By Jeffrey S. Weinstein and Sara F. Lilling
A notification rings and the insured sees an urgent email from its spice supplier. The email states, in bold capital letters: ”RECALL! Spices Contaminated With Salmonella.” Panic ensues when the insured realizes that these spices have been incorporated into the insured’s tomato sauce, several large batches of which have already been shipped to hundreds of the insured’s customers. Some product goes directly to store shelves at the insured’s retail customers, but many of the insured’s customers incorporate the insured’s tomato sauce into their own products, such as pizzas and lasagnas.
|→||Tomato Sauce Manufacturer
(Third-Party Pizza or Lasagna Manufacturer)
The insured jumps into crisis mode and springs into action. It immediately notifies retailers and its own customers of the potential contamination (by email and an alert on its website) and initiates its own recall. It tests retention samples of the tomato sauce to confirm the Salmonella contamination, and if there is a positive finding, it destroys any remaining inventory, pulls product off supermarket shelves, sets up a crisis hotline, and retains consultants to initiate a rehabilitation campaign. The insured will also have to shut down its production facility for several days (or weeks, or longer) until the facility is cleaned, decontaminated of any Salmonella, and passes an inspection by the appropriate authorities. Its recall costs and business interruption losses are rising.
In the midst of the chaos, the insured contacts its insurance broker to notify the broker of the contamination incident. The insured has both a contaminated products insurance (“CPI”) policy with third-party recall liability coverage and a commercial general liability (“CGL”) policy. So, will either of these policies cover the insured’s losses in connection with the contamination incident and recall? And do these expenses fall only on the shoulders of one carrier, like the CPI insurer, or is an “other insurance” analysis necessary to determine whether there is any exposure under the CGL policy?
Although at first blush this situation would seem to assume that there will be a response from a contaminated products insurer, such policies do have limitations on their scope, particularly when it comes to costs incurred by an insured’s customer. Exposure under a CPI policy may also be limited where an insured has another policy that could respond to its losses. And that is where an insured’s CGL policy may come into play. Thus, although a CPI policy would seem like the likely first line of defense, it should not have to shoulder the entirety of the losses where there is other insurance available. At the outset of any claim investigation, it is important to determine what insurance policies the insured has put on notice, and to obtain copies of these policies for any potential “other insurance” analysis.
CONTAMINATED PRODUCTS INSURANCE
The typical CPI policy indemnifies the insured for losses resulting from an “accidental product contamination,” which generally means: (1) the accidental or unintentional contamination, impairment, or mislabeling (including mislabeling of instructions for use), during the manufacture, preparation, packaging, or labeling of the insured’s products, or publicity implying such; or (2) fault in design, specification, or performance of the insured’s products — provided always that the consumption or use of the insured’s contaminated products has, within a certain period of time (e.g., 120 days or 365 days), resulted in or may result in bodily injury or physical damage to tangible property other than products of the insured. See, e.g., Caudill Seed & Warehouse Co., Inc. v. Houston Casualty Co., 835 F.Supp.2d 329 (W.D. Ky. 2011). The typical CPI policy covers reasonable and necessary first-party expenses incurred by the insured ”solely and directly” as a result of a covered insured contamination event, including but not limited to: (i) recall costs (i.e., costs incurred in the recall, inspection, examination, disposal, and/or destruction of the contaminated products, such as: costs incurred in testing of the products; disposal and destruction costs; transportation costs; and costs to clean equipment or production facility); (ii) business interruption costs; (iii) rehabilitation costs; and (iv) consultant and advisor costs. See, e.g., id.; Fresh Express Inc. v. Beazley Syndicate, 2623/623 at Lloyd’s et al., 199 Cal. App. 4th 1038 (2011). A CPI policy generally covers the value of any recalled or destroyed contaminated products, including the value of any packaging that cannot be re-used. In instances where the insured’s product becomes an ingredient or component in its customers’ product, the CPI policy often also covers the value of the insured’s contaminated product in the customers’ product. Some CPI policies also offer coverage for third-party (or its customers’) recall costs, for instance when the insured’s products become an ingredient in a product manufactured or distributed by a customer of the insured.
Some CPI policies also offer, either in the main coverage form or by endorsement, coverage for “third-party product recall liability”, which includes product recall liability damages and even defense costs. This coverage often presents an “other insurance” situation with a general liability policy, discussed further below.
