October, 2007

The bodily injury and property damage liability insurance provided in coverage A of the current commercial general liability (CGL) form is subject to an assortment of exclusions. One of those is exclusion n., also known as the “sistership” exclusion (or “sistership” clause). It was in 1966 that insurance companies began to add to the standard form CGL liability policy exclusions such as the sistership exclusion, which sought to eliminate coverage for activities insurance professionals believed to be risks of developing and marketing a product.

The standard ISO form's sistership exclusion precludes coverage for “[d]amages claimed for any loss, cost or expense incurred by you or others for the loss of use, withdrawal, recall, inspection, repair, replacement, adjustment, removal or disposal of” the named insured's “product,” “work” or “impaired property” “if such product, work, or property is withdrawn or recalled from the market or from use by any person or organization because of a known or suspected defect, deficiency, inadequacy or dangerous condition in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.”

Typically, the exclusion bars coverage for the cost incurred when a product is recalled due to a known or suspected defect or deficiency that may cause injury or damage; and it applies only to costs incurred in order to prevent future damage/injury, not to damage/injury that has already taken place. If the exclusion is applicable, it does not eliminate coverage for all damage incurred because of the need to replace a product. Rather, it eliminates coverage only for damages incurred for the replacement.

Since its addition to the CGL policy, courts have been reluctant to apply the sistership exclusion, and have narrowly construed it to apply to only a limited number of situations. One significant restriction on the applicability of the exclusion is that the courts, in general, have not applied the exclusion if the product has already been put to use. Although the language of the exclusion states that the exclusion is to apply whether the insured's product is withdrawn from “the market or from use,” many courts have held that the exclusion applies only to recalls.

For example, the court in Erie Ins. Exchange v. Colony Dev. Corp., 736 N.E.2d 941 (Ohio App. 10 Dist., 1999), held that the sistership exclusion in the general liability policy of the insured developer of a condominium project did not apply to bar coverage for property damage claims asserted by an association of condominium residents where there was no indication that anything had been recalled or otherwise withdrawn from the market. The court explained that when a recall from the market occurs, damages are excluded from coverage for the removal from the market of sister products to prevent future failures, and that damages claimed for the initial failure are not excluded.

And in Forest City Dillon, Inc. v. Aetna Cas. & Sur. Co., 852 F.2d 168 (C.A.6 (Ohio), 1988), a case in which the insurer argued that its sistership exclusion excluded coverage for the cost of removing defective aluminum panels and of reinstalling non-defective replacement panels, the court observed:

“The sistership clause was developed to protect insurers against liability for the cost of recalls. The clause's name, in fact, reflects this purpose. Following an accident involving a defective airplane, the airplane manufacturer became obligated to recall the airplane's sisterships in order to correct the common defect that caused the crash of the first airplane. Insurance companies subsequently developed the “sistership” clause to make clear that, while they intended to pay for damages caused by a product that failed, they did not intend to pay for the costs of recalling products containing a similar defect that had not yet failed.”

Also, in U.S. Fidelity & Guar. Co. v. Wilkin Insulation, 144 Ill.2d 64 (Ill., 1991), the court held that the exclusion did not apply to the product that has already failed while in use and caused property damage to a third party. In that case, the underlying complaints alleged that the asbestos-containing product had already failed while in use, resulting in damage to the property of the building owners. The plaintiffs sought damages for the inspection of the buildings and the removal and replacement of the product. The court viewed such damages sought not as the cost of a preventative action withdrawing sister products from the market, but as a measure of the property damage which had already been incurred because of the product. Therefore, the court held that the policies' sistership exclusions did not apply to preclude potential coverage.

In Washington Energy Co. v. Century Sur. Co., 407 F. Supp 2d 680 (W.D. Pa., 2005), the court held that under Pennsylvania law, the sistership exclusion did not apply to bar coverage, so as to negate the insurer's duty to indemnify the insured natural gas company for losses incurred by the insured's customers when air infiltrated and contaminated the natural gas transmission lines with which the insured supplied the customers. According to the court, there was no evidence that the air infiltrated the natural gas so as to make the natural gas itself defective or dangerous, and, in any event, nothing was done to the gas after it was “withdrawn” from the transmission lines. Thus, the damages claimed were not related to the recall or withdrawal from use of the natural gas, but rather, from the loss of use of its transmission lines.

