What is Property Damage under a CGL Policy? A New Definition Emerges in Wisconsin Pharmacal v. Nebraska Cultures
The economic loss doctrine has proven to be the Swiss Army knife of legal defenses with useful tools to address numerous product liability and property damage exposures. With the issuance of Wisconsin Pharmacal Co.,LLC v. Nebraska Cultures of California, Inc. ("Pharmacal"), the Wisconsin Supreme Court added a new tool.1 In this decision, for the first time, the court endorsed using the economic loss doctrine (and specifically the integrated system rule) to interpret the scope of coverage for property damage under a Commercial General Liability policy.2 Prior to Pharmacal, Wisconsin courts had explicitly rejected using the economic loss doctrine for this purpose.3 This article will explore the cases that led to the Pharmacal decision and the questions remaining regarding the scope of Pharmacal.
I. Background: The Economic Loss Doctrine
Courts developed the economic loss doctrine in response to a dispute between sellers and buyers over the remedies available under a contract for the sale of goods. When goods do not meet expectations, the remedies available to a buyer are often limited under the contract. Disappointed buyers tried to bring tort claims to obtain more favorable remedies, such as consequential damages. In response, sellers argued that a buyer who agreed to certain, limited remedies in a contract should not be allowed to avoid the contract later with tort law.
The United States Supreme Court first acknowledged the economic loss doctrine in the 1986 case of East River S.S. Corp. v. Transamerican Delaval, Inc.4 The economic loss doctrine has three main purposes: “First, the economic loss doctrine preserves the fundamental distinction between tort law and contract law. Second, application of the doctrine protects the parties’ freedom to allocate economic risk by contract. Third, the doctrine encourages the purchaser, which is the party best situated to assess the risk of economic loss, to assume, allocate, or insure against that risk.”5
In 1989, the Wisconsin Supreme Court adopted the economic loss doctrine in Sunnyslope Grading, Inc. v. Miller, Bradford, Risberg, Inc.6 There, Sunnyslope purchased backhoes from the defendant, who warranted that the backhoes would be merchantable.7 After having repairs made under the warranty, Sunnyslope sued the defendant for additional economic damages related to lost profits, additional replacement parts, and labor charges.8 Relying upon the East River decision, the Wisconsin Supreme Court concluded “that a commercial purchaser of a product cannot recover solely economic losses from the manufacturer under negligence or strict liability theories.”9 Essentially, if the purchaser’s only claim is that the product did not meet expectations, tort remedies are not available.
The economic loss doctrine is subject to some exceptions, including the integrated system rule, which distinguishes between damage to the seller’s product (which is subject to only contract remedies) and damage to “other property” (which is subject to more favorable tort remedies). The first case in Wisconsin to explicitly address the integrated system rule in the economic loss context was Midwhey Powder Co. v. Clayton Indus.10 In Midwhey, the plaintiffs purchased an on-site energy production system to reduce energy costs in their manufacturing facility.11 The system included steam generators, which were faulty and never performed to expectations.12 In addition, the generators caused damage to the system’s turbines. Midwhey argued that the damaged turbines constituted damage to “other property” and allowed for tort claims against the defendants.13 In rejecting this argument, the Midwhey court explained, “because of the integral relationship between these two pieces of machinery, component parts of a single system, the turbines are not ‘other property.’”14 Stated differently, even though the turbine was not purchased from the defendant/seller, it became part of its product when the system was integrated together into a single unit.
II. "Other Property" v. "Property Damage": The Integrated System Rule and CGL Coverage
There has always been an obvious overlap between the integrated system rule and the analysis of covered damages under a Commercial General Liability (CGL) policy. The basic CGL policy provides coverage for “property damage” for which the insured is liable. Property damage is typically defined as “physical injury to tangible property.”15 Coverage is usually excluded, however, for damage to the insured’s own product. Therefore, much like the integrated system rule, courts must determine whether there is damage to property other than the insured’s own product when analyzing coverage under a CGL policy.
