A defective part from a subcontractor has damaged your product

What happens when a defective part makes it into your production run

In serial production, the damage is not in the defective part itself, but everywhere around it. The component itself costs a few euros, reworking the series costs thousands, and a market recall costs millions. Added to this are penalties from your contract with the customer, the loss of a delivery window, and in the worst case, the loss of the customer. In mechanical and electrical engineering, the difference between the value of the defective part and the actual impact is usually two to three orders of magnitude.

This disproportion is at the core of the whole issue. The supplier thinks in terms of the delivery price, and their terms and conditions usually limit liability to replacing the defective piece or to the price of the delivery. You think in terms of the costs of remediation at the end customer. If this difference is not resolved in the contract beforehand, it will be resolved by commercial power after the damage occurs, not by law.

The second surprising thing is the timeline. A defect in a component usually manifests itself only during operation, i.e., months after delivery, and by that time you have taken delivery of other batches from the same supplier. This multiplies the extent of the damage and at the same time worsens the evidentiary position, because traces of which batch was defective may no longer exist. That is why batch traceability is a matter for the contract, not for production hygiene.

The third thing determines what you can claim at all. A claim for defective performance and a claim for damages are two different legal concepts that can stand side by side: a right arising from a defect does not exclude damages, but you cannot claim under the title of damages what can be achieved through the right arising from a defect. So, you will have the defective part replaced or receive a discount, while the rework of your series is damage under Section 2913 of the Czech Civil Code and follows a different path. Companies often mix both items in a single complaint, thereby weakening both.

Four parts of a quality agreement without which it remains just a declaration

A quality agreement is a contractual document in which the customer and the supplier bindingly describe the required quality, the method of its verification, and the consequences of a deviation. In supplier practice, the English term "quality agreement" is commonly used for it. It differs from a standard technical appendix in that it adds legal consequences for the breach of parameters, and it is these consequences that make it a document usable in a dispute.

The first necessary part is the specification and the method of its verification. It is not enough to refer to a drawing and a standard; you need to specify which parameters are measured, by what method, with what frequency, and who keeps the results. For deliveries into serial production, a release process with a first sample and a signed report is customary. A deviation from the approved state can also be proven by a drawing, measurement, or an expert opinion, but the report shortens that work by months.

The second part is the change management process, and in practice, it is the most valuable clause of the entire document. A significant portion of serial production damages arises from the supplier changing the material, technology, or place of production without notification. The quality agreement must therefore contain a prohibition of unilateral changes without the written approval of the customer, a definition of what is considered a change, and the consequence of a breach. In a dispute, a breach of duty is most easily inferred from this clause.

The third part is traceability and incident response. This includes the obligation to mark batches, keep records for an agreed period, provide them within a certain time limit upon request, and participate in a joint cause analysis. Specify the deadlines in hours, not days: for a stopped production line, it matters whether the supplier arrives the same day or in a week.

The fourth part is the scope of costs to be reimbursed, and this is where quality agreements most often break down. List what is to be reimbursed: sorting, reworking, additional costs for express replacement delivery, costs of a service intervention at the customer, transport, and penalties applied by your customer. The list does not create the claim, which arises from the law, but it determines whether the item will be caught by a contractual limit or an exclusion of consequential damages, and it facilitates quantification.

Which of these four blocks is critical for a specific delivery differs depending on whether it is a safety part, a cosmetic component, or electronics with a long defect latency—which is why the lawyers at ARROWS law firm always assess the scope of the quality agreement according to the specific delivery and what you have agreed with your own customer.

Where your liability ends and the supplier's liability begins

You are liable to your customer for the entire product, even if the defect was caused by someone else. Whoever breaches a contractual duty shall compensate the other party for the damage arising therefrom, and can only be exonerated by an extraordinary, unforeseeable, and insurmountable obstacle that arose independently of their will. The failure of one's own supplier is generally not such an obstacle, as it lies within the sphere that you control by selecting the counterparty.

Your claim against your supplier is based on their own breach of the supply contract. You do not need to infer their position in relation to you or anyone else in the chain; you need to prove the duty, its breach, the damage, and the causal link. This is a significant difference from a situation where damage is suffered by someone with whom you do not have a contract.

