Opinion
File No. 1:03-CV-630.
March 24, 2005
OPINION
In this declaratory judgment action Plaintiff J.B. Laboratories, Inc. ("JB Labs") seeks a declaration that it has no duty under a pharmaceutical manufacturing contract to indemnify Defendant Zee Medical, Inc. ("Zee Medical") for personal injury lawsuits based on a defective product. In its counterclaim Zee Medical seeks a declaration that it is entitled to indemnification. This matter is currently before the Court on cross-motions for partial dismissal and summary judgment.
I.
The underlying facts are not in dispute. JB Labs is a contract manufacturer of pharmaceutical and nutritional products. As a contract manufacturer JB Labs manufactures products to specifications provided by its customers. JB Labs' customers specify the active ingredients, the appearance, and the brand name of the product. JB Labs then manufactures the customers' products on a contract basis. With the exception of a single acetaminophenbased pain medication sold exclusively to the Veterans Administration, JB Labs does not have any products of its own.
Zee Medical, a wholly owned subsidiary of McKesson Corporation, is a distributor of occupational first aid, safety and medical products. Zee Medical sells both proprietary products (Zee Medical products with the Zee name on them) and nonproprietary products (products with some other company's name on them). (Boss dep. at 73 90). Zee Medical does not manufacture its proprietary products. Instead, Zee Medical contracts with others to manufacture Zee Medical's proprietary products to Zee Medical's specifications.
Dilotab, a nonprescription hayfever and sinus medication, is one of Zee Medical's proprietary products. (Miller dep. at 22). Zee Medical has been marketing Dilotab since 1970. (Ex. C). Zee Medical owns the federally registered trademark "Dilotab." (Ex. B). As owner of the Dilotab name, Zee Medical decides what product to place that name on. (Easter dep. at 32). From 1988 to 2000, Zee Medical's drug product listing on file with the Food and Drug Administration disclosed that the active ingredients in Dilotab were 12.5 milligrams of phenylpropanolamine ("PPA") and 325 milligrams of acetaminophen. Pursuant to FDA regulation, Zee Medical could only place the Dilotab name on tablets that contained the active ingredients in the quantities listed on the drug listing form on file with the FDA. (Lloyd dep. at 57-58, 76). Accordingly, the Dilotab specifications Zee Medical gave to its suppliers from 1988 to 2000 called for the same formula of active ingredients.
From 1994 to November 2000 JB Labs manufactured Dilotab for Zee Medical, pursuant to Zee Medical's specifications. After manufacturing, JB Labs sent the Dilotab tablets in bulk to Zee Medical. Zee Medical packaged the tablets for distribution and determined what instructions and warnings were placed on the packages.
Zee Medical required all of its suppliers to sign a Supplier Qualification Form ("SQF"). JB Labs signed three SQFs on October 13, 1993, August 3, 1999, and February 26, 2002. Each of the forms contained an indemnification provision and an insurance provision. Under the indemnification provision the supplier agrees
To defend, indemnify and hold us harmless against any claims, liability or expense whatsoever, including counsel fees, arising through or out of death or injury to person or property alleged to have arisen through the use or consumption of your products unless due to negligent handling of the products after shipment by you.
SQF ¶ 10(a).
The insurance provision requires the supplier to instruct its insurance carrier to complete a certificate of insurance including products liability naming Zee Medical as an additional insured or covered by a broad or limited form vendors endorsement with limits of liability of $3,000,000 bodily injury/property damages, combined single limit. SQF ¶ 11.
In May 2000 a study released by Yale University associated the consumption of PPA, one of the active ingredients in Dilotab, with an increase in the occurrence of hemorrhagic stroke. In November 2000 the FDA recommended that makers of over-the-counter pharmaceuticals containing PPA voluntarily remove PPA from their products and that manufacturers and sellers cease the distribution and sale of products containing PPA. In November 2000 JB Labs stopped supplying Dilotab to Zee Medical and Zee Medical stopped distributing Dilotab.
Since November 2000 at least 8 personal injury lawsuits have been filed against Zee Medical seeking damages for injuries allegedly suffered by persons after ingesting Dilotab. The suits claim that Dilotab was negligently manufactured because it included PPA and/or because its failed to include appropriate warnings. The suits also allege that Zee Medical and/or its agents knew of the health risks associated with the ingestion of PPA prior to November 6, 2000, and failed to take appropriate action to protect consumers. JB Labs has been named as a defendant in some of the suits and Zee Medical has filed a third-party complaint against it in others. None of the suits claim manufacturing defects other than the inclusion of PPA.
Zee Medical has tendered the defense of the personal injury lawsuits to JB Labs. JB Labs' products liability insurance policy has covered Zee Medical's defense costs in the personal injury lawsuits, but the insurer has notified Zee Medical that there may be insufficient coverage to continue covering the defense costs and any eventual liability. By letter dated September 26, 2003, Zee Medical notified JB Labs that its obligation to defend and indemnify Zee Medical was independent of the insurance coverage and would continue in the event that the insurance policy was depleted.
JB Labs has refused to indemnify Zee Medical. Instead, JB Labs filed this action against Zee Medical. In Counts I-V, JB Labs seeks a declaratory judgment that JB Labs has no duty to indemnify Zee Medical based on the SQF, Zee Medical's negligence, unconscionability, public policy, and fraudulent inducement. In Count VI, JB Labs seeks a declaratory judgment that Zee Medical has a duty to indemnify JB Labs. In Counts VII and VIII, JB Labs seeks damages for misrepresentation and breach of contract.
