Insured’s $2 Million Claim For Loss Prevention Costs Scuttled By The Supreme Judicial Court

In Ken’s Foods, Inc. v. Steadfast Insurance Company, the United States Court of Appeals for the First Circuit asked the Supreme Judicial Court of Massachusetts to rule on the open question of law: “Whether Massachusetts allows an insured to recover on a common law claim against their insurer for costs which are outside the terms of the insurance policy that the insured incurred to prevent an imminent covered loss.”

In the case certified to the Supreme Judicial Court, Ken’s Foods, Inc. (Ken’s Foods) had experienced a malfunction in the wastewater treatment system at its Georgia manufacturing facility. It sought coverage under its environmental liability policy with Steadfast Insurance (Steadfast) for its various costs in addressing the issue.

Steadfast paid for the necessary environmental cleanup costs but did not cover the costs that Ken’s Foods incurred to avoid a business interruption. These costs, totaling $2 million, included a temporary wastewater treatment process and resulting payments for exceeding acceptable wastewater discharge levels.

Ken’s Foods’ pollution liability insurance policy would not cover an insured’s costs to prevent a covered business interruption loss. The policy covered cleanup costs and emergency expenses caused by a pollution event necessary to avoid imminent danger to public health, the environment, or costs resulting from a related suspension of operations. As a result of Ken’s Foods’ mitigation efforts, the Georgia facility never experienced a business interruption.

In its response to the First Circuit, the Supreme Judicial Court stated that Massachusetts law does not allow for recovery against an insurer on a common law claim for loss prevention costs outside the terms of the policy.

The Court emphasized that an insurance policy is a contract between two private parties that should be interpreted according to its plain terms, which reflect the benefit of the bargain struck by the parties, including their allocation of risk.

In this case, the costs at issue fit within none of the relevant coverages in the insurance policy and were, therefore, not recoverable. The Court stated that the plain language of the insurance policy controls and that there is no basis for imposing a common-law duty inconsistent with the coverages and exclusions contained in the policy.

Facts leading to Ken’s Foods’ $2 million extra-contractual reimbursement claim against Steadfast

Ken’s Foods had an environmental damage policy with Steadfast that had a $10 million limit that covered pollution incidents and the resulting loss of income incurred by the insured for any suspension of operations caused by such an incident.

In December 2018, Ken’s Foods’ Georgia processing facility accidentally discharged improperly treated wastewater into adjacent waterways. Ken’s Foods reported to Steadfast the pollution incident under the policy.

Ken’s Foods also took immediate action to prevent further discharges of improperly treated wastewater and to clean up the pollution caused by the previous discharge in cooperation with Georgia state and county authorities.

Ken’s Foods’ remedial actions to avert a suspension of the facilities operations started with stopping the actual pollution event.

The company also minimized further contamination by “continuously pumping contaminated water” through its “temporary wastewater treatment process” prior to releasing the water to the county for further treatment.

Ken’s Foods asserted in the litigation that it initiated this temporary wastewater treatment process “to preserve plant operations and reduce environmental impact.”

To have the county accept this partially treated wastewater for further treatment, the company negotiated financial “allowances” for the county to accept pre-treated water that otherwise would have exceeded acceptable discharge levels.

Ken’s Foods claimed that without having negotiated these allowances, its facility “would have been forced to cease operations” or, alternatively, it would have been required to “contract third-party services for hauling and processing of wastewater” and, thereby, incurred fees significantly higher than the allowances negotiated with the county.

By February 2019, the pollution incident had been remedied, and the facility had not had to suspend operations because of the pollution incident.

In avoiding a suspension of operations, Ken’s Foods estimated that it had incurred $2 million in costs.

If Ken’s Foods had not expended the $2 million and suspended operations instead, the company claimed Steadfast would have had to pay more than $10 million for the facility’s suspension of operations under the environmental policy.

Ken’s Foods based its $10 million potential suspension loss on this facility producing all of Ken’s Foods’ salad dressings, generating an average monthly profit of almost $10 million while employing 350 full-time workers earning a monthly payroll of $1.6 million.

Steadfast reimbursed Ken’s Foods for some remedial actions but refused to pay anything toward loss prevention costs.

Federal District Court finds no common law duty to reimburse loss prevention costs

After Steadfast denied further payment, Ken’s Foods filed a lawsuit in the Massachusetts federal court, alleging that it is entitled to receive nearly $3 million from Steadfast, along with interest, costs, and reasonable attorney’s fees, as well as treble damages under Chapters 93A and 176D of the Massachusetts General Laws for unfair claim practices.

