Danone to sue Fonterra over baby milk formula scare

French food group Danone intends to sue its primary dairy supplier Fonterra after a false alarm that instigated product recalls across multiple Asian countries, including China


After months of negotiations following the recall of its infant milk formulas last August, an unappeased Danone plans to sue its New Zealand based supplier Fonterra. The Paris-based food group intends to terminate the supply contract with the farming co-operative wholesale dairy exporter.

The recall, affecting nine Asian countries, was sparked when Fonterra found that some products were infected by bacteria that caused botulism, a fatal illness. On further investigation, it was found that the ingredient did not contain fatal bacteria and that the recall was based on a false alarm.

As one of the world’s largest dairy processors, Fonterra’s milk formula recall affected not only Danone, but also other multinationals. Fonterra has now reached agreements with the majority of the eight companies who were forced to recall their products. These agreements have included the extension of supply contracts for up to 10 years and compensation for losses over the recall.

Danone and Fonterra began negotiations after the recalls in China last October. Due to its domestic food quality issues, China is in high demand of foreign branded baby milk formula. Baby food accounts for 20 percent of Danone’s revenue and China is a key growth market. The recall forced Danone to lower its annual targets and, after failing to reach an agreement, the company became the first to initiate legal proceedings against its dairy wholesaler.

As New Zealand’s largest company, Fonterra controls approximately one-third of diary exports worldwide and is a dairy wholesaler for a range of multinationals

Danone is reportedly seeking full compensation for the losses suffered from the recall, which they allege to amount to €350m (USD $476m/£289m). Fonterra, however, recognised a contingent liability amounting to only NZD $14m. Danone will initiate proceedings in the New Zealand High Court as well as arbitration proceedings in Singapore. In a statement, Fonterra said that it has “been in ongoing commercial discussions with Danone and is disappointed that they have resulted in legal action” and that it “will vigorously defend any proceedings”.

As New Zealand’s largest company, Fonterra controls approximately one-third of diary exports worldwide and is a dairy wholesaler for a range of multinationals including Danone and Nestle. According to analysts, Danone is one of Fonterra’s biggest milk powder customers and following the announcement that Danone will be terminating its supply contract with the processor, Fonterra’s sharetrading units fell approximately 2 percent.

Rickey Ward, head of equities at Tyndall Investment Management in Auckland, told Reuters that the global demand for dairy products remains high, especially in China, and consequently Fonterra will not have issue in making up for cancelled orders.

“It’s not nice to lose a big customer … [but] there’s large global demand and short supply so Fonterra may be able to fill that void if there is a big void,” he continued. Nevertheless, in December Fonterra cut its dividend forecast from 32c to 10c per share, keeping the price of milk solids at $8.30/kg instead of raising it to an expected $9.00/kg.

In a statement, Danone said, “this affair illustrates serious failings on Fonterra’s part in applying the quality standards required in the food industry,” and that any future collaboration with Fonterra will rely on “full transparency and compliance with the cutting-edge food safety procedures applied to all products supplied to Danone.”

In its statement, Fonterra asserted that it “stands by its track record of having world-class food safety and quality standards, quality systems, and robust testing regimes across all its manufacturing facilities”.

Matt Goodson, managing director at Salt Funds Management told TVNZ’s ONE News: “it’s hard to know at this point how much of a claim by Danone is real and how much is negotiating tactics… At the moment this is a very news story driven equity market.”

Nevertheless, this legal battle between two key players in the dairy industry highlights the risk in over-reliance on sole suppliers. Although Fonterra’s future remains somewhat secure, it still stands to lose big over the loss of such a major client.