Zee Medical filed a counterclaim against JB Labs. In Counts I and II, Zee Medical seeks a declaratory judgment that JB Labs has a contractual and a common law duty to indemnify Zee Medical. In Count III, Zee Medical seeks a declaratory judgment that it has no duty to indemnify JB Labs. In Counts IV and V, Zee Medical seeks damages for breach of the contractual agreements to indemnify and to provide insurance coverage.
Currently before the Court are Zee Medical's motion to dismiss Counts III, V and VII of JB Labs' complaint for failure to state a claim, (Docket # 45), Zee Medical's motion for partial summary judgment as to Counts I and II of JB Labs' complaint and Count I of Zee Medical's counterclaim, (Docket # 60), and JB Labs' motion for partial summary judgment on Counts I and II of its complaint and on Counts I and V of Zee Medical's counterclaim, (Docket # 53).
II.
Zee Medical moves to dismiss Counts III, V, and VII of JB Labs' complaint for failure to state a claim on which relief can be granted. Count III seeks a declaratory judgment that JB Labs has no duty to indemnify based upon unconscionability. Count V seeks a declaratory judgment that JB Labs has no duty to indemnify based upon fraudulent inducement. Count VII seeks damages for misrepresentation.An action may be dismissed pursuant to Rule 12(b)(6) if the complaint fails to state a claim upon which relief can be granted. FED. R. CIV. P. 12(b)(6). When considering a motion to dismiss, all well-pleaded allegations in the complaint are treated as true. Dismissal of the complaint is proper only if it appears beyond doubt that the plaintiff can prove no set of facts in support of its claims that would entitle it to relief. Yuhasz v. Brush Wellman, Inc., 341 F.3d 559, 562 (6th Cir. 2003); Goad v. Mitchell, 297 F.3d 497, 500 (6th Cir. 2002).
A. Economic Loss Doctrine — Counts V and VII
Zee Medical contends that JB Labs' tort claims in Counts V and VII are barred by the economic loss doctrine.
The parties agree that Michigan law applies to JB Labs' tort claims. Michigan's economic loss doctrine provides that "[w]here a purchaser's expectations in a sale are frustrated because the product he bought is not working properly, his remedy is said to be in contract alone, for he has suffered only `economic' losses." Neibarger v. Universal Coops., 439 Mich. 512, 520-21, 486 N.W.2d 612 (1992) (internal quotations omitted). This doctrine "hinges on a distinction drawn between transactions involving the sale of goods for commercial purposes where economic expectations are protected by commercial and contract law, and those involving the sale of defective products to individual consumers who are injured in a manner which has traditionally been remedied by resort to the law of torts." Id. The economic loss doctrine bars a party from recovering in tort economic losses suffered as a result of a breach of duty assumed only by contract. Huron Tool Eng. Co. v. Precision Consulting Servs., 209 Mich. App. 365, 368, 532 N.W.2d 541 (1995). Accordingly, where a contractual relationship exists, the economic loss doctrine prohibits the bringing of tort claims which are factually indistinguishable from breach of contract claims. Id. at 374. Michigan's economic loss doctrine is broader than the doctrine applied in other jurisdictions. Quest Diagnostics, Inc. v. MCI WorldCom, Inc., 254 Mich. App. 372, 378 n. 4, 656 N.W.2d 858 (2002).
JB Labs has alleged that Zee Medical was obligated under the contract to provide a formulation of Dilotab that was safe for its intended purpose, and that Zee Medical breached its contractual obligations by providing a formulation of Dilotab that included PPA, and by failing to disclose information on the health risks associated with the use of PPA. (Complaint ¶¶ 100-01, 103). JB Labs relies on these same duties and failures to support its tort claims of fraudulent inducement and misrepresentation in Counts V and VII. (Complaint ¶¶ 75-77, 87, 90, 93). Zee Medical contends it is entitled to dismissal of the fraud in the inducement and the misrepresentation claims pursuant to the economic loss doctrine because these counts allege tort claims that are neither independent nor separate from the contract and are accordingly barred by the economic loss doctrine.
In response, JB Labs contends that the economic loss doctrine does not apply because the loss was caused by an unanticipated safety hazard; the loss was caused by a breach of disclosure duties antecedent to the contract; and because JB Labs is not seeking a contract remedy — the benefit of its bargain, but rather a tort remedy — restitution for the costs of defending personal injury actions brought by consumers of Dilotab.
Several courts have declined to apply the economic loss doctrine in a commercial setting where the plaintiff was seeking to redress losses arising from safety hazards that were not disclosed or that were outside the contemplation of the parties when their contracts were negotiated. See, e.g., Detroit Bd. of Ed. v. Celotex Corp., 196 Mich. App. 694, 493 N.W.2d 513, 518-19 (1992), Quest Diagnostics, 254 Mich. App. at 380-83. The safety hazard cases cited by JB Labs, however, are distinguishable from the case before this Court.
In Celotex the court allowed the Board of Education to sue the manufacturers of building products that contained asbestos for restitution of the expenses incurred in asbestos abatement. In declining to apply the economic loss doctrine the court noted that asbestos cases are unique in the law, and that the claims did not arise from the alleged inferior quality or unsuitability of the products, but from safety hazards that could not have been anticipated or bargained over when the products were sold. 196 Mich. App. at 703-05. Unlike Celotex, in the case before this Court the possibility of health risks associated with over-the-counter medications could have been anticipated and negotiated.
