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Wisconsin Pharmacal Co., LLC v. Nebraska Cultures of California, Inc.

Supreme Court of Wisconsin

March 1, 2016

Wisconsin Pharmacal Company, LLC, Plaintiff,
v.
Nebraska Cultures of California, Inc., Defendant-Appellant, Jeneil Biotech, Inc. and the Netherlands Insurance Company, Defendants, Evanston Insurance Company, Defendant-Respondent-Petitioner

Argued September 22, 2015

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[Copyrighted Material Omitted]

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REVIEW of a decision of the Court of Appeals. COURT: Circuit. COUNTY: Ozaukee. JUDGE: Thomas R. Wolfgram. (L.C. No. 2011CV32).

For the defendant-respondent-petitioners, there were joint briefs by Thomas R. Schrimpf and Hinshaw & Culbertson, LLP, Milwaukee, Mark F. Wolfe and Traub Lieberman Straus & Shrewsberry, Chicago. Oral argument by Thomas Schrimpf and Mark F. Wolfe.

For the defendant-appellant, Jeneil Biotech, Inc., there was a brief by Douglas M. Raines, James A. Baxter and von Briesen & Roper, S.C., Milwaukee, and oral argument by Douglas M. Raines.

For the defendant-appellant, Nebraska Cultures of California, Inc., there was a brief by Patryk Silver, Borgelt, Powell, Peterson & Frauen, S.C., Madison, and oral argument by Patryk Silver.

There was an amicus curiae brief by James A. Friedman, Todd G. Smith, and Godfrey & Kahn, S.C., Madison on behalf of the Wisconsin Insurance Alliance.

PATIENCE DRAKE ROGGENSACK, C.J. ANNETTE KINGSLAND ZIEGLER and REBECCA G. BRADLEY, JJ., did not participate. SHIRLEY S. ABRAHAMSON, J. (dissenting).

OPINION

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PATIENCE DRAKE ROGGENSACK, C.J.

[367 Wis.2d 230] [¶1] We review a published decision of the court of appeals[1] reversing an order of the Ozaukee County Circuit Court[2] that granted summary judgment to The Netherlands Insurance Company (Netherlands) and Evanston Insurance Company (Evanston). Our review centers on a coverage dispute between the insurers and their respective insureds, Jeneil Biotech, Inc. (Jeneil) and Nebraska Cultures of California, Inc. (Nebraska Cultures). The underlying claims against the insureds arise from their supplying a defective ingredient for incorporation into the plaintiff's, Wisconsin Pharmacal Company (Pharmacal), probiotic supplement tablets.

[¶2] The insurers argue that the insurance policies do not provide coverage for damages that may arise out of the underlying claims against the insureds. Specifically, the issues before us are: (1) whether the incorporation of a defective ingredient into the supplement tablets constitutes " property damage" caused by an " occurrence" under the policies' language; and (2) if there is " property damage" caused by an " occurrence," whether any of the policies' exclusions apply to negate coverage.

[¶3] We conclude that there is no " property damage" caused by an " occurrence" because the incorporation of a defective ingredient into the supplement [367 Wis.2d 231] tablets did not damage other property and did not result in loss of use of property. We further conclude that, even if the incorporation of a defective ingredient were to constitute " property damage" caused by an " occurrence," certain exclusions in both

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policies apply to negate coverage. Accordingly, we reverse the decision of the court of appeals.

I. BACKGROUND

[¶4] Pharmacal supplies a Daily Probiotic Feminine Supplement to a major retailer. This supplement is in the form of a chewable tablet and contains various ingredients, including a probiotic bacterial species known as Lactobacillus rhamnosus (LRA). In July of 2008, Pharmacal contacted Nutritional Manufacturing Services, LLC to manufacture supplement tablets containing LRA. Nutritional Manufacturing agreed to procure LRA and manufacture supplement tablets containing that ingredient. In order to procure LRA for production of supplement tablets, Nutritional Manufacturing contacted Nebraska Cultures, which agreed to supply LRA. Nebraska Cultures then contracted with Jeneil to supply LRA to Nebraska Cultures for subsequent sale to Nutritional Manufacturing. Nutritional Manufacturing thereafter obtained the ingredient from Nebraska Cultures along with a " Certificate of Analysis," representing the ingredient as LRA.