Additionally, CGL policies are not meant to cover contractual disputes. Thus, it is reasonable to conclude that coverage would not be provided in a case where the plaintiff is only entitled to seek contractual remedies under the economic loss doctrine. Until recently, however, Wisconsin courts steadfastly rejected practitioners’ attempts to borrow from economic loss doctrine jurisprudence to analyze insurance coverage under CGL policies.
Wisconsin courts explicitly rejected using the economic loss doctrine to assess damage to “other property” under CGL policies on several occasions.16 The Wisconsin Supreme Court explained the rationale for this rejection in Vogel v. Russo.17 The Vogels hired Russo to build a new single family home.18 Upon completion, the home had extensive water infiltration through the masonry due to faulty work of a subcontractor.19 The Vogels sued Russo and others in contract and tort to recover their damages.20 At trial, the damages awarded included repairing the masonry and surrounding building envelope components.21 The Wisconsin Supreme Court considered applying the integrated system test to determine whether coverage was available under the contractors’ policies for the awarded damages, but declined to do so.22 In doing so, the court stated, “[w]hile there are some theoretical overlaps with the case law involving the economic loss doctrine (because the cases sometimes also involve coverage questions), the economic loss doctrine is not really implicated here.”23
The Wisconsin Supreme Court first signaled a change in its approach to this issue in 1999 in Wausau Title v. Country Concrete.24 The Wausau Title court faced two issues on appeal. The first was whether the plaintiff could bring tort claims against the defendant/seller.25 The second was whether there was insurance coverage for the seller’s liability.26 The case involved a cement supplier who provided defective material to a customer.27 In assessing whether the plaintiff could pursue tort claims, the court determined that once the cement was mixed with the other materials to make a concrete block, the entire concrete block was an integrated system.28 This meant there was no damage to other property and the customer was limited to contractual claims under the economic loss doctrine.29 The court then briefly determined, without analysis, that there was no coverage under the subject policy.30
Five years later, in Am. Family Mut. Ins. Co. v. Am. Girl, Inc., the Wisconsin Supreme Court considered the connection between these two issues again.31 In that case, a warehouse building suffered severe sinking due to faulty soil preparation at the site.32 The building was ultimately torn down due to the extensive damage.33 The court was asked to determine whether there was insurance coverage for the general contractor that hired the negligent soils engineer.34 The court assumed that the economic loss doctrine would limit American Girl to contractual remedies.35 It went on to find that there was property damage caused by an occurrence under the subject policy.36 It explicitly stated that the economic loss doctrine had no bearing on the coverage decision: “The economic loss doctrine is a remedies principle. It determines how a loss can be recovered – in tort or in contract/warranty law. It does not determine whether an insurance policy covers a claim, which depends instead upon the policy language.”37 In other words, the court concluded that whether the plaintiff can collect contract damages or tort damages is not relevant to interpreting the language of an insurance policy.
American Girl includes a dissent by Justice N. Patrick Crooks which attempts to bridge the gap between the economic loss doctrine and coverage analysis and gave an early glimpse into the ideas that the Wisconsin Supreme Court would eventually adopt.38 Justice Crooks wrote that the nature of a CGL policy and inherent lack of coverage for contractual disputes should inform how the terms in the policy are interpreted.39 “The CGL policies at issue do not cover the insured’s contractual liability for economic loss. The CGL policies … cover ‘sums that the insured becomes legally obligated to pay as damages because of … ‘property damage’ … only if … the ‘property damages’ is caused by an ‘occurrence’ …’ The policies define an ‘occurrence’ as ‘an accident.’ The policy language does not list breach of contract/breach of warranty as a covered damage, nor can breach of contract/breach of warranty fall within the policies’ definition of ‘occurrence.’”40
In a footnote addressing Justice Crooks’ dissent, the majority in American Girl further differentiated the two issues by explaining that the economic loss doctrine determined the allocation of risk between the parties to the construction contract, whereas the interpretation of the general contractor’s insurance policy determined the allocation of risk between the general contractor and its insurer.41 This statement has some logical appeal. Under the economic loss doctrine, the court is asked to interpret the contract between the buyer and seller. In interpreting coverage, an entirely different contract is at issue – the CGL policy between the seller and the insurance company.
