June 27, 2012 Articles

Coverage for Food Contamination under a First-Party Property Policy

Companies need to realize that contamination under a first party property policy is very different from pollution under a third party liability policy

by Robert D. Chesler

Contamination of a product during its preparation and processing is a major risk for food manufacturers and others. The decision in PBM Nutritionals v. Lexington Insurance Company, 724 S.E.2d 707 (Va. 2012) is instructive on both the types of coverage that are available and the pitfalls that can prevent a company from obtaining coverage.

Some companies will undoubtedly be surprised to learn that PBM Nutritionals’ loss was even considered “contamination.” As part of the process to make baby formula, PBM used a heat exchanger to create steam that was controlled by a valve. The valve had a defect and the steam leaked. During the cleaning of the process equipment, the superheated water that resulted caused the water filters to disintegrate into their constituent components, including melamine and cellulose. When PBM tested its next run of product, 4 of 25 batches contained excess levels of melamine. PBM feared that the other batches had cellulose fragments mixed in. Companies need to realize that contamination under a first-party property policy is very different from pollution under a third party liability policy. Both the melamine and the cellulose definitely constitute contaminants.

PBM had purchased a contamination insurance policy, which paid its $2,000,000 limit. However, because PBM suffered a multi-million dollar loss, it next turned to its property insurance program. While that policy had a pollution exclusion, the exclusion did not apply if the release of pollutants “is itself caused by a peril insured against.” Under an all-risk policy, the superheating of the water caused by the defective valve would constitute such a covered peril. Property policies will not provide coverage simply if a product goes bad, but will provide coverage if a product is damaged by an outside force.

However, the property insurance policies in issue each had a contamination or pollution endorsement, and these endorsements did not have exceptions for other “perils insured against.” PBM argued that it should have coverage pursuant to the exception to the original exclusion. However, the court held that the exception in an exclusion did not create coverage, and that the endorsements applied.

The big takeaway from PBM Nutritionals is that policyholders must pay careful attention to their first party property policies. Policyholders should insist on the “peril insured against” language and avoid limiting endorsements. They should examine their operations and determine if they should investigate the purchase of a separate contamination policy. With the loss of the contaminated product, the business interruption, and the damage to reputation, contamination claims can cripple a company.

Keywords: insurance, coverage, litigation, Virginia, food contamination, first-party property, “peril insured against”

Robert D. Chesler, Lowenstein Sandler PC, Roseland, NJ.

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