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

We review a published decision of the court of appeals1 reversing an order of

the Ozaukee County Circuit Court2 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'

1 Wis. Pharmacal Co. v. Neb. Cultures of Cal., Inc., 2014 WI App 111, 358 Wis. 2d 673, 856 N.W.2d 505.

2 The Honorable Thomas R. Wolfgram of Ozaukee County presided.

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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 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 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

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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 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

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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 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 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

3 Because Nutritional Manufacturing assigned all claims to Pharmacal, we refer to all claims as Pharmacal's claims.

4 At oral argument, counsel indicated that Jeneil had elected not to move to dismiss this claim. The merits of the underlying claims between the various parties are not before us, and therefore, we do not address the propriety of this remaining cross claim for negligence.

Nos. 2013AP613 & 2013AP687

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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 hearings5 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

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. 5 After the first hearing, the circuit court allowed the parties to conduct discovery on the coverage issue.

Nos. 2013AP613 & 2013AP687

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Id., ¶¶20-26. The court of appeals also held that Netherlands

breached its duty to defend6 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 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 question of law that we review

6 At oral argument, counsel indicated that Netherlands refused to provide Jeneil with any defense, while Evanston had provided Nebraska Cultures with an initial defense.

Nos. 2013AP613 & 2013AP687

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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. 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

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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 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

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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 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

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.

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¶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 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

7 As the parties agree that no "bodily injury" has occurred, we do not address that policy language.

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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) (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.

¶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

Nos. 2013AP613 & 2013AP687

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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 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

8 A performance bond ensures successful completion of a contractual obligation. As Couch on Insurance explains, performance bonds protect the person to whom a contractual obligation is owed from the risk of loss directly arising from another's failure to perform according to the terms of a contract. Steven Plitt, Daniel Maldonado & Joshua D. Rogers, 1 Couch on Insurance § 1:15 (3d ed. 2009).

Nos. 2013AP613 & 2013AP687

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(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 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 (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 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,

9 We note there is no allegation that tablets containing LA were dangerous.

Nos. 2013AP613 & 2013AP687

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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]

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constitute[d] property other than the defective cement" itself.10

Id. at 251-52.

¶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 stated, the court of appeals did not perceive

the importance of an integrated system analysis when deciding 10 The Supreme Court also has discussed integrated systems. In East River S.S. Corp. v. Transamerica Delaval, Inc., 476 U.S. 858 (1986), the Court considered whether there was damage to other property where defective component parts were incorporated into a turbine. As a result of the defective parts, the turbine failed and was damaged. Id. at 867-68. Although recognizing that the integrated system had been negligently manufactured, the Court held that the turbine must be regarded as a single unit. Id. at 867. Therefore, any resulting damage to it or its component parts constituted only damage to the property itself. Id.

Nos. 2013AP613 & 2013AP687

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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.

¶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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LA, rather than LRA, with other ingredients, all of the

ingredients were integrated into one product, the tablets.

¶35 Therefore, similar to the effect of cement being

incorporated with other components into the paving blocks in

Wausau Tile, the effect of LA being incorporated with the other

ingredients into tablets cannot be said to constitute damage to

other property. 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.

¶36 Furthermore, there was no physical injury to tangible

property caused by LA. To constitute "physical injury,"

property other than LA must have been physically altered by the

LA. Vogel, 236 Wis. 2d 504, ¶17; Wis. Label, 233 Wis. 2d 314,

¶31; Travelers Ins. Co. v. Eljer Mfg., Inc., 757 N.E.2d 481, 496

(Ill. 2001). Additionally, there must be an element of

causation. Wis. Label, 233 Wis. 2d 314, ¶32; Smith v. Katz, 226

Wis. 2d 798, 822, 595 N.W.2d 345 (1999).

¶37 Pharmacal argues that there was physical injury due to

blending other ingredients with LA into tablets. However, there

was no factual foundation presented from which one could

conclude that creating tablets using LA physically altered other

ingredients in a way that would not have occurred if LRA had

been used in the same tableting process. Stated otherwise, any

changes to other ingredients were not a result of the defective

ingredient; rather, any changes were a result of the tableting

process that would have occurred regardless of which probiotic

ingredient was supplied. Yet, property damage under the first

Nos. 2013AP613 & 2013AP687

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definition in the Netherlands policy requires physical injury to

tangible property that is caused by the insured. Accordingly,

we conclude that there was no "physical injury to tangible

property.

