SPECIFICALLY SPEAKING | PRODUCT LIABILITY
Effectively Managing a
Food Safety Product Recall
By Simon Oddy, David Perry and Joseph Bermudez
W
hen
horsemeat
DNA
was found in
products sold
as beef across
multiple countries, the incident affected many companies with otherwise
stellar reputations and underscored
the complexities of the global food
supply. Products used on a daily basis
have longer, more complex supply
chains, with ingredients coming from
an increasing number of geographical
sources that may have different regulations for processing, labeling and handling food.
With food product recalls on the rise,
more companies are wisely investing in product contamination and
product recall insurance. Yet, in these
24 | LitigationManagement | summer 2013
complex supply chains, the potential
for disputes and litigation regarding
insurance claims is also increasing.
The interaction of insurance policies
and the levels of coverage can lead to
complications in measuring the recoverable loss and understanding the
interplay between product contamination, product recall and product
liability.
Multiple Parties
Imagine this scenario: A small U.S.
business (Company A) imports a spice
from Mexico and sells it to Company
B, which adds ingredients before selling its flavoring product in turn to a
multinational food processor and distributor (Company C) that uses the
flavoring in its flagship product — a
food dressing.
An outbreak emerges when state
health departments begin receiving
reports of consumer illnesses. The
CDC and FDA are notified and investigators identify Company C’s dressing
as the likely source and further trace
Company A’s spice as the cause of
contamination. As crisis management
protocols engage, Company C isolates
and recalls the relevant batches using
the contaminated spice, yet media
coverage escalates as illnesses increase.
Company C finds itself at the heart of
a swirling crisis, having to respond
to concerned and angry retailers and
consumers.
In the aftermath, Company C and
Company B file claims against
Company A totaling $2.5 million alleging financial damages from the use of
A’s spice. The claims include lost profits, loss associated with future product
launches due to consumer concerns,
shipping, brand reputation and other losses from the recalled product.
Fortunately, Company A is covered
for product liability and dedicated
product recall coverage and ultimately
submits a claim to its insurance company for its own losses, as well as those
of its customers. However, before any
claim is paid, an investigation, review
and due diligence process must occur.
This will involve insurance adjusters,
relevant experts, forensic accountants,
and other resources. Herein lies the
key — documenting the cause of the
alleged contamination, its impact and
the resulting losses.
Companies B and C will be understandably impatient to receive
payment for their damages while
Company A will look to preserve the
business relationship with B and C.
Company A will also seek to recover
any payments it makes to B and C
in settlement of their claims, while
documenting its own direct losses.
To increase the chances of a mutually acceptable settlement, Company
A engages its customers early in this
review process so that the third party
claims can be supported and documented before crucial evidence is lost,
damaged or deteriorates. The review
will need to consider the claim support available for losses suffered by A,
B and C.
Company A’s actions will be critical to
ensure that cooperation from B and C
is feasible even if there are differences
between B and C’s view of the financial
impact of the loss and their demands
of A in comparison to the assessment
by the insurance companies. This difference might be referred to as an
expectations gap and relates to uninsured losses.
Managing the Expectations
Gap
Disconnects and assumptions from
one or all parties emerge at various
stages of a contamination event and
can significantly impact how claims
are resolved. Practical experience has
shown that expectations gaps are best
managed early in the process. Such
gaps may exist when one or all parties
believe that:
X Crisis management insurers should
make claim payments immediately
based on a gut-feel estimate or on
limited loss investigation.
X The required information and document review could be performed
after initial payments are made or
can be undertaken remotely.
X The insurance policy will cover all
financial losses for the insured and
its customers without consideration
of cause and effect.
X Expenses incurred and allocated
to dealing with the problem that
are normal operating costs should
become part of a claim.
X One policy will cover all losses
associated with a product recall.
X Unaffected/uncontaminated production batches that are returned
by customers or held in inventory
should automatically be considered
contaminated.
X Indirect overheads are included
in the inventory valuation or costs
avoided are not considered in the
loss of gross profit calculations.
X Overall sales trends for the Insured’s
product portfolio are not considered.
Anticipating these disconnects and
mitigating them through effective
communication can help all parties navigate a food recall and related
insurance claims more efficiently.
Navigating Key Decisions
Company A has a number of decisions
in order to manage the tension created
with its customers. It must set clear
expectations, reassuring its customers
that their claim will be addressed, but
it will need to obtain supporting documentation for the amounts claimed by
its customers. If a gap caused by uninsured losses exists between Company
A’s coverage and the settlements being
claimed by its customers, A must
decide whether it will pay the difference above what is not covered by
insurance, and how best to manage
the business relationship with customers, recognizing the litigation risk, if
they are dissatisfied with settlement
amounts.
