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Product Contamination: Strong Underwriting is Key

Insurance Law360
November 15, 2016

By Matthew L. Gonzalez and Jonathan MacBride
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In 2011, the Food Safety Modernization Act, regarded by many as a major reform of the food safety provisions of the Federal Food, Drug and Cosmetic Act, significantly expanded the powers of the U.S. Food and Drug Administration, adding a layer of compliance responsibilities to the food services industry.[1] These responsibilities, extending to manufacturers, processors, packers, distributors and importers (to name a few), seemed to place upon the food industry greater accountability for product contamination. Among other things, the FDA has authority to mandate product recalls if it finds a reasonable probability that a food item will cause adverse health consequences to humans or animals.[2]

Significantly, the FSMA does not even require that the FDA be certain that the product will cause adverse health consequences to require a recall. Given the discretion provided to the FDA, the FSMA has increased the risk to companies of recalls mandated by the government. This, in turn, has increased the risk of voluntary recalls to avoid such a mandate. Whether the recall is voluntary or mandatory, however, should be irrelevant for an insurer considering whether to underwrite a risk. A recall is a recall and should be considered as part of an insured’s loss history. Knowledge of such information in advance of writing a risk enables an insurer to more properly evaluate its exposure, and to determine the correct terms upon which to agree to bind coverage.

In February 2016, the Western District of Pennsylvania, applying New York law, confirmed this viewpoint holding that an insurer was able to rescind its product contamination policy due to an insured’s material misrepresentations made during the application process concerning its loss history. H.J. Heinz Co. v. Starr Surplus Lines Insurance Co., (W.D.Pa.).[3] In reaching its decision, the court highlights good underwriting practices that help to protect an insurer from such unknown risks.

Prior to 2013, Heinz had purchased accidental contamination insurance (ACI).[4] In 2013, as a cost reduction measure, Heinz elected to forego such insurance due to high premiums and high self-insured retentions.[5] However, in 2014, Heinz considered purchasing ACI coverage once again, but only if it were at a lower premium with a lower self-insured retention.[6]

During the application process, Starr asked Heinz to respond to a series of questions. Included in the list of questions were:

  • “In the last 10 years has the Applicant experienced a withdrawal, recall or stock recovery of any products or has the Applicant been responsible for the costs incurred by a third party in recalling or withdrawing any products, whether or not insured or insurable under an accidental and malicious contamination policy?” And,
  • “Has the Applicant, its premises, products or processes been the subject of recommendations or complaints made by any regulatory body, internal or third party audit over the past 12 months or have any fines or penalties been assessed against the Applicant by any food or similar regulatory body over the last 3 years?”

The application stated that “All questions must be answered fully. Please attach additional sheets if more space [is] required.”[7] In order to complete the application process, Heinz was also requested to certify that the “statements set forth [in the Application] or attached hereto are true and that no material information has been withheld.”[8] Heinz further “agree[d] and acknowledge[d] that its duty without limitation is to disclose [to Starr] any and all matters material to the underwriting” and that Heinz would “inform the Underwriters of any material alteration to the risk” that occurred up to the time of the policy’s inception.[9]

After careful consideration of the evidence presented, the court concluded that Heinz intentionally failed to disclose information related to six earlier losses.[10] Heinz argued that it withheld this information from its application based on its belief that Starr would not consider the misrepresented matters to be material and/or based on its belief that the losses would not be covered by an ACI policy.[11]

Applying New York law, the court noted that both intentional and unintentional misrepresentations will void a contract of insurance if the misrepresentation is material.[12] Here, the application specifically requested information on prior recalls whether or not insured or insurable. According to the court, not only did the language of the application require disclosure of these losses, but the court found reliable Starr’s testimony that the information was material to the underwriting analysis because it would have written the risk on different terms, if at all, had it known this information.[13] Ultimately, the court determined that Heinz misrepresented the information on its application to either obtain a lower self-insured retention and/or to secure a lower premium.[14]

The court noted that under New York law, an insured has no duty to volunteer information that has not been requested.[15] Thus, mere nondisclosure of these losses would not have voided the policy had the underwriter not asked the questions. In order to void the policy under those circumstances, Starr would have had to prove by clear and convincing evidence that the failure to voluntarily disclose this information was intended to defraud Starr. The court determined that Starr did not meet this burden.[16]

