Wisconsin Pharmacal’s Impact on Insurance Coverage

WDC Journal Edition: Summer 2016
By: Joanna R. Glaser, Jeffrey Leavell, S.C.

In Wisconsin Pharmacal Co., LLC v. Nebraska Cultures of California, Inc., the Wisconsin Supreme Court recently addressed a number of significant commercial general liability insurance coverage issues.[1] Perhaps most significantly, the court’s decision confirmed the application of the integrated system rule of the economic loss doctrine to the coverage analysis. The full effect of the decision remains to be seen, but the court certainly clarified several aspects of the law that insurers need to know when addressing commercial general liability insurance coverage issues in Wisconsin.

Wisconsin Pharmacal

On March 1, 2016, the Wisconsin Supreme Court decided Wisconsin Pharmacal. The case involved a coverage dispute between insurers and their respective insureds. The underlying claims against the insureds arose from the insureds having supplied a defective ingredient that was incorporated into Wisconsin Pharmacal (“Pharmacal”)’s probiotic supplement tablets.[2]

Pharmacal engaged Nutritional Manufacturing Services to manufacture the tablets. Nutritional Manufacturing contracted with defendant Nebraska Cultures to supply the probiotic bacteria. Nebraska Cultures subcontracted with Jeneil Biotech, Inc., to obtain the necessary bacteria for the tablet for Nutritional Manufacturing.[3] Unbeknownst to Nutritional Manufacturing, the bacteria ingredient it received from Nebraska Cultures was defective, in that it was a different type of bacteria than required.[4] Nutritional Manufacturing made the supplement tablets by blending the defective bacteria with the other ingredients into tablets, which were ultimately supplied to Pharmacal, who packaged and sent them to the retailer.[5] Once the defective ingredient was discovered, the tablets were recalled by the retailer and those containing the wrong bacteria were destroyed.[6]

Pharmacal brought an action against the defective bacteria suppliers and their general liability insurers, alleging tort and breach of contract claims.[7] After several claims were dismissed with prejudice, the remaining claims alleged that the suppliers incorrectly supplied the wrong bacteria.[8] The suppliers’ insurers moved to bifurcate and stay, pending a determination of whether they had duties to defend and indemnify.[9] The insurers then moved for summary judgment on the basis that there was no duty to defend or indemnify because there was no “property damage” caused by an “occurrence.”[10] Judge Thomas Wolfgram in Ozaukee County granted the insurers’ motions for summary judgment, but the court of appeals reversed, concluding that the incorporation of a defective ingredient was “property damage” caused by an “occurrence” and that there were no exclusions that precluded coverage.[11]

The supreme court accepted review and issued a lengthy decision that addressed a number of coverage arguments and policy exclusions. The decision addressed whether there was “property damage” caused by an “occurrence,” as well as whether the “your product” and “impaired property” exclusions applied. Important to the majority’s analysis[12] and discussed throughout its opinion was the application of the integrated system rule.

Was there Physical Injury to Tangible Property?

The supreme court reiterated the well-known principle that commercial general liability policies do “not cover an accident of faulty workmanship but rather faulty workmanship which causes an accident” resulting in property damage.[13] Stated another way, “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.”[14]

The question then became what constituted the insured’s “product” or “work” such that what constituted “other property” could be determined. Through its analysis in Pharmacal, the supreme court at times blended the questions of: (1) whether there was “property damage” as defined by the policy; and (2) if there was “property damage,” whether it was excluded from coverage. Thus, in analyzing whether there was physical injury to tangible property, the supreme court also considered whether any of that physically injured tangible property was property other than the “work” or “product” of the insured, which would generally have been excluded by the “your work” and “your product” exclusions.

Although most general liability policies contain a definition of “your work,” it is usually defined to broadly include the work or operations performed by the insured, as well as the materials and equipment provided by the insured in connection with that work.[15] Pharmacal offers important guidance on how “the product” or “the work” of the insured should be analyzed. The supreme court held that the integrated system rule, traditionally used in the context of the economic loss doctrine, should be used for purposes of the insurance coverage analysis:

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.[16]

“The integrated system rule holds that once a part becomes integrated into a completed product or system, the entire product or system ceases to be ‘other property’ for purposes of the economic loss doctrine.”[17]

The supreme court’s application of the integrated system rule in Pharmacal to a coverage evaluation represents an evolution from and clarification of previous decisions holding that the coverage analysis is separate and distinct from the economic loss doctrine analysis.[18] For example, in Jacob v. Russo Builders, the court of appeals had refused to apply the integrated system rule to a construction defect coverage case, asserting that courts had only recognized the use of the rule in product defect cases.[19] Although Pharmacal related to a product defect, going forward, the court’s decision and rationale is clearly not limited to products liability cases. The court broadly described the integrated system rule as “necessary when evaluating coverage under a CGL policy” and stated that “[t]o answer the question of what constitutes other property that has suffered physical injury, we analyze whether a supplement tablet is an integrated system.”[20]

