Morris Manning & Martin, LLP

Recent Recalls Lead to Coverage Disputes and Policy Changes

11.20.2012

We are all too familiar with stories of contaminated food and drugs that sicken and even kill consumers.  Given the increasing number of product recalls and their enormous financial impact, it is not surprising the demand for recall insurance has increased exponentially in the middle market. 

Why has the number of recalls increased so dramatically?  The answer is twofold.  First, food and drug regulators have increased scrutiny on producers and become much better at identifying the sources of illnesses caused by contaminated food and medicines.  Second, in January of 2011, Congress passed the Food Safety Modernization Act (“FSMA”).  The FSMA gave the U.S. Food and Drug Administration the power to order recalls.

Most recall coverage has two components.  First-party coverage insures the policyholders’ losses associated with removing a product from the market, evaluating contamination levels, notifying consumers and other third parties and destroying the product if necessary.  Third-party coverage insures against losses from claims brought by vendors and retailers for their costs associated with the recall.

To date, insurers have provided meaningful coverage for recalls, but as recalls and losses escalate, so too will coverage disputes and litigation.  Three likely areas of contention are as follows: 1) whether there is coverage for contamination unlikely to cause illness; 2) whether contamination must occur during manufacturing to be covered; and 3) whether reasonable expectation of contamination (as opposed to actual contamination) is sufficient to trigger coverage.

Because recall insurance is a relatively new coverage, many of its components remain unchallenged in the courts.  This too is changing rapidly, and because the claims at issue often are high dollar, both claimants and insurers are willing to fight.  Take for example Daniele Int’l, Inc. v. Penn-Star Ins. Co., filed on October 9, 2012, in the U.S. District Court for the District of Rhode Island (C.A. No. 12-709).  Daniele is suing Penn-Star for $33,181,174.00, the amount of a default judgment Daniele was awarded against Penn-Star’s insured, Wholesome Spice & Seasonings, Inc.  The default judgment was issued in litigation over a 2010 recall of salami contaminated with salmonella that was traced back to peppercorns sold by Wholesome.  Daniele had purchased 50,000 pounds of the pepper and claims extensive testing by regulators failed to identify any potential source of salmonella other than Wholesome’s pepper.  The $33.2 million judgment purportedly encompasses recall expenses, lost profits and reputational damage.  Daniele has alleged a direct right of recovery against Penn-Star.  (Complaint, ¶ 20).  Presumably, Daniele will have to prove coverage for Wholesome’s claim, and with the amount at stake, Penn-Star likely will launch an aggressive defense.

While insurers such as Penn-Star do not want public coverage disputes to deter possible insureds from purchasing recall insurance, insurers must look at the long term ramifications of legal precedent possibly broadening the scope of coverage of recall policies.  Finally, insurers should consider narrowing recall policy language to limit coverage to actual and harmful contamination occurring during manufacturing.