March 3, 2016 – A probiotic supplier supplied the wrong probiotic to a company that uses probiotic ingredients in health supplement pills, forcing a product recall. But the supplier’s error is not covered by insurance, the Wisconsin Supreme Court has ruled.

In Wisconsin Pharmacal Company LLC v. Nebraska Cultures of California Inc., 2016 WI 14 (March 1, 2016), a 3-2 majority ruled that “incorporation of a defective ingredient into the supplement tablets did not damage other property,” under the policy of insurance.

Wisconsin Pharmacal Co., which makes probiotic supplement pills for sale by a major retailer, contracted with Nutritional Manufacturing Services LLC to procure a certain type of probiotic – Lactobacillus rhamnosus (LRA) – for inclusion in the supplement pills.

Nutritional Manufacturing, in turn, contracted with Nebraska Cultures of California Inc. to supply the LRA, and Nebraska Cultures contracted with Jeneil Biotech Inc. to supply LRA that Nebraska Cultures would then sell to Nutritional Manufacturing.

When Nebraska Cultures received and then sold the probiotic to Nutritional Manufacturing, a “certificate of analysis” certified the ingredient provided was LRA.

Nutritional Manufacturing then blended what it thought was LRA with other ingredients obtained from other vendors to form the supplemental tablets.

The tablets were then shipped to Wisconsin Pharmacal, which packaged the product and sent it off to the retailer. But those supplemental tablets did not contain LRA.

Jeneil Biotech actually supplied a different probiotic (LA) than the LRA indicated on Wisconsin Pharmacal’s product labels. The retailer notified Wisconsin Pharmacal, which confirmed through independent testing. The retailer then recalled the product.

All the supplement pills were destroyed. Nutritional Manufacturing assigned claims against Nebraska Cultures and Jeneil Biotech to Wisconsin Pharmacal, which filed tort and contract claims against both of them, as well as their general liability insurers.

Nebraska Cultures filed a cross-claim for negligence against Jeneil. Thus, the circuit court dismissed Wisconsin Pharmacal’s claims against Jeneil and its insurer.

It also dismissed Wisconsin Pharmacal’s tort claim against Nebraska Cultures, leaving only the contract claim, as well as Nebraska Cultures’ cross-claim for negligence.

Before the merits of those claims proceeded, the court ruled that this error was not covered under general commercial liability policies with Evanston Insurance Co. (Nebraska Cultures’ insurer) and The Netherlands Insurance Co. (Jeneil’s insurer). A state appeals court reversed, concluding it was covered, and the insurers appealed.

A 3-2 supreme court majority (two justices did not participate) reversed the appeals court, concluding there was no initial grant of coverage and exclusions applied.

The majority interpreted the Netherlands’ policy under Wisconsin law, and the Evanston policy under California law, since the policies did not include choice of law provisions.

Netherlands Policy: Integrated System

The Netherlands’ general liability policy said Jeneil was covered for “property damage” caused by an “occurrence” for which Jeneil was liable. Property damage included “physical injury to tangible property, including all resulting loss of use of that property,” as well as “loss of use of tangible property that is not physically injured.”

The majority ruled that providing a defective ingredient to Wisconsin Pharmacal, thereby forcing a recall of the end product, was not “property damage” under the policy.

Citing prior Wisconsin cases interpreting commercial general liability policies, the majority noted that the insured risk “applies to physical injury to tangible property other than, but which is caused by, a defect in the product or work the insured supplied.”

“We must determine whether the incorporation of LA, the defective component Jeneil provided, into the supplement tablets constitutes physical injury to tangible property other than the LA itself,” wrote Chief Justice Patience Roggensack, joined by Justices David Prosser and Michael Gableman to form the three-justice majority.

If a supplement tablet is an “integrated system,” the majority noted, damage to the integrated system would not be damage to “other property” that is covered.