The use of the integrated system rule in determining coverage is significant for insurance companies and their defense counsel addressing coverage. The use of the integrated system rule helps define the “work” of the insured, and in a practical way. When an insured’s product is incorporated as a component of a new product in a way that makes them inseparable, it is proper to consider it part of the whole. As explained by the supreme court in Pharmacal:

... [I]n Wausau Tile ... 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….

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.

... 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.[21]

Application of an integrated system analysis in construction defect cases will clearly have a substantial impact on coverage. For example, consider a case where an individual enters into an agreement with a general contractor for the construction of a new home. The general contractor hires a subcontractor to pour the concrete foundation footings and supports of the home. If the footings fail along with integrated flooring and walls, and the court focuses only on the foundation as the work, the other component parts of the completed home like the flooring and walls might be considered “property damage” to other property, outside of the “your work” exclusion, and therefore likely covered by the foundation subcontractor’s CGL policy. However, through application of the integrated system rule, which Pharmacal confirms is necessary when evaluating coverage under a CGL policy, the flooring and walls of the newly built home are arguably incorporated into a single integrated system, such that no damage would be seen to have resulted to property other than to the elements of the integrated system and completed product or work of the insured—the home.

It is of course possible to argue that a building is much different than a product like a supplement tablet or a cement paver, in which each separate ingredient is impossible to separately identify by the naked eye. However, the Wisconsin Supreme Court’s decision in Wausau Tile, Inc. v. Cty. Concrete Corp.[22] discusses in detail what constitutes an “integrated system,” which shows that an integrated system analysis actually is applicable in the construction arena:

Damage 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” ….

… [T]he United States Supreme Court has recognized that courts have interpreted the Supreme Court’s decision in East River as standing for the proposition that when harm results from a defective component of a product, the product itself is deemed to have caused the harm. Saratoga Fishing Co. v. J.M. Martinac & Co., 520 U.S. 875, 883, 138 L. Ed. 76, 117 S. Ct. 1783 (1997). In emphasizing that its holding in Saratoga did not affect this rule, the Court quoted East River’s explanation of the rule’s importance:

Since all but the very simplest of machines have component parts, [a holding that a component part of a machine was “other property”] would require a finding of “property damage” in virtually every case where a product damages itself. Such a holding would eliminate the distinction between warranty and strict products liability...

In the instant case, it is undisputed that the pavers were integrated systems comprised of several component materials, including Medusa’s cement.… The circuit court determined that Medusa's “concrete is an indistinguishable, integral part of the pavers” which “cannot be separately identified from the finished product.”Other courts have held that various substances incorporated into finished products constitute integral components of those products. See, e.g., Casa Clara, 620 So. 2d at 1247 (Fla. 1993) (holding that defective concrete became an integral part of homes purchased by the plaintiff such that the homes were not "other property"). Because the inference that Medusa's cement was an integral component of the pavers reasonably follows from the facts alleged in the complaint, we must regard it as true…. Accordingly, we reject Wausau Tile's contention that the pavers constitute property other than the defective cement.[23]

Arguably, the main components of a home—e.g., the foundation, framing members, masonry, support beams, etc.—are integral pieces of the completed building. Without each component, there would obviously be no building. Whether the same coverage argument could be made in a case involving mere building renovations rather than where an entire building is the product being purchased by the owner is uncertain. Time will tell just how far the courts will permit application of the integrated system rule to reach.

Was there Loss of Use to Property Not Physically Injured?

Beyond the discussion of application of the integrated system rule, Pharmacal also offers interesting insight into the proper interpretation of “loss of use” property damage, the second type of property damage defined by most CGL policies. Prior Wisconsin decisions have recognized “loss of use” property damage when property possessed by one with the right to use it has been rendered completely useless by the insured.[24] In Pharmacal, the plaintiff argued that there was “loss of use” property damage to the defective tablets, because the incorporation of the defective ingredient into the tablets rendered the entire tablet, including all of the other ingredients, useless to Pharmacal.