¶38 Finally, Jeneil asserts that the cartons, shippers,

inserts, tooling and dies associated with the supplement tablets

suffered physical injury, thereby constituting property damage

to tangible property. However, the materials associated with

shipping the supplement tablets did not undergo any physical

alterations due to LA. The presence of the defective ingredient

in the tablets did not cause any alterations to these materials

that would not have otherwise occurred. For example, the

defective ingredient did not cause the tablets to explode or

corrode through the shipping materials such that they underwent

some physical alteration that would not have occurred if the

tablets had contained the contracted-for LRA. Therefore, we

conclude that there is no physical injury to the cartons,

shippers, inserts, tooling and dies caused by the defective

ingredient.

¶39 We next consider whether the incorporation of a

defective ingredient constitutes property damage due to "loss of

use of tangible property that is not physically injured" under

the Netherlands policy.

b. property damage (loss of use)

¶40 As set forth above, Pharmacal's underlying claims

allege that Jeneil incorrectly supplied LA to Nutritional

Manufacturing and Pharmacal when the parties agreed upon, and

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paid for, LRA. According to Jeneil, the incorporation of a

defective ingredient rendered the other ingredients and the

supplement tablets totally useless to Pharmacal, thereby

constituting property damage due to "loss of use of tangible

property that is not physically injured."

¶41 However, we previously have stated that "[d]iminution

in value——even to the point of worthlessness——is not the same as

'loss of use' under the insurance policy, which by its plain

language contemplates some sort of loss of use in fact, not a

reduction in value." Vogel, 236 Wis. 2d 504, ¶26.

¶42 In Vogel, the plaintiffs hired a contractor to build

their home. Id., ¶3. The contractor, in turn, hired a

subcontractor to perform the foundational work, concrete work

and brick work. Id. Upon completion of the home, a number of

deficiencies in the workmanship were discovered. Id., ¶¶4-7.

Among other things, the plaintiffs could not use their

fireplaces, the brickwork was incomplete, and the walls were

shoddily constructed. Id., ¶¶6-7. After trial, the circuit

court found that the home was "essentially a 'tear-down'" and

that the entire home was worthless as constructed. Id., ¶¶12

13. The plaintiffs were awarded various damages, including cost

of repair and replacement damages for the defective masonry

work. Id., ¶12. The subcontractor sought coverage under its

CGL policy. See id. We held that, although the home was

essentially worthless in value due to the defective workmanship

and needed to be reconstructed, such damages for diminution in

value did not constitute "property damage" caused by "loss of

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use." Id., ¶26. The homeowners lost the entire value of their

home; they did not simply lose its use for some period of time.

Id.

¶43 Here, Jeneil similarly failed to perform in the manner

in which it had contractually agreed to perform. Jeneil

erroneously supplied LA, which was incorporated into the

supplement tablets. Once Pharmacal and the retailer realized

that the tablets contained LA rather than LRA, the tablets were

recalled. The recalled tablets were worthless due to the

inclusion of LA rather than LRA and were subsequently discarded.

As with the homeowners in Vogel who lost the entire value of

their home, Pharmacal did not lose the use of the tablets;

rather, it permanently lost the entire value of the tablets.

¶44 Furthermore, although Wisconsin appellate courts have

held that property damage caused by loss of use may occur with

temporary loss, they never have concluded that loss of use may

occur when the loss of the property is permanent.

¶45 For example, the court of appeals held that there was

loss of use when a farmer temporarily could not use his field

for an entire growing season. W. Cas. & Sur. Co. v. Budrus, 112

Wis. 2d 348, 352, 332 N.W.2d 837 (Ct. App. 1983). In Budrus,

the farmer purchased 400 pounds of seed labeled "Birdsfoot,"

which is feed for cows. Id. at 350. However, after planting

the seed on his 40-acre field, he discovered that the seed had

been mislabeled and that it was actually "Rape" seed, which is

feed for pigs and was useless to him. Id. The farmer sued the

seed supplier for damages resulting from crop loss and loss of

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production, as it was too late into the season to replant. Id.;

Wis. Label, 233 Wis. 2d 314, ¶54. The supplier sought coverage

under his insurance policy, and the court of appeals concluded

that there was property damage due to loss of use of the

farmer's 40-acre field. Budrus, 112 Wis. 2d at 352.

