A $10 Million Subrogation Problem for the PCI Market?

Is Subrogation Viable Under Product Contamination Insurance?

An Insured Event results in a $10 million Loss.  Naturally, subrogation is an immediate consideration.  Based on the findings of a root cause investigation and the determination that a supplier caused the insured’s Loss, the insurer will subrogate against the supplier recovering much if not all the paid Loss.  At least, in theory.

Earlier this month, a federal judge in Maine quickly dismissed a subrogation complaint seeking $10 million in damages under a product contamination insurance (PCI) policy.  The unusual grant of a motion to dismiss raises a critical issue as to whether subrogation is viable under product contamination insurance/product recall insurance (PCI/PRI) policies.

The Claim’s Circumstances

Advanced Pierre Foods, Inc. (APF) was insured under a Starr Response Product Contamination Policy, which contained an Accidental Contamination limit of $10 million.  In 2014, APF and Mountaire Farms Inc. (MFI) entered into a supply contract, which provided for the delivery of raw chicken parts.  In February 2015, MFI shipped to APF’s Portland, Maine facility approximately 120,000 pounds of fresh boneless chicken parts.  APF used the chicken to prepare ready-to-cook dishes for retail.  Shortly thereafter, individuals were sickened with Salmonella Enteritidis in two states.  The United States Food Safety Inspection Service (FSIS), the investigative arm of the U.S. Department of Agriculture, linked the outbreak to APF’s raw chicken products, and a health alert was issued on July 1, 2015.  The resulting recall involved 1,707,494 pounds of raw chicken product.  APF suffered losses in excess of $10 million, including recall costs, lost sales, loss of business, and loss of customers.  APF’s root cause investigation traced the source of the Salmonella to MFI’s products. 

Filing in Maine Over Other Jurisdictions

After paying a limits loss, Starr retained counsel to pursue subrogation.  MFI, with operations in Maryland, Delaware, Virginia, North Carolina, and Arkansas defended the suit that was filed in Maine.  Based on the court’s ruling in Starr Surplus Lines Insurance Company v Mountaire Farms Inc, 2018 WL 3676839 (D. Me Aug. 2, 2018), the choice of jurisdiction may have been determinative. 

The Extraordinary Grant of a Motion Commonly Dismissed

In its complaint, Starr alleged three counts, (I) breach of implied warranty of merchantability; (II) breach of implied warranty of fitness for a particular purpose; and (III) a claim for strict liability. 

Rather than file an answer to the complaint, MFI’s counsel filed a motion to dismiss.  Such motions are not commonly granted.  In its motion, MFI raised four arguments: (1) all claims fail because Salmonella is an inherent and recognized characteristic of raw chicken; (2) Starr’s strict liability claim is barred by the economic loss doctrine (ELD); (3) APF’s contract with MFI waived all prior warranties; and (4) Starr’s claims are preempted under the Poultry Products Inspection Act.  The court quickly granted MFI’s motion based on the initial two arguments and never reached the remaining arguments. 

Salmonella as a Product Defect

Starr argued that MFI was strictly liable as a merchant of chicken, which was defective, and such defect caused APF’s damages.  In response, MFI argued it is widely known Salmonella is inherent in raw chicken and eliminated through cooking.  On this basis, Salmonella cannot render chicken “defective,” “unfit for its particular purpose,” or “unreasonably dangerous.”  The federal judge reviewed the two tests Maine courts utilize with defective food product claims.  The traditional test, known as the foreign-natural test, “provides that a food manufacturer cannot be strictly liable for supplying a product with natural ingredients that is free of foreign ingredients”.  Id. at *2.  Under the other test, known as the reasonable expectations test, regardless of whether a substance in a food product is natural, liability exists where a consumer would not have reasonably expected to find the substance in the product.  Id.  The court found that under either test, MFI prevailed.  The court further ruled that even if Starr’s claims could succeed under either test, they were also barred by the application of ELD. 

Maine’s Strict Adherence to ELD

Under Maine’s strict adherence to ELD, Starr’s claims were barred because it only alleged “economic harm to APF’s raw chicken product itself.”  Id. At *4.  As the court explained, under ELD, “courts do not permit tort recovery for a defective product’s damage to itself or, in other words, where the injury suffered is merely the failure of the product to work properly rather than personal injury or resulting injury to other property.”  Id.  Further, the court ruled that “costs associated with product recalls are purely economic and thus barred by the economic loss doctrine.”  Id.  The court ruled that because Starr’s complaint did not allege facts identifying other sources of loss in addition to the financial losses barred by ELD, Starr did not assert a viable strict liability claim. Id.

Based on the court’s rulings, Starr’s complaint was dismissed.

Valuable Lessons

Will ELD always defeat subrogation for PCI/PRI claims?  The short answer is no.  As noted above, Maine was likely the toughest available jurisdiction in which to file this specific subrogation claim.  Did options exist?  The locations of MFI’s operations appear to have provided viable alternatives: from Virginia, which follows the minority rule in applying ELD; to Maryland, which follows the intermediate rule; to North Carolina, which follows the majority rule but also allows notable exceptions. 

The structure of how the claims were initially presented in the complaint may have also allowed the rare grant of a motion to dismiss. 

Like PCI/PRI coverage, subrogation is an expertise.  Moreover, certain subrogation experts specialize in the food industry and other PCI/PRI-related industries.  And, because ELD is always a significant consideration with PCI/PRI subrogation, determining which jurisdiction to file suit may prove critical, as it did here.

As MFI argued, APF waived all prior warranties under its contract with MFI.  Underwriters are strongly encouraged to review their PCI/PRI applications in this regard.  Additionally, whether PCI/PRI is required in an insured’s supply chain is another matter Underwriters are encouraged to consider.

 

Joe Bermudez
STEWART | SMITH
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jbermudez@stewartsmithlaw.com
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