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General Corporate and Business LawProduce Business Law/PACA
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Recalls arising from a food safety event involving potentially unsafe agricultural products are now a fact of life in the produce industry. Hardly a week goes by that some industry publication does not include a story of a major recall of fresh produce. Under the recent Food Safety Modernization Act, the U.S. Food and Drug Administration now has the right to order a mandatory recall of any food product believed to be reasonably likely to cause harm; supplementing its existing authority to indirectly force a voluntary recall through its public statements.
In light of the current political and regulatory environment, including a consuming public sensitized to food safety risks, a producer or distributor faced with even a threat of a potentially contaminated product has no practical choice but to immediately initiate a comprehensive recall to get its product off the shelves. Hopefully the recall will be successful and avoid endangering the health of any end users of the produce. However, even in such fortunate circumstances where contaminated produce never reaches the end user so that there is no liability from personal injuries, the direct and indirect costs associated with just the recall itself can be enormous and, in a widespread case, be so catastrophic as to threaten the very existence of even the largest produce companies.
It is against this ominous backdrop that participants in the produce distribution chain have shown increasing interest in the possibility of limited exposure to this business risk through insurance. The insurance industry has responded by providing, since approximately 2004, a variant of product contamination insurance in the form of dedicated, standalone “recall” insurance.
Insurers writing this coverage include Chartis, XL Insurance, Starr, Crum and Forster, Zurich, Lloyd’s, and Caitlin. The labels used by the insurers for this form of insurance are not uniform but generally include “recall” or “product contamination” in their name. Each insurer provides a varying mix of coverage for an insured company’s own costs associated with conducting the recall, known as “first-party” coverage, and may also include insurance for recall-related expenses and claims of third-party customers and distributors of the insured, known as “third party” coverage.
The typical insurance policy that most produce businesses have is a Commercial General Liability (“CGL”) policy. In general, there is little, if any, coverage for recall losses under the standard CGL policy. This type of policy is designed only to provide third-party coverage for the insured against claims of bodily injury and property damage by others. For example, if unsafe produce makes a consumer ill and the result is a personal injury lawsuit, the CGL policy would provide indemnity for both the company’s legal fees to defend itself in court as well as pay the damages awarded to compensate for the personal injury.
In general, however, a CGL policy will provide no first-party or third-party insurance for a recall as such loss is excluded under various standard policy language. The same lack of recall coverage holds true of the typical excess and umbrella policies too because they also are limited to third-party bodily injury and property damage claims.
A limited exception may be if the CGL policy has an endorsement for extra coverage for “limited product withdrawal expense,” also known as “product recall expense endorsement.” This additional coverage will cover some, but certainly not all, of the standard first-party costs incurred by the insured to logistically conduct the recall. But it will often provide no coverage for third-party recall costs and can be limited in amount of insurance coverage for the insured’s own losses with a cap at $1 million.
Contrary to what may seem like common sense, recall insurance is not always triggered by the occurrence of a recall. The key trigger is instead the actual or threatened contamination of the produce, whether caused accidentally or as the result of malicious tampering (excluding contamination caused by terrorism). Contamination includes the presence of any bacteria or disease-causing organism or condition that renders the produce unsafe for human consumption.
Without contamination of the insured’s own product, there is no coverage under all present forms of recall insurance. If, for example, one company’s produce is recalled and causes a general market rejection of all “like kind” produce, there is generally no coverage unless the competitor’s product is also contaminated.
There are, however, two general exceptions to the rule that contamination must be proven to obtain coverage. First, in the case of a government-initiated recall of the insured’s own product, contamination is presumed based upon the agency’s action. Second, at least one insurer is currently offering coverage for recalls of a “similar” product. But, such coverage is limited in amount to only 25 percent of the aggregate coverage amount of the policy.
Recall insurance may provide coverage for four potential categories of loss: (1) recall expense – the logistical costs of pulling the product off the shelves, including: inspection, testing, destruction and disposal costs of the contaminated product, employee overtime and extra personnel expenditures, costs to transport the recalled produce and also to redistribute non-contaminated, replacement produce shipping; dealings with regulatory agencies, communication expenses such as recall notices; employee travel costs, storage and warehousing of produce; and decontamination of sites; (2) lost profits – including refunds, loss of net profits, legal fees, and replacement of contaminated product with “safe” produce to fill order commitments; (3) crisis communication and response – costs to provide notice of the recall and manage the logistics of recalling the produce, such as the expense of hiring consultants and experts to provide crisis management and public relations assistance with the recall; and (4) product rehabilitation and restoration – costs to reestablish market share, goodwill, and lost reputation arising from a food safety event and recall; loss of business income for a fixed time period, and advertising campaigns and public relations expenses. The first two potential coverages focus on past losses to provide indemnity for losses already suffered, while the last two categories provide insurance coverage to pay in the future for forward-looking losses.
While the above four categories show all potential coverages under the ideal policy, this ideal policy is hypothetical only. The reality is that most policies do not offer all of the above sub-coverages under each of the four general categories of covered losses. In general, most recall policies include some coverages in all four potential loss categories, but the specific types of losses covered within each category vary by insurer. For example, some insurers include legal expenses as a form of coverage under some of the categories, while most do not. Furthermore, the four categories include both recall-related expenses incurred by the insured produce company and also third-parties who have been affected by the recall, such as the produce company’s customers and distributors.
