UK: Product Liability Insurance

Bacardi-Martini is a well-known drinks company that markets a number of brands of carbonated alcoholic drinks. In 1998, traces of benzene were detected in two of Bacardi’s product ranges. Although the quantity of Benzene found in the drinks did not pose a risk to health, public concern and the need to protect its business led Bacardi to implement an extensive product recall programme. The recalled product was destroyed.

The benzene had been introduced into the drinks as it had not been removed from carbon dioxide used to carbonate the drinks. Bacardi had contracted with Thomas Hardy Packaging Limited (THP) to manufacture and bottle Bacardi’s products. To enable THP to do so, Bacardi supplied THP with alcoholic concentrate and packaging materials. THP obtained the carbon dioxide for the manufacture of the drinks under a contract with Messer UK Limited (Messer). Messer, in turn, obtained the carbon dioxide from Terra Nitrogen (UK) Limited.

THP was adjudged to be in breach of its contract with Bacardi and liable to compensate Bacardi for its loss arising out of the recall. The proceedings before the Court of Appeal concerned an action by THP to recover the damages awarded against it from Messer on the basis of breach of implied terms of satisfactory quality and fitness for purpose under the contract for the supply of the carbon dioxide. Messer denied liability on the basis of clauses in the supply contract that purported (a) to limit Messer’s liability for direct physical damage to property to £500,000 and (b) to exclude all liability for economic loss.

Two issues fell to be determined by the Court. These were whether:

1 the contamination of Bacardi’s drinks amounted to direct physical damage to property; and

2 the clauses purporting to limit and exclude Messer’s liability were unenforceable by reason of the fact that the clauses were unreasonable for the purposes of the Unfair Contract Terms Act 1977.

The Court of Appeal endorsed the findings of the trial judge. These were that:

• the test to determine if there has been direct physical damage to property is whether there has been harm to existing property that reduces the value of that property;
• the property subject of the claim against Messer was the finished drinks manufactured by THP. This final product did not come into existence until after the carbon dioxide containing the benzene had been introduced during the manufacturing process. Therefore, it could not be said that the acts of Messer had caused harm to existing property. Consequently, the claim against Messer was not in respect of direct physical damage to property, but was simply one for the recovery of an economic loss suffered by Bacardi that had been passed onto THP as a result of the judgment entered against THP. In reaching this decision, the Court of Appeal supported the trial judge in rejecting the argument that there had been property damage to the other ingredients used to manufacture the finished drinks (i.e. the alcoholic concentrate supplied by Bacardi). The Court of Appeal considered the "more natural view" was that the concentrate and other ingredients used to produce the finished drinks ceased to exist once the manufacturing process was complete and were replaced by the finished drinks; and
• the clause in the supply contract purporting to exclude any liability of Messer to THP for economic loss was unreasonable for the purposes of the Unfair Contact Terms Act 1977 and therefore was unenforceable. Therefore, as the claim against Messer for the recovery of an economic loss, THP was entitled to make a full recovery from Messer of the damages THP had paid to Bacardi.

Although this case was one that concerned the construction to be placed on contractual terms, the decision of the Court of Appeal as to what can and cannot constitute physical damage to property is of considerable significance in the field of product liability insurance.

As was recognised by the Court of the Appeal in the earlier case of Rodan v. Commercial Union [1999] Lloyd’s Reports IR 495, product liability cover is typically restricted to liability for physical consequences caused by a product supplied by the insured. Although there was no evidence placed before the Court in Bacardi of the insurance cover Messer had the benefit of, if this had been limited to such "typical" product liability cover, then Messer would have been uninsured for the liability the Court determined it had to THP. This outcome may come as a surprise to insureds under product liability policies involved in the supply of raw materials to a manufacturer.

That said, it is not uncommon to find that a product liability policy also covers the insured in respect of a loss of use of third party property caused by a product supplied by the insured, in addition to coverage for physical damage to third party property. The Court of Appeal in Bacardi considered that the nature of the consequences of the contamination of the finished drinks was that they were rendered useless. Subject to the wording of the relevant policy, such a liability would appear to be caught by a product liability policy, if this additional protection in respect of a loss of use of third party property had been purchased by the insured.

Nevertheless, it is plain that the decision in Bacardi is a favourable one for insurers in that it does limit the scope of an indemnity provided by a product liability policy. The Court of Appeal did not have the benefit of any direct precedent to guide it in reaching its decision that neither the finished drinks nor the constituent ingredients were physically damaged. This in itself may lead to this decision being questioned in the future. However, any challenge to this decision is unlikely to be forthcoming in the short term as no appeal has been made to the House of Lords.

© Herbert Smith 2002

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