¶46 As the farmer was temporarily unable to use his

property until the next growing season, such damages constituted

loss of use under the insurance policy. See id. However, in

contrast to Pharmacal's tablets, the farmer's property was not

rendered permanently worthless such that he lost the entire

value of the field without the possibility of restoration.

¶47 Similarly, we have held that loss of use includes

damages arising from the removal and repair of a manufacturer's

defective transformer. Sola Basic Indus., Inc. v. U.S. Fid. &

Guar. Co., 90 Wis. 2d 641, 654, 280 N.W.2d 211 (1979). In Sola

Basic, the manufacturer used a transformer to operate its

electric furnace, which, in turn powered the manufacturer's

plant. Id. at 647. When a defective transformer had to be

removed and repaired, the electric furnace was rendered

unusable, causing the manufacturer to sustain additional costs

in order to operate its plant. Id. We concluded that these

damages, resulting from the inability to use the electric

furnace while the transformer was being repaired, constituted

loss of use under the insurance policy's language. Id. at 654.

¶48 It is also significant that the temporary inability to

use the electric furnace during repair of the transformer in

Sola Basic was a loss of use of property other than the

Nos. 2013AP613 & 2013AP687

23

defective product (the transformer), just as the loss of use of

the farmer's field in Budrus was a temporary inability to use

property other than the defective product (the seed). By

contrast, in the case before us, the claim for loss of use is a

permanent loss of use of the defective product itself, the

tablets.

¶49 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. Instead, Pharmacal

permanently lost the entire value of the tablets. Accordingly,

we conclude that the Netherlands policy does not provide

coverage because there is no property damage due to "loss of use

of tangible property that has not been physically injured."11

¶50 As we have concluded that incorporation of LA, the

defective ingredient, into the tablets does not constitute

property damage under either definition of the Netherlands

policy, there is no initial grant of coverage. However, in the

interest of completeness, we proceed to consider whether there

has been an "occurrence."

c. occurrence

¶51 The policy defines "occurrence" as "an accident,

including continuous or repeated exposure to substantially the 11 For these same reasons, we further conclude that the policy does not provide coverage for the permanent loss of use of the cartons, shippers, inserts, tooling and dies associated with the supplement tablets.

Nos. 2013AP613 & 2013AP687

24

same general harmful conditions." While Jeneil intentionally

provided a probiotic ingredient, the parties do not dispute that

Jeneil's provision of a defective ingredient was accidental.

However, we are not persuaded, simply because Jeneil accidently

supplied a defective ingredient, that this constitutes an

"occurrence" for purposes of coverage under the policy.

¶52 To the contrary, we note that, while faulty

workmanship "can give rise to property damage caused by an

'occurrence,'" it does not follow that faulty workmanship itself

constitutes an occurrence. Glendenning's Limestone & Ready-Mix

Co. v. Reimer, 2006 WI App 161, ¶30, 295 Wis. 2d 556, 721 N.W.2d

704 (quoting Am. Fam. Mut. Ins. Co. v. Am. Girl, Inc., 2004 WI

2, ¶48, 268 Wis. 2d 16, 673 N.W.2d 65).

¶53 For example, in American Girl, a soil engineer

negligently gave faulty advice regarding the ability of the soil

to support a building. Am. Girl, 268 Wis. 2d 16, ¶¶12-13.

After the building was constructed pursuant to that advice, the

soil began to settle, which caused the building to sink and

sustain damage. Id., ¶¶13-14. We held that soil settlement,

which lead to sinking and cracking of the building, constituted

an "occurrence" under the policy. Id., ¶5; see Glendenning's

Limestone, 295 Wis. 2d 556, ¶27. Importantly, although the soil

engineer negligently, or accidentally, rendered the faulty

advice, this advice was not an "occurrence." Am. Girl, 268

Wis. 2d 16, ¶5. Rather, the faulty advice caused the

"occurrence," which, in turn, caused property damage. Id.

Nos. 2013AP613 & 2013AP687

25

¶54 Similarly, where windows were defectively constructed,

that defective construction did not, in itself, constitute an

"occurrence" simply because defects arose via an accident.

