The importance of contract review and product recall cover
I received a call early in the week from a business owner (the Insured) who was being sued for failure of their product and had been told their insurance program would not respond.
The background of the case was that the Insured was a company that mixed food stuffs under contract for a major manufacturer. They entered into a long term contract for this work which gave the business some security or so they thought. The Insured was to source the ingredients from a third party who was on a list provided by the customer. The Insured did this and things went along fine for a few years. The ingredients, subject to a seperate contact to which the Insured is not part, were to be treated for a number of things by the suppliers before it was delivered to the Insured’s premises for blending and packaging. The Insured was to either sieve or filter the ingredients as part of the blending process. The Insured found that there normal filter for the process was damaged and so to keep inside the requirements of the service agreement/contract they used a filter with smaller holes. This immediately detected that there was some living organisms in the supplied product and production immediately stopped and the customer and supplier were immediately notified.
The Insured’s customer was horrified at the discovery and on testing of their own found that product had been received by them with the same infestation which had not been detected. Product had to be withdrawn from supermarkets. The cost of any recall including the cost of the product, the loss of profits, the collection and dumping costs, the testing costs not to mention legal fees always adds up to a minimum of 6 figures and often much more.
At common law the Insured has done nothing wrong. It has followed the terms of its contract to the letter and when they discovered the infestation in the product being supplied to them they advised their customer. They did not choose the supplier of the product. Their own processes were within or more stringent that the contact required and I repeat they discovered the problem. Allegedly the supplier of the food product started to outsource the treatment for the insects to an outside contractor and allegedly they have not done it correctly.
Under these circumstances you would expect the Customer to be thanking the Insured and singing their praises. Unfortuneately big business does not always work this way. It has gone to the Customer’s legal department who have already looked to recover their losses from the Insured (not to my knowledge from the supplier of the product where the infestation arose and who outside the scope of their agreement outsourced the part of the process which should have removed/prevented the infestation). The Customer is relying on the contract to protect them.
More and more we see large corporations with their risk management and legal teams, often with the help of external law firms, draft contacts which transfers the risk to their contractors and sub-contractors. More and more contractor do the same and transfer it down to sub-contractors and sub-sub-contractors. Often the small business owners and sole traders do not have the expertise to understand the contacts they enter into. They often only look at the revenue stream and “sign the bottom line”.
Finding out too late that contractually they are liable for the loss of the product and the product recall, the Insured has turned to their products liablity policy and their product contamination cover and found, I have since confirmed, that the loss is not covered. At several million dollars this loss has the potential to destroy the business.
In reality there should be a right or recovery back from the party (ies) that released product that was out of specification and not fit for its use. The trouble is to fund the legal action necessary at the same time fulfil the obligations of the contact with the Customer and still keep operating knowing that this could happen at any time again and they do not have the correct insurance.
This is where the broker can bring real value to their client. Understanding all the contracts a client has entered into is an important part of the role of a broker. Ideally this review should be taken before the contract can be signed as often harsh and unfair conditions can be removed by negotiation.
The quality of the product liability policy and product recall and product contamination covers can then be reviewed to ensure that they are not “Clayton’s” covers. Cover when you have no cover. The scary thing is that some of the premiums charged for product recall and contamination are significant but when I read them I struggle to see when they would ever cover anything, particularly where the Insured product goes to form part of a larger more complex product and the failure of the Insured’s product damages the finished combined product.
In summary, it is far too late after the loss to find a contractual obligation to make good something that normally a business would not be held responsible for under any current legislation or the common law. Remember big companies are for every transferring their risk to smaller companies under the guise of risk management. Secondly, products liability does not cover the product itself. Only physical loss or damage, and personal injury arising from the use of the product. Thirdly, most product liability and product recall/contamination policies exclude contractual liability unless the Insured would have been found negligent or legally liable outside the contract anyway. Finally, many product liabilty and product recall or contamination policies exclude damage to property into which the insured product forms part. Ridiculous situations arise where a tradesman fits say a wood burning metal fire box into a house and through his negligence the house burns down. The claim fails in the first instance as the insurer argues that with the incorporation of the fire place/fire box into the house, the house has become the product and there is no cover.
I often say that you get what you pay for but with this sort of cover, a client can by tens of thousands of dollars and still have no cover. This whole area is of grave concern to me and it certainly is to the Insureds I am attempting to assist in both case studies (the food manufacturer and the installer of the fire box).
LMI PolicyComparison can assist brokers with this while the site has a large data base of policies available in the market. Peter O’Brien in LMI’s Sydney office also heads a comprehensive contract review service which many brokers and clients avail themselves of.