Despite improvements in food safety standards over the last two decades, it appears foodborne illness continues to be on the rise. In December 2012, the FDA reportedly discovered Salmonella at an Indiana farm that, less than a year ago, had recalled all of its cantaloupes after the FDA linked the fruit to a Salmonella outbreak that allegedly killed three and sickened hundreds. Shortly thereafter, a national bagel restaurant chain issued a recall of a smoked salmon product after its supplier notified the company of a potential bacteria threat. And, several recent studies by the Centers for Disease Control, U.S. Public Interest Research Group, and others suggest these outbreaks are not anomalies.
With food contamination on the rise, even food companies that maintain strict quality control mechanisms and perform extensive due diligence on their suppliers may face the prospect of a recall or product liability claims. And, because food industry supply chains are long and complex, even problems experienced by small ingredient manufacturers can lead to, and recently have resulted in, widespread recalls causing millions of dollars in recall costs and potential tort liability for numerous other food manufacturers, distributors, and retailers. In light of this trend, food companies at all levels of the supply chain should prepare a careful recall risk mitigation plan by following three essential steps.
1. Identify Risk in Sufficient Detail to Enable an Effective Risk Mitigation Strategy
To prepare for a recall or food contamination incident, a company should begin by evaluating the potential risks that the company faces. The company needs to collect information from executives, managers, and other employees with the best knowledge of potential problems. In doing so, companies should focus on the details of these risks, defining them as specifically as possible.
For example, a company might begin with a broad observation of a potential liability or exposure, such as, “We are concerned about a contaminant being introduced into our product through a tainted ingredient.” That observation though should be only the start of the risk assessment. The company should follow up with key personnel, including executives, managers, and others to break this broad observation into more detailed and well-defined elements. For instance, a company’s personnel might break the “tainted ingredient” concern into numerous contributing risks, such as, “We are concerned that we will not be able to recover from a Chinese supplier if one of its ingredients contaminates our product,” or, “We are concerned that other companies in the supply chain will seek to recover costs of recall, including brand damage, if our product becomes contaminated.”
Although a company’s first step to attempt to remedy these risks should be improving the process and standards used in quality control and assurance, companies have to recognize their fears may come to pass even with the best quality controls. Thus, companies must match their specific risks against the risk mitigation strategies and insurance assets they have, or could have, in place.
2. Match Well-Defined Risks with Vehicles for Protection
The purpose of breaking risk into well-defined components is to enable the company to match those risks with the protections the company currently has in place, and also to identify areas where the company may lack adequate protection.
Companies should recognize all of the available vehicles for protecting against risk, such as insurance coverage, indemnities, additional-insured provisions, or other less traditional mechanisms such as bonding or risk pooling. In choosing the right risk transfer strategy, companies must consider that the broadening of food supply chains has decreased the effectiveness of certain traditional risk-spreading techniques.
For instance, two recent Supreme Court decisions have limited federal jurisdiction over suits against foreign manufacturers under certain circumstances. This potential narrowing of federal jurisdiction means food manufacturers may have a more difficult time pursuing claims against foreign ingredient manufacturers, particularly in countries, such as China, that have imposed high obstacles to suing local companies in their courts. These obstacles could render indemnities from those companies less valuable. Similarly, if a foreign supplier has insurance coverage that purports to apply to a domestic food company, it is important to confirm the insurance was purchased in a jurisdiction that allows the domestic company to pursue that coverage. For the same reasons lawsuits are challenging against the supplier, lawsuits against the suppliers’ foreign insurers also may be difficult.
States also have varying and evolving law that could limit the enforceability of indemnities or negate related insurance procurement requirements in supplier contracts. Companies must review the language of the indemnity they give and receive, thoroughly analyzing whether these, or other, provisions would be affected by the laws that are most likely to apply.
Companies also should be prepared to look to their own insurance portfolios if the indemnities or additional-insured provisions of the supplier’s policies fail. In assessing the types and amount of coverage they have, companies should not overlook the specific language of their insurance policies to ensure their coverage provides the protection they expect.
No insurance portfolio perfectly covers all of the risks companies might identify. Where a company identifies a potential coverage gap, the company must consider the costs and benefits of filling those gaps. It is not always desirable, or even possible, to fill in every gap or limitation in coverage. But it is important for companies to be aware of the limitations in their coverage so their risk management decisions are made consciously and not from ignorance or accident.
For example, although most food companies maintain commercial general liability policies that often cover the costs and liabilities arising from third-party bodily injury or property damage claims, those policies generally contain exclusions that bar coverage for some claims and costs associated with a product recall. After analyzing their recall risks—including potential third-party claims by companies further up the supply chain for their own recall costs—companies should determine if their coverage is sufficient.
Companies can assess the sufficiency of coverage using industry benchmarks, as well as considering the extent of protection needed to advance the company’s business goals in the face of a recall or contamination incident. This assessment might include a potential recall’s likely impact on a company’s brand reputation, finances, and ability to preserve its relationships throughout the supply chain.