[¶5] Having supposedly acquired LRA from Nebraska Cultures, Nutritional Manufacturing manufactured supplement tablets using the provided ingredient, which was defective because it constituted a different species of bacteria, Lactobacillus acidophilus (LA), rather than LRA. This manufacturing process required blending other ingredients that were obtained from other vendors, with the defective probiotic [367 Wis.2d 232] ingredient supplied by Nebraska Cultures and Jeneil. Once all of the ingredients were blended together, they were compressed into tablet form. Once mixed and compressed into tablet form, none of the ingredients could be separated from one another. After manufacturing supplement tablets, Nutritional Manufacturing supplied them to Pharmacal, which, in turn, packaged and shipped them to the retailer.

[¶6] In April of 2009, the retailer notified Pharmacal that the supplement did not contain LRA but, rather, it contained La. Pharmacal performed independent testing on supplement tablets and confirmed that they contained LA rather than the contracted-for LRA. Upon this confirmation, Pharmacal notified the retailer that the supplements were mislabeled as containing LRA when they actually contained La. In May of 2009, the retailer recalled the supplement. After the recall, Pharmacal destroyed the supplement tablets containing the defective ingredient.

[¶7] Nutritional Manufacturing assigned any and all of its causes of action against Nebraska Cultures and Jeneil to Pharmacal. On January 14, 2011, Pharmacal filed suit against Nebraska Cultures and its general liability insurer, Evanston, as well as Jeneil and its general liability insurer, Netherlands. Pharmacal alleged numerous causes of action,[3] including various tort and contract claims. Additionally, Nebraska Cultures filed a cross claim against Jeneil for negligence. In October of 2011, the circuit court dismissed with prejudice all of Pharmacal's claims against Jeneil and Netherlands. With respect to the claims against Nebraska Cultures and Evanston, the circuit court [367 Wis.2d 233] dismissed with prejudice all tort claims. Therefore, the remaining claims include: (1) Nebraska Cultures' cross claim against Jeneil for negligence; [4] and (2) Pharmacal's various

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contract-based claims against Nebraska Cultures. All of these claims allege that Jeneil and Nebraska Cultures incorrectly supplied LA to Nutritional Manufacturing and Pharmacal when the parties had contracted for LRA.

[¶8] Subsequently, Netherlands and Evanston moved to bifurcate and stay the merits of the proceedings pending the circuit court's determination of whether their respective insurance policies provided coverage, thereby triggering the insurers' duties to defend and indemnify. Netherlands and Evanston moved for summary judgment, arguing that the insurance policies did not cover any damages that may arise out of the remaining causes of action against Jeneil and Nebraska Cultures because there was no property damage caused by an occurrence.

[¶9] In October of 2012 and January of 2013, the circuit court held two hearings[5] on the coverage issue and ultimately granted the insurers' motions for summary judgment. The circuit court concluded that the facts of the case did not trigger the insurers' duties to defend. Specifically, the circuit court concluded that the incorporation of a defective probiotic ingredient into the tablets did not constitute property damage [367 Wis.2d 234] caused by an occurrence because it harmed only the product itself, which is an integrated system.

[¶10] The court of appeals reversed the circuit court's grant of summary judgment, concluding that the policies provided coverage. Wis. Pharmacal Co. v. Neb. Cultures of Cal., Inc., 2014 WI App 111, 358 Wis.2d 673, 856 N.W.2d 505. The court of appeals concluded that the integrated system rule was not relevant to the coverage dispute and that the incorporation of a defective ingredient constituted property damage to the product (the probiotic supplement tablets) caused by an occurrence under the policies' language and that no exclusion negated coverage. Id., ¶ ¶ 20-26. The court of appeals also held that Netherlands breached its duty to defend[6] by " reject[ing] Jeneil's initial tender, prior to the discovery of additional facts bearing on coverage." Id., ¶ 39.

[¶11] We granted the insurers' joint petition for review.

II. DISCUSSION

A. Standard of Review

[¶12] Reviewing a grant of summary judgment, we independently apply the same methodology as the circuit court and the court of appeals while benefitting from their analyses. Preisler v. Gen. Cas. Ins. Co., 2014 WI 135, ¶ 16, 360 Wis.2d 129, 857 N.W.2d 136. " The standards set forth in Wis. Stat. § 802.08 are our guides." Id. Summary judgment " shall be rendered if [367 Wis.2d 235] the pleadings, depositions, answers to interrogatories, and admissions on file, together with the affidavits, if any, show that there is no genuine issue as to any material fact and that the moving party is entitled to a judgment as a matter of law." Wis. Stat. § 802.08(2) (2013-14).