Glendenning's Limestone, 295 Wis. 2d 556, ¶28 (citing

Kalchthaler v. Keller Constr. Co., 224 Wis. 2d 387, 391, 392

n.2, 591 N.W.2d 169 (Ct. App. 1999)). However, when defective

windows allowed rain to leak inside, thereby causing property

damage to wooden floors within the building, the leaking of the

windows constituted an "occurrence." Id., ¶29.

¶55 In light of the foregoing, we conclude that, although

a breach of contract may give rise to property damage caused by

an "occurrence," a breach of contract, standing alone, does not

constitute an "occurrence." See id., ¶39 (explaining that "[a]n

'accident' may be caused by faulty workmanship, but every

failure to adequately perform a job, even if that failure may be

characterized as negligence, is not an 'accident,' and thus not

an 'occurrence' under the policy.").

¶56 In the instant case, Jeneil's provision of a defective

ingredient is analogous to the soil engineer's faulty advice and

the defectively constructed windows. An accidental provision of

a defective ingredient does not constitute an "occurrence" in

and of itself. Therefore, we conclude that there is no property

damage caused by an "occurrence" as defined by the Netherlands

policy. Consequently, this also precludes an initial grant of

coverage under the Netherlands policy. We now consider whether

there is an initial grant of coverage under the Evanston policy.

Nos. 2013AP613 & 2013AP687

26

2. Evanston policy

¶57 Evanston's CGL policy similarly provides coverage for

Nebraska Cultures' losses arising out of "bodily injury" or

"property damage" caused by an "occurrence." The policy defines

"property damage" as "physical injury to or destruction of

tangible property including, consequential loss of use thereof;

o[r] loss of use of tangible property which has not been

physically injured or destroyed."

¶58 California CGL policies have been described as

follows:

General liability policies, such as the ones in dispute here, are not designed to provide contractors and developers with coverage against claims [that] their work is inferior or defective. The risk of replacing and repairing defective materials or poor workmanship has generally been considered a commercial risk which is not passed on to the liability insurer. Rather[,] liability coverage comes into play when the insured's defective materials or work cause injury to property other than the insured's own work or products. . . . "This distinction is significant. Replacement and repair costs are to some degree within the control of the insured. They can be minimized by careful purchasing, inspection of material, quality control and hiring policies. If replacement and repair costs were covered, the incentive to exercise care or to make repairs at the least possible cost would be lessened since the insurance company would be footing the bill for all scrap."

Maryland Cas. Co. v. Reeder, 221 Cal. App. 3d 961, 967 (Cal. Ct.

App. 1990) (citations omitted).

¶59 Bearing these principles in mind, we first discuss

whether there is property damage under either policy definition.

Nos. 2013AP613 & 2013AP687

27

a. property damage (physical injury)

¶60 Under California law, "property damage is not

established by the mere failure of a defective product to

perform as intended." F & H Constr. v. ITT Hartford Ins. Co. of

the Midwest, 118 Cal. App. 4th 364, 372 (Cal. Ct. App. 2004);

Reeder, 221 Cal. App. 3d at 969. Simply stated, a liability

insurance policy is not a performance bond. F & H Constr., 118

Cal. App. 4th at 373.

¶61 Also, when considering whether a defective product has

caused property damage, California courts examine whether the

defective product is hazardous. If the defective product is

hazardous, courts have found immediate property damage to other

property caused by a defective product. See Watts Indus., Inc.

v. Zurich Am. Ins. Co., 121 Cal. App. 4th 1029, 1044-46 (Cal.

Ct. App. 2004) (concluding that a hazardous product manufactured

with excessive lead percentages permitted lead to leach into

water flowing in contact with the product, causing damage to

other property).

¶62 However, under California law, when contractually

nonconforming pile caps were welded onto steel composite piles

that had been driven into the ground to support a water pumping

facility, no property damage occurred because the nonconforming

caps did not result in physical injury to other property. F & H

Constr., 118 Cal. App. 4th at 373-74. To explain further, the

parties contracted for grade A-50 caps, but grade A-36 caps were

supplied and subsequently welded onto the piles, thereby

rendering the pilings inadequate to support the building. Id.

Nos. 2013AP613 & 2013AP687

28

The court determined that, even though the contractually

nonconforming caps rendered the pilings inadequate for their

intended purpose, there was no property damage to the piles or

any other property. Id.

