A Georgia intermediate appellate court recently held that the impaired property exclusion precluded coverage for allegations that the policyholder bakery sold contaminated bread to a sandwich shop. Lavoi Corp., Inc. v. National Fire Ins. of Hartford, No. A08A0683, 2008 WL 2468888 (Ga. App. Jun. 20, 2008). The underlying plaintiff, a sandwich shop franchise owner, alleged that the policyholder, a commercial bakery, provided it with contaminated bread.

The underlying plaintiff asserted causes of action for breach of the warranties of merchantability, wholesomeness, and purity; strict liability for a manufacturing defect; violation of the Deceptive Trade Practices-Consumer Protection Act; tortious interference with prospective business relations; and violation of federal antitrust laws, including the Robinson-Patman Act and the Sherman Act. Based on these causes of action, the underlying plaintiff sought economic damages, statutory damages, exemplary and punitive damages, attorney fees, costs, and prejudgment and post-judgment interest.

The liability policy purchased by the bakery excluded coverage for "'Property damage' to 'impaired property' or property that has not been physically injured, arising out of: (1) A defect, deficiency, inadequacy or dangerous condition in 'your product' or 'your work . . . .'" The policy defined "impaired property" as "tangible property, other than 'your product' or 'your work,' that cannot be used or is less useful because: (A) It incorporates 'your product' or 'your work' that is known or thought to be defective, deficient, inadequate or dangerous . . . ." After the insurer denied coverage based on this exclusion, the policyholder filed suit. On cross-motions for summary judgment, the trial court held that the impaired property exclusion precluded any duty to defend or indemnify the policyholder.

On appeal, the policyholder argued that it was entitled to at least a defense under the policy because the underlying plaintiff might have been able to prove that the policyholder's tainted bread contaminated sandwiches, which had to be destroyed, caused "property damage" to the underlying plaintiff and injury to its customers. Rejecting this argument, the court reasoned that the allegations of the underlying complaint were neither ambiguous nor incomplete, and did not include any allegation of bodily injury to the underlying plaintiff's customers. The court further reasoned that the impaired property exclusion applied because sandwiches made with the tainted bread fell within the policy definition of impaired property and the exclusion "specifically provides that the policy does not cover property damage to impaired property arising out of 'a defect, deficiency, inadequacy or dangerous condition' in the policyholder's product or work."

Accordingly, the appellate court ruled that the insurer had no duty to defend or indemnify the policyholder in connection with the underlying action. The court further held that, since the policyholder was not entitled to coverage, the insurer had reasonable grounds to deny coverage and could not be held liable for bad faith.