[¶13] While the parties do not dispute the facts giving rise to the underlying causes of action, our review requires us to interpret the insurance policies. " The interpretation of an insurance [policy] is a

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question of law that we review independently." Siebert v. Wis. Am. Mut. Ins. Co., 2011 WI 35, ¶ 28, 333 Wis.2d 546, 797 N.W.2d 484.

B. Choice of Law

[¶14] Initially, we note that there are two insurance policies at issue in this case. Jeneil's coverage is governed by the Netherlands policy, while Nebraska Cultures' coverage is governed by the Evanston policy. The parties agree that the Netherlands policy should be interpreted according to Wisconsin law, while the Evanston policy should be interpreted according to California law. We agree as well.

[¶15] When parties do not specifically provide a choice of law provision in the policy, we have " adopted the 'grouping-of-contacts' approach for resolving conflicts questions raised as to a disputed contract." Utica Mut. Ins. Co. v. Klein & Son, Inc., 157 Wis.2d 552, 556, 460 N.W.2d 763 (Ct.App. 1990). This approach provides that insurance coverage is " determined by the law of the [jurisdiction] with which the contract has its most significant relationship." State Farm Mut. Auto. [367 Wis.2d 236] Ins. Co. v. Gillette, 2002 WI 31, ¶ 26, 251 Wis.2d 561, 641 N.W.2d 662 (alteration in original) (internal quotation marks and citation omitted).

[¶16] We conclude, as agreed by the parties, that Wisconsin has the most significant relationship to the Netherlands policy. Accordingly, we interpret the Netherlands policy in accordance with Wisconsin law. We further conclude, as agreed by the parties, that California has the most significant relationship to the Evanston policy. Accordingly, we interpret the Evanston policy in accordance with California law.

C. Duty to Defend

[¶17] As another initial matter, we address the court of appeals' conclusion that Netherlands breached its duty to defend by " reject[ing] Jeneil's initial tender, prior to the discovery of additional facts bearing on coverage." Wis. Pharmacal, 358 Wis.2d 673, ¶ 39. At oral argument, Jeneil contended that a remand is necessary to determine the consequences of Netherlands' breach of the duty to defend.

[¶18] Contrary to the court of appeals' holding, " [a]n insurer does not breach its contractual duty to defend by denying coverage where the issue of coverage is fairly debatable as long as the insurer provides coverage and defense once coverage is established." Elliott v. Donahue, 169 Wis.2d 310, 317, 485 N.W.2d 403 (1992). An insurer may avoid breaching the duty to defend by requesting " a bifurcated trial on the issues of coverage and liability[] [and] mov[ing] to stay any proceedings on liability until the issue of coverage is resolved." Id. at 318. However, " [a]n insurer may need [367 Wis.2d 237] to provide a defense to its insured when the separate trial on coverage does not precede the trial on liability and damages." Mowry v. Badger State Mut. Cas. Co., 129 Wis.2d 496, 528, 385 N.W.2d 171 (1986) (emphasis added); Elliott, 169 Wis.2d at 318.

[¶19] In this case, Netherlands and Evanston jointly moved to bifurcate and stay the proceedings pending a determination of coverage. Although Evanston provided an initial defense, the circuit court ultimately concluded that the insurers' duties to defend were not triggered because their respective policies did not provide coverage. As this coverage determination by the circuit court properly came prior to any proceedings regarding the merits of the underlying claims, Netherlands did not

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breach its duty to defend. We now turn to the discussion of whether there is coverage under the policies.

D. Coverage, General Principles

[¶20] We interpret insurance policies from the perspective of a reasonable insured. Acuity v. Bagadia, 2008 WI 62, ¶ 13, 310 Wis.2d 197, 750 N.W.2d 817. When the language of an insurance contract is unambiguous, we apply its plain and ordinary meaning. Preisler, 360 Wis.2d 129, ¶ 18.

