When the Damage Is Done

By Jeffrey S. Weinstein and Sara F. Lilling

            Let’s say an instant oatmeal product incorporates a dried milk ingredient that has been manufactured in a facility with unsanitary conditions and that the milk ingredient may be contaminated with Salmonella as a result.  The instant oatmeal product then becomes legally unsaleable because it incorporated the milk ingredient.  Has there been “property damage” to the instant oatmeal product under a commercial liability insurance policy even if there is no finding that either the milk ingredient or the instant oatmeal product was actually contaminated with Salmonella?  

            In Netherlands Insurance Co. v. Main Street Ingredients, LLC, 745 F.3d 909 (8th Cir. 2014), the Eight Circuit, applying Minnesota law, held that the instant oatmeal product did indeed suffer “property damage” in such circumstances, and thus the insurer had a duty to defend and indemnify its insured in an underlying suit by the instant oatmeal manufacturer. And this decision has interesting implications in the world of Contaminated Products insurance.

            In Netherlands, Malt-O-Meal Company (“Malt-O-Meal”), a cereal company, brought suit against Main Street Ingredients LLC (“Main Street”), its supplier of dried milk products, in Minnesota state court, asserting claims of strict products liability, breach of warranties, and breach of contract.  This action arose out of the 2009 voluntary recall of dried milk that Main Street had purchased from Plainview Milk Products Cooperative (“Plainview”), and that Main Street subsequently sold to Malt-O-Meal.   Plainview had initiated a recall of its dried milk in June 2009 after the U.S. Food and Drug Administration (“FDA”) found Salmonella bacteria in Plainview’s plant on food-contact surfaces and in areas used to manufacture dried milk products. The FDA had observed thirteen instances of unsanitary conditions in Plainview’s plant, deeming the food “prepared, packed, or held under unsanitary conditions” to be “adulterated” under 21 U.S.C. § 342(a)(4).  Plainview issued a voluntary recall of its dried milk products, because the dried milk “had the potential to be contaminated with Salmonella.”  745 F.3d at 911.

            In March 2011, Netherlands Insurance Company (“Netherlands”) brought suit against its insured, Main Street, in federal court, seeking a declaratory judgment that Netherlands had no duty to defend or indemnify Main Street in the underlying state court suit with Malt-O-Meal. 

            In May 2012, the Minnesota state court granted Main Street’s motion for summary judgment on the strict liability claim, and Malt-O-Meal and Main Street subsequently settled the remaining claims for $1,400,000.

            In January 2013,the district court in the federal action granted Main Street’s motion for partial summary judgment.  The parties stipulated to entry of final judgment, and the district court awarded $1,400,000 plus interest to Main Street.  Netherlands timely appealed. 

            The commercial liability policy at issue provided, in part, that Netherlands “will pay those sums that the insured becomes legally obligated to pay as damages because of . . . ‘property damage’ to which this insurance applies.”  The policy defined “property damage” as:

  1. Physical injury to tangible property, including all resulting loss of use of that property.  All such loss of use shall be deemed to occur at the time of the physical injury that caused it; or
  • Loss of use of tangible property that is not physically injured.  All such loss of use shall be deemed to occur at the time of the ‘occurrence’ that caused it.

745 F.3d at 914.         

            On appeal, Netherlands argued that it had no duty to indemnify Main Street because the dried milk did not suffer “property damage.”

            The Eight Circuit held, however, that the instant oatmeal was physically affected because it incorporated the dried milk that was manufactured in unsanitary conditions.  “[B]ecause the dried milk was ‘prepared, packed, or held under insanitary conditions whereby it may have become contaminated with filth, or whereby it may have been rendered injurious to health’ and was therefore ‘adulterated,’ 21 U.S.C. § 342(a)(4), whether or not it contained Salmonella, so too was the instant oatmeal.”  745 F.3d at 916.   The Court noted that as a result of the FDA’s findings of unsanitary conditions and Plainview’s voluntary recall, Malt-O-Meal’s instant oatmeal could not be sold lawfully with an assurance that it meets regulatory standards, regardless of whether it could be safely consumed.  The Eight Circuit concluded that under Minnesota law, this constitutes physical “property damage” to the instant oatmeal (i.e., “physical injury to tangible property”). 

            The Court also held that the “your product” exclusion and the “impaired property exclusion” in the liability policy were not applicable. 

            With respect to the “your product” exclusion, the policy excludes from coverage “‘[p]roperty damage to ‘your product’ arising out of it or any part of it.”  745 F.3d at 917.  “Your product” includes “[a]ny goods or products . . . manufactured, sold, handled, distributed, or disposed of by . . . [y]ou.”  Id.  The Court held that the exclusion was not applicable because Main Street was not seeking indemnity for property damage to its dried milk, but for property damage to Malt-O-Meal’s instant oatmeal by inclusion of the dried milk.  Id. at 918.  

