.  A 3PL is expected to post truthful, non-disparaging information, and to the extent that it fails to do so, the 3PL risks liability exposure that is unlikely to be "contracted away".

VI. Negligent Hiring/Oversight Claims

When a 3PL's customer suffers a loss caused by service providers (including carriers) hired or overseen by a 3PL, a 3PL can be directly liable for its negligence if the competence of the service provider is called into question or if the 3PL failed to properly oversee or supervise the service provider.

A.  Representative Liability Concerns. A common example of negligently hiring a service provider is when a 3PL engages a carrier with inadequate insurance coverage, a history of poor business practices or no legal authority to act as a carrier.  A common example of negligently overseeing a service provider is when a 3PL fails to ensure that a carrier has appropriate security measures in place for the transportation of high value products such as electronics and computers, or fails to ensure that the carrier has implemented such measures.  See, Government of the United Kingdom of Great Britain and Northern Ireland v. Northstar Services, Ltd., 1 F.Supp.2d 521 (Md. 1998); See, also, Office Max, supra (3PL allegedly failed to adequately oversee the management, selection and operation of carriers for a shipper customer).
 
B.  Contract/Risk Assessment.  Negligent hiring/oversight claims are usually directly attributable to a 3PL's own negligence.  It is therefore very difficult for a 3PL to convince its customer to contractually shift the 3PL's responsibility and liability on such claims.    

VII. Delay Claims

Delay in the delivery of shipments can cause a loss to the 3PL's customer.

A.  Representative Liability Concern.  When there is a loss claimed due to delay, the carrier frequently claims the 3PL failed to adequately inform the carrier of the time-sensitive nature of a shipment.  Regardless of such a dispute over liability between a 3PL and a carrier, the 3PL's customer typically still looks to the 3PL for immediate compensation for its loss. If the 3PL has negligently failed to notify the carrier of the time-sensitive nature of the load, the 3PL's customer has a direct cause of action against the 3PL for the 3PL's negligence in causing the customer's delay damages.  See, Starmakers Publishing Corp, v Acme Fast Freight, Inc. 646 F.Supp. 780 (S.D. N.Y. 1986).

B.  Contract/Risk Assessment.  It is not unusual for carriers and 3PLs to contractually disclaim liability for delay claims.  However, delay claim losses arising from a 3PL's negligence typically fall outside of contractual liability disclaimers between a 3PL and its customers.  In those circumstances, 3PLs have liability exposure for such delay losses.  As with negligent hiring/oversight claims, delay claims can be directly attributable to a 3PL's own negligence.  It is therefore very difficult for a 3PL to convince its customer to contractually shift the 3PL's responsibility and liability on such claims.

VIII. Hazardous Materials Claims

3PLs are often involved in arranging the transportation of hazardous materials in their capacity as a broker or freight forwarder. 

A.  Representative Liability Concerns. Negligence claims arise against 3PLs in their capacity as a broker or freight forwarder when they fail to advise or require the carrier to procure or maintain the requisite insurance coverage and paperwork mandated by law or otherwise.  Maintenance, pick-up and disposal issues are also present and are part of the dangers inherent in the transportation of hazardous materials.

B.  Contract/Risk Assessment.  Claims against a 3PL for failing to advise or require a carrier to procure or maintain requisite insurance coverage are usually directly attributable to a 3PL's own negligence.  It is therefore very difficult for a 3PL to convince its customer to contractually shift the 3PL's responsibility and liability on such claims. 

IX. Insurance Coverage Claims 

Insurance coverage disputes invariably arise because 3PLs are involved in many different aspects of the distribution chain that require insurance considerations.
 
A.  Representative Liability Concerns. A conflict between the applicability of a cargo claim insurance policy and a warehousemen's insurance policy sometimes occurs.  In such a situation, the 3PL is put in the difficult position of not having insurance proceeds immediately available to pay its customer's claim.  In some circumstances, the 3PL is at fault in causing the insurance coverage dispute and therefore has direct liability to its customer for such negligence.  Such a liability situation can occur, for example, when the 3PL's failure to properly retain and manage records on goods stored and transported, prevents a determination as to whether loss or damage to the goods occurred while being warehoused (covered under one insurance policy), or in transit (covered under a different insurance policy). 

