On February 6th, an intermediate level California appellate court held that a product contamination policy only covered contamination that occurs during or after manufacturing operations by the insured, meaning that there was no coverage where the policyholder’s product was found to be adulterated because it used an ingredient that had been contaminated by a third-party supplier.  The decision is Windsor Food Quality Co. v. Underwriters of Lloyds of London, 2015 WL 901867, 2015 Cal. App. LEXIS 195 (Cal.App., Feb. 6, 2015).  One of the three panel members filed a lengthy and convincing dissent that is arguably a more correct interpretation of the language at issue.

The policyholder was Windsor Food Quality Company, a frozen food manufacturer.  Windsor’s ground beef supplier was Westland/Hallmark Meat Company.  In January 2008, the United States Department of Agriculture (USDA) suspended Westland as a federal food supplier, and it subsequently announced a voluntary Class II recall of all of Westland’s products.  This occurred after a USDA investigation discovered that the supplier’s employees were knowingly using disabled or “downer” cattle that may have been infected with “mad cow” disease.  Windsor recalled all of its own products that had been made with Westland beef, and it incurred $3 million in recall costs in doing so.

The insured had a $4 million Contamination Products Insurance Policy issued by Lloyds.  Windsor sought coverage under two of the policy’s three “Insured Event” definitions – “Accidental Product Contamination” and “Malicious Product Tampering.”  Lloyds denied, and Windsor placed the matter in suit.  The carrier’s motion for summary judgment was subsequently granted by the trial court.

Early last month, a 2-1 panel of California’s Court of Appeal affirmed.  Justice Carol Codrington’s opinion was predicated in large part on the court’s conclusion that no “Insured Product” had been contaminated or tampered with because the panel read the definition of Insured Product  to mean that an ingredient in the insured’s frozen food products was only covered after it had been incorporated into them.  As the decision explained:

An “Insured Product” means “all products including their ingredients and components once incorporated therein of the Insured that are in production or have been manufactured, packaged or distributed by or to the order of the Insured . . . [Emphasis added.]”  In plainer language, Windsor must show that there was contamination or tampering with its product during or after manufacture, not before Windsor began the process.  In order for a frozen burrito to qualify as an insured product, there must have been contamination or tampering during production, manufacture, packaging, or distribution – not because one of its ingredients supplied by a third party was adulterated.

The majority also rejected claims that there was any evidence of tampering or that this was a compensible instance of accidental product contamination.  The accidental product contamination coverage grant was limited to situations in which the contamination “would lead to or has led to bodily injury, sickness, or disease of any person, animal or livestock physically manifesting itself within 120 days of its consumption or use.”  It was uncontested that no one had actually suffered an injury from Westland beef.  Accordingly to the majority, “the reason for the recall was Westland’s failure to notify the USDA about ‘downer cattle’ and to submit to an inspection” rather than any fear of imminent sickness or death.

Justice Art McKinster wrote a long and well-reasoned dissent, arguing that “the more reasonable reading of the policy is that the product, and all of its ingredients, are insured for adulteration regardless of when the adulteration occurs.  As he explained, using the majority’s burrito example:

By stressing the words “once incorporated therein,” the majority is interpreting [the insured product definition] as indicating that adulteration of the ingredient must occur after the ingredient has become part of the product (i.e., the meat ingredient must be adulterated “once incorporated into” the burrito).  I would suggest that if we accept this interpretation of when the ingredient must be adulterated, a large part of the production process would not be covered. . . . By adopting the majority’s emphasis on “once incorporated therein,” the meat or any other ingredient could be tampered with during the production process but before being “incorporated” into the burrito; as such, the adulteration would not be a covered loss.  (The adulteration of the meat occurring before it was “incorporated therein.”)

Neither opinion cited the full definition of accidental product contamination, but the standard Lloyds’ formulation clearly indicates that Justice McKinster is closer to the mark.  Product contamination insurance issued by the London market typically defines the term to mean “[e]rror in the manufacture, production, processing, preparation, assembly, blending, mixing, compounding, packaging or labeling . . . of any Insured Products, including the introduction of an ingredient or component supplied by a third party that is, unknown to the Insured, contaminated or unfit for its intended purpose, . . . which gives the Insured reasonable cause to believe that the use or consumption of such Insured Products” has or could lead to sickness of death within a four month window of time (emphasis added).  Where accidental contamination is at issue, that language seemingly makes it clear that ingredients can suffer a covered instance of contamination well before being incorporated into the policyholder’s finished product.

The majority also cited three decisions for the proposition that a product contamination policy “is not a recall insurance policy.”  In point of fact, as Justice McKinster pointed out, that is just what it is; the Lloyds policy at issue expressly covered “[t]he reasonable and necessary costs and expenses of recall or withdraw of the Insured Products” if necessitated by one of the three insured events.  The decisions cited by the majority simply stand for the proposition that only recalls arising from those three specific events are covered by such a contract of insurance.  See, e.g., Hot Stuff Foods, LLC v, Houston Cas. Co., 771 F.3d 1071, 1076 (8th Cir. 2014) (“Covering voluntary recalls that have no direct relation to public health hazards would increase the cost of the insurance, extending coverage to voluntary actions that should remain part of an insured’s cost of doing business.”); The Limited, Inc. v. Cigna Ins. Co., 228 F.Supp.2d 574, 580 (E.D.Pa. 2001) (“The plain language of the Policy and its title indicate that the parties intended to have coverage for only those specific instances of product tampering and accidental contamination, not for product recalls in general[.]”).