"Solace For Wis. Suppliers Over Defective Components"
The complexities of modern commerce are such that there are few products that do not incorporate products from other sources. In fact, most end products are made up of dozens, hundreds or even thousands of different components, made and sold by various suppliers, and assembled by manufacturers who then sell the products into the marketplace. When one of the parties in the supply chain inadvertently supplies the wrong component, the results can be calamitous, and invariably lead to lawsuits. When there's a lawsuit, the question arises (as it always should) — is there insurance coverage?
The answer has not always been as clear as one might think. When it comes to products that are blended, integrated or simply part of a single system, courts have struggled with whether there is property damage, a prerequisite to coverage for most general liability policies. Insurance companies are fond of the argument that there is no covered "property damage" when a defective component or ingredient ruins an integrated product without causing any other harm or, alternatively, that such a situation implicates the "Your Product" or "Your Work" exclusions.
Insurers also argue that a claim based on inadvertent false statements pertaining to use of the wrong ingredient (e.g., "Our product contains ingredient X" when in fact it contains ingredient Y) is not covered because it involves a "volitional" act of making a statement (even if the speaker believes it to be true) and therefore is not a covered "accident." Fortunately, the Wisconsin Court of Appeals recently brought some needed clarity to this perhaps unduly complicated area.
Wisconsin Pharmacal Co. LLC v. Nebraska Cultures of California Inc. 2013AP613, 2013AP687 (Wis. Ct. App. Oct. 29, 2014) involved a contract between a pharmacy wholesaler — Wisconsin Pharmacal — and a drug manufacturer — NMS. NMS procured a necessary ingredient for a supplement from yet another party — Jeneil. The retailer to whom Pharmacal ultimately sold the supplement discovered that the finished supplement contained the wrong ingredient. The finished supplement could not be used and had to be destroyed. Pharmacal sued NMS, Jeneil and their respective insurers.
The policies under which Pharmacal sought coverage were standard commercial general liability policies issued to Jeneil (the supplier of the wrong ingredient); the policies covered "property damage" caused by an "occurrence," (defined as an "accident"). The circuit court held that there was no property damage, no occurrence, and additionally, that the "business risk" exclusions (excluding coverage for damage to the insured's own work or product) barred coverage.
In a 2-1 decision, the Court of Appeals reversed. The court concluded that the act of blending the wrong ingredient with other ingredients made the supplements unusable and constituted property damage. The decision suggested that the act of blending the wrong ingredient with other ingredients physically injured those other ingredients so as to cause property damage.
The court's work was not done with the "property damage" issue. The insurers had also argued for application of the "Your Product" exclusion and that there was no "accident."
The court rejected these arguments. Addressing the "Your Product" exclusion, it found that the blending of the defective ingredients with other components did not convert the finished product into the insured's own product and that the damage was to third-party property. On the "accident" issue, it found no evidence to suggest that the act of supplying the wrong ingredient was intentional. In holding that the mere act of providing the wrong ingredient was not an intentional act, precluding coverage, the court distinguished prior case law which had held that false statements, even where innocently made, involved "volitional acts." The court noted that the case before it involved the unintentional provision of the wrong product, not false statements about property that was already damaged. This latter point drew a dissent (which could foreshadow further review by the Supreme Court). The dissent noted that "allegations of misrepresentation underlay all of the claims" and that "a misrepresentation is not an accident."
The decision is important for all manufacturers, and particularly for suppliers of component products (e.g., bulk ingredient suppliers who are sued because an ingredient they furnish ruins the end product) regardless of whether it is an "integrated" or "blended" product. The decision correctly found that such an act is covered under a standard general liability policy, but there is an important caveat to this: the fully integrated product must be ruined by the defective component. If the defective component can simply be replaced, there likely is no "property damage" — and no coverage.
Beyond this, and from a broader perspective, the decision is notable in several respects. First, it dispels the notion that property damage for purposes of insurance coverage is affected by whether a component is part of an "integrated" or "blended" product. Such a standard, employed by some courts, is a flawed analysis. A supplier of ingredients sued because it accidentally supplied the wrong ingredient reasonably expects that its general liability policy is going to provide coverage if the ingredient it supplies causes the destruction of another product, and whether the ingredient is "part" of that product or not is irrelevant to that expectation — and there is nothing in the policy that would necessarily lead to a different conclusion. What that supplier should not expect to be covered is the cost of repairing or replacing the defective component — that is the kind of "business risk" CGL policies are not intended to cover.
Second, and on a related point, the decision amply illustrates the distinction, not always well understood, between assessing the existence of property damage or application of the "Your Work" exclusion for purposes of insurance coverage and "other property" damage that permits the assertion of tort theories under the Economic Loss Doctrine or similar rule. In other words, under Wisconsin's (and many other states') construction of the Economic Loss Doctrine, Wisconsin Pharmacal had no claim for tort damages due to the lack of "other property" damage in an "integrated product" situation. Some courts have held that this same fact would mean no insurance coverage to NMS or Jeneil in the remaining contract claim. See, e.g., F & H Const. v. ITT Hartford Ins. Co. of Midwest, 118 Cal.App.4th 364 (2004) (finding no "property damage" where subcontractor supplied inadequate pile caps). But whether tort remedies exist for the aggrieved plaintiff should have nothing to do with whether there is insurance coverage for the defendant supplier whose misidentified ingredient ruins the product in which that ingredient was placed. They are two entirely separate issues.
Third, in focusing on the seller's act of providing the wrong ingredient rather than any accompanying statements made to the buyer, the decision strikes a needed blow in limiting the "volitional acts doctrine," an unfortunate insurance law development in some jurisdictions over the past couple of decades that has been employed to deny coverage for unintended harm simply because it resulted from an act of "volition," like making a false statement. While the doctrine has largely been confined to the area of negligent or innocent misrepresentation (and even in that context it is hard to justify since innocently made false statements can be considered as much an "accident" as any other act of negligence), it has gained traction in other areas. For example, Wisconsin had earlier embraced the doctrine, in Everson v. Lorenz, 695 N.W.2d 298 (Wis. 2005) on the basis of a Seventh Circuit decision denying coverage to a collection agency because it mistakenly repossessed the wrong vehicle, since the repossession involved a "volitional act." Red Ball Leasing Inc. v. Hartford Accident and Indemnity Co., 915 F.3d 306 (7th Cir. 1990). Nothing in the CGL policy makes such a distinction and logic refutes it. Particularly when taken to its logical conclusion, the volitional acts analysis wreaks havoc in all kinds of ways, from denying coverage to a doctor who mistakenly amputates the wrong leg, to a speeding driver who exercises "volition" in accelerating through an intersection to beat a red light. All of these scenarios may involve careless, blameworthy and volitional conduct, but it is negligent conduct in the sense that no harm was intended. Mitigating the financial risk of negligently caused, but unintended harm is why liability insurance exists, a point that courts adopting a "volitional acts" analysis sometimes seem to forget.