III. Wisconsin Pharmacal v. Nebraska Cultures
The Wisconsin Supreme Court finally took the leap and turned the integrated system rule into a coverage analysis tool in Wisconsin Pharmacal Co.,LLC v. Nebraska Cultures of California, Inc. ("Pharmacal").42 Pharmacal involved the manufacturing of a probiotic supplement tablet.43 Nebraska Cultures was contracted to provide a particular variety of probiotic to the tablet manufacturer.44 Nebraska Cultures obtained the probiotic to fulfill this contract from Jeneil Biotech, Inc.45 After the tablets were on the store shelves, it was discovered that Jeneil had provided the wrong probiotic variety.46 The tablet manufacturer incurred significant losses recalling and destroying the product.47
At the circuit court, The Netherlands Insurance Company argued that there was no coverage under its policy for Jeneil.48 Netherlands argued that the tablets were an integrated system and therefore, there was no property damage to “other property” under the policy.49 The circuit court agreed and granted summary judgment in favor of Netherlands.50 The court of appeals reversed, declining to apply the integrated system test to a coverage analysis.51
On review, the Wisconsin Supreme Court began its analysis by briefly citing the standard insurance agreement and definition of “property damage” under the Jeneil policy.52 The court then went on to discuss prior cases, including Vogel, which explained that the purpose of the CGL policy was to insure for property damage to “property other than to the product or completed work itself.”53 With the focus now squarely on the purpose of the CGL, rather than the language of the policy, the court repurposed the economic loss doctrine and stated, “[a]n integrated system analysis is necessary when evaluating coverage under a CGL policy…”54
The court continued by relying on Wausau Title to establish the use of the integrated system analysis in coverage evaluations.55 There are obvious similarities between the facts of Wausau Title and Pharmacal. Each involved an ingredient that was mixed with others to make a final product. Once mixed, the individual ingredients could not be separated. Further, the incorporation of the wrong or defective ingredient rendered the entire final product useless. The supreme court suggested that the court of appeals “overlooked significant portions” of Wausau Title where coverage was discussed.56 It also stated that the court of appeals “did not perceive the importance of the integrated system analysis when deciding whether claimed damage arose from physical injury to tangible property other than to [the insured’s product].”57
A dissent by Justice Shirley S. Abrahamson sharply criticized the majority’s conclusion. It pointed out that the definition of property damage under the CGL policy does not contain any language that requires a discussion of the insured’s product versus other property.58 The dissent further argued that Wausau Title was a liability case applying the economic loss doctrine and should not be read to guide insurance coverage analysis.59
Neither the majority nor the dissent in Pharmacal seems to paint a clear picture of Wausau Title. Contrary to the dissent’s statement, Wausau Title did, in fact, analyze coverage at the very end of the decision and found no coverage based on its earlier application of the integrated system rule under the economic loss question.60 However, it is also hard to agree with the majority’s statement that coverage was a “significant portion” of Wausau Title. The coverage analysis in Wausau Title lacked any depth and only constituted five paragraphs of a fifty-three paragraph decision.61
In the end, Justice Abrahamson’s dissent was correct about at least one thing: the majority decision in Pharmacal marks a large shift in coverage analysis law in Wisconsin. By inserting the “other property” analysis into the definition of property damage, the Pharmacal court provides an avenue for insurers to deny coverage under the insuring agreement, where the burden of proof rests on the insured. Previously, the discussion of damage to the insured’s product versus damage to other property was analyzed under the policy’s exclusions, with the burden of proof on the insurer.
