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AMERICAN HOME ASSURANCE COMPANY v. MERCK & CO.

September 9, 2005.

AMERICAN HOME ASSURANCE COMPANY, Plaintiff,
v.
MERCK & CO., INC., Defendant, v. A.I. MARINE ADJUSTERS, Counterclaim Defendant.



The opinion of the court was delivered by: VICTOR MARRERO, District Judge

DECISION AND ORDER

This dispute between insurer American Home Assurance Company ("American Home"), and its insured, pharmaceutical manufacturer Merck & Co., Inc. ("Merck"), primarily concerns American Home's denial of liability for certain losses to shipments of products that Merck claims under an insurance policy bound and issued by American Home effective July 1, 2000 (the "Policy"). As described in numerous opinions that this Court and Magistrate Judge Francis have issued in the action,*fn1 Merck and American Home have agreed to select for review on motions for summary judgment several of the disputed claims as prototypes (hereinafter, the "Prototype Claims") in order to facilitate the settlement or more efficient litigation of remaining claims. Each of the Prototype Claims concerns finished pharmaceutical products or Active Pharmaceutical Ingredients ("APIs") that were allegedly damaged or exposed to harmful conditions during transit.

Merck and American Home have now filed cross-motions for summary judgment on several of the Prototype Claims, Merck on Prototype Claims 1-6 and American Home on Prototype Claims 1, 2 (in part), 3, and 6. Each party puts forth starkly different interpretations of the "Control of Damaged Goods" clause (the "CDG Clause") of the Policy under which Merck seeks coverage for the losses claimed in the Prototype Claims, dramatically different views of many of the facts surrounding the Prototype Claims, and widely varying interpretations of those facts.

  Upon review of the parties' voluminous submissions in this matter, the Court concludes that while it may develop a definitive interpretation of the CDG Clause and other relevant contractual provisions at this stage of the litigation, the Court cannot determine as a matter of law whether or to what extent Merck is entitled to coverage under the CDG Clause for any of the losses claimed in Prototype Claims 1-6. Consequently, it grants in part the parties' cross-motions for summary judgment and denies them in part. I. BACKGROUND*fn2

  A. THE POLICY

  The CDG Clause under which Merck claims coverage for Prototype Claims 1-6 states as follows:
The Assured [i.e., Merck] shall have full right to the possession of all goods involved in any loss under this policy and shall retain control of all damaged goods. The Assured, exercising a reasonable discretion, shall be the sole judge as to whether the goods involved in any loss under this policy are fit for use as originally intended or in any other capacity, and no goods so deemed by unfit for use shall be sold or otherwise disposed of except by the Assured or with the Assured's consent, but the Assured shall allow this Company [i.e., American Home] any salvage obtained by the Assured on any sale or other disposition of such goods.
In addition, property insured by this policy shall be deemed to have suffered an insured loss if, as a result of a fortuitous event:
Said property is deemed unfit for use by any government regulatory body and/or agency, anywhere in the world, or as a result of reasonable interpretation of regulations promulgated by said bodies and/or agencies;
or the only means of determining the existence or extent of damage is through "destructive testing."
(Policy at 10.) Neither of the parties claims that coverage is available to Merck under the first paragraph of the CDG Clause. Moreover, no "government regulatory body and/or agency" has actually deemed "unfit for use" any of the pharmaceutical products that are the subject of Prototype Claims 1-6. Merck instead asserts that the Prototype Claims are covered under an interpretation of the CDG Clause that would insure Merck "if, as a result of a fortuitous event: Said property is deemed unfit for use" as a result of its "reasonable interpretation of regulations promulgated by said [government regulatory] bodies and/or agencies." In the alternative, Merck argues that it is entitled to coverage under the "destructive testing" provision of the CDG Clause. American Home, while acknowledging that coverage is available to Merck under the CDG Clause, disputes Merck's proffered interpretation of the clause.