The concept of an "assistant" applies elsewhere: where your own liability for someone you involved in the delivery is assessed. A person who uses an agent, employee, or other assistant in the course of their activity shall be liable for the damage caused by them as if they had caused it themselves; however, if a person has undertaken to perform a certain activity independently in the performance of another's obligation, they are not considered an assistant (Section 2914 of the Czech Civil Code).

The Supreme Court concluded on this matter that the decisive factor is the degree of autonomy or, conversely, dependence of the auxiliary person on the main person, and that an independent assistant or subcontractor is liable for the damage themselves; the main person is liable for the fulfillment of their duty only if they were negligent in selecting them or did not supervise them sufficiently (judgment of the Supreme Court file no. 25 Cdo 1221/2020 of 22 March 2022, available at rozhodnuti.nsoud.cz).

For your company, a practical conclusion follows regarding the documentation of supplier selection. A documented audit, an approved sample, and ongoing evaluation are not bureaucracy, but proof of careful selection and supervision. If they are missing, you open the door for your customer to argue that you are liable for the failure of the person you involved in the delivery, even where you would not otherwise be liable.

What you must do before the deadline for reporting a defect expires

The time limit for reporting a defect is stricter than most purchasers expect. If the buyer does not notify the defect without undue delay after they could have discovered it with timely inspection and sufficient care, the court will not grant them the right arising from defective performance; the same applies to a hidden defect if the defect was not notified without undue delay after the buyer could have discovered it with sufficient care, but no later than two years after the handover of the item (Section 2112 of the Czech Civil Code).

Two things should be added to this. The court will only take the delay into account if the supplier raises the objection of late notification, and the supplier cannot raise it if the defect is a consequence of a fact they knew or must have known about at the time of handover. However, you cannot rely on this: you must allege and prove both exceptions, and that is usually much more expensive than notifying the defect in time.

Moreover, you essentially make the choice of claim for defective performance only once. If the defective performance constitutes a material breach of contract, you have the right to the delivery of a new item, to repair, to a reasonable discount, or to withdraw from the contract; a choice once made cannot be changed without the other party's consent (Section 2106 of the Czech Civil Code). The law provides two exceptions to this, and in practice, you need to know both.

The first exception concerns a repair that turns out to be impracticable. The second occurs when the supplier does not remedy the defect within a reasonable time or notifies you that they will not remedy it; then you can demand a reasonable discount instead of the remedy, or withdraw from the contract. However, both exceptions rely on you having a written record of the complaint process, otherwise, they become a matter of dispute.

Why you cannot rely on special liability for a defective product when your own production is damaged

Companies often think they have a special liability regime for damage caused by a defective product, where they do not have to prove fault. For damage to one's own production, this path ends before it begins. The provisions on damage caused by a defective product do not apply if the defect caused damage to the defective product itself or damage to an item intended and used predominantly for business purposes (Section 2943 of the Czech Civil Code).

This does not mean you are without a claim. The general liability for breach of a contractual duty still applies, and it is the path through which serial damages between businesses are commonly resolved. It just means that you cannot rely on the special regime with a lighter burden of proof, and that you bear the full burden of proving the duty, its breach, and the causal link. This gives even greater weight to the documentation you agree upon in advance.

The second consequence concerns insurance, and this is where arguments are often imprecise. What the supplier's insurer will pay is determined by their insurance policy and policy conditions, not by your document. Liability insurance policies commonly contain an exclusion for recall and rework costs, so request proof of coverage in advance and have it documented by a confirmation from the insurer, not just a declaration from the supplier. Whether your supply chain has real coverage or just paper will be assessed by the lawyers at ARROWS law firm based on the specific insurance policy.

How to proceed when a customer has already made a claim against you is discussed in a separate article on defending against a major claim for damages.

How to negotiate a quality agreement when the supplier is stronger

The most common reaction from a supplier is to refer to their own terms and conditions with a liability limit equal to the price of the delivery. Accepting such a limit means bearing the difference between the price of the part and the actual damage yourself. A counter-proposal that is accepted in the market is a limit derived from the annual turnover with the given supplier, not from the value of a single delivery, and the exclusion of the limit in case of an unannounced change.