[¶21] However, if terms of an insurance contract are " fairly susceptible to more than one reasonable interpretation," the policy is ambiguous. Id., ¶ 19 (quoting Hirschhorn v. Auto-Owners Ins. Co., 2012 WI 20, ¶ 23, 338 Wis.2d 761, 809 N.W.2d 529). " Policy language is not ambiguous merely because more than one dictionary definition exists or the parties disagree [367 Wis.2d 238] about its meaning." Id. Similarly, policy language is not ambiguous merely because courts have come to differing interpretations. Peace v. Nw. Nat'l Ins. Co., 228 Wis.2d 106, ¶ 60, 596 N.W.2d 429 (1999). If the policy is ambiguous, the court's construction is constrained and ambiguities are construed against the insurer, in favor of coverage. Hirschhorn, 338 Wis.2d 761, ¶ 23.

[¶22] Bearing the foregoing in mind, we determine whether the policies provide coverage for incorporation of a defective ingredient into supplement tablets. Our procedure for determining whether coverage exists under an insurance policy follows three steps. First, " we examine the facts of the insured's claim to decide whether the policy makes an initial grant of coverage." Preisler, 360 Wis.2d 129, ¶ 22. If the policy terms clearly do not cover the claim, generally, our analysis ends. Id. However, " if the claim . . . triggers a potential grant of coverage, we secondly examine whether any of the policy's exclusions preclude coverage for that claim." Id. And third, " if an exclusion precludes coverage, we analyze exceptions to the exclusion to determine whether any exception reinstates coverage." Id.

E. Initial Grant of Coverage

1. Netherlands policy

[¶23] Netherlands' commercial general liability (CGL) policy provides coverage for Jeneil's losses that " the insured becomes legally obligated to pay as damages [367 Wis.2d 239] because of 'bodily injury'[7] 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. . . .; or (b) Loss of use of tangible property that is not physically injured." We first discuss whether there is property damage under either definition.

a. property damage (physical injury)

[¶24] With respect to the standard CGL definition of property damage, we previously have concluded that,

The risk intended to be insured [in a CGL policy] is the possibility that the goods, products or work of the insured, once relinquished or completed, will cause bodily injury or damage to property other than to the product or completed work itself, and for which the insured may be found liable.

Wis. Label Corp. v. Northbrook Prop. & Cas. Ins. Co., 2000 WI 26, ¶ 27, 233 Wis.2d 314, 607 N.W.2d 276 (alteration in original)

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(emphasis added) (internal quotation marks and citation omitted). Stated otherwise, the insured risk (i.e., physical injury to tangible property) applies to physical injury to tangible property other than, but which is caused by, a defect in the product or work the insured supplied. Vogel v. Russo, 2000 WI 85, ¶ 17, 236 Wis.2d 504, 613 N.W.2d 177) abrogated, in part, on other grounds by Ins. Co. of N. Am. v. Cease Elec. Inc., 2004 WI 139, ¶ 25 n.6, 276 Wis.2d 361, 688 N.W.2d 462.

[367 Wis.2d 240] [¶25] In Vogel, where the CGL policy defined property damage using the same terms as does the Netherlands' policy, we carefully explained the risk to which CGL policies apply. We again said that,

[t]he risk intended to be insured [in a CGL policy] is the possibility that the goods, products or work of the insured, once relinquished or completed, will cause bodily injury or damage to property other than to the product or completed work itself, and for which the insured may be found liable.

Id. (emphasis and alteration in original) (quoting Bulen v. W. Bend Mut. Ins. Co., 125 Wis.2d 259, 264-65, 371 N.W.2d 392 (Ct.App. 1985).

[¶26] We emphasized the nature of coverage afforded by a CGL policy: " A CGL policy's sole purpose is to cover the risk that the insured's goods, products, or work will cause bodily injury or damage to property other than the product or the completed work of the insured." Id. at 513 (emphasis in original). " A CGL policy, therefore, is not a performance bond." [8] Id. (further citations omitted). Therefore, 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.

[¶27] To answer the question of what constitutes other property that has suffered physical injury, we [367 Wis.2d 241] analyze whether a supplement tablet is an integrated system because if it is, damage to the system has been defined as damage to the product itself, not damage to other property. See Wausau Tile, Inc. v. Cnty. Concrete Corp., 226 Wis.2d 235, 249, 593 N.W.2d 445 (1999). We have explained how an integrated system affects the determination of what property is " other property" as follows:

What constitutes harm to other property rather than harm to the product itself may be difficult to determine. A product that nondangerously fails to function due to a product defect has clearly caused harm only to itself. A product that fails to function and causes harm to surrounding property has clearly caused harm to other property. However, when a component part of a machine or a system destroys the rest of the machine or system, the characterization process becomes more difficult. When the product or system is deemed to be an integrated whole, courts treat such damage as harm to the product itself.

