The decision in PBM Nutritionals v. Lexington Insurance Company, No. 110669 (Va. Cir. Ct., April 20, 2012), highlights the hurdles a company must overcome when trying to obtain insurance coverage for a first-party loss involving 'contamination.' The case provides a guide for food companies on how best to structure their insurance programs to avoid pollution and contamination issues in first-party policies.
Some companies will undoubtedly be surprised to learn that PBM Nutritionals' loss was even considered contamination. As part of the process to make baby formula, PBM used a heat exchanger that was controlled by a valve to create steam. The valve had a defect, and the steam leaked. During the cleaning of the process equipment, the superheated water that resulted caused the water filters to disintegrate into their constituent components, including melamine and cellulose. When PBM tested its next run of product, four of 25 batches contained excess levels of melamine. PBM feared that the other batches had cellulose fragments mixed in.
Fortunately, PBM had purchased a contamination insurance policy, which paid its $2,000,000 limit. However, since PBM suffered a multimillion-dollar loss, it next turned to its property insurance program. At first this seemed promising. While the policy had a pollution exclusion, the exclusion did not apply if the release of pollutants "is itself caused by a peril insured against." Under an all-risk policy, the superheating of the water caused by the defective valve would constitute such a covered peril.
However, the property insurance policies in issue each had a contamination or pollution endorsement, and these endorsements did not have exceptions for other "perils insured against." PBM argued that it should have coverage pursuant to the exception to the original exclusion. However, the court held that the exception in an exclusion did not create coverage and that the endorsements applied.
The big takeaway from PBM Nutritionals is that policyholders must pay careful attention to their first-party property policies. Policyholders should insist on the "peril insured against" language and avoid limiting endorsements. They should examine their operations and determine if they should investigate the purchase of a separate contamination policy. With the loss of the contaminated product, the business interruption, and the damage to reputation, contamination claims can cripple a company.
For more information related to this case or other food insurance coverage issues, please contact:
Robert D. Chesler