¶63 This is in contrast to a situation in which hazardous

property is connected to a building such that it damages the

building. For example, property damage was found where asbestos

was connected and linked to a building, thereby rendering the

entire building's air supply hazardous. Armstrong World Indus.,

Inc. v. Aetna Cas. & Sur. Co., 45 Cal. App. 4th 1, 92-94 (Cal.

Ct. App. 1996). Similarly, where a nut cluster cereal was

contaminated by wood splinters, there was property damage

because the splinters rendered the cereal hazardous for

consumption. Shade Foods, Inc. v. Innovative Prods. Sales &

Mktg., Inc., 78 Cal. App. 4th 847, 865-66 (Cal. Ct. App. 2000).

The court stated that there may be a "finding [of] property

damage where a potentially injurious material in a product

causes loss to other products." Id. However, "property damage

is not established by the mere failure of a defective product to

perform as intended." F & H Constr., 118 Cal. App. 4th at 372.

¶64 In the instant case, a defective ingredient was

incorporated into the supplement tablets. Unlike the obvious

hazardousness of asbestos connected to a building or wood

splinters in cereal, there is no evidence suggesting that the

defective probiotic ingredient, LA, is hazardous. The tablets

were simply labeled as containing one probiotic ingredient when

they actually contained another. Therefore, due to the

Nos. 2013AP613 & 2013AP687

29

incorporation of a defective ingredient, the tablets were not

the product for which the parties had contracted.

¶65 Although a defective ingredient rendered the tablets

inadequate for their contracted purpose, the mere presence of a

defective ingredient did not render them hazardous.

Accordingly, we conclude that there is no property damage under

this policy definition.12 We next consider whether there is

property damage due to "loss of use of tangible property that

has not been physically injured" under the Evanston policy.

b. property damage (loss of use)

¶66 Under California law, loss of use damages refer to the

rental value of temporary replacement property, rather than the

value of replacing the property itself. Advanced Network, Inc.

v. Peerless Ins. Co., 190 Cal. App. 4th 1054, 1062-63 (Cal. Ct.

App. 2010). Such damages for loss of use of property are

distinct from loss of property. Id. at 1062. California courts

utilize the following example to illustrate this distinction:

[A]ssume that an automobile is stolen from its owner. The value of the "loss of use" of the car is the rental value of a substitute vehicle; the value of the "loss" of the car is its replacement cost. . . . The measure of damages for the loss of use of personal property may be determined with reference to the rental value of similar property which the plaintiff can hire for use during the period when he is deprived of the use of his own property.

12 For these same reasons, we further conclude that the incorporation of a defective ingredient does not constitute physical injury to the cartons, shippers, inserts, tooling and dies associated with the supplement tablets.

Nos. 2013AP613 & 2013AP687

30

Collin v. Am. Empire Ins. Co., 21 Cal. App. 4th 787, 818 (Cal.

Ct. App. 1994) (internal quotation marks and citation omitted).

Moreover, while Pharmacal may not be able to use its property

because it is permanently unusable, such damages do not

constitute loss of use damages but, rather, "the value of the

property itself. Had [the insurer] wished to insure 'loss of

property,' its policy would have so provided." Id. at 818-19.

Therefore, where damages are unrelated to the rental value of

temporary replacement property, such damages do not constitute

loss of use under California law. See F & H Constr., 118 Cal.

App. 4th at 377.

¶67 As set forth, in full, above, the incorporation of a

defective ingredient rendered the tablets worthless for their

contracted purpose, and they were discarded due to their lack of

value. Therefore, Pharmacal's underlying claims are not for

loss of use damages because they relate to the permanent

uselessness of the tablets and not to the value of temporary

replacement property.13 Accordingly, we conclude that the

Evanston policy does not provide coverage because there is no

property damage due to "loss of use of tangible property that

has not been physically injured."

¶68 As we have concluded that the incorporation of a

defective ingredient into the tablets does not constitute 13 For these same reasons, we further conclude that the policy does not provide coverage for the permanent loss of use of the cartons, shippers, inserts, tooling and dies associated with the supplement tablets.

Nos. 2013AP613 & 2013AP687

31

property damage under either definition in the Evanston policy,

there is no initial grant of coverage. However, in the interest

of completeness, we proceed to consider whether there has been

an "occurrence."

c. occurrence

¶69 The Evanston policy defines "occurrence" as "an

accident, including continuous or repeated exposure to

substantially the same general harmful conditions." California

courts interpret "[t]he plain meaning of the word 'accident'

[a]s an event occurring unexpectedly or by chance." Ray v.

