By Ronald J. Levine, Herrick, Feinstein
Food technology – from 3D printing to new food categories like cell-based proteins and vegan fast food – is making rapid strides. For example, for those interested in stepping into new advances in plant-based foods on the ground floor, it is wise to research well beyond a company’s balance sheet to avoid falling into a potential legal hole. Over the past few years we have seen some established conglomerates quickly take over smaller food companies in an effort to diversify their portfolios with “healthy” or other innovative products that may be attractive to a new market, ultimately creating a significant headache led.
In order to uncover lurking landmines, it is essential to ask hard questions about questions such as the processing of the target company’s ingredients, the basis for labeling claims and insurance coverage. Investors need to take a close look at the three P’s of the company: Processes, Philosophy, and Protection.
Whether it’s recalling contaminated food or labeling words like “natural,” food manufacturers have faced hundreds of class action lawsuits in recent years. For example, if a company claims that its products are “healthy,” it is critical that the manufacturer demonstrate that the ingredients meet the Food and Drug Administration’s definition, or the company could face claims that the product is is incorrectly marked.
Additionally, prospective buyers should conduct a thorough ingredient source investigation and quality control as a company could face serious liability claims if its ingredients exhibit high levels of toxicity. Toxins can be introduced into the food through ingredients purchased from suppliers or through the company’s manufacturing process itself. Regardless of the source, the discovery of toxins can turn a potentially profitable product into financial disaster in a matter of days.
Questions a potential investor should consider when evaluating a food company’s processes include:
- Is the company up to date with the changing landscape of food regulations? Any food manufacturer involved in labeling must adhere to the ever-evolving regulations of the Food and Drug Administration, the Department of Agriculture, state and local authorities, and other regulatory agencies.
- Does the company carefully review the information it uses on its labels and advertising?? Words such as “natural” and “healthy” should not be used unless the company has studied the regulations and knows how courts interpret these words. Products on the shelves of retail stores with labels containing these words will no doubt attract the attention of plaintiffs’ attorneys, whether or not they attract more consumers.
- Does the company go “on the envelope” when promoting its products?? If the company oversells the “Puffery” product, it could well be in trouble. The company can drive sales with grandiose claims, but the extra profit could be eaten away by defending claims by private plaintiffs or the Federal Trade Commission.
In addition to examining the quality control, labels, and target indications, buyers should make an assessment of the management. Some food businesses are just one step away from a founder’s kitchen stove. Sometimes these founders believe that the concoction they come up with is the perfect cure for the common cold or obesity. The rise of social media has created fertile ground for selling dreams of quick health solutions. Hundreds of thousands of potential consumers could be tricked into buying useless, relatively cheap products that they believe will replace expensive drugs.
It is time consuming and expensive to develop scientific support for health and medical claims. A company shouldn’t make grandiose claims unless they’re willing to back them up with facts and data. An investor should be very careful when looking at a company that makes wildly unsubstantiated claims about their product, especially health claims, as this can lead to legal action by federal agencies, social activists, and competitors – which could have serious adverse consequences for the company .
It is also important to assess past, present, or potential future claims against a company. These risks include personal injury claims, consumer fraud class actions, recalls, or government investigations. Legal technology is very progressive – with one click the entire legal history of a company, a product or an ingredient.
Social media is a good place to look for plaintiffs attorneys who may be bringing claims against the company. Websites are used to find and attract new customers to their businesses. Even if there are no current claims against the company, claims may arise. Investors need to carefully analyze the company’s insurance coverage. In addition to the classic commercial liability insurance, it is important to check the insurance cover for false advertising and product liability, as well as whether suppliers have added the company as additional insured. The growth of hacking and ransomware has added another important form of coverage – cyber insurance.
Although the food industry offers a significant opportunity to benefit from the food industry, every buyer must take the time to educate themselves and develop a nuanced understanding of the company’s processes, philosophy and protective measures. This 3Ps due diligence leads the investor to a fourth P: Peace of Mind.
About the author: Ronald Levine is an attorney with the New York law firm Herrick Feinstein with 35 years of experience advising consumer goods companies on complex commercial disputes, specializing in food and beverage law and regulation. Ron has extensive experience in food and beverage affairs and also teaches a food and cosmetics regulation course at Rutgers University and serves as chair of the external advisory board of the Institute for FoodNutrition & Health at Rutgers.
The views and opinions expressed herein are those of the author and do not necessarily reflect those of Nasdaq, Inc.