  Unlike the parties' dispute over the interpretation of the valuation clause of the Policy, in which each side put forth facts supporting the conclusion that its interpretation of the clause was proper, see American Home Assurance Co. v. Merck & Co., Inc., No. 03 Civ. 3850, 2005 WL 1153723 (S.D.N.Y. Apr. 13, 2005) ("American Home R&R"), the parties' dispute over the CDG Clause is not informed by substantial factual evidence. The parties instead rely on various interpretive guides available under Pennsylvania law, which governs this action, see id., to assist the Court in developing a proper interpretation of the CDG Clause.

  The Court also must interpret the "Sue and Labor" Clause ("Sue and Labor Clause") of the Policy. The clause states as follows:
In case of any imminent or actual loss or misfortune, it shall be lawful and necessary to and for the Assured, his or their factors, servants, and assigns, to sue, labor and travel for, in and about the defense, safeguard, and recovery of the said goods and merchandise, or any part hereof, without prejudice to this insurance; to the charges whereof, this Company will contribute according to the rate and quantity of the sum hereby insured; nor shall the acts of the Assured or this Company, in recovering, saving and preserving the property insured, in case of disaster, be considered a waiver or an acceptance of abandonment.
(Policy at 7.) American Home argues that Merck violated its obligations under this clause, which is of ancient origin,*fn3 to salvage the pharmaceuticals that are the subjects of the Prototype Claims. The parties present no extrinsic evidence to aid the Court in interpreting this provision.

  B. THE PROTOTYPE CLAIMS

  1. Prototype Claim 1 In Prototype Claim 1, Merck seeks insurance coverage under the CDG Clause for losses allegedly sustained to a shipment of the Merck vaccines VAQTA, COMVAX, and thimoserol-free RECOMBIVAX (collectively, the "Vaccines"), which are used to protect recipients from various forms of hepatitis.*fn4 The federal Food and Drug Administration ("FDA"), which regulates all of the products that are the subjects of the Prototype Claims, licensed Merck to sell the Vaccines subject to certain conditions. These conditions included the requirement that Merck distribute along with the Vaccines product circulars that direct purchasers to store the Vaccines at 2-8° Celsius ("C"), and state, with varying levels of emphasis, "do not freeze since freezing destroys potency."

  The shipment at issue in Prototype Claim 1 departed from Merck's West Point, Pennsylvania facility in a refrigerated truck owned by independent trucking company Prime, Inc. ("Prime"), for delivery to a Merck distribution facility in Reno, Nevada. The bill of lading for the shipment directed Prime to maintain the set point of the refrigeration unit inside the truck at 42° Fahrenheit ("F"), which corresponds to a temperature of 5.5°C.*fn5 Merck placed a TempTale3 ("TempTale") temperature monitor inside the truck to ensure that the proper temperatures for the vaccines were maintained. Merck has introduced evidence indicating that the accuracy of the TempTale unit was validated by its manufacturer, Sensitech Inc. ("Sensitech"), both before and after the shipment. (See Merck Rule 56.1(a) Statement ¶¶ 35-36.) Several other temperature measures were taken throughout the truck's journey to Reno. The ThermoKing refrigeration unit that cooled the Vaccines were located throughout the truck contained two gauges that recorded ambient temperatures; a Qualcomm Communications remote satellite data acquisition system (the "Qualcomm system") recorded ambient temperatures within the truck and sent them via satellite to Prime's offices, and the drivers of the truck allegedly recorded temperatures within the truck on a log book, using a readout on the ThermoKing refrigeration unit.

  While the parties strongly dispute the accuracy and significance of the various temperature measurements taken during the course of the trip, it is undisputed that the TempTale and at least one of the ThermoKing temperature sensors recorded temperatures at or below 0°C (32°F) for approximately 2.5 hours while the truck was in transit.*fn6 For at least one hour of that time, the two sensors recorded temperatures below 31.1°F, which Merck asserts is the freezing point of the Vaccines. The remaining temperature gauges recorded above-freezing temperatures throughout the trip, and the remaining measurements on the TempTale and the ThermoKing sensor registered temperatures that were above freezing.