Valley Forge Ins. Co., 77 Cal. App. 4th 1039, 1045-46 (Cal. Ct.

App. 1999).

¶70 Under California law, "[a]n accident . . . is never

present when the insured performs a deliberate act. . . .[W]here

the insured intended all of the acts that resulted in the

victim's injury, the event may not be deemed an accident merely

because the insured did not intend to cause injury." Id. at

1046 (alterations in original) (internal quotation marks

omitted) (quoting Merced Mut. Ins. Co. v. Mendez, 213 Cal. App.

3d 41, 50 (Cal. App. Ct. 1989)).

¶71 For example, in Ray, the California Court of Appeals

held that there was no "occurrence" where a roofing consultant

negligently gave faulty advice on the suitability of roofing

materials for a building. Id. at 1043. The unsuitability of

the roofing materials caused the building to be excessively hot,

rendering it uninhabitable for certain portions of the year.

Id. at 1044-45. The consultant sought coverage under his

Nos. 2013AP613 & 2013AP687

32

insurance policy for what the court characterized as breach of

contract claims, alleging that the consultant "rendered bad

advice" in recommending the roofing materials. Id. at 1045.

¶72 The court held that the faulty advice did not

constitute an accident because the consultant deliberately gave

the advice and intended the plaintiffs to utilize the roofing

materials that he had suggested. Id. at 1046. Therefore, the

faulty advice could not be considered an "occurrence" even

though it was occasioned by the consultant's negligence. Id.

¶73 In the instant case, 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. Moreover, Jeneil intended the ingredient to be

incorporated into the tablets. Given the deliberate nature of

these actions, the provision of a defective ingredient cannot be

said to constitute an "occurrence" under California law.

Consequently, this also precludes an initial grant of coverage

under the Evanston policy.

F. Exclusions

¶74 Finally, although we have concluded that neither

policy provides an initial grant of coverage to the respective

insureds, in the interest of completeness, we address whether,

if there were property damage caused by an "occurrence,"

exclusions apply and negate coverage.

¶75 Exclusions in insurance policies are written to

exclude described risks. Because they may limit coverage that

Nos. 2013AP613 & 2013AP687

33

is otherwise available, if they are ambiguous, exclusions are

construed narrowly against the drafter of the policy. Frost v.

Whitbeck, 2002 WI 129, ¶19, 257 Wis. 2d 80, 654 N.W.2d 225. If

the policy language is not ambiguous, we apply the plain meaning

of the words employed. Id., ¶17.

¶76 The court of appeals determined that damages stemming

from the recall of the supplement tablets were excluded under

both policies' recall, or "sistership," exclusions. Wis.

Pharmacal, 358 Wis. 2d 673, ¶32. The court of appeals went on

to conclude that damages unassociated with the recall expenses

were not excluded under any of the policies' remaining

exclusions. Id., ¶¶34-35; see Armstrong World, 45 Cal. App. 4th

at 113 (explaining that sistership exclusions negate coverage

for costs associated with preventative action of the recall, but

do not "operate to exclude coverage for actual damage caused by

the very product" that is the cause for the recall).

¶77 However, as set forth below, we conclude that, even if

the policies were to provide an initial grant of coverage, the

plain meaning of both polices' "impaired property" exclusions

operate to negate coverage. Therefore, we need not address the

sistership exclusions.

1. Netherlands policy

¶78 The Netherlands policy excludes coverage for:

"Property damage" to "impaired property" or property that has not been physically injured, arising out of: (1) A defect, deficiency, inadequacy or dangerous condition in "your product" or "your work"; or (2) A delay or failure by [the insured] or anyone

Nos. 2013AP613 & 2013AP687

34

acting on [the insured's] behalf to perform a contract or agreement in accordance with its terms.

This exclusion does not apply to the loss of use of other property arising out of sudden and accidental physical injury to "your product" or "your work" after it has been put to its intended use.