IV. Pharmacal's Repercussions: Haley v. Kolbe & Kolbe Millwork
After the Pharmacal decision, it was only a matter of time before cases would arise to test the limits of this new coverage analysis tool. The first notable case applying Pharmaca's holding was issued just five months later in the United States District Court for the Western District of Wisconsin’s decision in Haley v. Kolbe & Kolbe Millwork Co.62
Kolbe involved a lawsuit brought by homeowners against a window manufacturer alleging various contract and tort claims related to damages to their homes caused by defective windows.63 In the relevant decision, the district court reviewed a renewed motion by Kolbe’s insurers regarding the coverage available to Kolbe for the homeowners’ damages.64 The damages included replacement of the windows, damages caused to surrounding building materials during replacement of the windows, damages to the interior of the homes from leaks in the windows, and diminished home values.65 When the coverage motion was first before the court, it found coverage based on the allegations of interior water damage.66
The coverage motion was renewed by Kolbe’s insurers based on the Pharmacal decision.67 Kolbe’s insurers also relied upon prior Wisconsin economic loss cases involving defective windows wherein courts concluded that the entire home became the window supplier’s product under the integrated system rule.68 The district court begrudgingly applied Pharmacal and these other cases to deny coverage:
The Wisconsin Supreme Court began its analysis by stating that the meaning of “property damage” in the policy was limited to “damage to property other than to the product itself” … even though the language of the policy did not include that limitation. (The court did not explain its reasoning for this interpretation, but its decision is nevertheless binding on this court…). After inserting the phrase “other property” into the policy, the court held that the meaning of the phrase should take on the same meaning in the context of insurance coverage as it does in the context of the economic loss doctrine, which meant that the integrated system rule should apply to questions of insurance coverage.69
Kolbe appealed to the United States Court of Appeals for the Seventh Circuit, which was not as willing to treat Pharmacal as controlling on the coverage question.70 The court acknowledged the holding in Pharmacal, but rejected the argument that the entire prior case law on the economic loss doctrine should be automatically applicable to coverage cases.71 Rather, the court focused on the factual similarities between the concrete blocks in Wausau Tile and the probiotic tablets in Pharmacal.72 In both cases, the entire final product was worthless and not repairable.73 In Kolbe, the homes at issue still had value and could be repaired.74 It held that since Kolbe’s defective windows had not destroyed the entire product, the integrated system analysis was not necessary.75
Obviously, the Seventh Circuit’s narrow reading of Pharmacal is not binding on any Wisconsin court. Nonetheless, it drew an interesting distinction that could limit application of Pharmacal to cases where the entire value of the end product was destroyed by the seller’s defective or deficient product. This does not rule out its application in construction defect cases. American Girl involved a building that was so damaged it was razed. The more difficult questions will arise in cases involving commercial goods such as the electrical system in Midwhey, where the defective part is integrated with other components.
Coverage lawyers have long recognized and argued for application of the integrated system rule to the analysis of covered property damage under a CGL policy. Until recently, the Wisconsin Supreme Court has steadfastly refused to make the connection. The decision in Pharmacal opens new doors for coverage attorneys. Where the economic loss doctrine was previously solely a tool to limit damages recoverable from product sellers, it is now available to limit coverage for those same sellers. The economic loss doctrine is becoming a defense lawyer’s do-it-all tool, like a good Swiss Army knife.
Crystal Uebelher is a supervisor in the Litigation Department at SECURA Insurance. She is responsible for overseeing the defense of SECURA and it insureds in insurance and general liability disputes throughout the United States. Crystal also assists property and casualty claims representatives in evaluating coverage and liability exposures and provides assistance in drafting manuscript coverage forms. Crystal earned her B.S. in Political Science and Public Administration in 2003 from the University of Wisconsin–Green Bay and her J.D. in 2007 from the University of Wisconsin (magna cum laude, Order of the Coif). She also earned her Chartered Property and Casualty Underwriter (CPCU) designation in 2017.
