By: Jordon S. Steinway

In Wisconsin Pharmacal Company, LLC v. Nebraska Cultures of California, Inc., 2016 WI 14 (March 1, 2016), the Wisconsin Supreme Court ruled that the incorporation of a defective ingredient into a dietary supplement did not result in damage to other property and, therefore, was not covered under a commercial general liability policy.

Wisconsin Pharmacal Company, LLC (Pharmacal) was to supply a feminine health probiotic supplement to be sold under the label of a major retailer.  The product called for Lactobacillus Rhamnosus A (“LRA”) as an ingredient.  Pharmacal contacted Nutritional Manufacturing Services, LLC (NMS) to locate a supplier of LRA, and to manufacture the supplement tablets.  NMS contacted Nebraska Cultures of California, Inc. (Nebraska Cultures) to locate the LRA, and Nebraska Cultures in turn arranged with Jeneil Biotech, Inc. (Jeneil) to supply the LRA.  The retailer later informed Pharmacal that the supplement tablets did not contain LRA, but rather contained a different species of bacteria, Lactobacillus acidophilus (“LA”), and Pharmacal confirmed this through independent testing.  The retailer recalled Pharmacal’s daily probiotic feminine supplement.

NMS assigned its claims to Pharmacal, and Pharmacal filed suit against Nebraska Cultures, and its insurer, Evanston Insurance Company (Evanston), as well as Jeneil and its insurer, Netherlands Insurance Company (Netherlands).  Pharmacal alleged various tort and contract causes of action.  With respect to coverage, the Wisconsin circuit court ruled that there was no damage to property other than the integrated product into which the mistaken ingredient had been incorporated, and that this did not constitute “property damage” other than to the product itself, and there was not an “occurrence.”  The Wisconsin Appellate Court reversed, concluding that the policies provided coverage.  Wisconsin Pharmacal Co., LLC v. Nebraska Cultures of California, Inc., 2014 WI App 111.  The Wisconsin Supreme Court granted the insurers’ joint petition for review, and reversed the appellate court ruling.

With respect to the Netherlands Policy, the Wisconsin Supreme Court (applying Wisconsin law) concluded that combining a defective ingredient with other ingredients, and incorporating them into supplement tablets, formed an integrated system.  In other words, upon blending LA, rather than LRA, with other ingredients, all of the ingredients were integrated into one product, the tablets.  The LA could not be separated from the other ingredients, nor could the other ingredients be separated from each other.  Therefore, because no damage resulted to property other than ingredients of the integrated system and the completed product, the Court held that there was no injury to other property.  The Court also rejected Pharmacal’s argument that there was physical injury due to blending other ingredients with LA into tablets.  The Court countered that any changes to other ingredients were not the result of the defective ingredient, but were instead a result of the tableting process that would have occurred regardless of which probiotic ingredient was supplied.  On this basis, there was no “physical injury to tangible property.”

The Court further noted that, while Jeneil argued 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, the Court concluded that the Netherlands Policy did not provide coverage because there was no “property damage” due to “loss of use of tangible property that has not been physically injured.”  Because the incorporation of LA, the defective ingredient, into the tablets did not constitute “property damage,” there was no coverage.  The Court then added that the accidental provision of a defective ingredient does not constitute an “occurrence” in and of itself.

The Court made the same rulings with respect to the Evanston Policy, which was analyzed under California law.

Even though the Court concluded that neither policy provides an initial grant of coverage to the respective insureds, the Court went on to address whether any exclusions would apply to preclude coverage assuming that there was “property damage” caused by an “occurrence.”  In short, the Court held that the plain meaning of both policies’ “impaired property” exclusions operate to negate coverage (under Wisconsin and California law), thereby obviating the need to even address the sistership/recall exclusion.

This ruling is favorable to insurers, and carries on the recent trend of courts rejecting the incorporation theory.

If you have any questions about how this could impact your business, please contact:

Jordon S. Steinway | Partner

312.762.3169 / jsteinway@batescarey.com