3PLs can also be held liable for failing to ensure that the correct insurance coverage was maintained on the stored or transported product.  For example, failing to identify an exclusion for rust on insurance coverage for steel products being stored can cause liability exposure to the 3PL.  Also, because inventory value can fluctuate significantly, 3PLs can be held liable for their negligence in failing to accurately assess the inventory value or failing to report such change in inventory value to its insurer, thereby resulting in a gap in insurance coverage.

B. Contract/Risk Assessment.  Insurance is procured and maintained to ensure that risks are covered.  In the event that a 3PL has failed to ensure that the appropriate insurance is in place, it has liability risk that is difficult to contractually limit or eliminate.

X. Attorney Fee Claims 

Claims for the recovery of attorney's fees related to a loss can be significant and are of concern to 3PLs because of the monetary risk.  

A. Representative Liability Concerns. 3PLs face breach of contract liability for failing to provide agreed upon services.  Under such breach of contract claims, a 3PL may be liable for the claimant's attorney's fees because attorney's fees are recoverable if the contract so provides.  Under negligence and other claims against a 3PL, attorney's fees are not normally recoverable.

B. Contract/Risk Assessment.  3PLs can contractually avoid attorney fee claims.  However, in negotiating a contract, 3PLs' customers typically require, at a minimum, a provision entitling the prevailing party in any contractual dispute to the recovery of its reasonable attorney's fees.  Because the 3PL is providing the services under such a contract, the 3PL is the party that is most likely to be sued for failing to provide the agreed upon services.  Thus, as a practical matter, 3PLs are usually bound by contract provisions entitling their customer to an award of attorney's fees for breaches of the contract by the 3PL.

XI. Conclusion

Businesses that are considering entering the third party logistics market, or for those that are already offering such services, must recognize that the rewards of growth are not immune from the risks of liability.  This document has carefully analyzed a variety of operational risks which, if not managed effectively, could lead to unexpected and egregious legal consequences.

Experts within the transportation industry generally agree that their industry is changing at a pace never before experienced, and the internet is a principal cause.  Electronic service delivery has meant that industry executives have been forced to redraft their business models to adapt to the new "playing field". Fierce competitors have become partners in .com start-ups, attempting to maximize the strength of collective networks.  New non-asset based .com competitors have emerged, aiming to build networks through contracts with regional and national carriers.  Shippers who maintain owned and contracted networks are also entering the 3PL business and are doing so electronically.  Internet shopping/service "portals" are also being launched that allow transportation carriers of all sizes to shop on-line for every facet of their business needs, from purchasing tires and gasoline to route mapping and insurance.

What we can learn from all of these changes is that when business models are changing within an industry, there will certainly be significant winners and unfortunate losers.  In both cases, companies will make decisions concerning service offerings that had, previously, never been possible, but for the emergence of electronic commerce.  The winners will likely be those 3PLs that have successful management teams who are able to recognize and harness the internet opportunity, with a capital base to build and launch their new initiative.  The losing companies will be those that have neither the capital, nor the management or leverage to build comprehensive networks necessary to be considered real competitors. 

As these industry changes unfold, companies will make mistakes. 3PLs will inevitably over-commit or even over-sell their service capabilities. Conducting business over the Web will increase the likelihood that companies will misuse, misdirect or otherwise destroy important and sometimes, confidential client information.  Contracts designed to insulate businesses from unexpected mistakes will be challenged and will not be all encompassing, thereby leaving businesses exposed to liabilities for their alleged service failures. 

What 3PLs do to protect these risks, before a loss occurs, will be a major ingredient in maintaining a strong balance sheet.  Some risk will be controlled by transferring it to the insurance market. Other risk may be self-insured, controlled contractually or eliminated altogether by avoiding service offerings that are outside the 3PL's normal capability.  Whatever choices 3PLs make to manage risk, it is clear that these choices must be made in light of a highly litigious business environment.  Wrong choices can be devastating and may create circumstances that a 3PL cannot overcome.  Hopefully, this document will play a meaningful part in helping 3PLs effectively manage their future.