British Columbia Court of Appeal broadens CGL coverage for defective products

On April 12, 2011, the British Columbia Court of Appeal released the first appellate decision in Canada dealing with a commercial general liability (CGL) policy since the Supreme Court of Canada’s September 23, 2010 decision clarifying CGL coverage (discussed in Dispute Resolution’s Fall 2010 edition). It appears to have significantly broadened the scope of CGL coverage for loss of use of the insured’s products.

In this case a customer placed an order for printed plastic bags, to fill with soil and manure and sell to Canadian Tire. The manufacturer supplied over 1.1 million bags. The customer began to fill the bags, but quickly discovered that the ink was coming off them, making them unreadable and mixing with the soil and manure, making them potentially unusable as well.

The manufacturer provided the customer with new bags and it used them to meet its commitments to Canadian Tire. The customer then sued the manufacturer for $784,221.34 in losses, arising from removing the materials from the defective bags and disposing of them, and the loss of about 10% of the soil and manure in the salvaging process. The manufacturer settled that lawsuit and then claimed indemnity from its insurer.

The manufacturer’s CGL policy was relatively standard. It provided that the manufacturer had coverage for “property damage” due to an “accident” or “occurrence”. It defined “property damage” as “physical injury to or physical destruction of tangible property, including loss of use thereof, or loss of use of tangible property that has not been physically injured or destroyed”.

The trial judge ruled that the policy covered only the value of the lost soil and manure, about $12,000. The manufacturer appealed.

In between the trial decision and the appeal being heard, the Supreme Court of Canada decided that there was nothing in the terms “property damage” or “occurrence” in CGL policies that restricted their application to a third party’s property, rather than the insured’s property. As a result, it became clear that “property damage” could include damage to any tangible property.

In light of that, the insurer conceded that the manufacturer’s claim was for “property damage”, because its faulty bags were “injured” and the customer lost the use of them. As well, the insurer conceded that the faulty workmanship that caused the defective bags was an “accident” or “occurrence” within the meaning of the policy and resulted in property damage to 10% of the customer’s soil and manure.

But, despite those concessions, the insurer argued that the policy’s “work and product” exclusion excluded the manufacturer’s claim. That exclusion stated that the policy did not apply to claims for property damage to “goods or products manufactured or sold” by the manufacturer. The insurer argued that the losses suffered by the customer was caused by its loss of use of the damaged bags and that the exclusion of the manufacturer’s claims was consistent with the general purpose of liability coverage and the “own product” exclusion.

The Court of Appeal rejected this argument, concluding that, while the clause excluded claims for damage to the manufacturer’s bags, it did not exclude compensation for the customer’s costs of separating those bags from its soil and manure, repackaging it in different bags and salvaging the old soil and manure later. The Court found that the clause did not exclude coverage for “claims that flow from” the manufacturer’s defective work or work product. It excluded only coverage for property damage to goods supplied by the manufacturer. To hold otherwise, according to the Court, would be a “perversion” of the Supreme Court of Canada’s decision.

The insurer also argued that the “work performed” exclusion in the policy, which stated that there was no coverage for claims arising from the loss of use of tangible property that was not physically injured or destroyed by the failure of the manufacturer’s products or work performed, operated to exclude the manufacturer’s claim.

However, the Court rejected this argument too, concluding that it was clear that the 10% of the soil and manure that had remained in the defective bags was physically injured or destroyed, at least in the sense that it had ceased to be useable for its intended purpose.

This decision of the Court of Appeal about the work and product exclusion appears to broaden CGL coverage for damages caused by defective products supplied by insureds. If the defective product costs money to replace and repair, or causes damage to other property, it appears likely that the “work and product” exclusion will not bar coverage, and the insurer will be required to indemnify the insured for these amounts.