Uh-Oh, Do I Have Coverage For My SpaghettiOs?

Product and food recalls, such as the well-publicized car recalls earlier this year and the recent recall of 15 million pounds of SpaghettiOs, continue to plague large and small businesses across industries. For the month of May 2010 alone, the Consumer Products Safety Commission (“CPSC”) and the Food and Drug Administration (“FDA”) listed nearly 50 product and food recalls, including the recall of 1.8 million toy dart guns and 1.2 million water bottle spouts. The May 2010 recalls involved a broad range of products and industries, including electronics, machinery, pharmaceuticals, sporting goods, house wares, clothing, baby food and various types of produce. Because recalls and corresponding liabilities can be hugely expensive, insurance procurement and coverage issues should be considered in connection with any recall risk assessment or plan.

Product recall coverage may sound simple enough. However, coverage may be found in unexpected places. Conversely, unexpected exclusions and other limitations may threaten coverage. For example, policyholders may not expect coverage to be available under commercial general liability (“CGL”) policies for their own costs of withdrawing, recalling or replacing their own product because of a known or suspected defect. However, policyholders may be able to add such coverage to their CGL policies by endorsement. For example, ISO’s “Product Withdrawal Expense Coverage Form” provides coverage for “[r]eimbursement for product withdrawal expenses incurred by the insured because of a covered product withdrawal.” See ISO Form No. CG 00 66 12 04.

On the other hand, policyholders may expect their CGL policies to cover costs associated with third-party claims for bodily injury or property damage arising out of a recall. However, insurers may argue that such coverage is barred by “sistership” or other similar exclusions. Sistership exclusions, which are common in CGL policies, exclude coverage for damages arising out of withdrawing, recalling or replacing the insured’s product because of a known or suspected defect or deficiency. Sistership exclusions derive their name from their original application to grounding “sister” aircraft when a defect was found in an aircraft of the same model.

Insurers frequently attempt to deny coverage based on sistership exclusions. However, sistership exclusions do not bar coverage for all types of recall liabilities. For example, courts have found that sistership exclusions do not apply to: (1) recalls initiated by third-parties, as opposed to the insured; or (2) the inspection, removal or replacement of a product that has already caused damage. See e.g., Mid-Continent Cas. Co. v. Titan Const. Corp., 2009 WL 1587215 at *6 (W.D. Wash. 2009) (“Sistership exclusions apply only to withdrawal of a product by the insured, not by a third party.”); Centillium Communications, Inc. v. Atlantic Mut. Ins. Co., 528 F.Supp.2d 940, 950 (N.D. Cal. 2007) (recognizing product recall or sistership exclusions apply to preventative or curative actions, in which a danger is merely apprehended, not to “actual damage caused by the very product giving rise to such an apprehension.”).

Policyholders can further protect themselves from sistership and other exclusions by adding coverage to their CGL policies by endorsement. For example, ISO’s “Product Withdrawal Expense Coverage Form” discussed above also expressly provides coverage for “[l]iability to others for damages an insured is legally obligated to pay because of product withdrawal expenses (including legal fees).” See ISO Form No. CG 00 66 12 04.

Finally, as an alternative to relying on CGL coverage alone for recall related expenses, policyholders can purchase specialty product recall insurance coverage. Such coverage is available from various insurers under various names, including “product recall,” “product tampering,” “product contamination” and “product withdrawal” insurance.

As with any insurance, policyholders purchasing specialty product recall insurance or endorsements to their CGL policies should pay close attention to the exact terms of the coverage, including but not limited to limits and sub-limits, retentions or deductibles, the scope of covered expenses and definitions of key terms. Like all insurance coverage, the key to coverage for recall expenses will ultimately depend on the actual terms of the relevant policy(ies) and the facts of the recall and associated liabilities at issue.