Insurance Matters: How Retailers Can Protect Themselves from Liability for Recalled Products
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Insurance Matters: How Retailers Can Protect Themselves from Liability for Recalled Products

In the growing world of medical and adult-use cannabis, the need for safe products is inarguable. What can you do to ensure that?

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In the growing world of medical and adult-use cannabis, the need for safe products is inarguable. Exactly what those safety measures will be, however, is subject to a debate that can range from access to packaging, labeling, advertising and beyond. Two aspects of safety that are often overlooked, but just as important, are  product testing and insurance.

The cannabis world has access to insurance policies that cover a variety of losses, including crop loss and personal injury. But in order to protect losses, cannabis-friendly insurance companies require applicants to test their product. Some carriers even ask for the testing facility the applicant uses, because the application becomes a part of the policy. In this way, a company can do more than simply say it is cannabis-friendly. The company can have the insurance and receipts to prove it.

In the long run, cannabis companies that avoid insurance or product testing will only open themselves to potential losses later down the line.

A $1-Million Difference

If the insured elects not to test its product after representing to its insurance carrier that it does, the carrier can deny or to exclude coverage.

In its most benign form, lack of coverage arising from the insured’s failure to test its products means a mere waste of money paid on annual policy premiums. But in its worst manifestation, it could mean no coverage in the event of a serious casualty event. Consider the implication of having no coverage in the wake of a customer who suffers extreme medical issues or death from ingesting tainted product. Or worse still, imagine a cluster of injured customers that ingested a bad batch of product. Such a scenario is not merely possible, but inevitable.

Product recalls, like the recent spate in the state of Arizona, are not uncommon in these early years of legal cannabis. In those triggering events, insurance policies kick into gear and begin working to ferret out the source of the problem. Retailers can benefit from having the proper types of insurance in place to protect themselves—particularly when selling products grown and manufactured by other parties.

Even though most cannabis carriers cap coverage for product liability claims at $1 million, loss of that coverage could make a world of difference in an industry where bankruptcy is still forbidden.

Third-Party Goods Muddy the Waters

The risk might be lessened for retailers who exclusively sell their own products, because, from a certain perspective, the retailer is self-insuring anyway by having total product control from seed to sale. These retailers ought to know if their products are clean and safe.

But retailers that deal in wholesale goods acquired from third parties do not have the self-assurance that comes from exclusive self-dependence. In the situation of a retailer dealing in third-party goods, contracts can often yield risk transfer between parties.

The cannabis industry need look no further than large retail stores like Target or Walmart, where manufacturers do not get product on the shelves unless manufacturers can demonstrate adequate insurance and product safety. Cannabis retailers ought to be no different, as they face the same types of risks. If more convincing is needed, consider these scenarios:

  • Why should a retailer be on the hook for something it did not cultivate, create or manufacture?
  • What if the retailer’s suppliers do not have the right coverage, or sufficient coverage?
  • What if the retailer's suppliers failed to obey the requirements of its own policy?
  • What if the cultivator or manufacturer says it is covered, but it is not?

Indemnification Keeps Loss from Snowballing

In a standard wholesale purchase contract, there ideally ought to be an indemnification clause. Indemnification clauses are essential to ensure that the cultivator or manufacturer would hold a retailer harmless for its action or inaction. This means that even without insurance, the cultivator or manufacturer is legally obligated to provide and pay for defense of the retailer, if the retailer ever got sued over the cultivator or manufacturer’s products.

The cultivator or manufacturer that is not testing its product is electing to pay to defend themselves out of pocket, because no insurance coverage would apply. That also means it is paying for the defense of the retailer out of pocket as well. Were that not bad enough: What if the uninsured defense money runs out before the claim is resolved?

If you think the calamity of under or uninsured sounds horrible — and it is — consider there could be further ability for a personal injury attorney to pierce the corporate shield. There are fiduciary duties of care that retailer and manufacturer board members must abide by. In this case, that duty means making sure they are selling safe, cannabis-friendly products that are both tested and insured. 

Multistate Operators Could Face Penalties in Multiple Jurisdictions

Believe it or not, the concussion wave could be even worse. Consider also that when a retailer or manufacturer is brought into a lawsuit for a product liability claim with a product that is not tested, the mere existence of that lawsuit — never mind how it may end — will devalue the company.

This is hugely important in the world of multistate operators. Multistate operators often rely upon external financial backers like banks and other lenders. In this scenario, a funding company can, and will, pursue claims against the retailer’s or manufacturer’s board of directors for making unsafe decisions and acting against state and local regulations. For the multistate operators that trade on the Canadian exchange, such lawsuits could also be brought by shareholders.

Such suits are called director and officer, and in such an instance there may not be coverage or paid defense for the directors, because they knowingly acted against state and local laws. Suffice it to say, product testing in the world of cannabis is hugely important. Plus, not all carriers are alike.

The wrong choice or wrong business practice can be devastating for everyone up the supply chain — from the retailer and straight at its owners. The simplest solution is to ensure your product and partners are insured through honest and transparent product testing.

Gary Michael Smith is an attorney and arbitrator and founding member of the Phoenix Arizona-based Guidant Law Firm. He is also a founding director and current president of the Arizona Cannabis Bar Association and board member of the Arizona Cannabis Chamber of Commerce. Additionally, he authored Psychedelica Lex: The Law of Psychedelics.

Danielle Hernandez is Director of Cannabis Practice and Agency Manager at Gilbert Insurance Group and board member of the Arizona Cannabis Chamber of Commerce.