It seems that product recalls are always in the news.
In late September, for instance, Tyson Foods recalled more than 130,000 pounds of chicken nuggets because of possible contamination with hard plastic. Vehicles and their parts, as well as child safety products, are also frequent recall targets.
Many manufacturers fail to realize that their commercial general liability (CGL) insurance policies typically will not cover any of the costs associated with a product recall. Although a particular company's insurance coverage depends on the language in its individual policies, the standard unendorsed CGL policy specifically excludes many costs and expenses related to the recall of defective products.
Under CGL policies, insurers are required to "pay those sums that the insured becomes legally obligated to pay as damages because of 'bodily injury' or 'property damage,'" and have the "duty to defend the insured against any 'suit' seeking those damages."
The standard recall exclusion, also known as the "sistership" exclusion, provides that the policy will not cover damages claimed for any loss, cost or expense incurred by the insured or others for the loss of use, withdrawal, recall, inspection, repair, replacement, adjustment, removal or disposal of your product, your work, or impaired property if withdrawn or recalled from the market or from use by any person or organization because of a known or suspected defect, deficiency, inadequacy or dangerous condition in it.
The Insurance Services Office offers the Product Withdrawal Coverage Form to address the product recall exclusion on the CGL form. The form pays for product withdrawal expenses, such as the cost of replacing the insured's product or repairing the defect in it, notification costs, and the costs to hire independent contractors or temporary workers.
The Product Withdrawal Coverage Form also covers certain product withdrawal liability expenses when another party has paid expenses for the withdrawal of the insured's product and then demands reimbursement from the named insured.
Even with the sistership exclusion in place and with the availability of separate coverage for product withdrawal, some courts have interpreted that the CGL policy provides coverage for product recall expenses.
An instant milk product was manufactured in a plant where salmonella was detected, prompting a recall. (Photo: iStock)
Instant milk recalled
In The Netherlands Ins. Co. v. Main Street Ingredients LLC, [Civil No. 11–533(DSD/FLN), 2013 WL 101876 (D. Minn. Jan. 8 2013)], the court, ruling in favor of the insured, found that damages for a food recall claim were covered by the liability policy.
Main Street Ingredients purchased instant milk from Plainview Milk Products Cooperative and resold the milk to America Cereal Corp., a subsidiary of Malt-O-Meal Co. In 2009, the Food and Drug Administration detected unsanitary conditions and salmonella at the Plainview manufacturing facility. As a result, Plainview issued a recall of all instant milk dating back to 2007, including the milk Main Streetsold to Malt-O-Meal. As a result, Malt-O-Meal initiated a recall of its instant oatmeal. At no point, however, did Main Street's instant milk test positive for salmonella.
In 2009, Malt-O-Meal filed a lawsuit against Main Street seeking damages resulting from the recall. Main Street notified Netherlands, its insurer. Netherlands agreed to defend Main Street under a reservation of rights. Main Street and Malt-O-Meal settled the underlying action, but prior to settlement, Netherlands filed an action seeking a declaration that it had no duty to defend or indemnify Main Street.
The court said that Main Street had to demonstrate an occurrence that the loss was not known prior to the policy period, and that property damage occurred.
The insurer argued that the underlying action was premised on a breach of contract, and that failure to comply with contractual obligations cannot constitute an occurrence. The court said that there is an occurrence as long as the insured did not engage in conscious wrongdoing. There was no evidence that Main Street intended to injure Malt-O-Meal. Therefore, the court found that the recall of the instant milk was an occurrence.
Because the instant milk never tested positive for salmonella in the underlying action, the insurer argued that there was no property damage. Netherlands said that regulatory measures, such as a recall requirement, were insufficient to demonstrate property damage absent a finding of actual contamination.
The court ruled that the policy language covered physical injury, and since the oatmeal was physically affected because it included instant milk that was manufactured in unsanitary conditions, there was property damage. The court also found that the inability to lawfully distribute products because of FDA regulations was an impairment of function and value sufficient to support a finding of physical damage. So, property damage was present in this case.
Netherlands argued that several exclusions applied, such as the recall exclusion. Netherlands said that Main Street sought coverage for recall of the instant milk, not the oatmeal. Main Street responded that it sought indemnity for damages from Malt-O-Meal's recall of the oatmeal.
The court found that damages for a food recall claim were covered by the liability policy. The complaint in the underlying action was for destroyed inventory; credits and fees to customers; recall freight; and additional costs, all of which the insurer said were purely economic damages, not property damage.
However, the court said that the policy covered damages that the insured must pay because of property damage, and although lost profits or other consequential damages do not constitute property damage, the court saw these as sums for which the insured may be liable because of property damage. A third-party's product was physically affected by the insured's product and the former was recalled. To the district court, this was property damage, and the policy applied.
Heinz conducted a silent recall and failed to disclose it as part of an insurance policy application. (Photo: iStock)
Material misrepresentations
Some companies have the forethought to purchase specialized coverage for product recall losses, but they can still run into difficulties.
Such was the case in H.J. Heinz Co. v. Starr Surplus Lines Ins. Co., [15cv0631, 2016 WL 374307 (W.D. Penn. Feb. 1, 2016)].
Starr sold Heinz an Accidental Contamination and Government Recall insurance policy, and in August 2014, Heinz submitted a claim for losses incurred because of a product recall in China. Starr moved to rescind the policy because it discovered Heinz had not disclosed certain losses during the application process.
For example, Heinz conducted a silent recall after the Chinese government detected higher-than-allowed nitrate levels in some of Heinz's baby cereal products, which resulted in the destruction of 245,000 pounds of product at a loss of $11 million to $12 million. Heinz contended that the loss was intentionally not disclosed because the broker believed it would not be covered by a contaminated products policy. The application, though, specifically asked for any withdrawals, recalls or stock recoveries, whether insurable or not.
Other large and small losses were also not identified on the application.
The court stated, "Starr has adequately demonstrated that Heinz made material misrepresentations, misrepresentations that this court finds were intentional," and granted rescission of the policy.
Product recall losses can have a devastating effect on companies. Knowing what is insurable and what coverages are available for such losses — and correctly applying for those coverage — can make a huge difference in how a company recovers.
Susan Massmann, CPCU, is managing editor of electronic publications for the reference division of ALM, the parent company of Treasury & Risk. Email her at smassmann@alm.com.
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