Because of the difference in what an individual policy does and does not cover and the differing needs of each individual produce company, it is important for any produce business interested in this coverage to shop around to compare the different policies and decide which coverages are most important. For a produce distributor with little public presence or few assets, there may be a greater emphasis on recall expenses and lost profits, to handle the immediate, short-term financial impact of paying for a massive recall. A more established, larger business with a major investment in its reputation and brand name may focus more on the rehabilitation coverage.
Recall insurance can fill an important need when, despite diligent precautions, a major food safety event occurs and a recall of the contaminated product is necessitated. It is critical that a produce company select a recall policy best suited for its particular business needs before there is a problem.
This can be done by making sure the insurance application is carefully completed. Insurers underwrite risks and approve policies to indemnify the insured from such risks based upon the information in the policy application. If the information given to the insurer on the front-end is wrong, the insurer will argue that it was not able to adequately judge the risk and charge an appropriate premium therefore. The end result is that produce customer may be drawn into a costly and long legal fight with an uncertain outcome on the issue of whether there is or is not coverage if there is a misrepresentation in the facts in the application. Of course, this will all occur after the food safety incident has occurred and the produce business is counting on the insurance to be there to cover major recall expenses. State law may allow an insurer to seek to rescind and cancel a contract of insurance, and thereby being liable for providing any insurance coverage thereunder, if there has been an intentional or even a negligent misstatement by the produce business of a material fact represented to the insurer in the application or omitted therefrom. There is no short cut to careful review and accurate and full completion of the policy application. Trying to save a few dollars in premiums by understating a risk in the application may seem like a wise, short-term answer to high insurance costs but may backfire on the insured when they need coverage to be there for a major recall with major financial repercussions to the produce company if there is no insurance safety net actually in place.
There is no single form of recall policy nor is there uniformity among the differing forms of policies used by the different insurers. The only way to make sure the coverage fits the insured’s needs is to spend a few hours actually reading and studying the exact policy language. Unfortunately insurance contracts are notoriously difficult for lay persons to read with highly specialized terms with defined legal meaning not apparent potentially from the language used. Further, many insureds to not realize that what their own insurance agent or broker tells them or even includes in writing may not be used later to create coverages not actually provided in the policy language itself. Finally, many insurance brokers and agents may have had very little exposure to recall insurance in general or as to recall policies for the produce industry in particular so their understanding of such coverages may be very limited.
It is well worth the relatively small investment needed to hire an insurance professional or legal counsel to review the proposed policies and assist the insured in comparing the potential coverages to make sure the produce company is actually getting what it is paying for. Moreover, a specimen policy showing the exact language to be used for the insurance product to be issued should always obtained from the insurance company’s representative and carefully reviewed before coverage is bound. Then, after a policy is selected, coverage should be confirmed in the declarations received at the time the actual policy is provided. If an insured has a question as to what is or is not covered, the best advice is to “get it in writing” directly from the insurer (not from the local agent or broker) before the policy is issued.
The cost of recall insurance is relatively expensive. Because of the insurance industry’s lack of many years of experience with the potential exposures of food safety incidents and recalls, the industry is still struggling with how to best price products to cover this risk and how to decrease premiums through spreading the risk among the entire industry. Because it will take time to fix this problem, produce businesses should expect recall insurance to remain expensive in the near future without some type of government intervention (which has been debated recently as a topic for inclusion in new federal agricultural legislation).
Recall coverage is not, unfortunately, complete protection for all recall-related losses. Insurance for recall expenses caused by the contamination of a competitors’ product is not likely to be covered in the near future, at least in the amount of insurance needed for a major recall. Insurance coverage amounts are usually available in the range of $1 million to a top limit of $10 million in coverage.
There are also dollar and percentage sub-limits on certain coverages. For example, one policy limits coverage for the costs incurred to rebuild the insured’s reputation after a recall to only 25 percent of the coverage under the rehabilitation category of coverage. For a well- established company with a large investment in its good name, such limited coverage may be insufficient for the substantial costs of media and public relations after the recall is completed. Another insurer limits coverage to only $1 million for all inventory of the insured in warehouses or in transit. For a large produce company with multiple warehouses and millions of dollars in stored produce, this coverage too may be far short of what is needed to compensate the insured for a major food safety incident.
Further, coverage for government recall may be an optional coverage available only for an extra, substantial premium and even then, in a limited amount. Deductibles may be high, as much as $500,000, but may be unavoidable if a produce company is primarily concerned with procuring insurance at the top-end of potential coverage for a truly catastrophic food safety incident that causes major recall losses of potential exposure. Also, insurance is useless if the insurer is not solvent when the loss occurs, so it is important to evaluate the insurer’s financial assets, experience, and industry ratings before buying a policy.
In closing, recall insurance is an important, potential option for the produce industry to help protect against the risk of the major expenses associated with a contaminated produce recall. Unfortunately, this type of insurance is no panacea and has limitations and disadvantages that must be considered. That being said, recall insurance will continue to evolve in future years to better address recall liability. And, the right recall policy, carefully chosen, can provide a valuable benefit to protect the produce business against the potentially catastrophic losses associated with a major recall of contaminated produce.
Tim Henkel is a partner of the Miami law firm of Henkel & Cohen, P.A. (www.ProduceBusinessLaw.com) and provides commercial litigation in trial and appellate courts, representation in PACA proceedings, and business counseling for growers, marketers, and other participants in the produce industry.