Policy Doesn’t Obligate Insurer to Cover Prevention Costs. Should Common Law?

By | June 13, 2022
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A salad dressing maker is seeking coverage from its insurer for costs it incurred in preventing a shutdown of one of its processing plants due to a pollution event.

Massachusetts-based Ken’s Foods maintains its insurer has a common law duty to cover the expenses it incurred to prevent an imminent covered loss even if its policy says otherwise.

But whether Massachusetts recognizes such a common law duty is unclear. The federal court — First Circuit Court of Appeals— that agreed to take up the case wants the state’s highest court to weigh in.

The company’s $10 million comprehensive environmental insurance policy, which was issued by Zurich subsidiary Steadfast Insurance Co., covered both clean-up expenses as well as business losses resulting from pollution events that cause a “suspension of operations.”

Steadfast denied the claim for costs related to preventing a suspension of business, arguing that while the insurance policy covers business losses resulting from a complete suspension of operations, it does not cover “ex ante” (before the event) prevention efforts.

Ken’s Foods sued in federal court, seeking nearly $3 million together with interest, costs and attorneys’ fees.

The Question

The federal appeals court in Boston is now asking the Massachusetts Supreme Judicial Court to weigh in on the question:

To what extent, if any, does Massachusetts recognize a common-law duty for insurers to cover costs incurred by an insured party to prevent imminent covered loss, even if those costs are not covered by the policy?

In December 2018, an accidental discharge at Ken’s Foods’ processing facility in Georgia caused wastewater to enter waterways. Ken’s Foods immediately addressed the “pollution event” to prevent further discharge and to clean up the pollution, including by fully cooperating with Georgia state officials. The source was contained by February 2019.

Ken’s Foods plant in McDonough, Georgia.
Source: Ken’s Foods.

Part of Ken’s Foods’ effort went to preventing a suspension of operations at its Georgia facility, which is one of four it has across the country. These efforts included stopping the actual pollution event, negotiating “allowances” with the county to accept pre- treated water that would otherwise have exceeded acceptable levels, and continual processing of the contaminated water before releasing it to the county for further treatment.”

Ken’s Foods’ Costs

All told, Ken’s Foods estimated that it incurred over $2 million in its efforts to prevent a suspension of operations. Due to its prevention efforts, Ken’s Foods never had to suspend operations at its Georgia facility, which manufactures its entire line of salad dressings and other food products, producing an average monthly profit of “at least” $9.6 million. The plant employs approximately 350 full-time employees who are collectively paid $1.6 million per month. Thus, without its prevention efforts, Ken’s Foods claims it would have incurred losses in excess of the $10 million coverage provided by its policy with Steadfast.

The “suspension of operations” coverage provision in the policy says that Steadfast will pay “other loss” if the pollution event directly causes a “suspension of operations.” Suspension of operations is defined to mean “the necessary partial or complete suspension of ‘operations’ at the ‘covered location’ as a direct result of a ‘cleanup’ required by ‘governmental authority.'”

Mitigation Efforts

The policy also discusses Ken’s Foods’ duties regarding mitigation. In the event of a suspension of operations, the insured must act in good faith to mitigate actual loss of business income, “diligently execute” a cleanup, and resume operations as soon as practicable.

A federal district court granted summary judgment for Steadfast because it concluded that there is no indication that Massachusetts common law entitles Ken’s Foods to recover “costs undertaken to avoid a suspension of operations [that] are not covered by the applicable insurance policy.”

While Ken’s Foods relies solely on a common law duty to force Steadfast to cover its preventative expenses, it points to no Massachusetts case recognizing such a duty. Ken’s Foods posits that the Massachusetts Supreme Judicial Court would recognize the duty, which it claims is “is deeply rooted in the common law.”

No Evidence

The federal court criticized Ken’s Foods for coming to federal court if it believed the state court would recognize its common law claims but decided to get involved because it could find no convincing evidence that the state court has in fact recognized such common law claims.

Steadfast disagrees that it has a common law duty and further contends that Massachusetts has categorically rejected applying any common-law duty that puts obligations on insurers beyond the express terms of the policy. But the federal court said it does not agree that Massachusetts has already decided the issue and there are no Massachusetts supreme court decisions on the matter.

The federal appeals court notes that an argument in favor of a common law duty is that it would align the interests of the parties. Without a duty to compensate for actions that prevented a covered loss, an insured may decide to just allow its operations to be suspended to ensure it receives insurance proceeds — in this case, $10 million — rather than eat the costs ($2 million by Ken’s Foods) to prevent the harm.

Interest in Prevention

The court further noted that an insured still has an interest in preventing a suspension of operations even if its insurance does not cover prevention costs, especially if the suspension would cost more than insurance would cover.

Ken’s Foods alleged that it would have been out $10 million per month if it had not prevented a shutdown. But the court said it is “not obvious” that Ken’s Foods would have permitted that to happen even if it were clear Steadfast had no obligation to reimburse the cost of prevention measures up to the $10 million coverage limit.

Even Ken’s Foods itself admitted that it “would have wanted to avoid firing any personnel and to meet its payroll obligations” and that its losses from a suspension of operations would have consumed the policy’s entire limit of liability.

The appeals court rejected the district court’s dismissal of Ken’s Foods’ argument “merely because no Massachusetts court had yet done so.” The appeals court called that “too stringent a standard.”

The court also found that precedents in other jurisdictions fail to “generally and persuasively” offer guidance in one direction.

Thus the federal court has turned to the state’s highest court:

“Importantly, whether Massachusetts common law recognizes an extra-contractual duty for insurers raises important questions concerning a significant, regulated industry. Moreover, we can see the question arising in future cases, and having an answer to the question from the SJC would eliminate an incentive for forum shopping.”

Topics Carriers

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