Wisconsin Supreme Court Rules That Inclusion of Defective Ingredient Does Not Constitute Property Damage
By Joseph Arnold and Matthew Taylor on April 7, 2016
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In Wisconsin Pharmacal Co., LLC v. Nebraska Cultures of California, Inc., et al., 2016 Wisc. LEXIS 12 (March 1, 2016), the Wisconsin Supreme Court in a 3-2 decision determined that two insurers had no duty to cover claims related to damages caused by the inclusion of a defective ingredient in a probiotic supplement because the inclusion of the defective ingredient did not damage other property and did not result in loss of use of property.
Brief Factual Background
Wisconsin Pharmacal Co., LLC (“Pharmacal”) manufactured a chewable Daily Probiotic Feminine Supplement which contained various ingredients, including a probiotic bacterial species known as Lactobacillus rhamnosus (LRA). In July of 2008, Pharmacal contracted with Nutritional Manufacturing Services, LLC (“NMS”) to procure LRA and manufacture the tablets. NMS in turn contracted with Nebraska Cultures for the LRA, and Nebraska Cultures then bought the LRA from Jeneil. The problem, of course, was that Jeniel supplied NMS with the wrong bacteria.
NMS manufactured the tablet with the ingredient it believed to be LRA but discovered that it had used a different bacteria known as Lactobacillus acidophilus (LA). In April 2009, after Pharmacal packaged and supplied the supplement to its retailer, Pharmacal learned that the supplement contained LA instead of LRA. As a result, the retailer recalled the supplement and Pharmacal destroyed the tablets containing the defective ingredient. NMS assigned its causes of action against Nebraska Cultures and Jeneil to Pharmacal, which sued Nebraska Cultures and its general liability insurer, Evanston Insurance Co., as well as Jeneil and its general liability insurer, The Netherlands Insurance Co.
The insurers filed motions for summary judgment, arguing that they did not owe coverage for the loss. The trial court concluded that the insurers had no duty to defend because the incorporation of a defective probiotic ingredient into the tablets did not constitute “property damage caused by an occurrence” because only the product itself was harmed. The intermediate appellate court reversed, concluding the policies provided coverage. The Wisconsin Supreme Court reversed the appeals court and determined that no coverage existed under the policies.
The Netherland’s CGL policy provided coverage for Jeneil’s losses that the “insured becomes legally obligated to pay as damages because of ‘bodily injury’ or ‘property damage’…caused by an ‘occurrence.’” The policy defined property damage as “a) Physical injury to tangible property, including all resulting loss of use of that property. . . .; or (b) Loss of use of tangible property that is not physically injured.”
Evanston’s CGL policy similarly provided coverage for Nebraska Cultures’ losses arising out of “bodily injury” or “property damage” caused by an “occurrence.” The policy defined “property damage” as “physical injury to or destruction of tangible property including, consequential loss of use thereof; o[r] loss of use of tangible property which has not been physically injured or destroyed.”
No Property Damage
The majority determined that there was no property damage, because combining a defective ingredient with other ingredients and incorporating them into supplement tablets formed an “integrated system,” or unified whole. Therefore, the Court reasoned that the defective ingredient (LA), could not be separated from the other ingredients, and no damage resulted to property other than ingredients of the integrated system. Because the injury was sustained by the integrated system itself, the resulting damage caused by LA’s inclusion in the tablet did not occur to other property.
The Court additionally noted that the defective ingredient rendered the tablets inadequate for their contracted purpose; however, the mere presence of a defective ingredient did not render them hazardous. For this reason, the Court concluded there was no property damage under the Evanston policy.
No Loss of Use
Similarly, the majority rejected the parties’ argument that the incorporation of a defective ingredient rendered the other ingredients and the supplement tablets totally useless to Pharmacal, thereby constituting property damage due to “loss of use of tangible property that is not physically injured.” The Court reiterated that a “diminution in value, even to the point of worthlessness” was not the same as “loss of use.” The Court rejected the insured’s argument and found that Pharmacal did not actually lose use of the tablets, but rather lost the value of the tablets. Thus, the Court held that there was no property damage due to “loss of use of tangible property that has not been physically injured.”
The policies defined “occurrence” as “an accident, including continuous or repeated exposure to substantially the same general harmful conditions.” Although it was undisputed that Jeneil’s provision of the defective ingredient was accidental, the Court was not persuaded that the “accidental provision” of a defective ingredient, standing alone, satisfied the Netherlands policy’s definition of occurrence. Under Wisconsin’s American Girl case, the negligent conduct is not the occurrence, but it can cause an “occurrence,” which in turn causes property damage. Here, the provision of the defective ingredient did not cause an occurrence that led to property damage. In other words, the defective ingredient did not cause other property to malfunction or a third party to get sick, so the provision of the defective ingredient alone was not an occurrence.
The Court applied California law to the Evanston policy and followed a line of cases finding that deliberate conduct cannot be an occurrence even if the insured did not intend to cause the injury. So although Jeneil’s provision of a defective ingredient may have been negligent, Jeneil deliberately supplied the ingredient to Nebraska Cultures and intended the ingredient to be incorporated into the tablets. Given the deliberate nature of these actions, the Court found that the provision of a defective ingredient cannot be said to constitute an “occurrence” under California law.
In a dissenting opinion, Justice Shirley S. Abrahamson she disagreed with the majority opinion’s “unwise and unprecedented” application of the integrated system rule, which originates in the economic loss doctrine, to the interpretation of insurance policies. Justice Abrahamson, who was joined in the dissent by Justice Ann Walsh Bradley, compared the application of the economic loss doctrine to the alien creature in the classic science fiction film “The Blob,” noting the doctrine was often incoherent. Justice Abrahamson criticized the majority’s decision for infusing the economic loss doctrine, a tort principle, into insurance policy interpretation. Justice Abrahamson feared that the majority’s approach departed from a reviewing Court’s normal duty of strictly interpreting the plain language of the subject insurance policy.
This decision is available here.