COMMERCIAL GENERAL LIABILITY INSURANCE
A standard ISO Form CGL policy1 indemnifies an insured for those sums that the insured becomes legally obligated to pay as damages because of “bodily injury” or “property damage” caused by an “occurrence.” The CGL policy will be triggered if there is “bodily injury” or “property damage” to a third party’s product. Property damage means: (i) physical injury to tangible property, including resulting loss of use of that property; or (ii) loss of use of tangible property that is not physically injured. Thus, by illustration, property damage occurs when the insured’s contaminated product (e.g., tomato sauce) has been incorporated into a third-party’s product (e.g., pizza). Where the pizza contains the insured’s contaminated tomato sauce, there is little question that there has been “property damage” to that customer’s product. Because of the insured’s contaminated tomato sauce, for example, the customer’s pizza has been “physically injured.” See Travelers Ins. Co. v. Eljer Mfg., Inc., 197 Ill.2d 278, 301 (2001) (explaining that “tangible property suffers a ‘physical’ injury when the property is altered in appearance, shape, color or in other material dimension”); General Mills, Inc. v. Gold Medal Ins. Co., 622 N.W.2d 147, 152 (Minn. App. 2001) (where FDA found in cereal traces of a chemical that, although not harmful to customers, was not authorized for this use, the court held that because the cereal could not be legally sold, there was “an impairment of function and value sufficient to support a finding of physical damage”).
In the case of a product contamination, the CGL policy will often be called upon to address third-party claims arising from the incident. Customer claims often include the customer “value added” to manufacture its finished products. Whereas the CPI policy will cover the value of the insured’s product in the third-party product (e.g., value of the contaminated tomato sauce), the CGL policy typically covers the “value added” by the customer to manufacture their own products (e.g., the value of the dough, cheese, etc. added to manufacture the pizza).
Some CGL carriers reflexively deny product contamination/product recall claims based on certain exclusions. Most CGL policies exclude coverage for: “k. Damage to Your Product”; “m. Damage to Impaired Property or Property Not Physically Injured”; and “n. Recall of Products, Work or Impaired Property.” Although these Exclusions are often asserted, they are not always applicable in product contamination claims.
“k. Damage to Your Product” means “property damage” to “your product” arising out of it or any part of it. For there to be coverage under the CGL policy, there must be damage to a third-party’s product (e.g., the insured’s customer’s pizza). This Exclusion would apply to the extent that there is a claim under the CGL policy for damage to the insured’s product (i.e. the tomato sauce) that has not been incorporated into the third-party’s product, but it would arguably not apply to a claim by the insured’s customer for damage to its product (i.e. pizza). Thus, this Exclusion would not apply to a claim by the insured’s customer for damage to its pizza product that incorporated the insured’s contaminated tomato sauce.
“m. Damage to Impaired Property or Property Not Physically Injured” means “property damage” to “impaired property” or property that has not been physically injured. “Impaired property” means tangible property, other than “your product” or “your work” that cannot be used or is less useful because it incorporates “your product” or “your work” if such property can be restored to use by the removal of “your product” or “your work” or by your fulfilling the terms of a contract or agreement. This Exclusion generally applies where the property can be restored to use by the repair, replacement, adjustment, or removal of the insured’s defective product. This Exclusion would likely be inapplicable if the contaminated tomato sauce has already been incorporated into its customer’s pizza, because the pizza cannot be “fixed” by removing the insured’s product. See Amerisure Mut. Ins. Co. v. Hall Steel Co., No. 286677, 2009 WL 4724303 (Ct. App. Mich. Dec. 10, 2009) (defective wiper brackets that incorporated deficient steel could not be “restored to use” by “repair, replacement, adjustment, or removal” of the deficient steel or by compliance with the purchase contract); Shade Foods, Inc. v. Innovative Products Sales & Marketing, Inc., 78 Cal. App. 4th 847 (2000) (finding covered property damage where diced almonds containing wood splinters were incorporated into finished nut clusters and cereal boxes, because potentially injurious material in the product caused loss to other products with which it was incorporated. The wood splinters in the almonds caused covered property damage to the nut clusters and cereal products in which the almonds were incorporated).
Because the claim involves a product recall, a CGL carrier may look no further than this Exclusion: “n. Recall of Products, Work or Impaired Property,” which refers to damages claimed for any loss, cost, or expenses incurred by the insured or others for the loss of use, withdrawal, recall, inspection, repair, replacement, adjustment, removal, or disposal of: (1) “Your product”; (2) “Your work”; or (3) “Impaired property”; if such product, work, or property is withdrawn or recalled from the market or from use because of a known or suspected defect, deficiency, inadequacy, or dangerous conditions. This Exclusion is often referred to as the “sistership” exclusion2 because it applies where products are recalled from the market because of known defects in their sister products. See Aetna Cas. and Surety Co. v. M & S Indus. Inc., 64 Wash. App. 916, 923 n.3 (Ct. App. Wa. 1992). The exclusion is not applicable where a third party, rather than the insured, initiates the product recall. Id. at 924. Coverage still is available because the insurer does not bear the costs of the insured’s curative or preventive measures, but the insured retains protection against a foreseeable element of claims that commonly arise when the insured’s product must be withdrawn from the market. Id. at 925 (holding that the sistership exclusion did not apply because there were no defective “sister” products that were withdrawn from the market, and it was the third parties, not the insured, who withdrew the products); see also Amerisure, 2009 WL 4724303, at *5 (the “sistership” exclusion is inapplicable where a third party, not the insured, initiates the product recall). This exclusion might apply to the extent that there is a claim under the CGL policy for losses incurred in connection with the insured’s loss of use, withdrawal, recall, or disposal of its own product, but it should not apply where there is a claim by the insured’s customer for such losses if the insured’s customer has incorporated the insured’s contaminated product. The subject matter of the recall would not involve “Your product”, “Your work”, or “Impaired property.”
