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Customized Distribution Services v. Zurich Insurance Company

373 N.J. Super. 480, 862 A.2d 560 (App. Div. 2004)

INSURANCE—Under a Warehouseman’s Liability form of insurance coverage, the loss in market value of misrotated product that results in its sale as outdated goods is covered.

A distributor operated a warehouse for the storage of a beverage product. The beverage manufacturer notified the distributor that the distributor had been shipping inventory out of turn, with expiration dates outside of a specified twenty-day window. It warned the distributor that this misrotation would force it to sell the affected product to secondary markets as a lower grade product and at less than fifty percent of the bulletin price. As a result, the manufacturer claimed that it sustained a loss over one million dollars. It sued the distributor to recover that loss. The distributor notified its insurer of the claim, telling it that the product had been selling poorly, causing the distributor to use more space than was anticipated. According to the distributer, this caused the product rotation problem. The insurance company denied coverage on the basis that the manufacturer’s loss was due to poor product sales. It cited provisions in the distributor’s insurance policy that excluded losses caused by or resulting from delay, loss of use, loss of market or from gradual deterioration.

The distributor then notified the insurer that it had received new correspondence from the manufacturer showing that one hundred percent of the claim was due to misrotation, and not because the product was not selling. The insurance company responded that the distributor was covered for direct physical loss, and not for gradual deterioration, and that any role misrotation may have played was irrelevant for the purposes of coverage. The distributor then sued the insurance company for coverage.

The insurer moved for summary judgment, contending that there was no coverage under the distributor’s Warehouseman’s Liability form because the alleged misrotation did not cause a direct physical loss. It also asserted that if the impending expiration was a “loss” as defined by the policy, it was expressly excluded by the exemption for loss based on gradual deterioration. The insurance company also argued that the product had not actually expired, but merely that the period had passed in which it could be distributed at full market value. Therefore, it argued there was no coverage because there was no direct, physical loss.

The distributor argued that a reduction in market value constitutes a loss. In response, the insurance company emphasized the section of the policy that excluded losses resulting from delay, loss of use, loss of market, or any other consequential loss. The distributor contended that this provision was ambiguous, and that “loss of market” did not exclude a “loss of market value.” The lower court granted the insurance company’s motion for summary judgment. It found that misrotation resulting in distribution at submarket values did not constitute a direct and physical loss. The lower court also found that the “loss of use” exclusion applied because there was a substantial loss of use given that the product could not be sold through the normal distribution channels.

On appeal, the Appellate Division concluded that the lower court erred in finding that there was no direct physical loss or a risk of such loss. For coverage to apply, it was not necessary that the product’s chemical composition be altered. Additionally, the policy’s use of the term “risk,” in “risk of direct, physical loss,” supported the view that the insurance policy did not require that there be any actual physical damage to or alteration of the material composition of the property or its packaging. The Court found that the product did in fact change – not in material composition, but in how it was perceived by the manufacturer’s customers as a result of an undue passage of time. Such a change is the functional equivalent of damage of a material nature or an alteration in physical composition. Because of this change, the product lost value as if it had gone bad in some other material way.

The Court also held that the “loss of market” exclusion was to make it clear that the policy was intended to insure warehouses were actually operating warehouses, not holding products in order to speculate in them. To find coverage in this case would not be contrary to such a purpose. There was no dispute that the distributor was acting as a warehouse. Furthermore, the only pertinent language in the exclusion was whether the distributor’s liability was the result of delay, loss of use, loss of market or any other consequential loss. The Court held that it was not. The policy’s clause appeared to describe the damages of the insured, not that of others. The damages the distributor sought to have covered were not its consequential damages, nor did it lose a market or use of the product. Therefore, the Appellate Division reversed the lower court’s decision, holding that the Warehouseman’s Liability form issued by the insurance company covered the losses claimed by the manufacturer as a result of the distributor’s misrotation of the product.

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