A Liberty Mutual Holding Co. Inc. unit is liable to pay a $1.4 million settlement in connection with the recall of powdered milk that may have been contaminated with salmonella, an appellate court ruled Tuesday.

In July 2009 the U.S. Food and Drug Administration ordered the recall of powdered milk that La Crosse, Wis.-based Main Street Ingredients L.L.C. had bought from Plainville, Minn.-based Plainview Milk Products Cooperative, stating that products Plainview had manufactured over the previous two years may have been contaminated with salmonella.

The milk had been sold in turn to Lakeville, Minn.-based Malt-O-Meal, according to the ruling by the 8th U.S. Circuit Court of Appeals in St. Louis in The Netherlands Insurance Co. v. Main Street Ingredients L.L.C.

As a result of the FDA notice, Malt-O-Meal recalled its instant oatmeal that contained the recalled dry milk, according to the ruling.

Malt-O-Meal then sued Main Street, which was insured by Liberty Mutual unit The Netherlands Insurance Co., Keene, N.H., for coverage in connection with the incident.

In June 2012, Malt-O-Meal and Main Street reached a $1.4 million settlement in the case.

Meanwhile, Netherlands Insurance sued Main Street in U.S. District Court in Minneapolis seeking a declaratory judgment on whether it had a duty to defend or indemnify Main Street under terms of its policy.

The court awarded $1.4 million to Main Street, and Netherlands appealed the ruling.

A three-judge appellate panel unanimously affirmed the lower court's ruling.

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The Netherlands policy states it “will pay those sums that the insured becomes legally obligated to pay as damages because of … 'property damage' to which this insurance applies,” said the ruling. “The 'insurance applies to … 'property damage' only if … 'property damage' is caused by an 'occurrence.'”

“Because Main Street did not intentionally sell to Malt-O-Meal FDA-condemnable dried milk, the sale of FDA-condemnable dried milk was an 'accident' that constituted an 'occurrence' under the policy,” said the ruling.

The appellate court held that an impaired property exclusion in the policy did not apply, stating the instant oatmeal manufactured by Malt-O-Meal was not “impaired property” because it could not be “restored to use,” and because the instant oatmeal was “physically injured.”

A recall exclusion in the policy also does not apply, said the ruling. “The damages sought here were not for the recall,” but for Malt-O-Meal's property damages, said the ruling, in affirming the lower court's decision in the case.