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INSURANCE NOTES

No Coverage Exists For Product Recall Because Insured’s Errors Were Not “Accidental Contamination” And Were Not Linked To Insured’s Losses

11.14.2011

In Fresh Express Inc. v. Beazley Syndicate 2623/623 at Lloyd’s, 199 Cal.App.4th 1038 (published 10/4/2011), the California Court of Appeal held that no coverage exists under a first-party product recall policy, because (1) the insured’s “errors” (namely, violating its own company procedures by buying spinach from farms that did not follow good agricultural practices (“GAPs”)) did not give rise to coverage for “Accidental Contamination,” as that term was defined in the policy, and (2) the insured’s “errors” were not linked to the insured’s losses sustained during the 2006 E. coli spinach contamination scare. Although the result might have been different if the insured’s spinach was the source of the E. coli outbreak (it was not), this ruling is important for insurers, because the Court of Appeal carefully read and enforced the policy language.

The insured was a distributor of bagged fresh spinach and other leafy greens. The insured itself did not grow spinach, but instead bought spinach from various farms. To reduce the risk of E. coli contamination, the insured had established its own GAPs. Farms from which the insured bought spinach were required to follow these GAPs. However, in August 2006, the insured violated its own company procedures by making “spot purchases” of spinach from farms that did not follow its GAPs.
 
In September 2006, the United States Food and Drug Administration (“FDA”) issued a “no consumption advisory,” warning “consumers not [to] eat bagged fresh spinach” due to an outbreak of E. coli 0157:H7, a particularly virulent strain of the pathogen. According to the FDA advisory, there had already been reports of 50 cases of illness and one death. At the time it issued the advisory, the FDA did not know the source of the E. coli outbreak.

Within a few hours, the insured stopped distributing spinach products.  It did not actually initiate a product recall, despite the fact that it had bought spinach from farms that did not follow its GAPs.  The insured reasoned that stores had already taken spinach off the shelves, the FDA had advised consumers not to eat spinach, and that a recall would not have been as effective as the FDA advisory, and would have damaged the insured’s reputation. 

The FDA conducted an investigation which included the insured, the farms from which it bought spinach, and unrelated spinach distributors and farms. Within two weeks, the FDA determined that the source of the outbreak was a distributor and farm that were unrelated to the insured. The FDA subsequently withdrew its advisory.
 
In connection with the E. coli outbreak and FDA advisory, the insured allegedly sustained nearly $18.7 million in losses, consisting of lost profits on spinach and non-spinach products, contractual payments, in-field contractual obligation costs, customer credit memo costs, disposal costs, rebranding costs and consultant costs. The insured made a claim for coverage under its first-party product recall policy, which had limits of $12 million.
 
The product recall policy provided coverage where “losses arise because of Accidental Contamination . . . .” The policy defined “Accidental Contamination” to mean:
Error by [the insured] in the manufacture, production, processing, preparation, assembly, blending, mixing, compounding, packaging or labeling (including instructions for use) of any Insured Products or error by [the insured] in the storage or distribution of any Insured Products whilst in the care or custody of [the insured] which causes [the insured] to have reasonable cause to believe that the use or consumption of such Insured Products has led or would lead to bodily injury, sickness, disease or death of any person(s) . . . .
The insurer disclaimed coverage. The insured filed suit for breach of contract and bad faith, alleging that its spot purchases from farms that did not follow its GAPs were “errors” under the policy, which gave the insured “reasonable cause to believe” that its products were “partially responsible for the E. coli outbreak.”
 
Following a bench trial, the trial court ruled in favor of the insured. The trial court found that the insured’s spot purchases from farms that did not follow its GAPs were “errors” under the policy and that the losses were caused by the E. coli outbreak. The trial court ruled that there was no bad faith and awarded the policy limits of $12 million as damages.
 
The Court of Appeal reversed. It focused on the policy definition of “Accidental Contamination,” as well as the requirement of a link between the insured’s losses and its “errors.”
 
First, the Court rejected the trial court’s ruling that the “Accidental Contamination” was the E. coli outbreak. Examining the definition of “Accidental Contamination,” defined to mean an “error by” the insured that caused it to reasonably believe that use or consumption of its products would lead to bodily injury, the Court reasoned the E. coli outbreak was not an “error by” the insured. Therefore, the Court concluded, the E. coli outbreak was not “Accidental Contamination.”
 
Second, even though the insured had committed “errors” by buying spinach from farms that did not follow its GAPs, there was no evidence to show that the insured’s “errors” had any connection to the E. coli outbreak or the FDA advisory. Rather, the sole cause of the outbreak and the advisory was an unrelated entity’s contaminated spinach – not any “errors” by the insured. In other words, there was nothing to link the insured’s losses to its “errors.” Drawing from the policy’s requirement that “losses arise because of Accidental Contamination” [emphasis added], the Court determined that “the requisite nexus” for coverage was missing. Thus, the Court ordered that the case be dismissed.
 
The insured has petitioned for review by the California Supreme Court. As of this date, the California Supreme Court has not decided whether to accept review.

 


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