In Quest the plaintiffs sued an excavator hired by MCI when the excavator broke a water main and interrupted the plaintiffs' water supply. The court held that the suit against the excavator was not barred by the economic loss doctrine because there was no contract between the plaintiffs and the excavator and thus no opportunity to bargain for any allocation of risk. 254 Mich. App. at 380-81. Unlike Quest, in the case before this Court there was a contractual relationship between the parties.
JB Labs also suggests that the economic loss doctrine should not apply because it has alleged fraud in the inducement. In Huron Tool the court recognized that the economic loss doctrine would not preclude a plaintiff from pursuing "a claim for fraud in the inducement extraneous to the alleged breach of contract." 209 Mich. App. at 374. As the court observed, "where the only misrepresentation by the dishonest party concerns the quality or character of the goods sold, the other party is still free to negotiate warranty and other terms to account for possible defects in the goods." Id. at 373. "[A] claim of fraud in the inducement, by definition, redresses misrepresentations that induce the buyer to enter into a contract but that do not in themselves constitute contract or warranty terms subsequently breached by the seller." Id. at 375. In the case before this Court the alleged misrepresentations concerned the quality of the goods that were the subject matter of the contract. The alleged misrepresentations were not extraneous to the contract, so they do not take this matter outside of the economic loss doctrine.
Finally, JB Labs contends that the economic loss doctrine does not apply because it is not seeking a contract remedy — the benefit of its bargain, but rather a tort remedy — restitution for the costs of defending personal injury actions brought by consumers of Dilotab. This effort to avoid the economic loss doctrine also fails because the risk of health complications associated with the ingestion of over-the-counter medications and the risk of defending personal injury suits could have been anticipated and discussed during contract negotiations.
The Court is satisfied that JB Labs' tort claims are inextricably intertwined with its breach of contract claims and are barred by the economic loss doctrine. Accordingly, Counts V and VII of JB Labs' complaint will be dismissed.
B. Unconscionability — Count III
Zee Medical contends that JB Labs has failed to state a claim for unconscionability in Count III because this was an arms length commercial transaction between two sophisticated parties and JB Labs voluntarily chose to enter into this relationship and to sign the SQF on three separate occasions.
The parties do not agree on what law governs the unconscionability and other contract claims addressed below. JB Labs contends that California law applies because the standard terms and conditions attached to each of the purchase orders provides that the purchase orders will be governed by California law. Standard Terms ¶ 16. Zee Medical notes, however, that the indemnification and insurance provisions that are at issue in this case are not contained in the purchase orders, but in the SQF, and that form does not contain a choice of law provision. Moreover, Zee Medical contends that Michigan law should be applied to the contract issues because Michigan has a strong public policy of immunizing drug manufacturers from liability for defective drugs where the drug complied with FDA standards. See Taylor v. Smithkline Beecham Corp., 468 Mich. 1, 7, 658 N.W.2d 127 (2003) (holding that by enacting M.C.L. § 600.2946(5), the Michigan legislature "has determined that a drug manufacturer or seller that has properly obtained FDA approval of a drug product has acted sufficiently prudently so that no tort liability may lie."). According to Zee Medical, if California law were applied, Michigan's public policy of immunizing manufacturers and sellers from liability when their product complied with FDA standards would be thwarted because California does not have a similar statute.
This statute provides in pertinent part:
In a product liability action against a manufacturer or seller, a product that is a drug is not defective or unreasonably dangerous, and the manufacturer or seller is not liable, if the drug was approved for safety and efficacy by the United States food and drug administration, and the drug and its labeling were in compliance with the United States food and drug administration's approval at the time the drug left the control of the manufacturer or seller.
M.C.L. § 600.2946(5).
The Michigan public policy is not relevant to this dispute. The Michigan statute relied on by Zee Medical applies to product liability actions for personal injury or property damage. M.C.L. § 600.2946(5). The statute does not purport to affect contractual relationships between drug manufacturers and sellers. Moreover, where, as here, the parties are a manufacturer and a seller of the same drug who both come within the protections of the statute, the public policy would not affect the debate between them.
A federal court sitting in diversity applies the choice-of-law provisions of the forum state. NILAC Intern. Marketing Group v. Ameritech Services, Inc., 362 F.3d 354, 358 (6th Cir. 2004) (citing Klaxon Co. v. Stentor Electric Mfg. Co., 313 U.S. 487, 496 (1941)). "The Michigan Supreme Court recognizes the validity of contractual choice of law provisions if (1) there is a `reasonable relationship' between the chosen state and the transaction, and (2) its enforcement would not offend public policy considerations." Automotive Logistics Productivity Imp. Systems, Inc. v. Burlington Motor Carriers, Inc., 986 F. Supp. 446, 448 (E.D. Mich. 1997) (citations omitted). Zee Medical is a California corporation. Although the SQF does not contain a choice of law provision, each of the purchase orders provided that California law would apply to the parties' contractual relationship. Because the contractual choice of law provision bears a reasonable relationship to the transaction and because the choice of law does not offend Michigan public policy, the Court will apply California law to the contract issues in these motions.
