Nutritionals v. Lexington Ins. Co.

724 S.E.2d 707

PBM NUTRITIONALS, LLC

v.LEXINGTON INSURANCE COMPANY, et al.

Record No. 110669.

Supreme Court of Virginia.

April 20, 2012.

Robert F. Redmond, Jr. (Brendan D. O'Toole; William Mullen, Richmond, on briefs), for appellant.

Michael R. Ward, Richmond (Melissa Y. York, Richmond; William A. Schneider; Morris & Morris; Morrison Mahoney, on brief), for appellee Lexington Insurance Company.

E. Ford Stephens, Richmond, (R. Braxton Hill, IV; S. Perry Coburn; Richard C. Bennett, Richmond; Micah J. Knapp; Christian & Barton; Cozen O'Connor, on brief), for appellees Arch Insurance Company and Ace American Insurance Company.Amicus Curiae United Policyholders (Ian D. Titley; William G. Passannante, Rene F. Hertzog; Amy Bach, Gavin Law Offices; Anderson Kill & Olick, on brief), in support of appellant.Amicux Curiae Complex Insurance Claims Litigation Association (Laura A. Foggan; Parker J. Lavin; Wiley Rein, on Brief), in support of appellees.

Present: All the Justices.

OPINION BY Justice S. BERNARD GOODWYN.

In this appeal, we consider whether the circuit court erred in construing pollution exclusion endorsements in a commercial property insurance policy as precluding coverage for a multi-million dollar infant formula loss resulting from the infiltration of filter elements into the formula during the manufacturing process.

Background

PBM Nutritionals, LLC (PBM) filed a declaratory judgment action in the Circuit Court of the City of Richmond against Lexington Insurance Company (Lexington), Arch Insurance Company (Arch) and ACE American Insurance Company (ACE) (collectively the Insurers). PBM sought insurance coverage for its loss resulting from infiltration of filter elements into the infant formula it manufactured between January 22 and January 30, 2009. The Insurers claimed that the insurance policies' “Pollution Exclusion Endorsements” excluded coverage for PBM's infant formula loss because the formula was “contaminated.” The circuit court found that the Insurers were not liable under the policies for PBM's infant formula losses, and PBM appeals.

Facts

Infant Formula Loss

PBM manufactures and produces infant formula at a facility located in Burlington, Vermont. PBM manufactures its infant formula by mixing dry ingredients with hot, filtered water. To heat the water, PBM uses a heat exchanger, a vessel in which steam heats water flowing through tubes. A butterfly valve regulates the steam by opening or closing to allow more or less steam into the heat exchanger. Once heated, the water is released from the heat exchanger and passes through water filters, to ensure its cleanliness before it enters the liquefying tank where it mixes the dry ingredients. Industrial dryers then dry the created mixture into finished infant formula.

On December 14, 2008, PBM conducted a routine cleaning and discovered a defect in the butterfly valve. The defect allowed steam to leak into the steam tube when the valve was in the closed position. PBM ordered a replacement valve, but it did not arrive until late January 2009. Until January 20, 2009, PBM continued to manufacture infant formula and conduct routine cleanings. PBM's testing revealed no problems with the infant formula produced during this period.

Between January 20 and January 22, 2009, PBM conducted an extensive cleaning of the system in preparation for the manufacture of its Profylac brand infant formula. PBM can complete a routine cleaning in 4 to 6 hours, but a Profylac cleaning takes between 42 and 46 hours. During this Profylac cleaning, water was sealed inside the heat exchanger water tube and in the filter housing. Because the butterfly valve was leaking, steam seeped into the heat exchanger and superheated the water in the water tube and the filter housing. Unable to withstand the superheated water, the water filters disintegrated into their constituent components of cellulose, melamine and other filter materials, which infiltrated the water.

After the Profylac cleaning, PBM began to manufacture its Profylac formula, unaware that it was using superheated water that contained melamine and other filter materials to mix the formula ingredients. When PBM tested the batches of Profylac made during this period, it discovered that 4 of the 25 batches contained levels of melamine that exceeded the Food and Drug Administration (FDA) limit of one part per million. The other 21 batches had melamine levels within the FDA limit, but PBM feared they contained disintegrated filter components.

Prior to trial, the parties stipulated that the “[e]levated levels of melamine detected in infant formula batches made between January 22, 2009 and January 30, 2009 are evidence of the disintegration of the water filters and the infiltration of melamine and other filter media into the infant formula.” PBM's Executive Vice–President Scott F. Jamison testified that all batches manufactured during this period had no salvage value, were unfit for human consumption, and were unmarketable as a result of the infiltration.