Thus, assessing the sufficiency of the amount and types of insurance that a company has ultimately should turn on strategic business judgments about the company’s willingness to accept risk and the costs and benefits of taking steps through insurance or other contractual means to spread that risk. In that light, many companies may find specialty contamination and recall policies to be useful additions to a risk mitigation portfolio, but others may decide the risk associated with a recall does not justify the expense of obtaining a recall policy, particularly where the company has concerns about the breadth and cost of the recall coverage provided.
3. Understand the Legal Coverage Positions Insurers May Take to Limit Coverage
In evaluating the extent and types of coverage to maintain, food companies’ cost-benefit analyses need to consider the likelihood and strength of arguments that insurers might assert to avoid or narrow coverage once a claim arises.
Initially, evaluating a company’s coverage portfolio entails a review of the policy’s language. However, companies should not restrict their analysis only to the language used in a specific policy form. Rather, a company must evaluate that language in light of the legal trends and coverage positions that insurers recently have taken.
For instance, the language of product contamination and recall policies varies substantially regarding what event triggers the insurers’ coverage obligations. One of the key triggers companies often seek is an “accidental contamination” of their products requires a recall to avoid causing foodborne illnesses to consumers. Virtually all modern recall policies applicable to food companies contain an accidental contamination trigger, but recent cases show insurers and their policyholders sometimes disagree as to what exactly ought to happen for those policies to respond.
Insurers recently have argued, with some success, that recall policies limit coverage only to recalls of contaminated products that their policyholders can prove actually were contaminated with a dangerous microbe. In Little Lady Foods, Inc. v. Houston Casualty Co., 819 F. Supp. 2d 759 (N.D. Ill. 2011), a food manufacturer recalled its product after testing revealed the presence Listeria. At the time of the recall, the company did not know whether the Listeria present in the product was of a strain that causes bodily injury. After the recall, tests concluded the Listeria was not the strain that could cause such injury. Based on these later tests, a U.S. district judge for the Northern District of Illinois concluded the recall did not trigger the policy’s requirement that the recall resulted from contamination that “may likely result in bodily injury.” This result was despite the fact that the insured’s product had tested positive for Listeria and the company had acted responsibly in recalling its product to prevent causing consumers harm.
At least one court has relied upon Little Lady in denying recall coverage. In Ruiz Food Products v. Catlin Underwriting U.S., Inc., No. 1:11-cv-00889, 2012 WL 4050001 (E.D. Cal. Sept. 13, 2012), the court found a recall would not trigger the accidental contamination requirement in Ruiz Food’s recall policy unless “contamination or impairment is actually present” in the recalled product. If other courts follow the Little Lady and Ruiz Food holdings, recall coverage could afford materially less protection than many policyholders might have expected when they purchased their coverage.
So far though, at least one court has distinguished Little Lady to reject an insurer’s effort to avoid coverage. In Hot Stuff Foods, LLC v. Houston Casualty Co., No. 11-4055, 2012 WL 2675225 (D.S.D. July 5, 2012), a federal district court distinguished Little Lady and rejected the insurer’s attempt to avoid its coverage obligations under a recall policy.
Hot Stuff Foods was a sausage manufacturer with an insurance policy covering it for expenses it incurred in connection with product tampering or product contamination. Due to a packaging error by Hot Stuff, sausages containing MSG were labeled as not containing it. Hot Stuff initiated a Class III recall, which the FDA defines as involving products that likely “will not cause adverse health consequences.” Hot Stuff then turned to its insurer for coverage of the recall-related expenses, contending MSG was a contaminant under the policy’s terms and it could cause bodily injury.
The insurer denied the claim, and, relying on Little Lady, pointed to expert testimony at trial that MSG likely could not cause bodily injury. The court rejected the insurer’s argument, finding that regardless of the recall’s Class III designation, the policy terms providing coverage for a product that “may likely” cause illness would be satisfied if there were any possibility of illness resulting from the ingestion of MSG—not, as the insurer argued, “a probability” of illness. Under this standard, the court determined the recall constituted “accidental contamination” because MSG “may likely result in physical symptoms of bodily injury, sickness or disease or death of any person.”
The Hot Stuff court distinguished Little Lady based on its finding that the undisputed evidence in the case proved MSG might cause injury in at least some instances, whereas the Listeria at issue in Little Lady had no meaningful possibility of causing injury.
While Hot Stuff represents a major win for policyholders facing denials of coverage based on bodily injury requirements in recall policies, it also serves as a reminder that policyholders must be vigilant about their choice of language in food recall policies. Had Little Lady, Ruiz Food, and Hot Stuff procured policies with language that made clear the policies would be triggered by a reasonable belief that contamination could cause bodily injury, all three companies might have avoided costly litigation, and Little Lady and Ruiz Food may have had coverage to pay for some or all of their recall costs.
Food contamination may be on the rise, but by performing a comprehensive analysis of risk exposure and potential coverage options and by carefully wording recall policies to maximize coverage, companies can ensure they have the right protection.
Cohen is a partner at the Washington, D.C. law firm of Gilbert LLP. Cohen can be reached at 202-772-2259. Grim is an associate at Gilbert LLP and can be reached at 202-772-3926.
For more information on recalls, read the April/May article “The Business of Recalls: From Booming to Bankrupt.”