A district court in California recently found that an insurer was not liable where its insured sought coverage under its Commercial Umbrella policy for loss it suffered as a result of the manufacture of a defective product. Ruling in favor of the insurer on partial summary judgment, the Northern District Court held that there was no “property damage” or “loss of use” under the policy where the defective product was incorporated into another product, but did not contaminate or otherwise created a dangerous product and where the resulting product was not wholly unusable.

In Silgan Containers Corp. National Union Fire Insurance Co. of Pittsburgh, PA, Silgan sued its insurer, National Union, for coverage of a claim involving its manufacture of a defective product. Silgan manufacturers steel and aluminum containers with pull-tabs used as packaging for food products. In 2004, one of its customers, Del Monte, began receiving complaints that the pull-tab cups were malfunctioning. Del Monte notified Silgan of the issue and after investigation, Silgan determined that there were various factors involving both design and manufacture contributing to the container defect. Del Monte then notified Silgan that it would no longer accept its products. Del Monte disposed of all rejected cups manufactured by Silgan, including cups that had already been filled with fruit by Del Monte and sought to recover over $6.5 million in costs from Silgan.

Silgan sought coverage for the claim under two insurance policies. One, a Commercial General Liability policy with Zurich, provided coverage up to $1.5 million in liability after a $250k deductible. The other, a Commercial Umbrella policy with National Union, provided coverage up to $25 million for certain occurrences that cause property damage. Zurich eventually accepted coverage of the claim. National Union, however, denied coverage on the basis that there was no physical injury to the fruit contained in the defective fruit cups, and thus no property damage. Under the National Union policy “physical injury” is defined as “physical injury to tangible property, including all resulting loss of use to that property” or “loss of use of tangible property that is not physically injured.” Silgan brought suit in district court for coverage of the remaining $4.6 million. Both parties brought cross-motions for partial summary judgment seeking a determination regarding coverage of the Del Monte claims.

Silgan argued that the loss of fruit contained within the discarded containers qualified as property damage under the policy. National Union argued that the loss arose from Silgan’s breach of its contract with Del Monte, not from any physical injury or loss of use. In support of its argument, Silgan cited to several cases which have held that physical injury occurs where a defective product is physically incorporated into another product and results in rendering the larger product potentially dangerous. National Union cited to a 2004 California case, F&H Const. v. ITT Hartford Ins. Co. of Midwest, which held that the “mere incorporation of a defective but functioning [product] that might fail in the future [does] not constitute ‘property damage.’” 118 Cal. App. 4th 364 (2004). The F&H court adopted the plain meaning definition of “physical injury” and stated that it should be interpreted as “damage to tangible property causing an alteration in appearance, shape, color or in other material dimension.” Silgan alternatively argued that the second definition of “physical injury” involving “loss of use” was applicable.

Applying California law, the district court granted partial summary judgment in favor of National Union. The court was persuaded by the court’s reasoning in F&H. Silgan had not argued that there was any physical damage to the fruit, but rather the defect of the cans rendered the fruit unusable. Further, this was not a case, like those cited by Silgan, where the item incorporated resulted in contamination of the larger product or rendered it otherwise potentially dangerous.

The court was similarly not persuaded by Silgan’s “loss of use” argument, citing to the ninth circuit’s recent decision in Sony Computer Entertainment America Inc. v. American House Assir. Co., which held that where an insured’s defective property did not render the product it was incorporated with wholly unusable, there was no claim for loss of use. 532 F.3d 1007 (2008). The court found the same circumstances to be present here, where there had been no showing that the fruit within the defective cups was unusable. Instead Del Monte, in an exercise of its business judgment, had decided against selling or repackaging the fruit.

The court went on to state that even if coverage applied under the policy’s definition of “property damage,” certain exclusions in the policy would preclude coverage for at least a portion of the claim.

The Court’s reasoning and holding appear erroneous. Property damage includes “loss of use” of property, and Del Monte suffered the loss of use of the fruit product even if the fruit itself was not physically injured. There is no requirement that the other product be “contaminated” or “potentially dangerous.” Loss of use alone—with no physical damage—is clearly sufficient to constitute “property damage.” Such claims are potentially subject to the “impaired property” exclusion, but only if the product could be restored to use simply by replacing the insured’s product. Here, however, simple replacement of the lid alone was clearly not viable and the claim should have been covered. (This requirement of the “impaired property” exclusion was discussed in an earlier blog entry- here.)