Under California law unconscionability is a question of law for the court to decide. Jones v. Wells Fargo Bank, 5 Cal. Rptr.3d 835 (Cal.App. 2003). See also CAL. CIV. CODE § 1670.5(a) ("If the court as a matter of law finds the contract or any clause of the contract to have been unconscionable at the time it was made. . . ."). A contractual provision must be both procedurally and substantively unconscionable in order for a court to exercise its discretion to refuse to enforce it. Armendariz v. Foundation Health Psychcare Serv., Inc., 6 P.3d 669, 690 (Cal. 2000). Procedural unconscionability focuses on "oppression" or "surprise" due to unequal bargaining power. "The oppression component arises from an inequality of bargaining power of the parties to the contract and an absence of real negotiation or a meaningful choice on the part of the weaker party." Kinney v. United Healthcare Servs., Inc., 83 Cal. Rptr.2d 348, 353 (1999). Substantive unconscionability focuses on "overly harsh" or "one-sided" results. Armendariz, 6 P.3d at 690. The test frequently applied is whether the terms are "so one-sided as to `shock the conscience.'" Nyulassy v. Lockheed Martin Corp., 16 Cal. Rptr.3d 296, 306 (Cal.App. 2004) (quoting Kinney, 83 Cal. Rptr.2d at 353).
JB Labs has alleged that the SQF was drafted by Zee Medical, that Zee Medical had superior bargaining power, and that the SQF was presented under circumstances in which JB Labs was required either to adhere to its terms or reject it. (Compl. ¶¶ 61-63). However, it is also clear that both parties to the contract at issue were sophisticated corporations and that the indemnification provisions that JB Labs contends are unconscionable were contained in all three of the SQFs that JB Labs signed in 1993, 1999 and again in 2002. Although the SQF indicates that Zee Medical required an "unqualified affirmative answer" to the indemnification clause, JB Labs has not alleged that it ever attempted to negotiate different terms. Because JB Labs' allegations do not indicate that its inferior bargaining power resulted in a lack of meaningful choice, its allegations do not support a finding of either oppression or surprise due to unequal bargaining power. The allegations are accordingly insufficient to show procedural unconscionability. In addition, there is nothing inherently shocking about a contractual indemnification agreement. Accordingly, Zee Medical's motion to dismiss JB Labs' unconscionability claim will be granted, and Count III of JB Labs' complaint will be dismissed.
III.
JB Labs and Zee Medical have filed cross-motions for partial summary judgment on the duty to indemnify and the duty to provide insurance that are addressed in Counts I and II of JB Labs' complaint and Counts I and V of Zee Medical's counterclaim. As noted above, these contract issues are governed by California law.
Summary judgment is proper if there is no genuine issue as to any material fact and the moving party is entitled to judgment as a matter of law. FED. R. CIV. P. 56(c). In evaluating a motion for summary judgment the Court must look beyond the pleadings and assess the proof to determine whether there is a genuine need for trial. Matsushita Elec. Indus. Co. v. Zenith Radio Corp., 475 U.S. 574, 587 (1986). If the moving party carries its burden of showing there is an absence of evidence to support a claim then the non-moving party must demonstrate by affidavits, depositions, answers to interrogatories, and admissions on file, that there is a genuine issue of material fact for trial. Celotex Corp. v. Catrett, 477 U.S. 317, 324-25 (1986). "On summary judgment, all reasonable inferences drawn from the evidence must be viewed in the light most favorable to the parties opposing the motion." Hanover Ins. Co. v. American Eng'g Co., 33 F.3d 727, 730 (6th Cir. 1994) (citing Matsushita, 475 U.S. at 586-88). Nevertheless, the mere existence of a scintilla of evidence in support of the non-moving party's position is not sufficient to create a genuine issue of material fact. Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 252 (1986).
A. Indemnification
The SQFs signed by JB Labs included the following indemnification provision: Do you agree
a. To defend, indemnify and hold us harmless against any claims, liability or expense whatsoever, including counsel fees, arising through or out of death or injury to person or property alleged to have arisen through the use or consumption of your products unless due to negligent handling of the products after shipment by you?
Answer Yes
SQF ¶ 10(a).
The question raised by the parties' cross-motions for summary judgment is whether JB Labs' affirmative response to this provision requires it to indemnify Zee Medical in connection with the Dilotab product liability actions. All of the Dilotab suits at issue claim that Dilotab was negligently manufactured because it included PPA and/or because its failed to include appropriate warnings. None of the suits claim manufacturing defects other than the inclusion of PPA.
There is no dispute that Zee Medical specified the active ingredients for Dilotab, including PPA, and that Zee Medical contractually required JB Labs to manufacture Dilotab to Zee Medical's specifications. The question, then, is whether JB Labs agreed to indemnify Zee Medical against Zee Medical's own conduct in specifying PPA as an active ingredient in Dilotab and in failing to warn of dangers associated with PPA.
According to Zee Medical, under the plain and unambiguous language of this indemnification provision, JB Labs is required to indemnify Zee Medical for all claims arising out of the use or consumption of Dilotab, regardless of Zee Medical's fault, with the limited exception for negligent handling of the products by Zee Medical. Zee Medical accordingly requests the Court to enter summary judgment in its favor as to Counts I and II of JB Labs' Complaint and Count I of Zee Medical's Counterclaim and to enter a declaration that JB Labs is obligated to indemnify Zee Medical in connection with the Dilotab product liability actions.
JB Labs contends that Dilotab was Zee Medical's product and that the indemnification provision cannot be construed to require JB Labs to indemnify Zee Medical against Zee Medical's own negligence. JB Labs accordingly requests entry of summary judgment in its favor as to Counts I and II of its complaint and Count I of Zee Medical's counterclaim and to enter a declaration that JB Labs has no obligation to indemnify Zee Medical in connection with the Dilotab product liability actions.
