Between A Rock and A Hard Place – Or, When Is A Proposition 65 Exempt Business Not Really Exempt?

By Ann Grimaldi and Jennifer Karpinski Singh

It happens too often to overlook: a supplier that is exempt from Proposition 65’s requirements, because it employs less than 10 employees, receives a defense and indemnity demand from its retailer customer who, in turn, received a Proposition 65 Notice of Violation. The supplier believes itself exempt from Proposition 65’s requirements – or, more likely, is not even aware of this California right-to-know law. Yet the retailer’s supply agreement requires the supplier to “comply with all applicable laws” and to warrant that its products are labeled in compliance with “all applicable regulations.” Now, confronted with its customer’s defense and indemnity demand, the small supplier effectively has become ensnared in a Proposition 65 enforcement action.

Hindsight is 20/20: should the business have complied with Proposition 65 even though it was exempt? If the answer was “yes” before the new Proposition 65 warning regulations were adopted, the answer now is an even more emphatic “yes.” In anticipation of the new warning regulations becoming effective in August 2018, these exempt businesses should take immediate steps to better understand Proposition 65 and to manage the associated business and legal risks.

What is Proposition 65?

Proposition 65 is commonly viewed as a California consumer right-to-know law. It requires “persons in the course of doing business” to provide clear and reasonable warnings prior to exposing individuals to any one of the 900-plus chemicals on the Proposition 65 list. The law is enforced exclusively by civil lawsuits that can be brought by specified public enforcers or by any private person in the public interest. Alleged violators are subject to civil penalties of up to $2,500 per day of violation; successful plaintiffs (which include those who obtain settlements) are entitled to keep 25% of the penalties imposed. Under a separate California law, successful plaintiffs also are entitled to seek their attorneys’ fees. With these incentives in place, private Proposition 65 enforcement is a thriving California legal industry.

In Section 25249.11(b) of the Health & Safety Code, Proposition 65 defines “persons in the course of doing business” as excluding entities employing less than 10 employees. Thus, these small businesses are exempt from all of Proposition 65’s requirements. Or are they? The answer to this question could affect up to millions of microbusinesses.

The number of U.S. microbusinesses is growing

According to a U.S. Small Business Administration fact sheet, microbusinesses (businesses with less than 10 employees) are the most common type of U.S. employer firms, growing from 3.7 million firms in 2013 to 3.8 million firms in 2016. There were another 24 million non-employer microbusinesses in 2015. Microbusinesses made up 74.8% of all private sector employers in 2016. And, from 2010 to 2016, these microbusinesses accounted for 11% of total job gains.

Of course, not all microbusinesses distribute products that may end up in California, and not all become Proposition 65 targets. Still, these figures reveal a potentially expansive pool of businesses that – notwithstanding their exempt status – may become entangled in a Proposition 65 enforcement action.

Retailer customers demand compliance with all laws irrespective of supplier size

The ease of selling products online, and the availability of frictionless global sourcing, also have facilitated the growth of microbusinesses. Ironically, these microbusinesses’ very success – e.g., selling products to big box retailers or via marketplace – are their Proposition 65 undoing.

Large retailers’ supply contracts typically require all suppliers, regardless of size, to comply with all applicable laws, to label products in compliance with all applicable laws, and to defend and indemnify the retailers should something go south. Failure to comply with these provisions may invite a breach of contract claim.

For a supplier, especially a microbusiness, the desire to maintain a good business relationship typically overrides the desire to assert defenses to a breach of contract claim. And so, when the retailer customer presents a microbusiness supplier with a Proposition 65 Notice of Violation packaged with a demand for defense and indemnity, that supplier finds itself between a rock and a hard place. More often than not, it will defend and indemnify the retailer – at great expense. This pressure to defend and indemnify retailer customers will only intensify when the new Proposition 65 warning regulations become effective on August 30 of this year.

The new Proposition 65 warning regulations will put more pressure on microbusiness suppliers

In August 2016, the California Office of Environmental Health Hazard Assessment (OEHHA) adopted an expansive set of warning regulations, the first major update of those regulations since they were promulgated in 1987. The new regulations will become fully effective on August 30, 2018.

One of the key provisions in the new regulations addresses the obligation to warn as between a retailer and its suppliers. Attempting to resolve a decades-old tension between these two categories of supply chain entities, Section 25600.2(e) establishes the specific circumstances in which a retailer is primarily responsible for providing warnings. One of those circumstances is when the retailer has “actual knowledge” of an exposure requiring a warning and there is no supplier who is a “person in the course of doing business and who has designated an agent for service of process in California or has a place of business in California.” The “actual knowledge” triggering this provision can come from virtually any source, including a Proposition 65 Notice of Violation itself.

Microbusinesses – i.e., businesses employing less than 10 employees – are not considered “persons in the course of doing business” under Proposition 65. Thus, a retailer’s “actual knowledge” of an exposure requiring a warning puts it at risk of becoming primarily responsible for compliance and primarily liable for its failure to comply. This dynamic, born of the new warning regulations, may prompt retailers to more carefully vet their suppliers, perhaps even avoiding microbusiness suppliers unless those suppliers demonstrate that they can, and will, comply with Proposition 65.

Microbusinesses need to manage their Proposition 65 business and legal risks

And so, as a practical matter, the Proposition 65 microbusiness exemption is rendered a nullity. Business considerations are paramount: microbusinesses want to sell products, and they want to use lucrative distribution channels. Yet, they also want to avoid breach of contract claims, expensive enforcement actions and litigation. If a microbusiness sells products through retailers that are subject to Proposition 65, then it should be prepared to manage its business and legal risks. The only practical way to manage those risks is to comply with Proposition 65’s requirements.

A rock and a hard place, indeed.

Jennifer Karpinski Singh, now with Grimaldi Law, has practiced in a broad range of civil litigation since her graduation from the University of North Carolina School of Law in 2005. She has primarily focused on products liability and has successfully defended clients and secured summary judgments in state and federal courts throughout the United States. She is an active member of the California State Bar and the Illinois State Bar.

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