These options may be limited by the
leverage that exists between the companies. Company B or C may be a
dominant player, leaving Company
A with fewer options. The degree of
cooperation and documentation, or
lack thereof, from B and C can be critical in the claim review by Company
A’s insurer, affecting whether the resolution is timely and amicable.
The company’s systems should enable
a robust traceability exercise such that
Company A and its customers can
demonstrate the extent to which the
contaminated product actually made
it into the claimed finished products.
Where possible, only the specifically
contaminated product should be
accepted as returns, and related costs
should be recorded accordingly.
Measuring the Loss
The insurer’s goal in managing the
claim review is to develop an accurate evaluation of the recoverable
loss. Among the first steps insurance
adjusters take (frequently with the
assistance of forensic accountants)
is to analyze the claim against each
potentially invoked policy and to segregate costs to the appropriate policies
and coverage afforded by each.
The adjusters’ work includes establishing
the recall population and then testing a
representative sample of the potentially
affected products in order to determine
the extent of contamination, if such
exists. The quantum assessment, subject
to cover being triggered, will include an
summer 2013 | LitigationManagement | 25
assessment of incurred and future costs
as well as business interruption impact.
Forensic accountants will quantify the
cost of handling and disposal of the
recalled product, product replacement
and clean up. The two will work together
to value the more subjective aspects of a
claim, such as lost profits and lost market share — calculating losses in context
of broader market forces, sales prior to
the recall and product replacement (i.e.,
increased substitute product sales offsetting losses from the recalled product).
Subjective financial claims —
Forensics uses loss measurement techniques recognized by the judicial system
to estimate subjective losses such as loss
of gross profit or erosion of brand reputation, where external market factors
affect the numbers. The insurance contract will provide definitions on appropriate measurement for recoverable loss.
Product recall litigation is not limited
to food safety. Similar challenges are
involved in automotive recalls, toys,
accidental contamination, impairment or mislabeling, where a product
caused or can cause illness or death.
However, broader coverage-triggers in
some newer policies allow for certain
“softer” precursors as proof of contamination, such as:
X Has a company been recommended or requested by a governmental
agency to conduct a Class I or II
recall?
X Has media coverage implied or
alleged that the company is involved
in an accidental contamination event?
Experience and data suggest that these
additional triggers create the same crisis management requirements, loss of
business, damages, liabilities and reputation issues as an actual accidental
contamination event.
BEST PRACTICES
Given the high stakes in a product recall, it is essential to have a protocol for such
a crisis in place prior to an event. Following a few best practices can help minimize
damage to business relationships and financial position and help to avoid litigation:
K Create an atmosphere of productive communication with insurers, customers
and other parties to promote a smooth process.
K Engage the customers early in the process and encourage their participation in
the claim review.
K Set and manage expectations — among internal executives and customers —
for realistic claim estimates versus headline-grabbing loss figures.
K Provide the adjuster and team with access to data for segregation, measurement
and support of the losses.
K Be prepared to manage cash flow issues during the affected period.
K Have a crisis management plan in place before an event occurs to enable quick,
strategic responses that may help resolve a recall incident effectively.
When Litigation Occurs
If litigation is unavoidable, forensic
data is essential in strengthening the
case for all parties:
Supported financial claims —
Analysis is essential in supporting
aspects of a recall where factual data is
available regarding the financial measurement of the loss.
26 | LitigationManagement | summer 2013
consumer goods, construction materials, pharmaceuticals, cosmetics and
medical devices. In class action instances, the data is more complex because
settlements often involve financial
modeling to project a total picture of
future as well as current impact.
Broadened Coverage
Generally the trigger attribute for
a covered event has been proof of
Under product contamination or
product recall specialty policies,
insurers cover the engagement of crisis management experts — legal, PR,
food science and others — to help
companies navigate the many aspects
of a food recall. These experts operate
under NDAs given the sensitive data
involved. Due to their experience, they
also bring best practices to the timesensitive situation.
Given the complexities of the global
supply chain, it is almost inevitable
that contamination issues will occur.
Enhancing capabilities for managing
such a crisis with improved operations processes and better traceability
improves a company’s ability to support losses during the claims process.
The insurance company is motivated
to partner with its policyholder so that
it survives the crisis event. This will
enable the insured to get back to business as expeditiously as possible. LM
Simon Oddy, ACA, CFE, MCIArb is a Partner
in the New York office of RGL Forensics.
David Perry, ACII, PCA is the Director
and Executive Vice President in the Miami
Office of Charles Taylor Adjusting. Joseph F.
Bermudez is the regional managing partner of
Wilson Elser in Denver.