By: Sara F. Lilling
Let’s begin with a hypothetical: An insured manufactures caramel, which it sells to various customers. One of the insured’s customers purchased and used the caramel as a filling in its chocolate candy products. After the sale of the caramel, the insured learned that the sugar, one of the ingredients in the caramel, was contaminated with shards of glass. The insured notified its customer right before the customer was going to ship out its chocolate candy products. Has there been property damage to the third-party customer’s candy products that incorporated the contaminated caramel?
The majority of jurisdictions would likely find that there has been property damage to the customer’s chocolate candy products that incorporated the contaminated caramel. In Wisconsin, however, under a unique “integrated system” approach (discussed below), this is not necessarily the case. Under applicable Wisconsin law, courts would likely find that the customer’s chocolate candy products did not suffer property damage.
As we explained in an earlier blog post, Product Contamination: When The Spices Kick It Up a Notch, Who Will Respond?, a standard ISO Form Commercial General Liability (CGL) policy1 indemnifies an insured for those sums that the insured becomes legally obligated to pay as damages because of “bodily injury” or “property damage” caused by an “occurrence” where “property damage” is defined as: (i) physical injury to tangible property, including resulting loss of use of that property; or (ii) loss of use of tangible property that is not physically injured.” Thus, in the hypothetical above, most jurisdictions would find that the insured’s customer’s chocolate candy products were damaged by the incorporation of the insured’s contaminated caramel. Because of the insured’s contaminated caramel, the customer’s candy products have been “physically injured.” See National Union Fire Ins. Co. of Pittsburgh v. Terra Industries, Inc., 346 F.3d 1160 (8th Cir. 2003) (Iowa law) (finding that the incorporation of adulterated carbon dioxide into carbonated beverages was property damage caused by an occurrence); Thruway Produce, Inc. v. Mass. Bay Ins. Co. 114 F. Supp.3d 81 (W.D.N.Y. 2015) (New York law) (finding that incorporation of tainted apples into baby food products caused “[p]hysical damage to tangible property” and that the resulting damage by the incorporation of the tainted apples constituted “property damage”); Shade Foods, Inc. v. Innovative Products Sales & Marketing, Inc., 78 Cal. App. 4th 847 (Cal. Ct. App. 2000) (finding that the incorporation of almonds containing wood splinters into nut clusters for cereal was property damage).
However, under the current governing law in Wisconsin, which follows a rather unique “integrated systems” approach, there would likely be a finding of no property damage to the customer’s candy products.
Wisconsin courts have concluded that the insured risk under a CGL Policy (i.e., physical injury to tangible property) applies to physical injury to tangible property – other than to the product or completed work itself. See Wisconsin Pharmacal Co., LLC v. Nebraska Cultures of CA, Inc., 367 Wis.2d 221, 239 (2016) (citing Wisconsin Label Corp. v. Northbrook Prop. & & Cas. Ins. Co., 233 Wis.2d 314 (2000)).
In Wisconsin Pharmacal, the Wisconsin Supreme Court held that the incorporation of a defective ingredient into probiotic supplement tablets was not “property damage,” because there was no damage to other property, and the incorporation did not result in loss of use of property. In that case, Wisconsin Pharmacal supplied a probiotic supplement tablet to a major retailer. The tablet contained various ingredients, including a certain bacterial species known as Lactobacillus rhamnosus (LRA). The manufacturing process required blending of several ingredients, including LRA, and then compressing them into a tablet form. Once in tablet form, the ingredients could not be separated from one another. The retailer notified Wisconsin Pharmacal that the supplement contained a different species of bacteria and not LRA. The retailer recalled the supplement, and Wisconsin Pharmacal destroyed the supplement tablets containing the defective ingredient. Wisconsin Pharmacal then filed suit against the suppliers of the defective ingredient and their liability carriers. The liability carriers claimed that their insurance policies did not cover any damages because there was no property damage caused by an occurrence. Under Wisconsin law, “[d]amage by a defective component of an integrated system to either the system as a whole or other system components is not damage to ‘other property’ . . .” The Court concluded that the supplement tablet was an “integrated system” such that damage to the system is damage to the product itself, and not damage to other property. The defective bacteria could not be separated out from the other ingredients, and no damage resulted to property other than ingredients of the integrated system and the completed product, the tablets. Thus, incorporation of defective ingredients into the supplements was not “property damage.”