  After the shipment was received in Reno, Merck reviewed the readouts from the various temperature gauges on the truck and determined that the vaccines were unfit for use due to the possibility that they had frozen in transit. Merck claimed that the goods could not be sold pursuant to its reasonable interpretation of an FDA regulation, 21 C.F.R. § 211.208 ("Section 211.208"), which states in its entirety as follows: Drug products that have been subjected to improper storage conditions including extremes in temperature, humidity, smoke, fumes, pressure, age, or radiation due to natural disasters, fires, accidents, or equipment failures shall not be salvaged and returned to the marketplace. Whenever there is a question whether drug products have been subjected to such conditions, salvaging operations may be conducted only if there is (a) evidence from laboratory tests and assays (including animal feeding studies where applicable) that the drug products meet all applicable standards of identity, strength, quality, and purity and (b) evidence from inspection of the premises that the drug products and their associated packaging were not subjected to improper storage conditions as a result of the disaster or accident. Organoleptic examinations shall be acceptable only as supplemental evidence that the drug products meet appropriate standards of identity, strength, quality, and purity. Records including name, lot number, and disposition shall be maintained for drug products subject to this section.

 Accordingly, Merck sought coverage under the CDG Clause of the Policy for the full (and substantial) market value of the Vaccines. American Home subsequently denied the claim.

  In its submissions to the Court on the instant motions, American Home strongly disputes the validity of Merck's claim for coverage. American Home first argues that Section 211.208 does not apply to the Vaccines. Next, it claims that even if Section 211.208 did apply to the shipment, the Vaccines could not have frozen during transit. It notes that several of the temperature gauges recorded above-freezing temperatures throughout the trip, that a test performed on the truck after the shipment did not record freezing temperatures within the truck, and that the accuracy of the gauges that did record below-freezing temperatures cannot be assured. It also claims that even if the readouts of the TempTale and the ThermoKing gauges were accurate, the Vaccines could not have frozen because they were packed in insulated containers and were not exposed to sufficiently cold temperatures for a sufficiently long period of time to have actually frozen.*fn7

  American Home further disputes that Section 211.208 would require Merck to destroy all of the Vaccines even if the below-freezing temperature readings created the possibility that some or all of the Vaccines may have frozen. It argues that at most, the alleged temperature excursion acted to create "a question whether drug products have been subjected to [improper storage] conditions." 21 C.F.R. § 211.208. According to American Home, under these circumstances Merck should have, pursuant to its duty to protect and preserve property under the Policy, conducted "salvaging operations" in order to return the Vaccines to the market upon proof that they met "all applicable standards of identity, strength, quality, and purity." Id. American Home claims that Merck violated its duty to mitigate by failing to make any effort to salvage the Vaccines. 2. The Fiberboard Drum Claims

  In Prototype Claims 2, 4, 5, and 6 (collectively, the "API Claims"), Merck has sought coverage for damage allegedly sustained to fiberboard drums of two active pharmaceutical ingredients ("APIs"), alendronate sodium ("AS") and rofecoxib, during various international air shipments.

  Prototype Claim 2 involves a March 9, 2002 shipment of twenty-nine cylindrical fiberboard drums of AS from Merck's facility in Ireland to its facility in Puerto Rico. To prepare each of the drums for shipment, the AS was packed in double-lined polyethylene bags, each of which was separately tied, and then placed in the drum. The drum was then closed with a plastic lid. According to Merck, this packing method represents a standard method for transporting APIs. (See Merck Rule 56.1(a) Statement ¶ 108.) Merck has presented documents indicating that each of the drums was certified as being in perfect condition when it left Merck's Ireland facility.

