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Instances of product recalls are on the rise causing companies and their insurers to bash out a new regime going forward. Stewart White and Nick Pester report

A number of recent high-profile product recalls has reopened the debate over the need for recall insurance and where the legal liabilities lie. Recent research conducted by Reynolds Porter Chamberlain into the number of products being recalled in the consumer goods, food and pharmaceutical sectors revealed a 16 per cent increase in recalls in 2005 (see diagram). This is a trend reflected in the number of products recalled across the EU – up 126 per cent in 2005, according to the latest European Commission statistics.

Recalls v risk

Product recall is expensive in terms of profitability and brand value, but much less so than the product liability claims that a recall can prevent. It is unsurprising that a high-profile recall, such as that of Sudan 1 dye in February 2005, has resulted in increased interest from producers in their potential liabilities and risk financing.

This has also been evident in relation to recent developments concerning the presence of benzene in beverages. Benzene is a known carcinogen that is excluded from foodstuffs, except in controlled quantities.

The US Food and Drug Administration had previously advised that interactions between certain ingredients in soft drinks might lead to the formation of benzene at levels that would exceed limits for water prescribed by the World Health Organisation.

Since the publication of that information, the UK Food Standards Agency (FSA) has ordered a survey of benzene in soft drinks (for which there is currently no prescribed limit). To date, the FSA has received results of tests for benzene carried out on 230 drinks on sale in the UK. While preliminary findings indicate that the issue is not a cause for major concern, the FSA is continuing to investigate. Testing is expected to be completed by early April, after which the results will be published.

Despite the reassuring preliminary findings, the effect of the FSA’s investigation appears to have contributed to an increase in demand for insurance cover. Recall insurer Beazley recently reported a 200 per cent rise in demand for product recall cover. That demand is expected to rise still further as a direct result of the FSA’s ongoing inquiry.

Increase in recalls

There are more general factors that have contributed to the increased level of awareness within industry. These include inadequate quality-control processes on production lines, where a recent increase in the number of products imported from outside the EU has made it potentially more difficult for suppliers to enforce quality control, particularly in instances where products are manufactured on the other side of the world.

Furthermore, in the context of increasing concern for ethical practice, coupled with the significant marketing costs incurred in the promotion of both new and household-name products, producers and suppliers are becoming more conscientious in the protection of both their brand names and reputations in the market. This is amplified further by an increasingly litigious consumer environment, which has led suppliers to be acutely aware of the risks they may face should a product cause personal injury or property damage.

Beyond self-regulation

There has also been the introduction of the General Product Safety Regulations 2005, which came into force on 1 October 2005.

The key obligation under these regulations is for producers to place onto the market only safe products, namely products presenting no, or minimal, risk when subject to ordinary use. Distributors must not supply products they know, or should presume, to be unsafe.

The regulations also for the first time create an ‘enforcement authority’ to regulate the industry (in the UK this is generally the local authority). If a producer or distributor concludes that the product it has placed on the market is unsafe, it must notify immediately the enforcement authority in writing and provide details of the potential risk and actions taken.

There is a range of remedies and punishments available to the enforcement authority, such as suspending the distribution or marketing of the product, withdrawing the product from the market completely, or even imposing criminal sanctions, such as imprisonment and fines of up to £20,000.

Implications for insurance

Most producers and distributors will already have in place adequate measures to respond to product safety issues. In spite of this, the regulations have introduced a new and wider mechanism covering production through to recall.

The explicit requirements laid down by the regulations may lead to a sharp increase in the number of product recalls over the coming months. This will, in turn, require both insurer and insured to take a closer look at the provisions currently in place within the relevant policies of insurance.

Stuart White is a partner and Nick Pester a solicitor at Reynolds Porter Chamberlain

In this respect, it is important to note that a typical product recall insuring clause will usually only be triggered by a decision taken by the insured in relation to a product’s withdrawal. A decision that has been forced upon the insured, for example by reason of any statutory power, is often expressly excluded. This has the obvious potential to cause problems in the context of the regulations, where the suspension or withdrawal of a product may be forced upon a supplier by the enforcement authorities.

The introduction of the regulations is likely to cause underwriters and the insured or their brokers to consider carefully the scope of their policies to ensure that the cover provided reflects accurately both the expectations of the parties and the post-regulatory landscape.

While it may be the case, therefore, that a short period of uncertainty may follow while policies are adapted to reflect the new regime, the regulations also provide clear guidelines to which underwriters and the insured can refer, both in tailoring cover to meet the needs of the current trading environment and to handle more efficiently the increasing numbers of products being recalled. •