In its analysis of “loss of use,” the supreme court drew an important distinction, which should impact the interpretation of “loss of use” property damage moving forward. The supreme court recognized that “loss of use” property damage must include more than mere diminution in value; it must encompass actual loss of use that is only temporary.[25] For example, the court compared the case to Vogel v. Russo,[26] in which the plaintiffs’ home had a number of defects, including fireplace defects that resulted in the loss of use of their fireplaces and decreased value of the home. In Vogel, even though plaintiffs lost the use of a section of their home—the fireplaces—the court concluded there was still no “loss of use” damages because the plaintiffs did not lose the actual use of their entire home.[27]

Similarly, the court in Pharmacal held that even though the tablets were rendered completely useless and had no value, the use of the tablets was not actually lost: “Pharmacal did not lose the use of the tablets; rather, it permanently lost the entire value of the tablets.”[28] In making this distinction, the court appears to have added a temporal element to the meaning of “loss of use.” The court stated:

[A]lthough 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.[29]

The court distinguished other cases where loss of use was found in which plaintiffs were only “temporarily unable to use” the property with situations like Pharmacal in which the property was “rendered permanently worthless … without the possibility of restoration.”[30]

The rule also appears to hold true for other loss of use cases not mentioned by the court, like Wisconsin Label Corporation v. Northbrook Property & Casualty Insurance Company.[31] In Wisconsin Label, there was no loss of use found where mislabeled products resulted in undercharged items being sold and items needing to be re-labeled. The court found there was no “loss of use” because the products themselves were still usable and were not actually diminished in value.[32] Under the court’s interpretation of “loss of use” in Pharmacal, the result would likely have been the same. Whether loss of use of property was temporary or permanent in Wisconsin Label would have made no difference because there, the court found there was no loss of use at all.

The court in Pharmacal also found it significant that the property that was unable to be used was the defective property itself, rather than “other property.”[33] Since there was no physical injury to tangible property other than the work or product of the insureds, or loss of use of property not physically injured, the court concluded that there was no initial grant of coverage.

While the supreme court in Pharmacal appears to have attempted to harmonize the “loss of use” case law, the nature of the loss of use and whether it is only temporary is very fact intensive and may be a hurdle to coverage determinations on summary judgment. For example, at what point does “loss of use” transform from temporary to permanent? What if it is possible to restore property that has been rendered useless, but only at a very significant expense or over the course of several months or years? Going forward, it is likely that additional guidance will be needed on the “loss of use” analysis applied by the court in Pharmacal.

Impaired Property Exclusion

Although the court in Pharmacal found that there was no initial grant of coverage, and could have ended its analysis there, for the sake of completeness it proceeded to discuss the application of several policy exclusions, including the impaired property exclusion.[34] Prior to Pharmacal, few published decisions in Wisconsin had actually interpreted this exclusion.[35] The impaired property exclusion generally states that coverage is excluded 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 acting on [the insured’s] behalf to perform a contract or agreement in accordance with its terms.[36]

The exclusion also contains an exception:

This exclusion does not apply to the loss of use of other property arising out of a sudden and accidental physical injury to “your product” or “your work” after it has been put to its intended use.[37]

Again relying on the integrated system rule, the court held that there was no damage to “other property” for purposes of the exception to the impaired property exclusion. Additionally, it found that, to the extent the defective ingredient caused loss of use property damage, it arose out of a defective product of the insured—the bacteria. Finally, the insured had been contractually required to perform a contract by supplying the proper probiotic. When it failed to do so, “property damage” was caused by the failure of the insured to perform its contract in accordance with its terms.[38] Therefore, the court held that the impaired property exclusion applied to exclude any initial grant of coverage that may have existed.

Interestingly, as pointed out by the dissent, the majority seemed to gloss over the language of the impaired property exclusion that states that, for the exclusion to apply, the defect in “your product” or failure to perform a contract in accordance with its terms must be able to be restored to use by the repair or replacement of the insured’s work or product, or by fulfilling the terms of the contract.[39] Arguably, the defective tablets could not be restored to use by simply replacing the defective bacteria, which was so integrated with the tablet that it would have been impossible to separate. In fact, even the majority recognized when analyzing “loss of use” that the property had been rendered permanently useless “without the possibility of restoration.”[40] Therefore, the court’s application of the impaired property exclusion may ultimately do little to clarify the scope of the exclusion.


The reach of the majority’s decision in Pharmacal remains to be seen. However, insurers, insureds, and their counsel are likely to test its boundaries, particularly with the application of the integrated system rule to the coverage analysis. The decision provides insurers and insureds with important guidance for defining property damage, but is likely to be met with resistance from those that ascribe to the dissenting view that the economic loss doctrine has no place in the interpretation of insurance policies. Only after the integrated system rule is applied to additional fact scenarios will we be able to understand the true impact the Pharmacal decision may have on future insurance coverage cases.