Id. at 249-50 (emphasis in original) (quoting Restatement (Third) of Torts § 21 cmt. e (1997)).[9] In short, " [d]amage by a defective component of an

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integrated system to either the system as a whole or other system components is not damage to 'other property' . . . " Id. at 249 (citing East River S.S. Corp. v. Transamerica Delaval, Inc., 476 U.S. 858, 867-68, 106 S.Ct. 2295, 90 L.Ed.2d 865 (1986)).

[¶28] An integrated system analysis is necessary when evaluating coverage under a CGL policy because we must decide whether the product is to be treated as a unified whole or whether a defective component can be separated out such that the claimed damage constitutes [367 Wis.2d 242] damage to property other than the defective component itself. Id. at 250-52.

[¶29] For example, in Wausau Tile, the manufacturer sold and distributed concrete paving blocks, which were " made of cement, aggregate, water, and other materials, for use mainly in exterior walkways." Id. at 241. The manufacturer contracted with another company to supply the cement and yet another company to supply the aggregate for incorporation into the paving blocks. Id. After incorporation, the paving blocks " suffered excessive expansion, deflecting, curling, cracking and/or buckling." Id. at 242 (internal quotation marks and citation omitted). These problems with the paving blocks resulted from defects in both cement and aggregate. Id.

[¶30] We employed an integrated system analysis to determine whether paving blocks were integrated systems comprised of cement, aggregate, and other components because if they were, damage by a defective component of an integrated system to other system components is not property damage to other property. Id. at 251-52. We concluded that because all components were combined to form paving blocks and the components could not be separated from the finished product, all components were part of an integrated system. Id. at 251. As such, we rejected the manufacturer's " contention that the [paving blocks] constitute[d] property other than the defective cement" itself.[10] Id. at 251-52.

[367 Wis.2d 243] [¶31] While in Wausau Tile we employed the economic loss doctrine to preclude tort claims for breaches of contract and/or warranty, id. at 246, more importantly, we explained that it is through an integrated system analysis that we determine what constitutes " other property." Id. at 250-51. Deciding whether the complained of injury is to other property is important because it is only damage to other property that is covered under a CGL policy. Vogel, 236 Wis.2d 504, ¶ 17; Wis. Label, 233 Wis.2d 314, ¶ 27.

[¶32] The court of appeals correctly discerned that the economic loss doctrine does not control a coverage dispute and, therefore is not at issue here. However, the court of appeals overlooked significant portions of our decision in Wausau Tile, where we also discussed whether there was insurance policy coverage for the claimed damage. Wausau Tile, 226 Wis.2d at 266-69. Simply

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stated, the court of appeals did not perceive the importance of an integrated system analysis when deciding whether claimed damage arose from physical injury to tangible property other than to the La. See Wis. Pharmacal, 358 Wis.2d 673, ¶ 19. Instead, the court of appeals applied law from other jurisdictions to reason that a product may be " physically injured by the incorporation of a defective, faulty, or inadequate part." Id., ¶ 20. Thereafter, the court of appeals incorrectly concluded that incorporation of a defective ingredient into the supplement tablets caused property damage by physically injuring other ingredients in the tablets. Id.

[367 Wis.2d 244] [¶33] The policy language at issue in Wausau Tile is substantively identical to Netherlands' policy language. Wausau Tile, 226 Wis.2d at 267 n.18. There, we concluded that the manufacturer's claims did not allege property damage because, as set forth above, damage by a defective component of an integrated system to either the system as a whole or other system components is not separable as damage to other property for which coverage is provided by a CGL policy. See id. at 250-52, 267-68.

[¶34] Similarly, applying an integrated system analysis to the instant case, we conclude that combining a defective ingredient with other ingredients and incorporating them into supplement tablets, formed an integrated system. Pharmacal could not separate out the LA from the other ingredients or the other ingredients from each other. No damage resulted to property other than ingredients of the integrated system and the completed product, the tablets. Stated otherwise, upon blending ...


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