The Court's interpretation of the indemnification provision is guided by the following provisions from the California Civil Code: "A contract must be so interpreted as to give effect to the mutual intention of the parties as it existed at the time of contracting, so far as the same is ascertainable and lawful." CAL. CIV. CODE § 1636. "The language of a contract is to govern its interpretation, if the language is clear and explicit, and does not involve an absurdity." CAL. CIV. CODE § 1638. "The whole of a contract is to be taken together, so as to give effect to every part, if reasonably practicable, each clause helping to interpret the other." CAL. CIV. CODE § 1641. "Several contracts relating to the same matters, between the same parties, and made as parts of substantially one transaction, are to be taken together." CAL. CIV. CODE § 1642. "A contract must receive such an interpretation as will make it lawful, operative, definite, reasonable, and capable of being carried into effect, if it can be done without violating the intention of the parties." CAL. CIV. CODE § 1643. "A contract may be explained by reference to the circumstances under which it was made, and the matter to which it relates." CAL. CIV. CODE § 1647. "However broad may be the terms of a contract, it extends only to those things concerning which it appears that the parties intended to contract." CAL. CIV. CODE § 1648. "In cases of uncertainty not removed by the preceding rules, the language of a contract should be interpreted most strongly against the party who caused the uncertainty to exist." CAL. CIV. CODE § 1654.
Contracts should also be interpreted in such a way as to make economic sense. See Hartford Fire Ins. Co. v. St. Paul Surplus Lines Ins. Co., 280 F.3d 744, 747 (7th Cir. 2002) (noting in a diversity suit applying California law that "[i]nterpreting contracts to make economic sense is a method of contract interpretation that we have commended in other cases.").
Indemnity agreements are construed under the same rules that govern the interpretation of other contracts. St. Paul Fire Marine Ins. Co. v. American Dynasty Surplus Lines Ins. Co., 124 Cal. Rptr.2d 818, 825 (Cal.App. 2002) (citing Myers Bldg. Indus., Ltd. v. Interface Tech., Inc., 17 Cal. Rptr.2d 242 (Cal.App. 1993)). There are, however, some unique considerations that apply to indemnity agreements. An indemnity clause that does not specifically address the issue of an indemnitee's negligence is referred to as a "general" indemnity clause. Rooz v. Kimmel, 55 Cal.App.4th 573, 583 (1997). The general rule in California has been that a party will not be indemnified for his or her own active negligence under a general indemnity clause. Id. at 583. While adhering to this long accepted rule that a general indemnity clause will not provide indemnity for consequences resulting from the indemnitee's own active negligence, the California Supreme Court clarified in Rossmoor Sanitation, Inc. v. Pylon, Inc., 119 Cal. Rptr. 449, 455 (1975), that
the question whether an indemnity agreement covers a given case turns primarily on contractual interpretation, and it is the intent of the parties as expressed in the agreement that should control. When the parties knowingly bargain for the protection at issue, the protection should be afforded. This requires an inquiry into the circumstances of the damage or injury and the language of the contract; of necessity, each case will turn on its own facts.119 Cal. Rptr. at 456. Subsequent to Rossmoor, California courts have recognized that "[a]lthough an indemnitee's active negligence may ordinarily preclude its recovery under a general indemnity agreement, the Supreme Court has cautioned against a strict application of such rule." Hernandez v. Badger Construction Equipment Co., 28 Cal. App.4th 1791, 1820 (1994). See also Morton Thiokol, Inc. v. Metal Bldg. Alteration Co., 193 Cal. App.3d 1025, 1030 (1987) ("[T]he enforceability of an indemnity agreement shall primarily turn upon a reasonable interpretation of the intent of the parties."). Rossmoor, Hernandez and Morton Thiokol "recognized the general rule that an actively negligent tortfeasor cannot recover under a general indemnity provision . . . that is silent on the issue of the indemnitee's negligence." Maryland Casualty Co. v. Bailey Sons, Inc., 41 Cal. Rptr.2d 519, 526 (Cal.Ct.App. 1995). "[T]he specificity of the language used is a key factor in construction of an indemnity agreement." Heppler v. J.M. Peters Co., 87 Cal. Rptr.2d 497, 509 (Cal.Ct.App. 1999). "To obtain greater indemnity, more specific language must be used." Id. (quoting Smoketree-Lake Murray, Ltd. v. Mills Concrete Constr. Co., 286 Cal. Rptr. 435, 442 (Cal.Ct.App. 1991)).
The same rules that apply to an indemnitee's active negligence also apply to claims based on strict product liability or breach of warranty. "California courts have consistently equated strict liability with negligence for purposes of construing indemnification agreements." Widson v. International Harvester Co., 200 Cal. Rptr. 136, 146 (Cal.Ct.App. 1984). "While an action based upon a manufacturer's strict liability or breach of warranty liability does not sound in negligence, we believe, upon a parity of reasoning, that the rule of construction applicable to an agreement where one seeks indemnification from his own negligence is equally applicable here." Dart Transportation Service v. Mack Trucks, Inc., 88 Cal. Rptr. 670, 677 (Cal.Ct.App. 1970).
The indemnification provision in the SQF at issue in this case broadly applies to "any claims" arising out of the use or consumption of "your products." It does not refer specifically to Zee Medical's negligence. Accordingly, it is a general indemnity clause. Under California law this general indemnity provision is not sufficient to indemnify Zee Medical for its own active negligence unless the court finds that it was the intent of the parties to provide for such indemnification.
Zee Medical contends that the Court need look no further than the clear language of the contract to the determine the parties' intent. According to Zee Medical, the language in ¶ 10 excluding indemnification for claims arising out of Zee Medical's negligent handling of the product made clear the parties' intent that JB Labs would be responsible for indemnifying Zee Medical for anything else, including Zee Medical's own negligence.
