Litigation Section Blog: The Economic Loss Doctrine May Apply To Determine Liability Coverage: Wisconsin Pharmacal Co., LLC v. Nebraska Cultures of California, Inc. :

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  • Litigation Section Blog
    July
    14
    2016

    The Economic Loss Doctrine May Apply To Determine Liability Coverage: Wisconsin Pharmacal Co., LLC v. Nebraska Cultures of California, Inc.

    Atty. Patryk W. Silver

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    The Supreme Court recently applied the economic loss doctrine’s “integrated systems” analysis in determining whether coverage is afforded where an insured provided a non-conforming product that was later incorporated into other property. The decision suggests that if an insured’s non-conforming work or product cannot be separated out from the integrated system, then there may be no “property damage” for insurance purposes even if the insured’s work or product damages the other property in the integrated system, writes Patryk Silver.

    Under Wisconsin law, the economic loss doctrine does not determine insurance coverage. Right?

    Wrong! Or perhaps ... maybe.

    The issue comes up in the wake of the recent Wisconsin Supreme Court decision in Wisconsin Pharmacal Co., LLC v. Nebraska Cultures of California, Inc., 2016 WI 14, 367 Wis. 2d 221, 239, 876 N.W.2d 72 (“Pharmacal”). This decision is significant because in some cases it arguably supports reliance on the economic loss doctrine (ELD) and its related “integrated systems” analysis when determining if there is “property damage” under a commercial general liability (CGL) policy.

    Patryk Silver com psilver borgelt Patryk Silver (Boston University, 2000) is a shareholder at Borgelt, Powell, Peterson & Frauen, Madison. His practice focuses primarily on insurance coverage in a variety of contexts.

    Pharmacal reverses a Court of Appeals decision and affirms a trial court grant of summary judgment in favor of two insurers (Evanston Insurance Company and The Netherlands Insurance Company). These insurers had issued liability policies covering Nebraska Cultures (a distributor) and Jeneil Biotech (a seller) of probiotic bacteria. Nebraska Cultures contracted to sell Jeneil’s bacteria to Nutritional Manufacturing (NM). NM incorporated the bacteria into its manufactured probiotic dietary tablet, which was sold to Wisconsin Pharmacal, a dietary tablet distributor. The tablets were later determined to contain the wrong bacteria. The tablets were deemed worthless and were destroyed. NM assigned its rights to Wisconsin Pharmacal, which in turn sued Nebraska Cultures, Jeneil, and their insurers. The insurers challenged whether their policies afforded liability coverage.

    The supreme court began its coverage analysis by considering whether the allegations showed “property damage.” In determining whether there was “property damage,” the supreme court asked whether the risk intended to be insured is the possibility that the insured’s good, products or work will cause damage to property “other than to the product or completed work itself.” Pharmacal at ¶ 24. To answer this question, the supreme court asked whether the incorporation of the wrong bacteria into the tablets constitutes physical injury to tangible property other than the bacteria itself. To answer this question the supreme court then analyzed whether the tablets constitute an “integrated system,” because “if it is, damage to the system has been defined as damage to the product itself, not damage to other property.” In so doing, the supreme court relied on Wausau Tile, Inc. v. County Concrete Corp., 226 Wis. 2d 235, 249, 593 N.W.2d 445 (1999) and applied the ELD “integrated systems” analysis. As the supreme court explained:

    [a]n integrated system analysis is necessary when evaluating coverage under a CGL policy because we must decide whether the product is to be treated as a unified whole or whether a defective component can be separated out such that the claimed damage constitutes damage to property other than the defective component itself.

    Pharmacal at ¶ 28. Because combining the wrong bacteria with other ingredients formed an integrated system (the tablets), and because there was no damage to property other than the integrated system, there was no “property damage,” hence no coverage grant. Id. at ¶ 34.

    Nebraska Cultures and Jeneil presented evidence that the buyer suffered damage to and loss of use of the buyer’s other ingredients used in the tableting process, and therefore there was “property damage” under the insurers’ policies. The supreme court disagreed, explaining that there was no “factual foundation” from which one could conclude that creating the tablets using the wrong bacteria physically altered the other ingredients used in the tableting process in a way that would not have occurred had the correct bacteria been used. Id. at ¶ 37. Additionally, there was no loss of use of the tablets, only loss of the value of the tablets. Id. at ¶ 43.

    While not essential to the coverage determination, the supreme court also concluded there was no “occurrence” for coverage purposes because “accidental provision of a defective ingredient does not constitute an ‘occurrence.’” Id. at ¶ 56. In reaching that determination, the supreme court explained that under Wisconsin law, faulty workmanship can give rise to property damage caused by an occurrence. However, here the accidental provision of the defective bacteria was itself faulty workmanship. Finally, the supreme court concluded that the policies’ “impaired property” exclusion barred coverage, even assuming a coverage grant. Id. at ¶¶ 77-82.

    In the future, practitioners may wish to explore Pharmacal when evaluating coverage under analogous circumstances – that is, where the insured provides a defective or non-conforming product that is later incorporated into other property such as to form an “integrated system” that is deemed non-conforming. If the insured’s work or product cannot be separated out from the integrated system, then there may well be no “property damage” even if the insured’s work or product damages the other property in the integrated system.





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