As the court opined, “The sistership exclusion was designed to exclude from coverage the costs incurred for withdrawing sister products discovered to have a common fault because such withdrawal involves expenses incurred to prevent accidents which have not yet occurred” and the exclusion “does not apply to damages incurred for withdrawal from use of the defective product.”

Some courts have held that (unless the policy expressly states otherwise) the exclusion is inapplicable unless the insured, as opposed to the purchaser, withdrew the product from use. There has been a division among the courts regarding whether the exclusion should apply if someone other than the insured (e.g. the purchaser) withdrew the product from use.

There is one line of authority that declares the exclusion ambiguous, construes the ambiguity in favor of the insured and concludes the “sistership” exclusion only applies to those recalls that are initiated by the insured. See Thomas J. Lipton, Inc. v. Liberty Mut. Ins. Co., 34 N.Y.2d 356 (App. 1974); Elco Ind. v. Liberty Mut. Ins. Co., 90 Ill. App.3d 1106 (1980).

As stated by the court in U.S. Fire Ins. Co. v. Good Humor Corp., 173 Wis.2d 804 (Ct. App., 1993), “The etymology and genesis of the 'sistership' exclusion shows that the exclusions should apply only to recalls initiated by the insured.”

Amendments made to the CGL form in 1986, however, were designed to resolve the issue in favor of insurers. The language of the current CGL policy makes it clear that costs associated with withdrawal of a product from the market “by any person or organization” are not covered; therefore, where the withdrawal is by a third party and not the named insured the sistership exclusion will still apply.

Several courts have noted that although the traditional sistership exclusion was silent on the issue of whether it should apply only when it is the insured who withdraws the product, the amendments to the form were made specifically to avoid the confusion surrounding the applicability of the exclusion when a third party recalls a product. See Olympic S.S. Co., Inc. v. Centennial Ins. Co., 117 Wash.2d 37 (Wash., 1991); U.S. Fidelity & Guar. Co. v. Wilkin Insulation Co., 144 Ill.2d 64 ( Ill. , 1991).

Another limitation to the sistership exclusion is that it does not typically exclude coverage for actual damages caused by the insured's product. For example, as held by the court in Newark Ins. Co v. Acupac Packaging, 328 N.J. Super. 385 (N.J. Super. A.D., 2000), the sistership exclusion in a CGL policy did not apply when the claim was for property damage allegedly suffered by a third party. Rather, it only applies when because of the actual failure of the insured's product, similar or sister products are withdrawn from use to prevent the failure of these other products, which have not yet failed, but are suspected of containing the same defect.

Courts have held that the sistership exclusion in an insurance policy did not apply in a variety of other circumstances as well.

For example, the court in Corn Plus Co-op v. Continental Cas. Co., 444 F. Supp 2d 981 (D. Minn. 2006), held that under Minnesota law, the sistership exclusion did not apply to the costs associated with repairing and replacing defective welds performed upon the plant's pipes. The court asserted that the only defective work involved was the insured's defective welding, and the plant owner became aware of the need to repair the weld not because of any other product or work, but because the insured's work proved to be defective.

Similarly, the court in Armstrong World Industries, Inc. v. Aetna Casualty & Surety Co. 45 Cal. App.4th 1 (Cal. App. 1 Dist., 1996), held that the sistership exclusion in an asbestos manufacturer's CGL policy did not bar coverage for claims alleging property damage to buildings containing asbestos building materials where the damage resulted from the mere presence of the materials, for which the insured would be held liable.

Despite the sistership exclusion typically being construed narrowly by the courts, there have still been instances where the court has found the exclusion to apply.