After notifying its insurance companies, PBM elected to destroy all batches manufactured after the Profylac cleaning. It sought insurance coverage for the formula it had to destroy.

The Insurance Policies

At the time of the loss, PBM had insurance policies with four different insurance companies. Specifically, PBM had property damage and business interruption policies with the Insurers. PBM also had a contamination insurance policy with Dornoch LTD.

PBM settled its claim with Dornoch for $2 million. The Insurers denied that their policies provided coverage for the loss.

To secure the policies from the Insurers, PBM retained an insurance broker to assist with purchasing sufficient insurance to manage the risk of owning a manufacturing plant. PBM sought a commercial property, or “all risks,” policy. Such policies insure “against all risks of physical loss or damage to property described herein, ... except as hereinafter excluded.”

PBM's broker ultimately arranged a “quota share” agreement whereby the three separate Insurers issued all risks policies to PBM and shared percentages of the risk of coverage. Under this agreement, ACE afforded coverage for 50% of any loss, while Arch and Lexington each afforded coverage for 25%. All three policies were based on a “manuscript form” or “broker's manuscript” prepared by PBM's broker. The manuscript form includes the insuring agreement, the terms of insurance, limits of liability, deductible, coverage, and perils excluded. PBM's broker selected the manuscript form by retrieving it from the public domain.

The manuscript form policy contained a provision entitled “Pollution.” This provision, Paragraph 9(H), states:

9. PERILS EXCLUDED

This policy does not insure:

....

H. Pollution. The Insurers will not cover loss or damage solely and directly caused by or resulting from the presence, release, discharge or dispersal of “pollutants” unless the presence, release, discharge or dispersal is itself caused by a peril insured against.

Definition: Wherever in this policy the word “ pollutant(s) ” occurs, it shall be held to mean any solid, liquid, gaseous or thermal irritant or contaminant, including smoke, vapor, soot, fumes, acids, alkalis, chemicals and waste.

PBM's broker solicited quotes from insurance companies for the coverage provided in the manuscript form policy he had prepared. As part of the negotiations, the Insurers asked for endorsements to change, alter, add, or delete coverage from that provided in the manuscript form policy. Based upon negotiations, each of the Insurers added endorsements, declaration pages, and certain forms to the manuscript form to complete their respective negotiated policies. Each Insurer added a similar pollution exclusion endorsement during this negotiating process.

A. ACE

ACE added to its policy a “Contamination and/or Seepage and/or Pollution Exclusion” endorsement, which provides:

This Policy does not insure against loss or damage caused by or resulting from any of the following causes ...:

Loss or damage caused by, resulting from, contributed to or made worse by actual, alleged or threatened release, discharge, escape or dispersal of CONTAMINANTS or POLLUTANTS, all whether direct or indirect, proximate or remote or in whole or in part caused by, contributed to or aggravated by any physical damage insured in this Policy.

....

CONTAMINANTS or POLLUTANTS mean any material which after its release can cause or threaten damage to human health or human welfare or cause or threaten damage, deterioration, loss of value, marketability or loss of use to property insured hereunder, including, but not limited to, bacteria, fungi, virus, or hazardous substances as listed in the Federal Water Pollution Control Act, Clean Air Act, Resource Conservation and Recovery Act of 1976, and Toxic Substances Control Act, or as designated by the U.S. Environmental Protection Agency.

An exception is also included in this pollution exclusion endorsement stating that the exclusion does not apply if the contamination or pollution arises from direct physical loss or damage to insured property from “Fire, Lightning, Explosion, Windstorm, Hail, Smoke, Aircraft or Vehicle Impact or Leakage from Fire Protection Equipment.”

B. Arch

The Arch policy contained a “Pollution & Contamination Exclusion Endorsement,” which states:

This policy does not cover any loss, damage, cost or expense caused by, resulting from, contributed to or made worse by actual, alleged or threatened release, discharge, introduction, escape or dispersal of contaminants or pollutants, all whether direct or indirect, proximate or remote or in whole or in part caused by, contributed to or aggravated by any physical damage insured by this policy.

....

Contaminants or pollutants means any material, whether solid, liquid, gaseous or otherwise, which, after its release, discharge, introduction, escape or dispersal, can cause or threaten damage to human health or human...