  The drums arrived at New York's JFK airport en route from Ireland to Puerto Rico. According to Aer Lingus Cargo, the entity responsible for shipping the drums involved in Prototype Claim 2 from Ireland to New York, a pallet containing a portion of the shipment was dropped while at JFK. On March 12, 2002, Merck's freight forwarder examined the shipment in New York and noted that two of the drums, drums 21 and 23, had been damaged. Merck ordered that the two damaged drums be quarantined and that the remaining twenty-seven drums be sent on to Puerto Rico. Two additional fiberboard drums, drums 8 and 17, were identified as being damaged upon their arrival in Puerto Rico. All four of the damaged drums were eventually shipped back to Ireland for further inspection. The inspections revealed that in drums 8 and 17, the polyethylene liners appeared to have been breached, with AS leaking out of the liners into the fiberboard barrels. In drums 21 and 23, however, there was no evidence that the polyethylene liners were breached; Merck employees and other inspectors observed no spillage of AS powder either inside or outside the fiberboard drums. It thus appeared that the AS was exposed to the environment in only two of the damaged drums, even if the fiberboard protecting the AS in each of the four drums had sustained damage. Nonetheless, Merck subsequently sought coverage under the CDG Clause for all four of the drums, claiming that under its reasonable interpretation of Section 211.208, the AS within each of the damaged barrels had "been subjected to improper storage conditions." 21 C.F.R. § 211.208. It conducted no tests or other evaluation of the AS contained within the four drums to determine whether the AS could be salvaged, in whole or in part.

  American Home, in its submissions to the Court, does not seek summary judgment with respect to drums 8 and 17, apparently recognizing that there is, at minimum, a genuine issue of material fact concerning whether Merck would be required to destroy the AS remaining in those drums after the polyethylene liners protecting the AS from the environment had been breached. It does, however, resist Merck's summary judgment motion with respect to those drums by arguing that Section 211.208 does not apply to APIs, and that Merck breached its duties to mitigate damages, and to sue and labor to minimize losses covered under the Policy, when it failed to take any steps to determine whether the AS remaining in drums 8 and 17 could be salvaged. It further argues, on behalf of its own motion for summary judgment with respect to drums 21 and 23, that even if Section 211.208 did apply to Prototype Claim 2 (an assertion it vigorously disputes), Merck cannot even establish that there was a question whether the drug products contained within the drums were "subjected to improper storage conditions" in the first instance. Absent evidence that the AS may have been exposed to environmental contamination, American Home argues, Merck cannot argue that its claim to coverage under the CDG Clause is a reasonable one. The remaining Prototype Claims concerning fiberboard drum shipments involve similar fact patterns and arguments. Prototype Claim 4 involves a shipment by air and truck of thirty one drums of rofecoxib from Merck's Singapore subsidiary to its Puerto Rico subsidiary, via Miami International Airport. As with the AS drums, the rofecoxib was packed in double-lined polyethylene bags, then placed in fiberboard drums. Merck has presented evidence indicating that the drums were all in good condition when they departed Singapore, but that one of the thirty-one drums was found to have been damaged upon its arrival at Merck's Puerto Rico facility. When a claims adjuster visited the facility to examine the drum, he was able to see that the drum had been cut on its side. Upon inserting a ballpoint pen into the cut, the adjuster noted that the pen, "when withdrawn, was found to be coated with a white pharmaceutical powder, confirming that the polyethylene liners are punctured." (Merck Rule 56.1(a) Statement ¶ 202.) Again, as with the drums in Prototype Claim 2 that had experienced breaches in their polyethylene liners, Merck claimed that it was required to destroy the drum pursuant to Section 211.208. American Home contests summary judgment on this claim in part by arguing that Merck failed to take reasonable steps to determine whether any of the rofecoxib in the damaged drum could have been salvaged. Prototype Claim 5 involves another shipment of rofecoxib from Merck's Singapore subsidiary to its Puerto Rico subsidiary. This shipment, which departed from Singapore on or about April 8, 2002, was verified by Merck as being in good condition before its departure. As with Prototype Claim 4, one of the drums in the shipment was found to have been punctured upon its arrival in Merck's Puerto Rico warehouse. A claims adjuster verified that the polyethylene liners had also been punctured, and that rofecoxib was leaking out of the drum.

  Prototype Claim 6 involves another shipment of AS from Merck's Ireland subsidiary, this one intended for a third-party customer in Japan. Two drums of AS were included in the shipment. The drums were in good condition when they left Merck's facility on June 19, 2003. Before the drums left Ireland for Japan, however, one was damaged by an employee of Merck's freight forwarder. A claims adjuster's inspection of the damaged drum found that the fiberboard was impacted and cracked, but that the polyethylene liners had suffered no physical damage, and no AS was leaking out of the ...


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