¶79 This exclusion operates to negate coverage where

property damage results from "the failure of the insured's

products to meet the level of performance which the insured

warranted or represented." Am. Motorists Ins. Co. v. Trane Co.,

544 F. Supp. 669, 688 (W.D. Wis. 1982). It also excludes

coverage when the insured fails to perform a contract according

to its terms. Moreover, the only exception to this exclusion

occurs when the damage to other property arises from "sudden and

accidental physical injury" to the insured's product. Id.

¶80 Here, there was no sudden and accidental physical

injury to the LA, other ingredients or supplement tablets.

Nutritional Manufacturing deliberately manufactured the tablets

with the ingredients supplied and Pharmacal deliberately

destroyed them. Therefore, there can be no loss of other

property resulting from sudden and accidental physical injury to

the insured's product.14 Furthermore, because the tablets

constituted an integrated system, as we have explained above,

there was no damage to other property on that basis as well. 14 Alternatively, the Netherlands policy excludes "[p]roperty damage" to the insured's product "arising out of it or any part of it." Therefore, even if we were to conclude that there were sudden and accidental physical injury to a defective ingredient, the other ingredients, or the tablets, such damages would be excluded as arising out of Jeneil's product.

Nos. 2013AP613 & 2013AP687

35

Accordingly, the exception to the exclusion is inapplicable.

Therefore, we need determine only whether the exclusion itself

applies.

¶81 We conclude that it does. Jeneil argues that the

incorporation of a defective ingredient constitutes loss of use

because the tablets and other ingredients were worthless as

labeled and could not be sold. However, we have already

concluded that no loss of use of other property occurred.

Stated otherwise, any loss of use was due to the incorporation

of Jeneil's defective probiotic. The Netherlands policy

specifically excludes damages caused by such a loss.

¶82 Furthermore, as repeatedly alleged by Pharmacal, the

provision of a defective ingredient constitutes a breach of

contract. We agree. The parties contracted for the sale of

LRA, but LA was supplied. This failure of Jeneil to perform a

contract in accordance with its terms is likewise excluded from

the Netherlands policy. Accordingly, we conclude that

Netherlands' "impaired property" exclusion operates to negate an

initial grant of coverage, if there were such a grant.

2. Evanston policy

¶83 The Evanston policy similarly excludes coverage for:

[A]ny Claim based upon or arising out of loss of use of tangible property which has not been physically injured or destroyed resulting from: (i) a delay in or lack of performance by or on behalf of the Named Insured of any contract or agreement; or (ii) a defect, deficiency, inadequacy or dangerous condition in the products, goods or operations of the Named Insured;

Nos. 2013AP613 & 2013AP687

36

provided, however, this exclusion does not apply to loss of use of other tangible property resulting from the sudden and accidental physical injury to or destruction of the Named Insured's Products . . . after such products . . . have been put to use by any person or organization other than an Insured[.]15

¶84 Under California law, this exclusion precludes

coverage for loss of use damages "arising out of [the insured's]

negligent failure to perform its contractual obligations" or its

defective product or work. Reg'l Steel Corp. v. Liberty Surplus

Ins. Corp., 226 Cal. App. 4th 1377, 1394 (Cal. Ct. App. 2014).

Pharmacal alleges that Nebraska Cultures breached its contract

by supplying a defective ingredient, which was subsequently

incorporated into the supplement tablets. Therefore, any

resulting loss of use damages arise out of Nebraska Cultures'

failure to properly perform its contractual obligations when it

provided LA, a defective component of the supplement tablets.

Such damages are specifically excluded by the Evanston policy.

Accordingly, we conclude that, even if there were an initial

15 For similar reasons as those set forth with respect to the Netherlands policy, the exception to the exclusion is inapplicable. The Evanston policy also excludes coverage for:

[A]ny Claim based upon or arising out of Property Damage to the Named Insured's Products arising out of it or any part of it, or for the cost of inspecting, repairing or replacing any defective or allegedly defective product or part thereof or for loss of use of any defective or allegedly defective product[.]

Therefore, even if we were to conclude that there were physical injury to a defective ingredient, the other ingredients, or the tablets, such damages would be excluded.

Nos. 2013AP613 & 2013AP687

37

grant of coverage, Evanston's impaired property exclusion

operates to negate such coverage.

In light of the foregoing, we conclude that there is

no "property damage" caused by an "occurrence" because the

incorporation of a defective ingredient into the supplement

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



The decision of the court of appeals is reversed and remanded for further proceedings consistent with this opinion.