The lawsuit was brought under diversity jurisdiction, which allows federal courts to hear a case involving parties from different states but requires federal judges to apply state law. In Ken’s Foods’ lawsuit, Massachusetts contract law applied.

During the summary judgment hearing, Ken’s Foods admitted that the insurance policy did not cover the type of preventative costs incurred in this case. However, Ken’s Foods argued that Massachusetts law imposes a common-law duty on insurers to reimburse expenses incurred to prevent an imminent covered loss.

The district court granted summary judgment in favor of Steadfast because it determined that Massachusetts common law did not permit Ken’s Foods to recover costs incurred to avoid a suspension of operations not covered by the applicable insurance policy.

Ken’s Foods appealed the dismissal of its lawsuit to the First Circuit Court of Appeals.

The First Circuit certifies a Massachusetts law question to the Supreme Judicial Court

The First Circuit Court of Appeals took a different tack than the district court. It determined that Ken’s Foods’ argument about a common law right under Massachusetts law for insureds to be reimbursed raised a significant undecided question of Massachusetts law. See Agency Checklists’ article of June 14, 2022, “New Rule Would Make Insurers Pay Insured For Preventing An Insured Loss,”. Since under a rule imposed by the United States Supreme Court, federal courts must follow, but not decide, state law, the First Circuit certified the open question to the Massachusetts Supreme Judicial Court, to wit:

“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?”

The Supreme Judicial Court first finds whether Steadfast paid what was due under the policy

The Supreme Judicial Court accepted the referral from the First Circuit, scheduled and heard arguments from counsel for Ken’s Foods and Steadfast, and on January 6, 2023, rendered their opinion on the question of whether a common law duty for Steadfast to reimburse Ken’s Foods under these circumstances existed.

In the first instance, the Supreme Judicial Court addressed the Steadfast payments due under the policy.

The Court found only two coverages applicable to Ken’s Foods’ insurance claims:

Coverage C for Steadfast to pay reasonable and necessary “cleanup costs” associated with a “new pollution event” at an insured location during the policy period: and,

Coverage H for Steadfast to pay lost income and expenses to reduce lost income resulting from a new pollution event that caused a “suspension of operations” at an insured location during the policy period.

On the first coverage, Steadfast paid Ken’s Foods over $850,000 for expenses related to cleaning up wastewater that had overflowed from the retention pond, paying fines for the initial discharge, and hiring legal representation for employees involved in a county enforcement action.

Before the Supreme Judicial Court, Ken’s Foods did not argue that the $2 million spent on maintaining operations should be considered “reasonable and necessary” cleanup costs under the relevant coverage provision.

As the Court pointed out, the policy explicitly excludes such costs in its provision prohibiting reimbursement for:

“Any costs, charges or expenses for maintenance, upgrade, or improvement of, or installation of any control to, any property or processes on, at, within or under a ‘covered location’ even if such maintenance, upgrade, improvement or installation is required:

By ‘governmental authority; or

As a result of ‘cleanup costs,’ ‘loss,’ ‘natural resource damages,’ or ‘other loss’ otherwise covered under the policy.”

Steadfast referenced this exclusion in its response to Ken’s Foods’ claims. Ken’s Foods did not contest the $2 million expenditure being barred from Coverage C by this exclusion.

The Court next addressed whether Ken’s Foods had any possible coverage under Coverage H, based upon a pollution event causing a “suspension of operations” at the insured location.

Under this coverage, a suspension of operations at a covered location was defined as a “necessary partial or complete suspension of ‘operations’… as a direct result of a ‘cleanup’ required by a ‘governmental authority.’” Also, Steadfast was only responsible for losses sustained four days after notification of a suspension and before the insured facility could resume operations.

In Ken’s Foods’ case, the insured facility never suspended operations, nor was it ever ordered to do so by the governmental authority. Instead, Ken’s Foods, as the Court pointed out, had implemented changes to its processes that allowed for the pretreatment and release of wastewater and negotiated pollution allowances and accompanying fines with the county authority. Therefore, the Court found that no suspension of operations was necessary.

Thus, according to the terms of Coverage H, Steadfast had no contractual responsibility for the $2 million in costs Ken’s Foods incurred.

