California and Illinois Hold Accidental Contamination Provisions Afford No Coverage

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1 California and Illinois Hold Accidental Contamination Provisions Afford No Coverage By Rina Carmel November 21, 2011 Two recent cases have examined policy definitions of accidental contamination and accidental product contamination under a product recall issued to a food distributor and a malicious tampering/accidental contamination policy issued to a food manufacturer, respectively. In both cases, the insureds food products were not actually contaminated, although the insureds incurred costs when contamination was suspected. Both courts read the policy language carefully and concluded that under the facts presented, no coverage existed. Fresh Express v. Beazley Syndicate The claim in Fresh Express Inc. v. Beazley Syndicate 2623/623 at Lloyd s, No. H035246, 2011 Cal. App. LEXIS 1265 (Sept. 8, 2011) (ordered published Oct. 4, 2011) came about as a result of the 2006 spinach E. coli scare. The insured, Fresh Express Inc., was in the business of distributing bagged fresh spinach and other leafy greens. Fresh Express did not grow spinach itself but bought spinach from various farms. To reduce the risk of E. coli contamination, Fresh Express had established good agricultural practices (GAPs). Fresh Express required the farms from where it bought spinach to follow its GAPs. However, in August 2006, Fresh Express violated its own company procedures by making spot purchases of spinach from farms that did not follow its GAPs. The following month, in September 2006, the U.S. 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, Fresh Express decided to stop distributing spinach products. Fresh Express did not actually initiate a product recall, even though it had bought spinach from farms that did not follow its GAPs. Fresh Express asserted that its decision was based on the facts that retailers had already stopped selling spinach, consumers were advised not to eat spinach, and that a recall would not have been as effective as the FDA advisory and would have damaged Fresh Express s reputation. The FDA conducted an investigation to trace the source of the E. coli outbreak. It investigated Fresh Express, the farms from where Fresh Express bought spinach, and spinach distributors and farms that were unrelated to Fresh Express. Within two weeks, the FDA determined that the source of the outbreak was a distributor and farm that were unrelated to Fresh Express. The FDA then withdrew its advisory..

2 Fresh Express made a claim under its Malicious Contamination, Accidental Contamination, and Products Extortion Insurance policy, asserting it had sustained a total of nearly $18.7 million in losses in connection with the E. coli outbreak and the FDA advisory. The specific categories of alleged losses consisted 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 total limits of the product recall policy were $12 million. The product recall policy provided coverage for insured events, defined to include accidental contamination as well as malicious contamination and products extortion which were not at issue in the case. The policy s insuring agreement stated that the insurer would reimburse [the insured] for losses as specified in this Policy arising out of Insured Events incurred by [the insured] only where such losses arise because of Accidental Contamination... (Ellipses and paragraph divisions omitted.) The policy defined accidental contamination to mean: Error by [Fresh Express] 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 [Fresh Express] which causes [Fresh Express] 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) or animal(s) physically manifesting itself by way of clear, obvious or visible symptoms within 120 days of use or consumption. The insurer disclaimed coverage. Fresh Express filed suit for breach of contract and breach of the implied covenant of good faith and fair dealing, alleging that its spot purchases from farms that did not follow its GAPs were errors under the policy, which gave it 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 Fresh Express. Specifically, the trial court found that Fresh Express had suffered losses... caused by an Insured Event, here the 2006 E. coli outbreak, and that the losses were covered under the product recall policy. The trial court found that the insurer had breached the policy, because the insured s spot purchases from farms that did not follow its GAPs were errors under the policy. The trial court ruled that there was no breach of the implied covenant of good faith and fair dealing. The trial court awarded the policy limits of $12 million as damages.

