Virginia Supreme Court Affirms No Coverage Under Property Policies For Contaminated Infant Formula Due To Product Exclusion Endorsements

On April 20, 2012, the Virginia Supreme Court unanimously affirmed a trial court decision holding that product exclusion endorsements precluded coverage under first-party property insurance policies for contaminated infant formula manufactured by the insured. In doing so, the court made new law in the commonwealth of Virginia. PBM Nutritionals LLC v. Lexington Ins. Co., et al., 724 S.E2d 707 (Va., April 20, 2012). Richard Bennett handled the trial and represented the insurers on appeal.

The policyholder was PBM Nutritionals, LLC, a Virginia infant formula manufacturer. PBM manufactured its products at a Burlington, Vt., plant by mixing dry ingredients with heated, filtered water. To heat the water, the insured used a heat exchanger that passed steam along the outside of tubes containing the process water. Once heated, the water then passed through filters downstream from the heat exchanger.

In December of 2008, the insured discovered that the valve that controlled the flow of steam into the heat exchanger was leaking steam in the closed position, and it ordered a replacement valve. It then continued to manufacture infant formula with no problems. Between January 20 and January 22, 2009, before the new valve had arrived, PBM conducted an extensive cleaning of the system in preparation for the manufacture of Profylac, a hypoallergenic baby formula product. Routine cleanings for other product runs take no more than four to six hours, but the Profylac cleaning process is 42 to 46 hours long. During this cleaning, the process water that was sealed in the heat exchanger's tubes and the filter housing became superheated by steam leaking through the defective valve, and that eventually caused the water filters to disintegrate into their constituent components (melamine, cellulose, and other filter materials).

After the cleaning, PBM – unaware that it was using process water with dissolved filter elements in it – manufactured 25 batches of Profylac. FDA-mandated melamine testing subsequently disclosed that all of the batches contained that substance, and PBM decided to destroy the entire Profylac run because it was convinced that melamine and other filter media had infiltrated all 25 batches. As its executive vice-president testified at trial, the product had no salvage value, was unfit for human consumption, and was unmarketable as a result of the contamination. The loss exceeded $6 million.

PBM made a claim under a product contamination policy...