1 Wisconsin Pharmacal Co.,LLC v. Nebraska Cultures of California, Inc., 2016 WI 14, 367 Wis. 2d 221, 876 N.W.2d 72.
2 Id. at ¶¶ 27-28.
3 See, e.g., Jacob v. Russo Builders, 224 Wis. 2d 436, 592 N.W.2d 271 (Ct. App. 1999); Vogel v. Russo, 2000 WI 85, 236 Wis. 2d 504, 613 N.W.2d 177; Bay Breeze Condo. Ass'n. v. Norco Windows, 2002 WI App 205, 257 Wis. 2d 511, 651 N.W.2d 738; Linden v. Cascade Stone Co., 2005 WI 113, 283 Wis. 2d 606, 699 N.W.2d 189.
4 East River S.S. Corp. v. Transamerican Delaval, Inc., 476 U.S. 858 (1986).
5 Wausau Title Inc. v. Country Concrete Corp., 226 Wis. 2d 235, 247, 593 N.W.2d 445 (1999) (internal citation omitted).
6 Sunnyslope Grading, Inc. v. Miller, Bradford, Risberg, Inc., 148 Wis. 2d 910, 437 N.W.2d 213 (1989).
7 Id. at 912-13.
8 Id. at 914-15.
9 Id. at 921.
10 Midwhey Powder Co. v. Clayton Indus., 157 Wis. 2d 585, 460 N.W.2d 426 (Ct. App. 1990).
11 Id. at 588.
12 Id. at 589.
13 Id. at 587.
14 Id. at 591.
15 See, e.g., Pharmacal, 367 Wis. 2d 221, ¶ 24.
16 See, e.g., Jacob, 224 Wis. 2d 436; Vogel, 236 Wis. 2d 504; Bay Breeze Condo, 257 Wis. 2d 511; Linden, 283 Wis. 2d 606.
17 Vogel, 236 Wis. 2d 504 (rejected on other grounds in Ins. Co. of North America v. Cease Elec., Inc., 2004 WI 139, 276 Wis. 2d 361, 688 N.W.2d 462).
18 Id. at ¶ 3.
19 Id. at ¶¶ 5-7.
20 Id. at ¶ 8.
21 Id. at ¶ 11.
22 Id. at ¶ 1.
23 Id. at ¶ 16.
24 Wausau Title, 226 Wis. 2d 235.
25 Id. at 245.
26 Id. at 266.
27 Id at 241-42.
28 Id. at 251-53.
30 Id. at 259-61.
31 Am. Family Mut. Ins. Co. v. Am. Girl, Inc., 2004 WI 2, 268 Wis. 2d 16, 673 N.W.2d 65.
32 Id. at ¶ 3.
34 Id. at ¶ 5.
35 Id. at ¶ 36.
37 Id. at ¶ 35.
38 Id. at ¶ 116 (Crooks, J., dissenting).
39 Id. at ¶ 93.
41 Id. n.4.
42 Pharmacal, 367 Wis. 2d 221.
43 Id. at ¶ 4.
46 Id. at ¶ 5.
48 Id. at ¶ 8.
50 Id. at ¶ 9.
51 Id. at ¶ 10.
52 The “policy provides coverage for Jeneil’s losses that ‘the insured becomes legally obligated to pay as damages because of ‘bodily injury’ or ‘property damage’… caused by an ‘occurrence.’ The policy defines property damage as ‘(a) Physical injury to tangible property including all resulting loss of use of that property…’” Id. at ¶ 24.
53 Id. at ¶¶ 24-25.
54 Id. at ¶ 28.
55 Id. at ¶ 29.
56 Id. at ¶ 32.
58 Id. at ¶¶ 104-05 (Abrahamson, J., dissenting).
59 Id. at ¶ 111.
60 Wausau Title, 226 Wis. 2d at 266-70.
62 Haley v. Kolbe & Kolbe Millwork Co, 2016 U.S. Dist. LEXIS 113752, 2016 WL 4487807 (W.D. Wis. Aug. 25, 2016), aff'd in part, rev’d in part, 866 F.3d 824 (7th Cir. 2017).
63 Id. at *1.
65 Id. at *2.
68 Id. at *3.
69 Id. at *3-4 (internal citations omitted).
70 Haley, 866 F.3d at 829.