3 The California Court of Appeal reversed. It held that no coverage exists under a first-party product recall policy, because Fresh Express s errors namely, violating its own company procedures by buying spinach from farms that did not follow its GAPs did not give rise to coverage for accidental contamination, as that term was defined in the policy, and secondly, Fresh Express s errors were not linked to its losses sustained during the 2006 E. coli spinach contamination scare. The court 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 of appeals rejected the trial court s ruling that the insured event of accidental contamination was the E. coli outbreak. Instead, the court of appeals followed the policy language, which defined accidental contamination to mean an error by Fresh Express that caused it to reasonably believe that use or consumption of its products would lead to bodily injury. Under the policy definition, the E. coli outbreak was not an error by the insured. Therefore, the E. coli outbreak was not accidental contamination. Second, even though Fresh Express had committed errors within the meaning of the policy, namely buying spinach from farms that did not follow its GAPs, there was no evidence to show that such 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. Based on the policy s requirement that losses arise because of Accidental Contamination (emphasis added), the court of appeals determined that the requisite nexus for coverage was missing. Fresh Express has filed a petition for review with the California Supreme Court. As of the date of posting, the California Supreme Court has not decided whether to accept review. If the California Supreme Court accepts review, the court of appeal s decision will not be citable. Little Lady Foods v. Houston Casualty Another recent case, Little Lady Foods, Inc. v. Hous. Cas. Co., No. 10 C 8280, 2011 U.S. Dist. LEXIS (N.D. Ill. Sept. 22, 2011), came about as a result of listeria contamination in the insured s Little Lady burrito product. Little Lady had begun to produce its burrito product through a new process that left the burrito partially uncooked when it left the plant. For that reason, Little Lady was required, by both the U.S. Department of Agriculture (USDA) and its own Hazard Analysis and Critical Control Plan (HACCP) to test the burrito product and equipment for harmful bacteria before shipping the burrito product.

4 Tests in January 2010 showed the presence of listeria. Of the seven strains of listeria bacteria, only one, listeria monocytogenes (LM), causes listeriosis, which can cause bodily injury in humans. However, a test result showing any strain of listeria bacteria meant that LM could be present, meaning that Little Lady could not distribute its burrito product until it confirmed that LM was not present. Little Lady notified the USDA and its customer and placed a hold on 57,374 cases of its burrito product. Little Lady made a claim under its Malicious Product Tampering/Accidental Product Contamination policy. That policy provided that the insurer agrees to indemnify [Little Lady] for LOSS resulting directly from an ACCIDENAL PRODUCT CONTAMINATION first discovered by [Little Lady] during the Policy Period. The policy defined loss to include expenses related to chemical analysis in order to ascertain whether [Little Lady s] PRODUCT(S) have been contaminated and/or to ascertain the potential effect of the ACCIDENTAL PRODUCT CONTAMINATION. The policy defined accidental product contamination to mean: any accidental or unintentional contamination, impairment or mislabeling (including mislabeling of instructions for use) during the manufacture, blending, mixing, compounding, packaging, labeling, preparation, production or processing... of [Little Lady s] PRODUCTS... provided always that the consumption or use of [Little Lady s] CONTAMINATED PRODUCT(S) has, within 120 days of such consumption or use, either resulted, or may likely result, in... physical symptoms of bodily injury, sickness or disease or death of any person(s)... The insurer advised Little Lady that the product must test positive for LM specifically. Tests for LM were negative. The insurer accordingly disclaimed coverage. Little Lady sold some of the product on the secondary market, and the remainder had to be destroyed. Little Lady sued its insurer for breach of contract and breach of the implied covenant of good faith and fair dealing. The court held, under Illinois law, that the policy afforded no coverage for Little Lady s claim. The parties disagreed as to whether the phrase may likely result in the definition quoted above meant that harm to be consumers had to be probable or merely possible. The court found that that debate misses the point, because harm was neither probable nor possible, because the product did not contain LM. Therefore, the policy was not ambiguous and afforded no coverage. The court further stated that the insured was essentially asking the court to rewrite the policy to provide coverage any time the insured feared contamination. The court further reaffirmed that public policy in particular, food manufacturers duties under USDA regulations plays no role in interpreting insurance contracts. Because the policy afforded no coverage, the court held that the insurer was not liable for breach of contract or bad faith. Accordingly, the court granted the insurer s motion for summary judgment and denied Little Lady s motion for summary judgment.

5 Little Lady has appealed to the U.S. Court of Appeals for the Seventh Circuit. Conclusion Fresh Express and Little Lady provide useful guidance to insurers and insureds alike on the parameters of coverage in claims involving suspected but not actual food contamination. Both sides should keep in mind that the Seventh Circuit and the California Supreme Court, if it accepts review, could change or refine the analyses, however. Rina Carmel is with Musick, Peeler & Garrett LLP in Los Angeles, California