Further, given the increased reliance on global supply chains, companies are finding it harder to control food safety and manage risk in order to avoid contamination and recall events. And where an international supplier is the cause of the recall, companies face significant hurdles in collecting damages.
In this environment, companies increasingly are looking to their commercial insurance to protect them from the costs associated with an event. Often, though, insurers assert that common commercial policies, such as general liability policies or property policies, exclude many of the costs of a contamination or recall event. Many food and beverage companies thus seek to supplement traditional commercial insurance policies with specialty contamination and recall policies.
Contamination and recall insurance is a fast-developing type of policy. Insurers are competing on their language to try to attract company business, and they are rapidly changing their policy language to address changes in the marketplace and in food regulation. For that reason, contamination and recall policies, unlike more traditional general liability and property policies, are not standardized across insurers. As a result, companies often can negotiate policy language to address the particular challenges that their businesses may present.
This article provides a primer on contamination and recall insurance policies, including what issues a company needs to consider in procuring such a policy and what disputes have commonly arisen between the insurers and policyholders.
Overview of Contamination and Recall Insurance
Contamination and recall insurance typically covers certain losses arising from specified types of contamination events, including product recalls resulting from contamination that can cause third parties bodily injury or property damage. Typically, a company may acquire coverage for its own economic losses, including recall costs, incurred as a result of a contamination, a third party's economic loss incurred by customers, or both. The basic insuring agreement in contamination and recall policies is illustrated by the following language from an XL America, Inc., insurance policy:
"The Company agrees . . . to reimburse the Insured for all or any Loss arising out of Insured Events . . . ." (emphasis added).
Thus, the two key issues are (1) what is an "insured event," and (2) what constitutes "loss."
What Constitutes an "Insured Event"
The coverage under a contamination and recall policy generally triggers upon the occurrence of an insured event. This term, or its equivalent, is defined differently in different insurers' policies, but generally the term includes a list of specified types of incidents. The most common insured events are accidental or malicious contamination of an insured's product. As discussed below, however, recent trends in food law, including the recent enactment of the Food Safety Modernization Act, along with competition among insurers for increased market share, have caused insurers to offer an array of policy enhancements that add new, sometimes broader, insured events.
Accidental contamination as an insured event. A variety of events can constitute an "insured event," but the most common is an accidental contamination. Although there is no standard definition in the insurance industry for what constitutes an "accidental contamination," most insurers generally define accidental contamination as having two key components: (1) The product is contaminated without the company's knowledge, and (2) consumption of the contaminated product has caused or may cause (within a set amount of time) bodily injury or property damage.
In determining what constitutes an accidental contamination, at least one court has held that under one insurer's policy language, there must be actual contamination of the company's product, regardless of whether the company is required to recall its product based on assertions of contamination. In one case, Fresh Express Inc. v. Beazley Syndicate 2623/623 at Lloyd's, 131 Cal. Rptr. 3d 129 (2011), the FDA issued an alert not to eat bagged spinach due to an E. coli outbreak. Based on this determination, a company recalled its bagged spinach, incurring about $18.8 million in lost business. The FDA subsequently determined that the source of the outbreak was not that company's product and retracted the advisory. The California state courts upheld the denial of coverage based on the policy's specific definition of "accidental contamination." The courts reasoned that, because "the E. coli outbreak" was not attributable to an actual contamination of the company's products, and coverage was restricted to those losses "arising out of" and "because of" an error by the company, the "outbreak" could not qualify as an insured event under the policy. The courts held that neither the recall itself nor the company's belief that the product had been contaminated was enough to trigger coverage. This case emphasizes the importance of examining closely the specific language used in a company's insurance policy.
Other cases too show how sometimes subtle variations in policy language may lead to different coverage results. In a handful of recent cases, courts have examined the policy requirement that the contaminated product "may likely cause" bodily injury or property damage. At least under one insurer's then-current language, that insurer argued, with some success, that its policies limit coverage only to recalls of contaminated products that in fact were contaminated with a material that had the potential to cause bodily injury or property damage, and that there was no coverage for contamination events even where, at the time of the recall, there had been positive tests that led the company reasonably to believe that the product had the potential to injure consumers.