The second common demand from a supplier is the exclusion of indirect and consequential damages. Here, you need to be careful about what is hidden under that term, because the law does not define it and it is interpreted according to the contract. Insist that the costs of sorting, reworking, express replacement delivery, and service intervention be explicitly designated as recoverable damages. Without this, the exclusion of consequential damages is a formulation on which the entire defense of the other party will be based.

The third point of negotiation is security. With suppliers with low capital, even the best clause is worthless if there is nothing to collect from. In practice, retention of payments, a bank guarantee for strategic components, or insurance with your company as a co-insured party are viable options. The order of strength is obvious; the order of feasibility is often the opposite.

The leverage in negotiations is volume and long-term partnership, not a legal argument. Therefore, a quality agreement is concluded during supplier nomination, when they are still competing for the contract, not after serial deliveries have begun. Companies that are successful in passing on costs make the document a condition of nomination and have it prepared as their own template. The context of acceptance and liability for a defective machine is discussed in the article on purchasing a turnkey production line.

The delay that a defective part causes in your schedule is addressed in a separate article: your subcontractor delayed you, and the penalty is on you. Both situations often occur together in practice, and the claims from them are calculated separately because one is about quality and the other is about time.

Mistakes that only become apparent with the first major damage

The most common mistake is a quality agreement signed without a link to the framework agreement. The document then lives its own life, has no specified governing law or court, and in a dispute, there is a dispute about whether it is part of the agreement at all. The framework agreement should include an explicit reference with a determination of the order of documents in case of conflict; otherwise, you will argue about the content of the obligation before you even get to the damage itself.

The second mistake is an agreed contractual penalty for a poor-quality delivery without reserving the right to claim damages. If a contractual penalty is agreed, the creditor is not entitled to compensation for damage arising from the breach of the duty to which the penalty relates, unless the parties explicitly agree otherwise. In serial production, the penalty is usually two orders of magnitude lower than the actual impact, so a single sentence can turn the economic outcome of the case against you.

The third mistake is continuing to take delivery without a written reservation after a defect has been discovered. Further orders or paid invoices do not in themselves cancel the claims made, but the supplier builds a defense on them that you have accepted the performance, and you then have to explain what was meant. A reservation does not have to stop deliveries; a single sentence with each payment stating that acceptance does not affect the claims made is sufficient.

The fourth mistake is a joint cause analysis conducted without legal supervision. The report from it often becomes key evidence later, and formulations like "both parties contributed to the situation" can be used as a basis for reducing compensation by a share of contributory negligence. Technicians sign it because it sounds conciliatory. Whether it makes sense in your supply chain to continue with a reservation or to stop taking delivery is assessed by the lawyers at ARROWS law firm based on how your own contract with your customer is set up.

The fifth mistake is relying on a verbal agreement on a corrective action. The supplier promises to sort at their own expense, delivers replacement parts, and the matter is closed without a written record. When the same defect appears a year later in another batch, there is no proof that it was a repeated breach of the same duty, and your position is weaker than at the first occurrence. Therefore, every corrective action belongs in a written report stating the cause, scope, and deadline. What a controlled claim process looks like is shown in the text on the complaint procedure from the seller's perspective.

Risks in a supply contract that only become apparent when damage occurs

Final summary

The article has shown that passing the costs of serial production damage onto the supplier is not decided after the damage occurs, but during supplier nomination. The law gives you a claim simply because the supplier breached the contract; the quality agreement decides whether you can support it with evidence and what will be left of it after contractual limits and exclusions.

For company management, two numbers and one date are essential. The first number is the highest realistic impact of a single defective batch, including penalties from your customer. The second is the liability limit you have agreed with the supplier today. The date is the moment when your ability to negotiate for a given commodity ends because you are already serially dependent on the supplier.

A postponed decision becomes silently more expensive. Each additional batch taken without a change management process and without traceability increases the extent of possible damage and at the same time worsens the evidentiary position. Companies that succeed in passing on the costs have the document concluded before the first serial delivery arrives.

The lawyers at ARROWS law firm will prepare and review the quality agreement and the related framework agreement, vet the business partner and their insurance coverage, negotiate the terms with the counterparty, and represent you in making the claim and in any subsequent dispute. Write to us at consultation@arws.cz or browse our service contracts and negotiations.