Having determined that the misrepresentation was material, the court next considered whether the insurer waived its right to rescind the policy because it either agreed to issue the policy despite having sufficient knowledge of the misrepresentation, or failed to promptly assert rescission after gaining sufficient knowledge during its investigation of the grounds for rescission.[17]

The court concluded that Heinz failed to meet its burden to demonstrate that Starr did not act promptly.[18] In reaching this determination, the court commented that the law places the burden on Heinz to show that Starr either had actual knowledge of the facts misrepresented or that it had been given information that was “sufficiently indicative of something more to be tantamount to notice of the unrevealed.”[19] Mere negligence by Starr was not sufficient.[20]

The court went on to state that while Starr was not perfect in its assessment, perfection is not the standard.[21] And, under these circumstances, the court determined that Starr acted more than reasonably.[22]

We caution that the court’s analysis of these issues under the laws of another state may have led to a different result. Thus, it is important to consider the lay of the land in the specific jurisdiction where you are doing business. For example, under New York law, unintentional misrepresentations proven by a preponderance of the evidence will void a contract of insurance. But had the court been applying the laws of the state of Pennsylvania, Starr would have been required to prove that the insured knowingly made false representations, or that the representations were made in bad faith, and that the representation was material to the risk being insured.[23] Unintentional misrepresentations would not have been sufficient to void the policy. Thus, Pennsylvania imposes a more difficult burden of proof than New York. In Heinz, this likely would not have mattered as the court found that the misrepresentations were intentional, but in other situations the choice of law could be determinative.

Conclusion

The FSMA allows, among other things, the government to issue mandatory recalls whenever there is evidence or concern that a facility’s food item has a reasonable probability of serious adverse health consequences. This means that companies may increasingly experience voluntary or involuntary recalls that may or may not have triggered coverage under an ACI policy, but should be relevant and material to underwriting any future ACI policies. With the increased number of recalls this legislation could generate, it is important that underwriters ask the correct questions in the application process to fully evaluate their exposure and preserve their rights to assert all policy defenses. The importance of making sure to specifically ask for all information that may be material to the underwriting process is highlighted by the increased burden of proof on the insurer if it does not ask for the information that it now seeks to use to rescind the policy. Finally, considerations about including a choice of law provision in the policies may also be important in preserving the ability to rescind the policy for intentional or unintentional misrepresentations.


Matthew L. Gonzalez is a partner at Zelle's New York office. Jonathan MacBride is a partner in Zelle’s Philadelphia office.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

[1] See the FSMA at
http://www.fda.gov/Food/GuidanceRegulation/FSMA/ucm247548.htm.

[2] See Title II Section 206 of the FSMA at
http://www.fda.gov/Food/GuidanceRegulation/FSMA/ucm247548.htm#SEC206. See also 21 U.S.C. § 350l (Mandatory Recall Authority) of the Federal Food, Drug, and Cosmetic Act.

[3] H.J. Heinz appealed this decision to the 3rd Circuit on March 2, 2016.

[4] Id. at *4.

[5] Id.

[6] Id.

[7] Id. at *9-10.

[8] Id. at *10.

[9] Id.

[10] Id. at *5.

[11] Id. at *3-4.

[12] Id. at *2.

[13] Id. at 13.

[14] Id. at *4.

[15] Id. at *5

[16] Id.

[17] Id. at *6-8.

[18] Id.

[19] Id.

[20] Id. at *6.

[21] Id. at *7.

[22] Id.

[23] New York Life Insurance Co. v. Johnson, 923 F.2d 279, 281 (3d Cir. 1991) (citing Lotman v. Security Mut. Life Insurance. Co., 478 F.2d 868, 870 (3d Cir. 1973)). Like New York, Pennsylvania requires clear and convincing evidence of fraud in cases where the insurer did not specifically ask for the information that it alleges is the basis for rescission. See Rohm & Haas Co. v. Cont'l Cas. Co., 781 A.2d 1172 (Pa. 2001).

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