By Susan Engstrom
Two commercial general liability insurers had a duty to defend window maker Kolbe & Kolbe Millwork Co. in a suit brought by homeowners alleging that the windows they had purchased from the company were defective and caused damage to their homes, the U.S. Court of Appeals for the Seventh Circuit ruled. Contrary to the insurers’ assertion, a recent decision from the Wisconsin Supreme Court did not mandate an "integrated-system" analysis in this case because the homeowners were seeking compensation for the repair or replacement of individual elements (i.e., stained walls and buckled plaster) of a larger structure. In addition, coverage was not precluded under the policies’ "your product" exclusion because the alleged consequential losses did not constitute damage to Kolbe’s product (Haley v. Kolbe & Kolbe Millwork Co., August 8, 2017, Flaum, J.).
In 2014, a group of homeowners filed a putative class action against Kolbe alleging that its windows were defective and had allowed air and water to leak into, and damage, their homes [see Products Liability Law Daily’s July 13, 2017 analysis]. The damages at issue in this case involved consequential losses from injury to property other than the windows themselves, such as stained walls and buckled plaster. Kolbe’s commercial general liability insurers, Fireman’s Fund Insurance Co. and United States Fire Insurance Co., accepted Kolbe’s tender of defense, but did so under a reservation of rights. They subsequently filed a motion for summary judgment, arguing that they had no duty to defend.
Integrated system. At the heart of the parties’ dispute was the integrated-system rule, a common-law rule from the so-called "economic loss" doctrine. Under that doctrine, the purchaser of a product is barred from using tort law to recover from the manufacturer any purely economic injuries arising from that product’s failure to work as expected. Because the economic loss doctrine applies only to economic injuries, it does not preclude actions in tort for injuries to property other than the defective product. However, if the defective product is a component of a larger, integrated system, damage by that component to the other elements of the system, or to the system as a whole, is likewise considered damage to the defective component itself and, thus, does not qualify as damage to "other property."
Although the economic loss doctrine generally does not apply to insurance coverage disputes, the Wisconsin Supreme Court recently applied an integrated-system analysis to a dispute involving damages arising from the incorporation of the wrong type of beneficial bacteria into a probiotic health supplement (Wisconsin Pharmacal Co. v. Nebraska Cultures of California, Inc.) [see Products Liability Law Daily’s March 2, 2016 analysis]. The insurance policy in that case, as here, covered injury to property other than the insured’s product itself. The state high court determined that coverage was not available because the combining of the ingredients into a single tablet created an integrated system such that the alleged injury—i.e., the inability to use the finished tablet—was not damage to "other property."
In the present case, the insurers contended that Pharmacal mandated an integrated-system analysis in all general liability insurance disputes. They asserted that the windows of a house have no function or purpose apart from—and, thus, form an integrated system with—their surrounding structures. As such, according to the insurers, damage to those structures caused by a defect in the windows constituted damage to the windows themselves and, absent any injury to "other" property, there was no coverage.
The Seventh Circuit disagreed. The question of whether an insurance policy covers a particular claim depends on the nature of the insured’s alleged loss. In Pharmacal, the only loss alleged was the plaintiff’s inability to use the supplement tablets as a whole. The plaintiff in that case did not seek reimbursement for the cost of repairing or replacing the tablets’ non-defective ingredients, presumably because even if there had been evidence of physical injury to those components, the components were indistinguishable from each other and from the larger product. Here, in contrast, the homeowners sought compensation for the repair or replacement of individualized elements of a larger structure. That kind of particularized demand was not at issue in Pharmacal. Accordingly, Pharmacaldid not require an integrated-system analysis in this case.
"Your product" exclusion. The insurers next argued that even if the policies afforded an initial grant of coverage for the faulty window claims, the policies’ "your product" exclusion removed that coverage. This exclusion barred coverage for property damage to Kolbe’s "product," which was defined as: (1) "goods or products … manufactured, sold, handled, distributed or disposed of by" Kolbe; and (2) "[c]ontainers …, materials, parts or equipment furnished in connection with such goods or products."
The parties agreed that the windows, which Kolbe had manufactured, met the first part of the "product" definition, but they disagreed as to whether the walls and other elements of the plaintiffs’ homes constituted Kolbe’s "product" under the second part of the definition such that coverage for any damage to those materials was excluded. The appellate panel concluded that a reasonable insured could understand the phrase "furnished in connection with" to mean furnished by the actors specified in the preceding clause—i.e., Kolbe. The court explained that "in connection with" is a phrasal preposition that, like other prepositions, is used to indicate a relationship between an object and its antecedent. However, the particular relationship may differ, depending on the context in which the preposition appears.
Here, because both the "containers…, materials, parts or equipment" and the "goods or products" were capable of being "furnished" or supplied, the reader reasonably could assume that the former items must come from the source of, or from someone acting in agreement with the source of, the latter items; and the first clause clearly identified that source as the insured (i.e., Kolbe). At the very least, the definition of "your product" was ambiguous and, thus, the court was required to construe it in favor of coverage. Because Kolbe did not supply or request that anyone else supply the drywall and other materials allegedly damaged in the plaintiffs’ homes, the damage—although arising from Kolbe’s "product"—was not also to that product. Thus, the "your product" exclusion did not eliminate coverage for those claims.
In sum, because there might be coverage for at least one of the claims in the underlying suit, the insurers had a duty to defend Kolbe against all claims alleged in that suit.
The case is No. 16-3563.
Attorneys: Dixon R. Gahnz (Lawton & Cates, SC) for Mary Haley. Gordon Davenport (Foley & Lardner LLP) for Kolbe and Kolbe Millwork Co., Inc.
Companies: Kolbe and Kolbe Millwork Co., Inc.
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