THIRD-PARTY PRODUCT RECALL LIABILITY
What happens if any of the insured’s customers bring claims against the insured for breach of contract or breach of warranty, for example? As discussed briefly above, some CPI policies offer coverage for third-party product recall liability, which includes product recall liability damages and defense costs. Product recall liability damages include any sums that the insured becomes legally obligated to pay as compensatory damages to a distributor, purchaser, or user of the insured products. Defense costs of the insured include reasonable and necessary fees resulting from the investigation, negotiation, settlement, or defense of a claim or suit. Similarly, these product recall liability costs may also be covered under a CGL policy.
A typical product contamination/product recall claim consists of both first-party costs and expenses and third-party costs and expenses.
- Some of these claimed costs and expenses will be covered by the CPI policy only, such as: recall costs, business interruption costs, rehabilitation costs, and consultant and advisor costs.
- Some of these claimed costs and expenses will be covered by the CGL policy only, such as: claims of bodily injury after consuming a contaminated product.
- Some of these claimed costs and expenses may be covered by both the CPI and CGL policy, such as third-party recall costs and third-party recall liability damages.
For the costs and expenses covered under both a CPI and CGL policy, how are these costs allocated or shared between the carriers? This presents an “other insurance” situation.
Insurance policies often include “other insurance” provisions that limit or eliminate the insurer’s liability when there is additional and concurrent insurance to cover the same loss. There are generally three types of “other insurance” clauses are: “pro rata” clauses; “excess” clauses; and “escape” clauses. The “pro-rata” clause limits an insurer’s liability to the total proportion that its policy limits bear to the total coverage available to the insured. The “excess” clause provides that the insurer will be liable only after the exhaustion of the limits of any other applicable insurance. An “escape” clause provides that an insurer will have no liability to the insured when other insurance coverage is available.
To the extent that there is coverage for expenses under both the CPI policy and the CGL policy, a closer review of the “other insurance” provisions in each policy should be made. Many CPI policies have an “excess” other insurance clause, and thus, will only be on the hook for certain costs and expenses when the limits of any other applicable insurance are exhausted. Why is this significant? Because the standard ISO Form CGL policy has an “other insurance” clause that would make it primary to the extent there is overlap with a CPI policy, and the CGL carrier would be obligated to pay the overlapping costs first. So, although a CPI policy may be the obvious first place to look in the case of a product contamination and recall, its obligations for third-party recall costs and third-party recall liability damages may only become relevant after limits under the CGL policy have been exhausted.3
Thus, in the handling product contamination/recall claims, it is very important to itemize and quantify an insured’s claimed losses, and to determine to what extent, if any, any claimed costs and expenses under the CPI policy overlap with a CGL policy.
SHARING THE LOSSES
The insured that has both CPI and CGL policies will likely be able to recoup some, if not all, of its first-party and/or third-party losses in connection with its contamination and recall incident, assuming the policies have been triggered, there is no applicable exclusion, and all conditions precedent have been met. The CPI policy should cover the recall costs, business interruption costs, rehabilitation costs, and the consultant and advisor costs. The CPI policy often also covers the value of the contaminated product, including packaging. In instances where the contaminated product has been incorporated into a customer’s product, the CPI policy should cover the value of the contaminated product, though the CGL policy would cover the “value added” by the customer. The CPI policy and CGL policy could both cover third-party recall costs, if applicable, and assuming the sistership exclusion is not applicable under the CGL policy. In addition, both the CPI and CGL policies may cover third-party recall liability. In those situations where the policies overlap, an “other insurance” analysis should be conducted to see how the claimed losses will be allocated. Based on the language of the policies’ “other insurance” provisions, certain third-party costs may not be recoverable under the CPI policy unless and until the limits of a CGL policy are exhausted. To the extent that the insurers cooperate and understand the differences and intersection points of their respective policies, they can avoid messy disputes down the road. More importantly, a clear understanding of the insurers’ respective responsibilities can maintain the focus on helping their mutual insured manage its contamination/recall crisis, without creating an insurance crisis too.
- See Commercial General Liability Coverage Form, CG 00 01 04 13.
- See The Recall Expense Exclusion—When Your Ship Does Not Come In, Craig F. Stanovich, IRMI (July 2010) available at https://www.irmi.com/articles/expert-commentary/the-recall-expense-exclusion-when-your-ship-does-not-come-in.
- In cases where the policies at issue both have excess other insurance clauses, the clauses would be deemed to be “mutually repugnant” and would in effect cancel each other out so that both policies contribute on a pro rata basis. See, e.g., Home Ins. Co. v. Certain Underwriters at Lloyd’s London, 729 F.2d 1132, 1136 (7th Cir. 1984); Great Northern Ins. Co. v. Mt. Vernon Fire Ins. Co., 92 N.Y.2d 682, 687 (1999).