Stick With the Greek Yogurt: Wisconsin Supreme Court Holds Wrong Ingredient in Probiotic Tablet Does Not Constitute “Property Damage”

In Wisconsin Pharmacal Co. LLC v. Nebraska Cultures of California, Inc., Nos. 2013AP613, 2013AP687, 2016 WL 785203 (Wis. March 1, 2016), the Wisconsin Supreme Court held that the incorporation of the wrong ingredient into probiotic supplement tablets that rendered the tablets useless for their contracted purpose, did not constitute “property damage” caused by an “occurrence.” The Court also held that the “impaired property” exclusions in the policies otherwise applied to preclude any “property damage” liability coverage for the underlying claims, and therefore the insurers did not owe any duty to defend or indemnify the claims.

Wisconsin Pharmacal Company (Pharmacal) contracted with Nutritional Manufacturing Services LLC (NMS) to manufacture certain supplement tablets containing the probiotic bacteria Lactobacillus rhamnosus (LRA). NMS then contracted with Nebraska Cultures of California, Inc. to supply the LRA for the tablets. Nebraska Cultures in turn contracted with Jeneil Biotech, Inc. to supply the LRA to Nebraska Cultures.

Using an ingredient represented as LRA from Nebraska Cultures, NMS manufactured the supplement tablets. The manufacture of the tablets required the blending of other ingredients with the ingredient supplied by Nebraska Cultures and then compressing all the ingredients to form a tablet. Once in tablet form, the ingredients could not be separated from one another.

After the manufacturing of the tablets and shipment to a retailer, it was discovered that the ingredient provided by Nebraska Cultures was not LRA, but instead was a different bacteria species, Lactobacillus acidophilus (LA). The retailer recalled the tablet and thereafter, Pharmacal destroyed the tablets.

After NMS assigned to Pharmacal all of its causes of action against Nebraska Cultures and Jeneil, Pharmacal filed suit against Nebraska Cultures, Nebraska Cultures’ general liability insurer (Evanston Insurance Company), Jeneil and Jeneil’s general liability insurer (Netherlands Insurance Company). Nebraska Cultures also filed a cross-claim against Jeneil. All of the claims alleged that Nebraska Cultures incorrectly supplied LA to NMS and Pharmacal, when the parties had contracted for LRA.

After moving to stay and bifurcate the merits portion of the litigation, the insurers moved for summary judgment and argued that the claims against Nebraska Cultures and Jeneil did not allege “property damage” caused by an “occurrence.”

The circuit court granted the insurers’ motion for summary judgment and held that the incorporation of LA into the tablets did not constitute “property damage” caused by an “occurrence” because LA harmed only the product itself, which was an integrated system.

The court of appeals reversed, finding that the integrated system rule was not applicable. The court of appeals held that the incorporation of LA constituted “property damage” to the product (i.e., the tablets) caused by an “occurrence” and that no exclusion applied to preclude coverage.

Applying Wisconsin law to the Netherlands policy, the Wisconsin Supreme Court determined that there was no physical injury to other property or any loss of use of tangible property, as required by the policy’s definition of “property damage.” In finding that there was no physical injury, the Court determined that combining LA with other ingredients to form the supplement tablet constituted an integrated system. The Court determined that the complaint of injury was sustained by the integrated system itself (i.e., the tablets), and that no other property was injured. The Court rejected the argument that there was physical injury due to the blending of LA with the other ingredients into the tablets. The Court reasoned that any changes to the other ingredients were the result of the tableting process, not from the use of LA. The Court also rejected the argument that there was physical injury to any “cartons, shippers, inserts, tooling and dies” associated with the tablets, because such materials did not undergo any physical alteration as a result of the use of LA in the tablets.

In finding that there was no “loss of use,” the Court held that the recalled and discarded tablets were rendered permanently worthless due to the inclusion of a wrong ingredient, which is a loss distinct from the temporary “loss of use” of property. The Court also determined that the accidental provision of the wrong ingredient did not constitute an “occurrence.”

In addition, the Court determined that the “impaired property” exclusion of the Netherlands policy applied to otherwise preclude coverage, on the basis that any loss of use was due to the incorporation of Jeneil’s product (i.e.,LA). In finding that the “impaired property” exclusion applied, the Court held that the exception to the exclusion was inapplicable because there was no sudden or accidental injury to the LA, other ingredients or the tablets themselves.

Applying California law to the Evanston policy, the Court likewise held that there was no physical injury as required by the definition of “property damage” because the mere presence of the defective ingredient (i.e., LA) did not render the tablets hazardous. The Court also held that there was no “loss of use” because the tablets were rendered permanently worthless from the incorporation of LA, and that there was no “occurrence” because the provision of LA and the intentional incorporation of LA into the tablets, were deliberate actions and not an accident, as required by the policy’s definition of “occurrence.”

The Court likewise determined that the Evanston policy’s “impaired property” exclusion applied to preclude coverage because any loss of use arose out of Nebraska Culture’s failure to properly perform its contractual obligations – a loss that fell entirely within the scope of the exclusion.

Tressler Comments

In its well-reasoned analysis, the Wisconsin Supreme Court discussed the important distinction between damage caused by the incorporation of a defective product into an integrated system and damage to another product or property. This case demonstrates the importance in pinpointing the specific damage alleged in the underlying claim, and determining whether the insured’s defective product is alleged to have damaged any other property, as opposed to the integrated product alone.