The Supreme Judicial Court’s ruling on Ken’s Foods’ common law reimbursement claim

Having found the scope of the coverage for Ken’s Foods under Steadfast’s policy, the Court next addressed the certified question: Ken’s Foods’ claim it had a common-law right for reimbursement of costs incurred to prevent an imminent covered loss, even if those costs were not covered by Steadfast’s policy.

The Court noted that while it had never addressed whether such a common law right existed in Massachusetts, this issue had divided other state courts and legal commentators. The Court listed rulings on both sides of the question, such as negative statements that:

 [A]bsent a provision that provides for reimbursement; the insurer has no obligation to reimburse an insured for costs to prevent an imminent insurable occurrence from occurring

“Most courts . . . have not allowed an insured to recover prevention costs from the insurer without an express recovery provision.

While other courts have taken positive positions, stating:

[T]he common law also recognizes the right of the insured to seek compensation from the insurer for the costs of mitigation.

[The law recognizes an] insured’s “duty to mitigate an insured loss” and “corresponding common-law right to recompense from the insurer for the cost of these efforts.

[C]osts are reimbursable if “incurred to prevent or minimize a covered loss, thus benefiting the insurer.”

The Supreme Judicial Court did not elect between these competing positions in the abstract. Instead, the Court chose only to consider the specific policy language at issue, including the coverage provisions, exclusions, and any terms that the policy did not contain that Ken’s Foods was asking the Court to implicitly incorporate into the policy as a matter of common law.

The Court concluded that the plain language of the coverage provisions and exclusions was controlling and that there was no legal basis for imposing a common-law duty inconsistent with those provisions and exclusions.

The court emphasized that the policy was a contract between two private parties and that the parties were entitled to the “benefit of their stated bargain,” including their “allocation of risk.”

In this case, the Court noted the parties were two sophisticated business entities, and the Court refused to reconsider their “contractual risk allocation.”

The Court found that “The policy’s maintenance exclusion further supports the conclusion that the parties did not intend to insure the costs at issue. The policy expressly excluded coverage for costs, charges, and expenses of maintenance, upgrades, or ‘improvement of . . . processes,’ ‘even if such maintenance, upgrade, improvement, or installation is required . . . [b]y ‘governmental authority;’ or . . . [a]s a result of ‘cleanup costs’ . . . or ‘other loss’ otherwise covered under the policy.’

The alternative wastewater treatment process that Ken’s Foods developed to continue operations, and the accompanying costs, charges, and expenses it incurred, appear to fall within this express exclusion.”

Finally, the Court rejected the existence of a common law duty requiring reimbursement outside the terms of the policy, stating:

“…the $2 million in expenses to prevent a suspension of operations was for Ken’s Foods to bear. Ken’s Foods seeks reimbursement that is not allowed by the plain, express terms of the policy in both the coverage provisions and the exclusions. Here, we are also dealing with ‘sophisticated commercial parties’ capable of and responsible for their own contractual risk allocation. Given the express allocation of risk and the sophisticated parties that contracted to allocate this risk, we decline to imply a common-law duty to fill in the gap in coverage.”

The Supreme Judicial Court’s final decision on the certified question of the First Circuit

The Supreme Judicial Court’s final response to the First Circuit was: “We answer the certified question as follows.

“There is no common-law duty for insurers to cover costs incurred by an insured party to prevent imminent covered loss, when the plain, unambiguous terms of the insurance policy at issue speak directly to the question of mitigation and reimbursement and do not provide coverage, and the costs are otherwise excluded by other provisions of the policy. To provide for recovery in these circumstances would be to rewrite the insurance contract and reallocate the risks negotiated by the parties.”

The final action on Ken’s Foods’ lawsuit will be by the First Circuit

Since Ken’s Foods’ lawsuit is pending in the federal courts, the Supreme Judicial Court’s decision does not formally end the case. Upon receipt of the formal opinion from the Massachusetts Reporter of Decisions, the First Circuit will affirm the lower court’s decision to dismiss Ken’s Foods’ claim.

Owen Gallagher

Insurance Coverage Legal Expert/Co-Founder & Publisher of Agency Checklists

Over the course of my legal career, I have argued a number of cases in the Massachusetts Supreme Judicial Court as well as helped agents, insurance companies, and lawmakers alike with the complexities and idiosyncrasies of insurance law in the Commonwealth.

Connect with me directly, by calling me at 617-598-3801.