In Wausau Tile, Inc. v. County Concrete Corp., 226 Wis.2d 235 (1999), the Wisconsin Supreme Court held that a manufacturer of concrete paving blocks could not maintain tort-based claims against its cement supplier after the cement, an ingredient of concrete, had caused the paving blocks to crack and buckle. The court held that concrete paving blocks were an integrated system such that incorporation of defective cement into the paving blocks was not property damage to “other property,” and the economic-loss doctrine applied.2 The Court said: “Damage by a defective component of an integrated system to either the system as a whole or other system components is not damage to ‘other property.’’ 226 Wis.2d at 249.
In Land O’Lakes, Inc. v. Ratajczak, Jr., 2016 WL 8222933, at *1 (E.D.Wis. Aug. 24, 2016), Land O’Lakes filed an action alleging that defendants sold it adulterated whey protein concentrate for use in plaintiff’s cattle food supplement. The Court held that there was no property damage under the integrated systems approach because once the adulterated whey protein was mixed into the product, it became the product and did no harm to other property. Thus, the insurers had no duty to defend under the policies.
There are exceptions to the application of the “integrated systems” approach in Wisconsin, and that this approach will not be applicable in all circumstances. For example, in Haley v. Kolbe Millwork Co., 866 F.3d 824 (7th Cir. 2017) the Seventh Circuit, applying Wisconsin law, distinguished Wisconsin Pharmacal and held that the integrated systems analysis was not mandated. In Haley, plaintiffs claimed that windows purchased from the defendant manufacturer were defective and allowed air and water to leak into and damage the plaintiffs’ homes. The CGL insurers argued, among other things, that the policies did not cover the damage to the plaintiffs’ homes because each home formed an “integrated system” with defendant’s windows, and thus the entire house should be treated as defendant’s “product” for insurance purposes. The insurers argued that under Wisconsin Pharmacal there was no initial grant of coverage because the windows of a house have no function or purpose apart from – and thus form an “integrated system” with – their surrounding structures. The Seventh Circuit ruled that this argument stretches Pharmacal beyond its intended reach and declined to follow it. Thus, application of the “integrated systems” approach will be fact and circumstance specific.
Turning back to our hypothetical, if the insured’s customer were to bring a claim against the insured for property damage in Wisconsin, a Wisconsin court could find that there has been no property damage to the chocolate candy products, because once the contaminated caramel was incorporated into the chocolate candy products, it seemingly became an integrated system. Like Wisconsin Pharmacal, and unlike Haley, the components were essentially indistinguishable from the larger product.
The Wisconsin Pharmacal decision has the potential for “other insurance” ramifications, especially in contaminated products cases, which typically involve a contaminated products insurance (CPI) policy that contains third-party coverage (sometimes, by endorsement) as well as the insured’s CGL policy. For claims involving Wisconsin insureds, CGL carriers will likely look to the Wisconsin Pharmacal decision as a basis to deny coverage.
A typical CPI policy indemnifies the insured for first-party losses resulting from an “accidental product contamination” which generally means: (1) the accidental or unintentional contamination, impairment, or mislabeling (including mislabeling of instructions for use), during the manufacture, preparation, packaging, or labeling of the insured’s products, or publicity implying such; or (2) fault in design, specification, or performance of the insured’s products — provided always that the consumption or use of the insured’s contaminated products has, within a certain period of time (e.g., 120 days or 365 days), resulted in or may result in bodily injury or physical damage to tangible property other than products of the insured. See, e.g., Caudill Seed & Warehouse Co., Inc. v. Houston Casualty Co., 835 F.Supp.2d 329 (W.D. Ky. 2011). Some CPI policies also offer, either in the main coverage form or by endorsement, coverage for “third-party product recall liability,” which includes product recall liability damages and defense costs. This third-party coverage often presents an “other insurance” situation with a general liability policy. Other insurance analyses can involve the law of two (or more) states, which can entail additional complications to the question of which policy pays for which claimed cost. And if Wisconsin law becomes a factor as respects the liability policy, the pressure on the CPI policy to pay for third-party recall costs may increase.
Wisconsin Pharmacal, which remains good law since 2016, presents a unique approach to assessing property damage by using an integrated systems analysis. The decision effectively limits coverage available under a general liability policy in certain circumstances, and in those cases, other insurers or the insureds themselves are left to shoulder the costs. CPI insurers should be mindful of how this decision could affect recovery under an “other insurance” analysis of CGL policies issued to Wisconsin insureds.
- See Commercial General Liability Coverage Form, CG 00 01 04 13.
- Under the economic loss doctrine, a purchaser of a product cannot maintain claims of negligence or strict liability to recover from the product’s manufacturer loss which is solely economic. The economic loss doctrine does not preclude a product purchaser’s claims of personal injury or damage to property other than the product itself.