[1] 2016 WI 14, 367 Wis. 2d 221, 876 N.W.2d 72.

[2] Id., ¶ 4.

[3] Id.

[4] Id., ¶ 5.

[5] Id.

[6] Id., ¶ 6.

[7] Id., ¶ 7.

[8] Id.

[9] Id., ¶ 8.

[10] Id.

[11] Id., ¶¶ 9-10.

[12] There was a dissenting opinion authored by Justice Shirley Abrahamson, which Justice Ann Walsh Bradley joined. Justices Annette Kingsland Ziegler and Rebecca Bradley did not participate.

[13] Bulen v. W. Bend Mut. Ins. Co., 125 Wis. 2d 259, 265, 371 N.W.2d 392 (Ct. App. 1985).

[14] Wisconsin Pharmacal, 367 Wis. 2d 221, ¶ 26 (quoting Vogel v. Russo, 2000 WI 85, ¶ 17, 236 Wis. 2d 504, 613 N.W.2d 177) (emphasis added).

[15] See, e.g., ISO Form CG 00 01 12 07, Page 16 of 16.

[16] Wisconsin Pharmacal, 367 Wis. 2d 221, ¶ 28.

[17] Linden v. Cascade Stone Co., 2004 WI App 184, ¶ 25, 276 Wis. 2d 267, 687 N.W.2d 823.

[18] Am. Family Mut. Ins. Co. v. Am. Girl, Inc., 2004 WI 2, ¶ 35, 268 Wis. 2d 16, 673 N.W.2d 65 (“The economic loss doctrine is a remedies principle. It determines how a loss can be recovered.... It does not determine whether an insurance policy covers a claim, which depends instead upon the policy language.”).

[19] 224 Wis. 2d 436, 452, 592 N.W.2d 271 (Ct. App. 1999).

[20] Wisconsin Pharmacal, 367 Wis. 2d 221, ¶¶ 27-28.

[21] Id., ¶¶ 33-35.

[22] 226 Wis. 2d 235, 593 N.W.2d 445 (1999).

[23] Id. at 249-52 (emphasis added; citations omitted).

[24] See, e.g., Sola Basic Indus., Inc. v. U.S. Fidelity & Guaranty Co., 90 Wis. 2d 641, 644, 280 N.W.2d 211 (1979) (removal of accidentally damaged transformer from plant rendered plant’s furnaces unusable); W. Cas. & Surety Co. v. Budrus, 112 Wis. 2d 348, 350, 352, 332 N.W.2d 837 (Ct. App. 1983) (wrong seed accidentally planted caused famer’s loss of use of his farm field); U.S. Fire Ins. Co. v. Good Humor Corp., 173 Wis. 2d 804, 824, 496 N.W.2d 730 (Ct. App. 1993) (collection and storage of recalled contaminated ice cream caused loss of use of storage space for merchantable goods). See also discussion in Wisconsin Label Corp. v. Northbrook Prop. & Cas. Ins. Co., 221 Wis. 2d 800, 812, 586 N.W.2d 29 (Ct. App. 1998).

[25] Wisconsin Pharmacal, 367 Wis. 2d 221, ¶¶ 41-48.

[26] 236 Wis. 2d 504, ¶ 6, 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.

[27] Id., ¶ 26 (“Nor do the damages in this case constitute ‘loss of use’ damages under the insurance policy. There is no evidence that the Vogels ever lost the use of their home....”)

[28] Wisconsin Pharmacal, 367 Wis. 2d 221, ¶ 43 (emphasis added).

[29] Id., ¶ 44 (emphasis added).

[30] Id., ¶ 46.

[31] 221 Wis. 2d 800.

[32] Id. at 814-15.

[33] Wisconsin Pharmacal, 367 Wis. 2d 221, ¶ 48.

[34] The court also addressed whether or not there had been an “occurrence” for purposes of an initial grant of coverage, but this did not appear to have a significant impact on existing coverage analysis, so it is not discussed here. Comparing the accidental provision of the defective ingredient to defective work standing alone, the court held that there was no “occurrence” based solely on the accidental provision of the wrong bacteria. Id., ¶¶ 55-56. Perhaps the court would have reached a different conclusion had it found that wrong bacteria had caused “property damage.”

[35] See, e.g., Hamlin, Inc. v. Hartford Accident & Indem. Co., 86 F.3d 93 (7th Cir. 1996).

[36] Wisconsin Pharmacal, 367 Wis. 2d 221, ¶ 78.

[37] Id.

[38] Id., ¶¶ 80-82.

[39] Id., ¶ 141 (Abrahamson, J., dissenting).

[40] Id., ¶¶ 44, 46.