JB Labs, on the other hand, contends that the contract language is not as clear as it might appear on first blush. The indemnification provision requires suppliers to agree to indemnify Zee Medical against any claims arising out of "the use or consumption of your products." While JB Labs agrees with Zee Medical that the term "your" refers to JB Labs, JB Labs contends that the term "your products" does not refer to Dilotab. JB Labs contends that this provision is designed to apply to those suppliers of Zee Medical who in fact design and manufacture their own products. JB Labs, however, did not make its own product. It made Dilotab, which is Zee Medical's product.
In response, Zee Medical contends that "your products" means the product sold by JB Labs to Zee Medical regardless of whose proprietary products they were. The SQF provides that all statements and answers on the form apply to "all merchandise" purchased by Zee Medical from JB Labs without limitation. (SQF at pp. 1 3). According to Zee Medical, the use of the term "all merchandise" evidences the parties' intent that the indemnification provision have a broad application. The SQF does not carve out an exception to the indemnity provision for suppliers who produce Zee Medical's proprietary products.
According to JB Labs, the fact that the SQF uses both the term "all merchandise" and the term "your products" suggests that these two terms have different meanings. JB Labs contends that the SQF uses the term "all merchandise" expansively to describe the general applicability of the form and to define certain broad obligations, while it uses the term "your products" more narrowly to describe the supplier's indemnity obligation for claims arising out of its own conduct, such as design defects. JB Labs contends that the use of the term "your products" in the indemnity provision makes it clear that the product must be the supplier's product, not Zee's product, for the indemnity obligation to apply.
California courts have held that "[e]ven if the written agreement is clear and unambiguous on its face, the trial judge must receive relevant extrinsic evidence that can prove a meaning to which the language of the contract is `reasonably susceptible.'" Brobeck, Phleger Harrison v. Telex Corp. 602 F.2d 866, 871 (9th Cir. 1979) (quoting Pacific Gas and Electric Co. v. G.W. Thomas Drayage Co., 69 Cal.2d 33, 37, 69 Cal.Rptr. 561 (1968)). In this case some of the relevant extrinsic background evidence that affects the understanding of the term "your product" is evidence that Zee Medical primarily used this SQF when purchasing products that were designed and manufactured by its suppliers. The majority of Zee Medical's contracts were with suppliers who supplied their own proprietary products. In such cases the indemnity provision for "your product" reasonably provided that the supplier would indemnify Zee Medical against design defect claims arising from the supplier's negligence in designing its product. The form also reasonably required the supplier to attach "complete specifications for the products you will provide, including composition or ingredients," as well as drug product stability data and material safety data sheets. (SQF ¶ 12).
Zee Medical also used the form, however, when the supplier was manufacturing Zee Medical's own proprietary products, as in the case of Dilotab, without making any modifications to the form. The form did not fit as well when applied to suppliers who were manufacturing Zee Medical's own proprietary products. For example, the provision requiring the supplier to attach complete specifications does not make sense when applied to a supplier of Zee Medical's proprietary products because those specifications would already be well known to Zee Medical and in Zee Medical's possession. The evidence is undisputed that JB Labs never attached the Dilotab specifications to the SQF.
The Court finds that when the SQF is read as a whole and in the context of its primary use for nonproprietary products, the phrase "your products" is ambiguous when applied to a supplier who manufactures Zee Medical's proprietary products. It is ambiguous whether "your products" refers to "the products you manufactured," or to "the products that bear your name." Because of this ambiguity, it is unclear whether the indemnification provision was intended to apply to all of the products manufactured by the supplier or only to the supplier's own proprietary products.
The parties entered into several contracts relating to the same subject matter. Their agreement was evidenced not only by the SQF, but also by the individual Purchase Orders to which Zee Medical had attached its Standard Terms. Both forms must be construed together. CAL. CIV. CODE § 1642. The Standard Terms included the following indemnification provision:
Seller shall defend, indemnify and hold Buyer harmless against any claim, loss, liability, or expense, including reasonable attorney's fees, arising through or out of death or for injury to person or property alleged to have arisen by reason of any act or omission of Seller in the performance of this Agreement. Seller shall also maintain full force and effect during the continuance of this Agreement, policies of comprehensive general liability and product liability (with a broad form vendors endorsement) insurance, with limits of at least $1,000,000 and shall provide evidence thereof to Buyer. Standard Terms ¶ 7 (emphasis added). This indemnification provision is limited to claims arising from "any act or omission of Seller." It does not purport to require the Seller to indemnify the Buyer for the Buyer's own negligence. If the indemnification provision in the SQF is construed to cover the Buyer's (Zee Medical's) own negligence, it would conflict with paragraph 7 of the Standard Terms and paragraph 7 would be rendered superfluous. The only way paragraph 7 of the Standard Terms can be reconciled with paragraph 10(a) of the SQF is to limit paragraph 10(a)'s application to acts or omissions of the seller.
Zee Medical contends that if the Court accepts JB Labs' argument regarding the definition of "your products" then JB Labs would not have liability even in the event it was at fault. That is not true. The Standard Terms provide that JB Labs will indemnify Zee Medical for claims arising from JB Labs' acts or omissions and common law liability would still attach.
