Oct. 29, 2014 – Insurers have a duty to defend businesses that supplied the wrong ingredient for inclusion in a probiotic health supplement, a state appeals court has ruled, concluding that the error caused “property damage” that is covered under their policies.
In Wisconsin Pharmacal v. Nebraska Cultures of California Inc., 2013AP613 (Oct. 29, 2014), a three-judge panel (2-1) concluded that property damage occurred when the wrong ingredient was integrated with other materials and rendered the pills unusable.
Jeneil Biotech Inc. manufactures and supplies food and supplement additives and ingredients to other companies that manufacture food and supplement products.
Jeneil contracted to supply an ingredient called Lactobacillus rhamnosus (rhamnosus), a bacterium that is commonly used in probiotic supplements.
Jeneil sold the rhamnosus to Nebraska Cultures of California, which had agreed to find the rhamnosus and supply it to Nutritional Manufacturing Services LLC (NMS). In turn, NMS manufactured a chewable probiotic tablet that incorporated the rhamnosus.
Those tablets were sold to Wisconsin Pharmacal Company, which sold, packaged and shipped the tablets to a major retailer. Pharmacal had contracted with NMS.
But the retailer later informed Pharmacal that the tablets did not contain rhamnosus; Jeneil had wrongly supplied an ingredient called Lactobacillus acidophilus, a different bacteria with probiotic characteristics. Pharmacal confirmed through independent testing and the retailer recalled the pill.
Pharmacal sued Nebraska Cultures and Jeneil, and their respective insurers. On the issue of insurance coverage, the circuit court ruled that there was no initial grant of coverage because Jeneil and Nebraska Cultures did not cause property damage.
Jeneil and Nebraska Cultures, which had contracted to supply the rhamnosus, had commercial general liability policies that covered liability for “property damage.” The insurers argued that the error did not trigger covered liability for property damage.
The circuit court agreed with the insurers. But an appeals court majority reversed.
The 2-1 majority noted that the wrong ingredient was blended with other materials to form the tablets, and the process was not reversible. Once the error was uncovered and the recall initiated, the entire inventory of probiotic tablets was destroyed.
“And the tablets were unusable because when they were created by physically altering the raw ingredients, one of the ingredients was the wrong ingredient,” wrote Judge Lisa Neubauer. “Thus … there was a physical injury to the other tangible property.”
The insurers argued that there is no property damage to “other property” under the “economic loss doctrine” when a defective part is integrated into a larger system. But the majority noted that the doctrine is not determinative when insurance policies apply.
“[T]he policies require physical injury to tangible property, which has been shown here,” Judge Neubauer wrote. “That a purchaser is limited to recovery in contract for losses associated with a product does not negate the fact of physical property damage.”
The insurers also argued that coverage is not triggered unless property damage is caused by an “occurrence,” an unexpected or unforeseen accident. There was no “occurrence,” the insurers argued, because the error was merely a breach of contract.
“Under Wisconsin law, coverage is based on the facts alleged in the complaint and those revealed in discovery, not on the labels or characterizations put on the causes of action in the complaint,” wrote Judge Neubauer.
“Thus, that property damage ‘is actionable in contract but not tort does not make it ‘non-accidental’ or otherwise remove it from the CGL’s definition of ‘occurrence.’”
Finally, the majority rejected the insurers’ claim that coverage does not apply because the complaint alleged that the error was committed intentionally or with knowledge.
The panel noted that an intentional act doesn’t always negate coverage, those claims were dismissed, and the record did not show the error was intentional.
“[I]t is reasonable to infer that … conduct in providing the wrong product was negligent – the incorporation accidentally caused property damage,” Neubauer wrote. “We reject the insurer’s attempt to uncouple negligent conduct causing property damage from discrete intentional acts associated with the supply and incorporation of the product.”
Judge Paul Reilly dissented. He said Pharmacal order rhamnosus from Nebraska and Jeneil and those companies represented that what they supplied was rhamnosus.
“The majority misses the simple question presented: does a CGL policy provide coverage for claims based on misrepresentation? Twice our supreme court has decided that a misrepresentation is not an ‘accident’ nor an ‘occurrence,’” Judge Reilly wrote.