Wisconsin courts have undertaken an “integrated systems” analysis under the “economic loss doctrine,” which can “bar the recovery of purely economic losses in consumer transactions through tort remedies” that allege product defects.

But the appeals court panel, in this case, had ruled that the economic loss doctrine, which examines integrated systems, does not control when insurance policies apply.

The majority, however, said the courts can employ an integrated systems analysis to determine “other property,” even when the economic loss doctrine does not apply.

The majority went on to hold that blending the defective probiotic ingredient with other ingredients to create the supplement tablets formed an integrated system.

“Stated otherwise, upon blending LA, rather than LRA, with other ingredients, all of the ingredients were integrated into one product, the tablets,” wrote the chief justice.

“Accordingly, we conclude that the complained of injury was sustained by the integrated system itself, i.e., the tablets, such that no other property was injured.”

The majority said there was no evidence that incorporating LA, rather than LRA, altered other ingredients. “[A]ny changes were a result of the tableting process that would have occurred regardless of which probiotic ingredient was supplied,” Roggensack wrote.

Jeneil argued that the policy also covered “loss of use of tangible property that is not physically injured,” and the defective probiotic rendered the product useless.

But the majority said “loss of use” is different than “loss of value.”

“While Jeneil argues that the incorporation of a defective ingredient rendered the tablets and other ingredients useless, thereby constituting loss of use, Pharmacal did not actually lose use of the tablets,” Chief Justice Roggensack explained.

Finally, the majority ruled that a breach of contract alone does not constitute an “occurrence” unless the breach gives rise to property damage: “An accidental provision of a defective ingredient does not constitute an occurrence in and of itself.”

Evanston Policy: Not Hazardous

Under California law, the Evanston policy did not cover Nebraska Cultures’ liability for a defective probiotic ingredient, the supreme court majority ruled.

In determining whether “property damage” has occurred, the majority noted, California courts hold that “nonconforming” components that are combined with other components cannot cause property damage unless the nonconforming components are hazardous.

“Although a defective ingredient rendered the tablets inadequate for their contracted purpose, the mere presence of a defective ingredient did not render them hazardous,” Chief Justice Roggensack wrote.

And California does not treat “loss of use” the same as “loss of value,” the majority noted, unless relating to “rental value of temporary replacement property.”

Finally, the majority said there was no “occurrence,” under California law, because “occurrences” are “accidents,” but the companies here performed deliberate acts.

“Jeneil’s provision of a defective ingredient may have been occasioned by negligence; however, Jeneil deliberately supplied the ingredient to Nebraska Cultures, which, in turn, supplied the ingredient to Nutritional Manufacturing,” Roggensack wrote.

Even if the policies granted initial coverage in this situation, the majority noted, the policies contained exclusions that barred coverage for property damage that arose from deficiencies, defects, or inadequacies in the insured’s own work or products.

Dissent

In a dissenting opinion, Justice Shirley Abrahamson, joined by Justice Ann Walsh Bradley, compared the majority’s decision to the 1958 movie, The Blob.

“Like the ever-expanding, all consuming alien life form portrayed in the 1958 B-movie classic The Blob, the economic loss doctrine [continues] to be a swelling globule on the legal landscape of this state,” wrote Abrahamson, quoting herself from a 2005 case.

“In the instant case, the majority expands the already swollen flow of economic jurisprudence into heretofore unknown territory, grafting the ‘integrated system’ rule from the economic loss doctrine onto the analysis of two commercial general liability (CGL) insurance policies’ definitions of ‘property damage’ and ‘occurrence,’” she wrote.

The dissenters would have affirmed the appeals court, which said property damage occurred when the wrong ingredient was integrated, rendering the pills useless.

Abrahamson noted that Justice Annette Ziegler withdrew from the case, but the majority opinion stated that she “did not participate,” along with Justice Rebecca Bradley.

“Recusal of a justice is a significant issue for the parties and this court,” Justice Abrahamson wrote. “Why does the majority opinion not state that Justice Ziegler withdrew from further participation?”