In one such case, Atlantic Mut. Ins. Co. v. Hillside Bottling Co., Inc., 387 N.J. Super. 224 (N.J.Super.A.D., 2006), the insured manufactured carbonated beverages on behalf of customers utilizing ingredients supplied by both the customer and the insured. After a beverage from the insured's plant was found to be contaminated with ammonia during the production process, the insured's customers recalled all the beverages that had the insured's product code.

After first determining that any claims arising from the creation of a contaminated product were precluded by the CGL policy's business risks exclusion since they arose out of “your product” or “your work,” the court went on to explain why the sistership exclusion barred claims arising from the recall of the insured's own product because the damages sought were based on the product recall. According to the court, the sistership exclusion limits coverage provided under the CGL policy by excluding the cost of recalling apparently undamaged products to search for damaged components which have not yet been discovered. The court determined that the insured's recall extended to all of the beverages that bore its plant code without regard to whether the products were actually contaminated. The court therefore concluded that the claims arising from the recall of the beverages fell under the purview of the sistership exclusion.

In Hi-Port, Inc. v. American Intern. Specialty Lines Ins. Co., 22 F.Supp.2d 596 (S.D.Tex., 1997), the court concluded that the exclusion applied in a case in which the insured's customer, for which it had blended antifreeze, “recalled all packages of product it suspected were from the same batch of antifreeze as the packages containing the defective antifreeze because (it was) suspected they would be similarly defective.”

Clearly, the CGL form will not cover product recall-related expenses in situations where the sistership exclusion is found to apply. Some companies chose to add product recall endorsements to their policies. Such endorsements operate to modify the sistership exclusion, although often these endorsements are quite narrow in scope and do not sufficiently protect companies from product recall losses.

Such was evident in Sokol and Co. v. Atlantic Mutual Ins. Co., 430 F.3d 417 (7th Cir., 2005), a case in which the court held that under Illinois law, the damages incurred by food manufacturer Sokol as a result of spoiled peanut butter packets it supplied to customer Continental Mills for inclusion in Continental's cookie mix boxes fell within the sistership exclusion. Continental had withdrawn the peanut butter paste from the market, replaced and disposed of it after the customer discovered it was rancid or “off taste.”

Although Sokol had argued that its payment to Continental should be covered under the product recall expense endorsement, the court disagreed. By its terms, the endorsement to the CGL policy was limited to recalls initiated “by the insured or by a government body.” According to the court, because it was Continental rather than Sokol or the government that had initiated the removal and replacement of the peanut butter, there was no coverage under the product recall expense endorsement. The court, held, therefore, held that summary judgment in favor of Atlantic was properly granted.

Some companies therefore chose to purchase product recall insurance to cover some of this product recall-related risk. Such insurance typically covers a variety of recall-related expenses, such as advertising, transportation and disposal. That coverage which is limited by the sistership exclusion in a general liability policy serves as a fairly good explanation of what is covered under a product recall policy, although the scope of a product recall policy can be far greater.

In 2004, ISO introduced a separate coverage form (CG 00 66) that provides broader coverage than the previously available limited product withdrawal expense endorsement (CG 04 36 10 01 and CG 04 36 12 04). The new product withdrawal expense coverage form provides reimbursement for product withdrawal expenses incurred by the insured because of a covered product withdrawal, and liability to others for damages an insured is legally obligated to pay because of product withdrawal expenses (including legal fees). See “Product Withdrawal Coverage Form”, Casualty & Surety, Public Liability section. Product Withdrawal Coverage Form

Unlike general liability policies, however, coverage under a product recall policy can vary significantly from one insurer to another and even among the coverage forms available from any one insurer. And, because product recall insurance is typically expensive, when deciding whether or not to purchase it (and, if so, what limits to purchase), companies need to consider the size of their organization, the financial resources available to respond to such losses, whether or not they have a high profile and, of course, the product itself and the likelihood that it would be contaminated or tampered with.

Cost considerations not withstanding, many companies feel confident that the research and development capabilities and quality control procedures they have in place make any significant product recall situations unlikely. Therefore, many companies chose to retain the financial risk associated with a large product recall and simply forego product recall insurance altogether.