In Little Lady Foods, Inc. v. Houston Casualty Co., 819 F. Supp. 2d 759 (N.D. Ill. 2011), for example, a food manufacturer recalled its product after testing revealed the presence of listeria, but after the recall, the listeria was found to be a listeria strain that does not cause bodily injury in humans. A federal court concluded that there was no coverage because the contamination did not satisfy the policy's requirement that it "may likely result in bodily injury." That was true even though, at the time of the recall, the company may well have acted reasonably in initiating the recall.
That same insurer has made that same argument in other situations. In Caudill Seed & Warehouse v. Houston Casualty Co., 2011 WL 6370366 (W.D. Ky. Dec. 20, 2011), a court granted the insurer's motion for summary judgment that there was insufficient evidence that "bodily injury" would occur. This was despite the fact that the FDA specifically noted that salmonella in the insured's products "posed an acute, life-threatening hazard to health."
Certain courts, however, have distinguished Little Lady and required an insurer to provide coverage. In Hot Stuff Foods, LLC v. Houston Casualty Co., 2012 WL 2675225 (D.S.D. July 5, 2012), a court rejected the same insurer's argument, under the same policy language, finding that the policy terms provided coverage where there was any possibility of illness resulting from the ingestion of monosodium glutamate (MSG)—not, as the insurer argued, "a probability" of illness. The court determined that a recall resulting from contamination with MSG constituted "accidental contamination" because the insurer's expert admitted that, in at least some cases, MSG might cause bodily injury. The court also found the insurer's policy language to be ambiguous, meaning that the language must be construed in favor of coverage as a matter of law.
While Hot Stuff represents a major win for policyholders facing denials of coverage based on bodily injury requirements, it also serves as a reminder that policyholders must be vigilant about their choice of language in food-recall policies. If the insureds in these cases had procured policies with more favorable language, they might have avoided costly litigation and had coverage to pay for some or all of their recall costs.
Other "insured events." Given these decisions, other developments in food law, and the competitive insurance marketplace, insurers increasingly are offering additional endorsements that may expand a company's potential coverage.
One of the most widely added endorsements has been in response to the passage of the Food Safety Modernization Act (FSMA) in January 2011. The FSMA provides the FDA authority to make recalls mandatory, regardless of whether the product is "actually contaminated" or "has caused or would cause" bodily injury.
Insurers are now providing endorsements that add as an insured event a government-mandated recall. Although these types of endorsement existed prior to the FSMA, insurers have modified their application in light of the FSMA's grant to the FDA of a mandatory recall power.
Government-mandated recall endorsements generally provide that a recall required or, sometimes, recommended by the government triggers coverage so long as there is a "reasonable probability" that the product would result in bodily injury or property damage. Although they may vary considerably in scope among insurers, these endorsements typically broaden potential coverage because, unlike the "accidental contamination" provision, they often contain no requirement for an "actual contamination" of the product and no requirement that the potential contamination actually cause, or may cause, bodily injury or property damage.
Another endorsement offered by insurers is a "third-party expense indemnity," which involves both first- and third-party coverage for those in the food-supply chain. While a standard general liability policy and basic recall form may not cover a customer's recall expenses, such as customer direct loss of profit or claims for economic damages arising from a contamination event, these may be covered by the third-party expense indemnity endorsement.
Insurers continue to develop new provisions that they market as coverage enhancements. Policyholders should be vigilant to ensure that they know all of the available options. Companies then should carefully review and negotiate the specific language used to maximize the scope of the protection that they acquire.
