A company that destroys its inventories of goods or products due to contamination or some other defect sometimes makes a claim under its first-party property insurance, especially if it has not purchased recall or similar specialty insurance. In the contaminated products context, numerous players in the production chain may assert first-party claims, including producers and suppliers of products, such as the growers of spinach in the 2006 e. coli scare, processors and manufacturers of products that incorporate a defective component such as pet food manufacturers that incorporated tainted Chinese wheat, and retailers and sellers of products, such as Taco Bell, which closed numerous restaurants in the Northeast in response to e. coli contamination scares.
Commercial first-party property policies generally provide two types of insurance: coverage for loss of property and coverage for lost income resulting from a covered cause of loss (including "extra expense" to restore lost property). We review some of the issues that have arisen, or are likely to arise, in the contaminated food and product context.
Insured Cause of Loss: First-party property policies typically come in two forms: named-peril policies and "all-risks" policies. Named-peril policies insure against loss from specifically-identified causes of loss. These policies are often manuscripted to account for the particular business of the insured. For claims under a named-peril policy, the insured bears the burden of showing that its loss was caused by a specified peril. Compare Continental Food Products v. Ins. Co. of N. Am., 544 F.2d 834 (5th Cir. 1977) (insured failed to establish that the cause of thawing frozen meat was "due to, or caused by, derangement, breakdown, or stoppage of refrigeration machinery and/or refrigerating plan and/or insulation, provided such derangement, breakdown or stoppage continues for not less than 24 consecutive hours," as specified in policy), with Henri's Food Products Co. v. Home Ins. Co., 474 F. Supp. 889 (E.D. Wisc. 1979) (insured satisfied its burden of showing that its loss was from the covered peril of "smoke," where chemical residues were deposited on the insured's pourable salad dressings stored in a warehouse that were contaminated by vapors from volatile organic compounds stored nearby).
Under "all-risks" policies, direct physical causes of loss are covered unless excluded. A threshold question in the contaminated products context is whether destruction of inventory is from a physical cause of loss, so as to qualify for coverage. Actual damage and/or introduction of a defective component into a product is generally determined to be covered, whether the component renders the product harmful or merely unsuitable for its intended use. See Blaine Richards & Co. v. Marine Indem. Ins. Co. of Am., 635 F.2d 1051 (2nd Cir. 1980) (fumigation of beans by unapproved pesticide is physical damage, even if reconditioning and sale at lower prices is possible); cf. Zurich Am. Ins. Co. v. Cutrale Citrus Juices USA Inc., 2002 WL 1433728 (M.D. Fla. Feb. 11, 2002) (under general liability policy, introduction of food-grade propylene glycol constitutes property damage, even though product could have been sold under different labeling).
The destruction of property for fear of contamination due to public health concerns and market consequences creates challenging questions as to coverage. For example, in the Taco Bell incident in late 2006, the source of contamination originally was thought to be linked to scallions, which resulted in the destruction of scallions and products into which such scallions were incorporated. However, scallions were later determined not to be the source of the contamination. The question then arises as to whether the destruction of product linked to scallions was a covered cause of loss. An analogous situation arises from the destruction of entire lots of products when damage only to a small portion of products is established, and destruction of the remainder of the products occurs as a precautionary measure. Certain courts have allowed coverage in such circumstances. See S. Wallace Edwards & Sons v. Cincinnati Ins. Co., 353 F.3d 367 (4th Cir. 2003) (coverage for destruction of all products potentially exposed to anhydrous ammonia, including non-tested product); Duensing v. Travelers Cos., 849 P.2d 203 (Mont. 1993) (coverage for destruction of entire candy inventory after worker was exposed to hepatitis A); Pillsbury Co. v. Underwriters at Lloyd's London, 705 F. Supp. 1396 (D. Minn. 1989) (coverage for destruction of cans of creamed corn where faulty production process made contents susceptible to spoilage).
Before destroying inventory, the insured is well-advised to involve its insurer. See American Home Assur. Co. v. Merck & Co., Inc., 386 F. Supp. 2d 501 (S.D.N.Y. 2005). In Merck, the policy provided, inter alia, that the insured had the sole discretion to determine fitness of its product for use and whether or not to dispose of it. The insured destroyed three separate lots of pharmaceutical product that had undergone irregularities in shipment. The court denied summary judgment to the insured regarding coverage, criticizing the insured for failing to involve the insurer.
