Food Products Coverage: The Communicable Disease Exclusion Lacks Bite

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[authors: Christopher C. Loeber and Kevin B. Dreher]

State and federal courts reject efforts to categorize salmonella as a "communicable disease."

While the quality of the United States' food supply continues to be exceptionally reliable, problems do occasionally arise. Contamination by food-borne bacteria is a threat that is well known to the industry, and salmonella contamination is one example that has made recent headlines. Companies implement a wide variety of quality control and sterilization protocols in an effort to prevent contamination events from occurring. At the same time, those businesses purchase insurance as protection against outbreak-related losses.

As the cost of food-borne bacteria–related losses continues to rise, insurance coverage litigation is becoming more common. Morgan Lewis is on the front line of this fight and is successfully defending our clients' rights to the full benefit of their insurance policies. We recently defended against an insurer's attempt to use a "Communicable Disease Exclusion" to deny coverage for a salmonella-related loss. Fortunately for the food industry, the carrier's arguments did not hold up in court.

Liability Insurance Products Marketed and Sold to the Food Industry

One of the primary risks faced by food manufacturers and distributors continues to be loss suffered due to unanticipated food-borne contaminants such as salmonella. Over the last several years, there have been numerous salmonella outbreaks despite the food industry's efforts to test, control, and prevent such events. In those few cases where this problem has arisen, the industry has promptly acted to identify the products affected and to remove them from the marketplace. The costs for companies to respond to such events can be significant—that is where insurance comes in.

The insurance industry has developed products that it specifically markets to the food sector. And, when a food company finds itself embroiled in a food-borne bacteria claim or suit, the food-specific policy is designed to pay (i) for a lawyer to defend the company and (ii) any resulting settlements or judgments.

With the ever-increasing number of lawsuits spawned by food-borne bacteria outbreaks, a comprehensive and reliable insurance program is an absolute must. Yet, a trend has developed in recent years: food industry policyholders spend a great deal of money purchasing food-specific insurance policies only to find that once the lawsuits start and the insurance coverage is needed, a disagreement ensues between policyholder and carrier as to precisely what is covered.

The "Communicable Disease Exclusion" is a provision that insurance companies have attempted to use to avoid paying food-borne contamination–related claims. In one case we recently handled, the exclusion read as follows:

This insurance does not apply to "bodily injury" or "property damage" [or "personal injury and advertising injury"] arising out of the transmission or alleged transmission, by any insured, of any communicable disease, including but not limited to Acquired Immune Deficiency Disease (AIDS).

Significantly, the policy in question nowhere defined the key term "communicable disease." This exclusion was included in a niche policy that was sold to a food company—with the main purpose of protecting the company against losses caused by food-borne contaminants.

The wording of the policy suggests that a "Communicable Disease Exclusion" such as this applies to sexually transmitted diseases, not to food-borne bacteria. Nevertheless, that wording did not prevent the carrier from arguing in two separate courts that salmonella-related losses were specifically excluded by this provision.

New Jersey Ruling Rejects Communicable Disease Exclusion as a Defense to Coverage

In New Jersey state court, the insurer filed a declaratory judgment action asserting that the Communicable Disease Exclusion precluded coverage for our client's losses arising from a food-borne salmonella outbreak. We countered that the Communicable Disease Exclusion could not apply because (i) it would defeat the reasonable expectations of the food industry policyholder—i.e., that the insurance it purchased actually applied to the most common type of losses faced by the food industry; (ii) salmonella is not a communicable disease under the policy; and (iii) a more specific exclusion in the policy, the Fungi and Bacteria Exclusion, contained a provision that expressly covered losses caused by food-borne bacteria, such as salmonella.

On June 21, 2011, after months of briefing and two separate oral arguments, the New Jersey court entered a summary judgment ruling that precluded the insurance company from relying on the Communicable Disease Exclusion as a basis to deny coverage. The court specifically found a conflict between the policy's Communicable Disease Exclusion (a general exclusion) and the Fungi and Bacteria Exclusion (a more specific exclusion) when it came to salmonella. Due to this conflict, the New Jersey court ruled that the Fungi and Bacteria Exclusion controlled and that it would be reasonable for the policyholder to expect coverage for salmonella-related losses.

Federal Ruling Finds Communicable Disease Exclusion Ambiguous

Notwithstanding the New Jersey state court decision, the insurance carrier pursued a nearly identical suit in the U.S. District Court for the Western District of Wisconsin. But the ultimate outcome was the same. In an opinion dated February 15, 2012, the federal court ruled that "the Communicable Disease Exclusion does not preclude coverage of plaintiff's [salmonella-contamination-related] claims."

In the federal action, the court did not look to the internal inconsistencies in the policy to find in favor of coverage (as the New Jersey court had previously done). Instead, the federal court found that the terms of the policy were ambiguous and that coverage should be afforded because it comports with the "reasonable expectation" of the policyholder. In the words of the court, it would be objectively reasonable "to believe that the Communicable Disease Exclusion would not exclude coverage for damage from actual or alleged food borne bacteria, including salmonella. . . . This would be precisely the type of risk [the policyholder] would want to insure against."

Implications

In this recent case, our client's product was not the cause of the salmonella outbreak. Yet even that fact was not enough to avoid the protracted litigation of two separate insurance coverage suits.

Today's litigious claims environment poses a real risk for food and beverage companies. Where unintended losses arise due to food-borne contaminants—even where the policyholder is completely innocent of any wrongdoing—the policyholder may not have the insurance protection that it thinks it does.

To mitigate such risk, food and beverage companies should play an active role when it comes to their insurance. Companies should do the following:

  • Comprehensively evaluate the risks they face.
  • Remain aware of the legal coverage positions taken by insurance carriers vis-à-vis those risks.
  • Carefully review, analyze, and understand the terms, conditions, and exclusions contained in their policies.
  • Negotiate aggressively—at the policy procurement or renewal stage—to obtain the broadest protection available.