The parties' intent cannot be garnered from their negotiations. There is no evidence in this case that the parties had any discussion about the meaning or scope of the indemnity provision. JB Labs' President, Frank Lamb, who executed the contract on behalf of JB Labs in 1993, testified that he interpreted ¶ 10(a) to mean that JB Labs was obligated to manufacture the products under the specifications given to JB Labs by Zee Medical. (Lamb dep. at 50-51). He did not, however, discuss this interpretation with anyone from Zee Medical. Jon Baker, who executed the contract on behalf of JB Labs in 1999, testified that he chose to do business with Zee Medical and that he read and signed the SQF without asking that it be modified. (Baker dep. at 54-56, 61). He had no discussions with Zee Medical about the terms. (Baker dep. at 54). No one at JB Labs understood that by signing the SQF they were agreeing to indemnify Zee Medical for Zee Medical's own negligence in designing or attaching warnings and instructions to Dilotab. The price JB Labs charged Zee Medical for Dilotab did not include any premium to account for any obligation to indemnify Zee Medical for Zee Medical's negligence. (Baker Aff. ¶¶ 2-3).
Because the indemnification provision was drafted by Zee Medical, because it is written in broad and general language, because it does not expressly address Zee Medical's negligence, because it appears to have been drafted for suppliers of proprietary products rather than for suppliers of products made to Zee Medical's specifications, because ambiguities arise when the form is applied to Zee Medical's proprietary products, and because there was no discussion or consideration for indemnifying Zee Medical from its own negligence, this Court concludes that indemnification for Zee Medical's own negligence was not a "knowingly bargained for" protection. See Rossmoor, 119 Cal. Rptr. at 456. There was no agreement between the parties that JB Labs would indemnify Zee Medical for Zee Medical's own negligence in designing Dilotab or for any other non-manufacturing defects in Dilotab.
There is no dispute that all of the lawsuits at issue claim that Dilotab was negligently manufactured because it included PPA and/or because it failed to include appropriate warnings. None of the suits claim manufacturing defects other than the inclusion of PPA. JB Labs is not contractually bound to indemnify Zee Medical for these claims because JB Labs was not responsible for the alleged defect out of which the product liability suits arise.
B. Insurance
Zee Medical alleges in Count V of its Counterclaim that JB Labs breached the parties' contract by failing to maintain $3,000,000 combined single limit bodily injury/property damage insurance and that Zee Medical has and will suffer damages as a direct result of JB Labs' breaches of its contractual obligations. (Counterclaim ¶¶ 48-52).
Plaintiff JB Labs has moved for summary judgment on Count V of Zee Medical's counterclaim on the basis that JB Labs maintained all insurance required during the entire time of the parties' supply relationship and the contract did not require it to continue to provide insurance coverage for some unspecified time period after the parties' supply relationship ended.
The SQFs signed by JB Labs required JB Labs to instruct its insurance carrier to name Zee Medical as an additional insured or covered by a broad or limited form vendors endorsement with limits of liability of $3,000,000 bodily injury/property damage, combined single limit, with thirty-day notice of cancellation. SQF at ¶ 11. The first page of the SQF provides the following notice:
The Insurance provision reads as follows:
11. Insurance Instruct your insurance carrier to complete a Certificate of Insurance including Products Liability as follows:
a. To Zee Medical, Inc. P.O. Box 19527 Irvine, CA 92713
b. Limits of Liability: $3,000,000 bodily injury/property damage, combined single limit.
c. Zee Medical, Inc. is named as additional insured or covered by a broad or limited form vendors endorsement.
d. 30 day notice of cancellation.
e. Mail renewal certificate to us when current policy expires.
(SQF ¶ 11).
Please note that clearance will not be issued to a new supplier until an approved certificate of products liability insurance is received at our Home Office. Also, continued clearance is contingent upon our receipt of a renewal certificate when the present certificate expires.
SQF p. 1.
It is undisputed that from 1994 through 2002, during the time JB Labs was supplying products, including Dilotab, to Zee Medical, JB Labs maintained the requisite insurance in place. See Def.'s Resp. to Pl.'s Mot. for Summ. J. at 19. JB Labs' insurance carrier provided annual Certificates of Insurance to Zee Medical reflecting this coverage and the expiration date for each policy. The last certificate of insurance supplied to Zee Medical was in March 2002, with an expiration date of March 1, 2003.
JB Labs stopped manufacturing Dilotab for Zee Medical in November 2000.
Zee Medical contends that JB Labs' position that its insurance coverage obligation ended when the supply relationship ended renders the insurance provisions of the contract illusory and turns commercial reality on its head. According to Zee Medical, it would be absurd to release JB Labs from the insurance obligation after it placed its products into the stream of commerce and while its products were still available on the market. Zee Medical suggests that it would be consistent with the parties' intent and economic reality to interpret the SQF to provide meaningful insurance coverage, i.e., coverage until such time as the claims are barred by applicable statutes of limitation or until the products are no longer available.
In construing the insurance provision of the SQF the Court must look to the language of the contract and interpret it in such a way as to give effect to the intent of the parties at the time of contracting. CAL. CIV. CODE §§ 1636 1638. The SQF is silent on the issue of how long the insurance must be maintained. There is no language in the Form that would suggest that the insurance must be maintained for a certain number of years, or as long as the products are in the stream of commerce, or until statutes of limitation have run. Neither does it state that the insurance obligation ends when the supply relationship ends. All it states is that an approved insurance policy is a precondition to doing and continuing to do business with Zee Medical.
There is no evidence that the parties ever discussed the nature of the insurance obligation other than that it was a requirement for doing business with Zee Medical. Zee Medical has not presented the Court with any evidence that continuation of a vendor's endorsement beyond the parties' commercial relationship is standard commercial practice.
