Why it matters: A Massachusetts appellate court held that the loss of a bottled energy drink that was destroyed after quality control testing indicated that there was a risk of spoliation due to defective bottle caps was not covered under an "all risks" policy because the loss was excluded by a "faulty workmanship" exclusion. The insured produced an energy drink that was "shelf stable," meaning that it did not require refrigeration until after the bottle was opened. During production testing, a high percentage of bottles failed testing due to a defect in the bottle cap. As a result, the insured destroyed almost 2 million bottles. The insurer denied coverage and the court agreed. The court held that when a company assumes the obligation of completing its work in accordance with plans and specifications and fails to perform properly, it cannot recover under an all-risks policy for the cost of making good its faulty work. The court rejected the insured's position that while the exclusion might preclude coverage for the bottle caps, it did not operate to bar coverage for the loss of the product inside the bottles. The court reasoned that the losses cannot reasonably be characterized as separate. Instead, a problem with the bottle caps directly rendered the entire product damaged. The loss of that product falls squarely within the exclusion language for "faulty workmanship, material construction or design, from any cause."

Detailed discussion: H.P. Hood LLC entered into a contract with Abbott Laboratories to manufacture a milk-based specialty drink that would require refrigeration only after the bottle was opened.

To ensure that the drink would not go bad on the shelf, Hood needed bottles that would stay hermetically sealed after they left the bottling plant and made their way to eventual users. The company used a "secure seal test" to evaluate the bottles.

Hood began production in May 2009 and within days multiple bottles failed the secure seal test. Hood and Abbott agreed that none of the almost 2 million bottles from the production run could be marketed and the bottles were destroyed. Hood eventually discovered that the liner in the bottle caps became more slippery over time, affecting the amount of torque needed to seal the bottles properly.

Pursuant to an "all risks" property insurance policy issued by Allianz Global Risks US Insurance Company, Hood requested reimbursement for its losses. The insurer denied coverage, arguing that a policy exclusion for "faulty workmanship, material, construction or design, from any cause" precluded coverage.

Hood filed suit in Massachusetts state court. Siding with the insurer, a trial court dismissed the suit and an appellate panel affirmed.

When a company assumes the obligation of completing its work in accordance with plans and specifications and fails to perform properly, it cannot recover under an all-risk policy for the cost of making good its faulty work.

Hood argued that application of the exclusion should be limited to the bottle caps, while the rest of the losses—such as the loss of the product inside the bottle—should remain covered.

The court rejected Hood's position. The court concluded: "Whatever else can be said about the case before us, it is not one where an excluded occurrence involving initial property damage led to other property damage of a different kind. To the extent that Hood suffered property damage potentially subject to coverage, that loss was directly caused by, and completely bound up in, the increased risk of future spoilage indicated by the secure seal testing. Both conceptually and practically, the losses entailed here cannot reasonably be characterized as 'separable.' Instead, a problem with the bottle cap liners directly rendered the entire product unsaleable. The loss of that product falls squarely within the exclusion language."

To read the decision in H.P. Hood LLC v. Allianz Global Risks US Insurance Company, click here.