Exclusions: First-party property policies may contain exclusions applicable to contaminated product claims. In applying exclusions, courts sometimes will review the "dominant" cause of loss, which at times can involve an uncertain analysis.
Some first-party property policies may contain contamination exclusions. These exclusions have been interpreted broadly to include contamination not only from chemicals, but also from microorganisms such as bacteria. See Am. Produce & Vegetable v. Phoenix Assur. Co. of New York, 408 S.W.2d 954 (Tex. Civ. App. 1966) (exclusion applicable to chemical exposure); Am. Cas. Co. of Reading, Pa. v. Myrick, 304 F.2d 179 (5th Cir. 1962) (exclusion applicable to damage from leakage from refrigeration units); Landshire Fast Foods of Milwaukee v. Employers Mut. Cas. Co., 269 Wis. 2d 775, 676 N.W.2d 528 (App. 2004) (exclusion applicable to destruction of prepared foods and sanitation of equipment after discovery of listeria).
Contamination exclusions may also contain exceptions that reinstate coverage. One such exception applies if the contamination is caused by a covered cause of loss. The recent case of Leprino Foods Co. v. Factory Mut. Ins Co., No. 02-cv-1559, 2007 LEXIS 55490 (D. Colo. Aug. 8, 2006) is illustrative of the interplay between the exclusion and any exceptions. The insured sought to recover a $13 million loss in contaminated cheese that had an off flavor and high concentrations of a naturally occurring compound found in fruit juices. The cheese was stored in a warehouse that was poorly maintained, including open vats and spills of juice. The court ruled that the contamination exclusion barred coverage and that the insured failed to sustain its burden of showing that the contamination was caused by other physical damage that was not excluded. But see Allianz Ins. Co. v. RJR Nabisco Holdings Corp., 96 F. Supp. 2d 253 (S.D.N.Y. 1999) (contamination exclusion inapplicable to cookies with off flavor and odor as result of third-party cleaning of warehouse floors); Gen. Mills v. Gold Medal Ins. Co., 622 N.W.2d 147 (Minn. App. 2001) (contamination exclusion inapplicable where risk of third-party negligence was not expressly excluded).
To the extent present in policies at issue in a contaminated products claim, the contamination exclusion and any exceptions thereto will be central issues as to the existence of coverage. Application of an exception for contamination caused by other physical damage not excluded may be especially pertinent, as factual issues may arise as to whether contamination is caused by a potentially covered event, such as a release of a contaminant, or by substandard practices by either the insured or a supplier of the insured, as in the recent lead-paint-containing toy circumstances.
Another potentially relevant exclusion is a governmental action or civil authority exclusion. In one case, a court found coverage for the destruction of salad dressing, holding that the exposure of the product to vapors, and not the excluded act of civil authority condemning the inventory, was the dominant cause of loss. See Henri's Food Products Co. v. Home Ins. Co., 474 F. Supp. 889 (E.D. Wis. 1979); see also Duensing v. Travelers Co., 849 P.2d 203 (Mont. 1993) (finding coverage for destruction of products where a worker was exposed to hepatitis A, holding the governmental action exclusion inapplicable because the insured's decision to destroy the inventory, and not a governmental embargo, was the dominant cause of loss).
First-party property policies may also contain product recall exclusions, with the intent being for such coverage to be purchased separately.
Business Interruption and Extra Expense
Where there is a covered loss, first-party property policies may also provide coverage for the loss of business income arising from the damaged property and for any extra expense that the insured incurs to maintain its business. Business interruption and related coverages generally protect against the risk that a property loss will affect the insured's ongoing ability to make a profit.
Business Interruption: Business interruption insurance typically provides coverage for actual loss of business income due to the necessary suspension of operations during the period of restoration of lost or damaged property. Business interruption coverage generally arises from damage to an insured's premises, so it may have limited application in the contaminated products context, where the loss of products may not result in suspension of an insured's operations. However, in at least one recent instance involving Taco Bell, several restaurants were closed while Taco Bell attempted to determine the source of contamination. In such an instance, the question arises as to whether the business interruption was caused by the direct physical loss of or damage to property.