JB Labs understood that its duty to provide insurance ended when JB Labs stopped supplying products to Zee Medical. (Lamb dep. at 52). According to Lamb, it was not JB Labs' practice to carry insurance to cover products that they sold to the customer in the past that are still in the stream of commerce. (Lamb dep. at 52). "It just doesn't make any business sense that you would carry insurance beyond the point where you stopped doing business with the customer." (Lamb dep. at 52).
JB Labs' understanding of the insurance provision is consistent with the understanding of the Zee Medical personnel. No one at Zee Medical was aware of any requirement in writing or otherwise that a vendor had to continue insurance coverage in favor of Zee Medical after the discontinuation of the supplier relationship. (Lloyd dep. at 49; Miller dep. at 13). According to Zee Medical personnel, the only consequence that attached to the failure of a vendor to continue insurance coverage was that Zee Medical would discontinue purchasing from that vendor. (Boss dep. at 53). There is no evidence that Zee Medical ever required any other suppliers to continue their vendors endorsements beyond the termination of their supply relationships.
The individual employees' understanding that the insurance obligation did not continue for some indeterminate period beyond the end of the supply relationship is consistent with the requirement in the SQF that the vendor give thirty-days' notice of cancellation of the policy. A thirty-day notice of cancellation would not be consistent with an obligation that would continue for years after the supply relationship ended.
Construing the insurance obligation as terminating at the end of the supply relationship is also consistent with Paragraph 7 of the Standard Terms attached to the Purchase Orders:
Seller shall also maintain full force and effect during the continuance of this Agreement, policies of comprehensive general liability and product liability (with a broad form vendors endorsement) insurance, with limits of at least $1,000,000 and shall provide evidence thereof to Buyer.
Standard Terms ¶ 7 (emphasis added).
Construing the insurance obligation as existing only during the supply relationship is also consistent with the parties' actions. JB Labs did not renew its vendors endorsement in 2003 because it was no longer a supplier to Zee Medical. There is testimony that it was the policy and practice of Zee Medical to notify all vendors prior to the expiration of an insurance policy that a renewal certificate was due. (Boss dep. at 53). Accordingly, if Zee Medical had understood that JB Labs had an ongoing duty to provide insurance coverage after the termination of the supply relationship, its policy and practice would have been to inform JB Labs of that obligation before March 2003 when the last insurance policy was scheduled to expire. Zee Medical did not notify JB Labs of such an insurance obligation. In fact, there is no evidence that Zee Medical ever notified JB Labs of any obligation to continue insurance coverage until Zee Medical filed its counterclaim in this action on January 4, 2004, well after JB Labs' last insurance policy had expired and when JB Labs was no longer in a position to extend the coverage.
The coverage offered by an insurance obligation that ceases upon the end of the supply relationship is not as illusory or as absurd as Zee Medical contends. JB Labs' insurance has already paid for much of Zee Medical's defense to the PPA cases.
Moreover, the Court takes note of the fact that the only insurance coverage at issue in this case is a vendor's endorsement. Zee Medical does not deny that JB Labs has continued product liability insurance on its own behalf for its own liability. "[T]he purpose of a vendor's endorsement is to protect the vendor (i.e., dealer or other distributor) against the expense of being dragged as an additional defendant into a lawsuit arising from a defect in a product that it distributes." Hartford Fire Ins. Co. v. St. Paul Surplus Lines Ins. Co., 280 F.3d 744, 746 (7th Cir. 2002). "[T]he vendor's endorsement is inapplicable if the vendor, whether by participating in the creation of the product or by altering or repairing it, may be responsible for the alleged defect out of which the products liability suit arises." Id. (construing California law). A vendor's endorsement "allows the insurer to coordinate the defense of multiple suits arising out of the same injury and spares the distributor the expense of hiring a lawyer to defend against a suit arising out of a design or manufacturing defect with which the distributor had nothing to do." Id. Vendor's endorsement policies are generally "cheap add-ons" to products liability policies, and they are cheap because they are generally limited to those situations in which the vendor is completely passive in relation to the harm giving rise to the liability and the vendor would be entitled to indemnity from the manufacturer even in the absence of the insurance. Id. at 747.
In other words, the vendor's endorsement probably has very little bearing on this case. To the extent the suits are based on the inclusion of PPA in Dilotab, they are aimed at Zee Medical's responsibility, and would not be covered by the vendor's endorsement. Even if a suit were filed that alleged defects in JB Labs' manufacturing of Dilotab, JB Labs has insurance coverage for its own liability, and the presence or absence of a vendor's endorsement does not affect Zee Medical's ability to bring a common law right of action against JB Labs for liability arising out of its role as manufacturer of Dilotab.
There is simply no evidence from which this Court can find a continuing obligation on the part of JB Labs to provide insurance coverage to Zee Medical for some unspecified period after the termination of the parties' supply relationship. No such obligation can be found in the SQF, the parties' negotiations, the parties' course of dealing, or in commercial practice. The most reasonable reading of the SQF is that the insurance was required only during the term of the supply relationship. To the extent there remains any uncertainty about the duration of the insurance obligation, the Court is required to construe the language of the contract most strongly against the drafter, Zee Medical. CAL. CIV. CODE § 1654. The Court concludes that the SQF did not require JB Labs to continue insurance coverage in favor of Zee after the parties' business relationship ended. Accordingly, the Court will enter summary judgment for JB Labs on Count V of Zee Medical's Counterclaim.
An order and partial judgment consistent with this opinion will be entered.