Author: Steve Kluting, Esq.
It's complicated. If you're involved in the buying or selling of ingredients for use in food at any juncture in the food supply system, figuring out who is ultimately liable for losses resulting from product contamination can be complex, uncertain and oftentimes counterintuitive. Liability among parties in the food supply system is one thing. Adding another layer of complexity to this already complicated issue is insurance coverage including:
- Whose coverage is applicable or available?
- What type(s) of coverage is involved? General liability? Product contamination? Other?
- What happens if multiple insurance coverages are available?
- And, perhaps worst of all, are there gaps in the insurance coverage?
Adding to this complexity is the patchwork of different rules used by courts in different states in ruling on these mission-critical issues. This article highlights a recent court case with significant coverage implications for food companies doing business in or through Wisconsin.
In Pharmacal Co., LLC v. Nebraska Cultures of California, Inc. (2016 WI 14)1, the Wisconsin Supreme Court arguably issued its most significant ruling of the past decade, impacting product liability law and liability insurance coverage by adopting the "integrated system rule" (a pro-insurance company doctrine). The integrated system rule makes recovery by insureds under their products liability coverage, and potentially their product contamination/recall insurance, a burdensome and complicated effort. Understanding and navigating this case law and how it might be applied to your product lines, your suppliers and customers, and your insurance program can be critical to your balance sheet - especially for those buying or selling ingredients.
At a very high level, the facts of the case are as follows:
- Pharmacal sold a probiotic chewable tablet to a national retailer.
- Pharmacal contracted with a contract manufacturer to source the probiotic bacteria Lactobacillus rhamnosus (LRA) and manufacture the tablet.
- That contract manufacturer sourced the LRA — what was supposed to be LRA — from an ingredient supplier. However, the ingredient supplier supplied the wrong probiotic bacteria, Lactobacillus acidophilus (LA), instead.
- Not knowing that it had been supplied the wrong ingredient, the contract manufacturer blended what it received with other ingredients and compressed the blend into a chewable tablet and packaged it.
- Pharmacal then unknowingly sold the packaged product, labeled as containing LRA when it in fact contained LA instead, to the national retailer.
- Some time later, the national retailer determined that the tablet didn't contain what it should have, notified Pharmacal, and then recalled the tablets and canceled further orders.
- Pharmacal destroyed the affected tablets, received an assignment of claims from its contract manufacturer and commenced litigation against its supply chain (and their general liability insurers).
- It should be noted that the tablets did not pose a health hazard or risk of bodily injury, despite the inclusion of the incorrect probiotic.
In its complaint, Pharmacal specifically alleged several breach of contract claims based on the supply of the incorrect species of probiotic bacteria (LA instead of LRA), rendering the tablets unsaleable. Pharmacal did not specifically allege that the tablets or conforming ingredients were altered in appearance, shape, color or other dimension by the inclusion of LA instead of LRA.
The ingredient supplier's general liability insurance carrier argued that no "property damage" (as defined under the insurance policy) had occurred, and therefore it was not liable for coverage or defense. Using a rule normally used in tort law, the court agreed with the insurance carrier. The court stated: "We conclude that there is no "property damage" caused by an 'occurrence' because the incorporation of a defective ingredient into the supplement tablets did not damage other property and did not result in loss of use of the property."
Finding no property damage meant that there was no insurance coverage available under the ingredient suppliers'general liability policies, even though it sold defective ingredients that were mixed with other ingredients and incorporated into finished product.
The court reached this conclusion by determining that the tablet is an "integrated system" (once the various ingredients — including the incorrectly supplied LA — had been blended and compounded, it formed an integrated system), and a defective ingredient of an integrated system does not cause property damage to the other ingredients or to the tablet itself.
This ruling — which has been criticized by some legal scholars — certainly heightens the risk for companies in the food supply system. It has the potential to create meaningful and unexpected gaps in your insurance and your supply chain's insurance, certainly as it relates to product liability coverage, but also potentially impacting your product contamination/product recall insurance.
We are alerting clients to this ruling and its potential impact on their businesses and insurance coverage, and are actively discussing innovative and responsive solutions. Court cases like this serve to reinforce the need to engage smart advisors who are dedicated to and experienced in food contamination issues, who can design customized insurance program solutions to mitigate these sorts of risks, and who can sharply articulate and argue advocacy positions to maximize your recovery.
We encourage you to reach out to your Gallagher broker or Gallagher's Product Recall team to discuss these issues in more detail.