What Constitutes "Loss"
Once a company establishes the occurrence of an insured event, the policy obligates the insurer to pay all "loss" arising from that event. In determining what constitutes loss, most policies define loss to include broad categories of damages. These broad categories can include the following, among other things:
• Crisis response expenses;
• Reasonable recall expenses;
• Replacement value of the product;
• Loss of gross profit;
• Brand rehabilitation;
• Customer's reasonable recall expenses (third-party loss); and
• Customer's loss of gross profits (third-party loss).
It is important to understand exactly what costs and losses fall into which category. If a company foresees recall-related expenses that fall outside all of these categories, the company should work with its broker and counsel to seek to expand the scope of the policy language. In addition, companies should pay careful attention to whether the policy imposes limitations or exclusions that might apply to some of these categories. For example, it is common for insurers to impose lower sub-limits of liability on loss-of-profit or brand-rehabilitation costs, even though these often can be the greatest sources of a company's recall-related loss.
Insurers also can question whether a specific expense falls within any of these categories. For that reason, when a recall event occurs, it is important for a company to
• track the costs it incurs in connection with the recall;
• when presenting to the insurer, describe the costs to make clear which cost falls into which category of loss; and
• be cognizant of the various sub-limits, such that costs fall within a category that is bounded only by the aggregate limit.
Although disputes nonetheless may arise with the insurer, by following these steps, a policyholder will increase the likelihood of coverage.
Exclusions and Limits
Given the increase in the number of recalls and, thus, the increased exposure to insurers, insurers increasingly are attempting to avoid coverage by asserting that a policyholder has failed to comply with policy conditions or by relying on policy exclusions to deny coverage. As a result, when a contamination or recall event occurs, the early decisions made by a company may have serious ramifications with regard to insurance coverage.
First, the policyholder needs to submit its claim timely. The notice of claim needs to identify the recall and also identify any outside firms that have been retained to assist with the recall (legal or otherwise). Timely notice is especially important because contamination and recall policies often are claims-made policies—that is, a policy that provides coverage only for claims made during the period the policy is in force or a specified period thereafter. The policyholder also needs to be aware that certain contamination and recall policies require separate notice to an insurer's claims services division, which typically is available under the policy to assist a policyholder with the recall event. Thus, the policyholder needs to review its policy thoroughly to ensure that all notices are provided.
Second, the policyholder needs to keep the insurer informed as events occur. Most contamination and recall policies contain cooperation and consent provisions, which insurers sometimes use to assert a right of approval before the policyholder takes certain actions, potentially including important steps in conducting the recall.
Third, the company needs to pay attention to deductibles. Contamination and recall policies often have deductibles, and depending on the nature of the coverage and the products involved, these deductibles may be high. The deductibles, however, do not always apply to all coverage, and they rarely apply to the insurer's obligation to provide recall and claims services.
Fourth, because many policies have deductibles that apply to each insured event, the company needs to be attuned to how an insurer may characterize the number of insured events. An analogous issue arises in the general liability context where insurers and food companies have disputed how many "per occurrence" deductibles apply. Compare Mason v. Home Ins. Co. of Ill., 532 N.E.2d 526 (Ill. App. Ct. 1988) (multiple occurrences found when customers served botulism-contaminated onions because the liability-causing conduct was the separate serving of the onions to each customer, not the preparation of the onions prior to serving), with Fireman's Fund Ins. Co. v. Scottsdale Ins. Co., 968 F. Supp. 444 (E.D. Ark. 1997) (multiple sales of contaminated meat at Taco Bell were the result of a single occurrence). How a company characterizes the contamination and recall may be critical to the determination of the number of deductibles, and companies thus should be careful to consider the insurance ramifications of their recall and communication strategies.
Food and beverage companies often can benefit from contamination and recall coverage. However, to maximize coverage during a recall, companies need to be sophisticated consumers, understanding how different policy language can be significant in a later coverage dispute. If a company faces a recall, careful cost tracking and coordination may be important to preserving its insurance coverage.
Keywords: litigation, products liability, insurance, coverage, deductible, recall, contamination, food and beverage industry