In our first installment in the April 12 Wisconsin Law Journal issue, we analyzed the Wisconsin Supreme Court’s seminal decision in Wisconsin Pharmacal Co., LLC v. Nebraska Cultures of California, Inc., 2016 WI 14.
Now in our second installment, we first discuss the relationship between Pharmacal and American Family Mutual Insurance Co. v. American Girl Inc., 2004 WI 2. Then we explain our grand takeaway: That we should all closely monitor Pharmacal’s progeny, which could greatly curtail the available coverage for product-defect and faulty-workmanship claims — coverage that businesses seem to believe they are entitled to under policies for commercial general liability.
Reconciling American Girl with Pharmacal: How do they coexist?
Part of the significance of Pharmacal is that it offers another avenue to better understand the contours of what constitutes an “occurrence” in light of American Girl. As noted above, Wisconsin courts generally employ the economic-loss doctrine to bar recovery, in tort cases, of pure economic losses in consumer transactions in which the only damage is to the product purchased by the consumer and there is no damage to “other property.”
Compare State Farm Fire & Cas. Co. v. Hague Quality Water, 2013 WI App 10, ¶¶ 6, 9, 12 (finding damaged drywall, flooring, and woodwork in the claimant’s home to not be part of an integrated system with a defective water softener in the home, reasoning the water softener was not integral to the functioning of the damaged property), with Bay Breeze Condo. Ass’n v. Norco Windows, 2002 WI App 205, ¶¶ 26-27 (finding defective windows that caused damage to interior and exterior walls and casements to all be components of an integrated system, “having no function apart from the buildings for which they were manufactured”).
In determining if there has been damage to “other property,” courts examine whether a defective product is an integral component of a larger “integrated system”; if so, then the damaged property is considered to be damage to the entire product, itself. Hague Quality Water, ¶¶ 7-8. Further, if the defective product has no function apart from its value as part of a larger system, damage to the larger system and its other component parts do not constitute damage to “other property.” Id., ¶ 8.
A seminal Wisconsin decision concerning the integrated system doctrine came in Wausau Tile, Inc. v. County Concrete Corp., 226 Wis. 2d 235 (1999). In this case, Wausau Tile contracted with Medusa Corp. to supply cement for pavers that Wausau Tile manufactured, sold, and distributed nationwide. Medusa contracted with County Concrete Corp. to supply the aggregate.
The pavers were eventually alleged to be defective, i.e., they expanded and cracked because of high levels of alkalinity in the cement caused by high concentrations of silica in the aggregate. The Supreme Court held that the pavers were integrated systems consisting of several component parts, including the cement provided by Medusa.
The Supreme Court reasoned that the cement was an integral component of the pavers. Thus, for purposes of the economic-loss doctrine, the damage to the pavers did not constitute damage to “other property.” As noted above, the decision in Pharmacal acknowledges the application of the integrated system doctrine in insurance coverage.
In a later case, the Supreme Court revisited ideas similar to those presented in American Girl, although it did not use the term “integrated system.” The coverage dispute in American Girl arose during a construction project when a general contractor hired a soil-engineering subcontractor who gave faulty site-preparation advice in connection with the construction of a warehouse.
As a result of the faulty advice, excessive settlement caused the building to sink and eventually be demolished. The Supreme Court decided there had been an “occurrence” because the harmful settlement of the soil underneath the building was not intended or expected.
Accordingly, the ruling in American Girl suggests that construction-defect claims, by themselves, could be included as part of the initial grant of coverage under CGL policies. Indeed, the decision directly states “faulty workmanship of a subcontractor can give rise to property damage caused by an ‘occurrence.’”
Despite the general language of American Girl, Wisconsin courts have since interpreted it to mean that faulty workmanship itself cannot be an “occurrence,” but faulty workmanship may be the cause of an occurrence. See Acuity v. Soc’y Ins., 2012 WI App 13, ¶ 24; Glendenning’s Limestone & Ready-Mix Co. v. Reimer, 2006 WI App 161, ¶ 27. In fact, the Glendenning court grappled directly with the above-cited statement in American Girl, which seemingly suggests that a subcontractor’s faulty workmanship can give rise to an “occurrence.” Glendenning reasoned that viewing the statement in the proper context necessarily means that a subcontractor’s faulty workmanship can lead to an occurrence, but that faulty workmanship is not an occurrence itself.
Specifically, the Glendenning court placed great stock in American Girl’s discussion of Kalchthaler v. Keller Construction Co., 224 Wis. 2d 387 (Ct. App. 1999) which involved a leaky window installed by a subcontractor that had damaged drapery and wallpaper. And since, in Kalchthaler, the faulty workmanship of the windows itself was not an occurrence, a fair reading of American Girl would similarly not allow for faulty workmanship itself to constitute an “occurrence.”
The decision in Pharmacal, which came from a dissenting justice in American Girl, should be understood as an attempt by the Supreme Court to distance itself from sections of American Girl that can be easily misread regarding whether faulty workmanship constitutes an “occurrence.” For instance, when discussing what constitutes an “occurrence,” the Supreme Court noted in American Girl it was not the faulty advice that was the “occurrence,” rather the faulty advice caused the “occurrence.” This minor, yet significant distinction is absolutely critical and served as the focal point in Pharmacal’s analysis of the policy’s “occurrence” requirement.
At bottom, Pharmacal not only clarifies American Girl but also put forward a decidedly insurer-friendly synthesis, considered against the backdrop of the integrated system doctrine, of what constitutes “property damage” that can be caused by an “occurrence.” However, until the integrated system doctrine is applied to an insurance-coverage dispute involving construction defects or faulty workmanship, we will have not yet fully realized the application of Pharmacal.