Contingent Business Interruption: Another form of business interruption coverage is contingent business interruption (CBI) coverage, which indemnifies an insured for the interruption of business caused not by damage to the insured's property, but to the property of suppliers of goods or services that prevents the suppliers from delivering goods or services to the insured, or to the property of direct receivers of goods and services that prevents the receivers from accepting such goods and services from the insured. This coverage has potential application in the contaminated products context, such as the inability of a supplier of an ingredient of the insured's product to supply such ingredient. The antecedent for CBI coverage is that the loss arises from an insured peril under the insured's policy, even though the loss is not to the insured. For example, in Pentair, Inc. v. American Guaranty & Liab. Ins. Co., 400 F.3d 613 (8th Cir. 2005), the court held that CBI coverage was not available where a foreign supplier was unable to operate due to loss of electricity from an earthquake. The court held that the supplier's property was not physically damaged; rather, an electrical substation not owned by the supplier was damaged, which was too remote for CBI coverage. But see Archer Daniels Midland v. Phoenix Assur. Co., 936 F. Supp. 534 (S.D. Ill. 1996) (coverage found where remote supplier suffers damage).
Accordingly, to determine whether CBI coverage applies in the contaminated products context, it will be necessary to examine the cause of loss. If, on the one hand, the cause of loss is a casualty, such as the accidental contamination of a raw material, CBI coverage might be available. If, on the other hand, a supplier goes out of business in the aftermath of a crisis or as a result of on a regulatory embargo, CBI coverage might not be available.
Extra Expense: Where there is a covered cause of loss, an insured under a first-party property policy may also seek coverage for extra expenses that it incurs to maintain its operations stemming from the damage to property. Such coverage typically includes expenses to repair or replace property, but only to the extent it reduces the amount of loss that otherwise would have been payable. In the contaminated products context, an insured may seek coverage for the replacement of inventory, raw materials and/or the decontamination of equipment. See, e.g., Northwestern States Portland Cement Co. v. Hartford Fire Ins. Co., 360 F.2d 531 (8th Cir. 1966) (coverage for replacement of inventory and raw materials to reduce loss). As with CBI, a threshold question is whether the extra expense is the result of a covered cause of loss. Another question may be how far extra expense can be extended, such as advertising and promotions to restore market.
Sue and Labor: First-party property policies sometimes contain a "sue and labor" clause, which generally permits the insured to take steps to prevent a threatened loss or, where a loss does occur, to diminish its scope. In return, the insurer may be liable for expenses incurred by the insured. See Int'l Commodities Export Corp. v. American Home Assur. Co., 701 F. Supp. 448 (S.D.N.Y. 1988), aff'd, 896 F.2d 543 (2d Cir. 1990). Availability of sue and labor coverage may depend on whether the work is undertaken in response to a covered peril. A sue and labor clause may also act to limit an insured's coverage if the insured is found to have violated duties to prevent or mitigate loss. See American Home Assur. Co. v. Merck & Co., Inc., 386 F. Supp. 2d 501 (S.D.N.Y. 2005).
When an insurer pays a first-party claim, it ordinarily succeeds to the insured's rights against others that may be responsible for the loss. In the contaminated products context, producers of raw materials, suppliers of components or final goods, shippers and others may be responsible for contamination, which could give rise to a claim for lost products. See, e.g., Zurich Am. Ins. Co. v. Cutrale Citrus Juices USA Inc., 2002 WL 1433728 (M.D. Fla. Feb. 11, 2002) (distributor of orange juice obtained reimbursement from supplier of juice contaminated by food-grade propylene glycol, which was incorporated into larger batch of juice). First-party property insurers called upon to provide coverage for contaminated products should identify all underlying relationships and contracts to evaluate subrogation claims.
The new product and food safety issues will present many challenges to insurers under first-party property coverages, often involving the contract provisions discussed here. As these issues are litigated, new law is likely to be developed on the scope of first-party property coverages as well.