            With respect to the “impaired property” exclusion, the policy excludes from coverage “property damage” to “impaired property” where “impaired property” includes “tangible property, other than ‘your product’ . . . that cannot be used or is less useful because: a.  It incorporates ‘your product’ . . . that is known or thought to be defective, deficient, inadequate or dangerous; or b.  You have failed to fulfill the terms of a contract or agreement; if such property can be restored to use by: a. The repair, replacement, adjustment or removal of ‘your product’ . . . ; or b.  Your fulfilling the terms of the contract or agreement.”  Id. at 919-20.   The district court found, and the Eight Circuit affirmed, that the exclusion was not applicable because: (i) the instant oatmeal that included the dried milk became a new product with the dried milk as an inseparable ingredient, and thus the instant oatmeal could not be “restored to use” by its removal; (ii) the instant oatmeal was “physically injured” and there was not simply a “loss of use.” 

            This case raises some interesting questions about potential “other insurance” issues that could arise in connection with a product contamination claim – even when there is no finding of an actual product contamination.  Would coverage also be available under a contaminated products insurance (“CPI”) policy under similar circumstances to those in Netherlands?  Under Minnesota law, the answer may be yes. 

            As we discuss in greater detail in our blog article, Product Contamination: When the Spices Kick It Up a Notch, Who Will Respond?, a typical CPI policy indemnifies the insured for first-party losses resulting from an accidental product contamination, provided that the use or consumption of the contaminated products has, within a certain period of time, resulted in or may result in bodily injury or physical damage to tangible property other than to the insured’s products. 

            A typical CPI policy contains a number of triggering mechanisms that do not necessarily require there to be actual contamination of the insured’s product.  Some cover losses resulting from “adverse publicity,” or the reporting of an accidental product contamination during the policy period, where the insured product is specifically named.  Some CPI policies also cover situations involving a “government recall” or “government hold” where a government sanctioned regulatory authority determines that an insured product is injurious to health and unfit for human consumption, and orders a recall of such products in order to comply with food safety regulations. In an adverse publicity situation, the product is not actually contaminated, and with a government recall/government hold situation, the product may or may not actually be contaminated, but coverage may be available in either situation so long as the remaining requirements of the trigger are met.

            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, such as recall costs, business interruption costs, rehabilitation costs, and consultant and advisor costs.   In instances where the insured’s product becomes an ingredient or component in its customer’s product, the CPI policy may also cover the value of the insured’s contaminated product in the customer’s product.  Some CPI policies also offer coverage for its customer’s 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 defense costs.  This last category may be relevant to an “other insurance” analysis with the insured’s GL policy.

            Hypothetically speaking, if Main Street also had coverage under a CPI policy, would the CPI policy provide coverage for Main Street’s losses?  What about for Malt-O-Meal’s losses?  There has been no actual finding of a contamination of the instant dried milk or the oatmeal products, only that the instant milk was manufactured in unsanitary conditions and thus, potentially contaminated and “adulterated.” Because there was no finding of an actual contamination of Main Street’s products, coverage under a CPI policy may be available if there was adverse publicity, implying that the products themselves were contaminated with Salmonella, or if there was some sort of government hold put on the instant dried milk, which in this case there was.  Barring the application of any policy exclusions (e.g., if the insured had knowledge of a defect in the manufacture, production, or preparation of the insured products and failed to take reasonable corrective action), coverage under the CPI policy could be triggered.  In such instance, there would be coverage for Main Street’s first-party recall expenses, and possibly Malt-O-Meal’s recall expenses if the policy offered it.  The CPI policy may also provide coverage for the value of the instant dried milk in Malt-O-Meal’s oatmeal.  And if the CPI policy provided coverage for third-party recall liability, under Minnesota law, coverage may also be available for the property damage to Malt-O-Meal’s oatmeal.  If some of these costs sound familiar, it is because there would also be coverage under the GL policy.  And this necessitates an “other insurance” analysis between the two policies.  Thus, under Minnesota law, there can be a finding of “property damage” under a general liability policy, even in the absence of actual contamination.  And because Contaminated Products policies may also provide coverage in such circumstances, we may see “other insurance” battles being waged between GL and CPI policies, even where the product at issue has not actually been contaminated at all.  This scenario provides a distinct difference from the traditional first-party claims for actual contamination that were intended to be covered by CPI policies when this type of insurance was first introduced into the marketplace some 30 years ago.  

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