It’s Not a Blob, It’s a Probiotic: Wisconsin Supreme Court Applies the “Integrated Systems” Rule in Coverage Dispute

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In Wisconsin Pharmacal Company, LLC v. Nebraska Cultures of California, Inc., 2016 WI 14, the Wisconsin Supreme Court applied the “integrated systems” rule to a coverage dispute. In a narrow decision, it reversed the Court of Appeals decision and determined that the incorporation of a defective ingredient into a tablet did not constitute “property damage” caused by an “occurrence.” Further, the Wisconsin Supreme Court concluded that even if “property damage” was alleged, exclusions would apply to bar coverage.

The coverage dispute arose when a company contracted to manufacture a probiotic and ended up being supplied with the wrong probiotic. It didn’t learn that until after manufacture had started. As a result, the tablets were recalled and destroyed.

In the ensuing coverage actions, the circuit court granted the insurers’ motions for summary judgment on the basis that the incorporation of the defective ingredient into the tablet did not constitute “property damage” caused by an “occurrence” since it only harmed the product itself, which was an integrated system. The Court of Appeals reversed, concluding the integrated system rule was not relevant to the coverage dispute. It instead held that the defective probiotic caused “property damage.”

In reversing the Court of Appeals, the Supreme Court analyzed whether the addition of the defective probiotic constituted physical injury to tangible property other than the probiotic itself. In order to do so, the question was then whether the tablet was considered an integrated system since damage to the system, itself, would not constitute “property damage.” The Supreme Court decided the blending of ingredients into a tablet warranted the conclusion that the tablet was an integrated system because the ingredients could not be separated. Similarly, the incorporation of the defective probiotic could not constitute an “occurrence” because, as in faulty workmanship cases, the inclusion of the ingredient could not, by itself, be an “occurrence.”

In addition, the Supreme Court rejected that there was “loss of use” because the tablets were rendered totally useless. Instead, clear Wisconsin precedent held that diminution of value, even to the point of worthlessness, is not the same as loss of use. Also, although there was no initial grant of coverage, the Court remarked how the impaired property exclusions in the policies barred coverage since they bar coverage from the failure of the insured’s products to meet the level of performance warranted.

Judge Shirley Abrahamson penned a vigorous dissent suggesting the majority’s ruling using the integrated system rule was akin to the title movie character in “The Blob”, an ever-expanding alien lifeform. Specifically, the dissent argued the integrated system rule basically allowed the majority to elevate the economic loss doctrine above the policy language. The dissent found compelling the distinction between using the integrated system rule in a tort liability lawsuit and in an insurance coverage dispute. As a result, the dissent insisted that adopting the integrated system rule in the realm of insurance coverage would be improper, as it would contravene the language of insurance policies.

The sharp dissent notwithstanding, the majority decision follows the jurisprudence of other states wherein similar losses are rejected on the basis that insurance policies should not function as performance bonds. However, the development of the integrated system rule should be monitored going forward in order to determine its limits on Wisconsin jurisprudence.