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 third party property damage, a necessary prerequisite to coverage with most general liability policies. Insurance companies are fond of the argument that there is no covered third party “property damage” when a defective component or ingredient ruins an integrated product without causing any other harm. Insurers also argue that claims 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 needed clarity to this perhaps unduly complicated area.
Wisconsin Pharmacal Co., LLC v. Nebraska Cultures of California, Inc. 2013AP613, 2013AP687 (Oct. 29, 2014) involved a contract between a pharmacy wholesaler (Wisconsin Pharmacal) and a drug manufacturer (NMS). NMS procured a necessary ingredient for the 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 Nebraska Cultures, 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 (barring damage to the insured's own work or product) barred coverage.
In a two-to-one 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 third party 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 that there was no “accident.”
The court rejected this argument and found no evidence to suggest that the suppliers’ 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 providing 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 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.