Posted In: Insurance Recovery
Insurance Blog: Ohio Court Adopts Integrated System Approach to Deny Coverage for Non-Conforming Integrated Products
By Stacy RC Berliner on February 19, 2019
On January 23, 2019, the Delaware County Court of Common Pleas held that a non-conforming ingredient integrated into pediatric formula did not constitute property damage to the remaining non-policyholder ingredients or formula. Scottsdale Insurance Company v. Spring Hill Jersey Cheese, Inc., Case No. 17-cv-03-0209. In 2013-2014, Nature’s One ordered egg-free nonfat dry milk (NFDM) from Spring Hill to be used in its egg-free baby formula. Spring Hill mistakenly sent NFDM that was not egg-free. Unfortunately, this mistake was not discovered until after the NFDM was mixed into other formula ingredients. It was impossible to separate the NFDM with egg allergens from the formula. Nature’s One was therefore unable to sell the egg allergen formula and it remains in storage.
Nature’s One brought breach of contract and breach of warranty claims against Spring Hill. Spring Hill sought coverage from its commercial general liability carrier, Scottsdale Insurance Company (Scottsdale), arguing that the damaged and unusable formula constituted “property damage” as defined by the policy because: (1) the egg allergen NFDM caused physical injury to Nature One’s pediatric formula; and /or (2) Nature’s One suffered “loss of use” of the pediatric formula that would have to be destroyed. Scottsdale, which initially provided a defense to Spring Hill, filed a declaratory judgment action seeking an order that it had no duty to defend and indemnify Spring Hill because Nature’s One did not suffer “property damage” as defined by the policy.
Relying upon the 2016 Wisconsin Supreme Court decision in Wisconsin Pharmacal Co. LLC v. Nebraska Cultures of California Inc. et al., the Delaware County Court of Common Pleas held that “property damage” does not result from the mere presence of a defective ingredient or component. The Spring Hill Court found that once the egg allergen NFDM mixed with other Nature’s One components, it became an “integrated system,” and coverage is only afforded when that integrated system causes physical injury to another tangible product. Since the “integrated system” did not cause property or bodily injury, there was no coverage. The Spring Hill Court also acknowledged the exception to this general rule: if the defective ingredient or component is hazardous, then there may be physical injury to tangible property. The Spring Hill Court, however, rejected the exception applied here, finding that while “the nonconforming NFDM [was] undoubtedly unsafe for consumption by children with egg allergies…egg is perfectly safe.”
In its opinion, the Spring Hill Court rejected a holding in a similar Ohio case holding that incorporation of a defective ingredient or component that is impossible to separate from a larger product constituted property damage. Moraine Materials Co., Inc. v. Ohio Casualty Ins. Co., 1979 Ohio App. LEXIS 10887 (Montgomery App. Dec. 12, 1979) (pouring of the defective concrete into the entire wall made it impossible to separate the good from the bad and therefore there was “physical damage” to the wall as a whole). The Spring Hill Court found that the Ohio Supreme Court holdings in Westfield and Ohio Northern, which relate to property damage to the insured’s own product (and not an integrated product or system), made the non-binding holding in Moraine “not good law.”
Not discussed in the opinion are other holdings that a defective component integrated into a larger part constituted “property damage” to the entire part. See, e.g., Transamerica Ins. Co. v. S.A.I. Mktg. Corp., No. 49256, 1985 WL 6860, at *5 (Ohio Ct. App. June 13, 1985) (“[a]llegations that the insured’s allegedly defective part caused damage or failure for an assembly incorporating it can constitute claims for ‘property damage’ or ‘physical injury.’”); Parker Hannifin Corp. v. Steadfast Ins. Co., 445 F. Supp. 2d 827, 833 (N.D. Ohio 2006) (finding “that property damage occurs as of the date the insured’s defective product/work is incorporated into another product. Under that rule, the cost of a repair/replacement program would probably not be excluded because the cost of the program would represent the cost of eliminating the property damage to a product that was not the insured’s product.”); Bundy Tubing Co. v. Royal Indemnity Co., 298 F.2d 151 (6th Cir.1962) (holding that property was damaged by the installation of defective tubing in a radiant heating system which caused the system to fail and become useless); Anthem Electronics, Inc. v. Pacific Employers Ins. Co., 302 F.3d 1049, 1052 (9th Cir. 2002) (finding that loss of use of scanners incorporating defective circuit boards constituted property damage); see also, Pittway Corp. v. American Motorist Ins. Co., 56 Ill App. 3d 338, 341-42 (2d Dist. 1977) (“[if] a component is so intertwined with the entire mechanism that the defect necessarily results in damage to the complete product the component will be deemed to have caused property damage.”); Nat’l Union Fire Ins. Co. of Pittsburgh v. Terra Indus., Inc., 346 F.3d 1160, 1165 (8th Cir. 2003) (incorporating contaminated carbon dioxide into a beverage satisfies the requirement of “property damage” caused by an “occurrence”). These courts rejected the argument that property damage occurs only when the “integrated system” causes damage to another product; rather, so long as the insured’s product causes damage or loss of use to a non-insured’s part or product, there is coverage.
The Spring Hill Court also rejected the argument that Nature’s One suffered “loss of use” of the pediatric formula. Again, citing the Wisconsin case, the Spring Hill Court found that Nature’s One only suffered “loss of value of property,” which does not constitute property damage. Other courts have found that allegations that the insured’s component part significantly diminished the value of the total assembly may create a duty for the insurer to defend. Aetna Casualty & Surety Co. v. PPG Industries, 554 F.Supp. 290 (D. Ariz. 1983); American Motorists Ins. Co. v. Trane Co., 718 F2d 842 (C.A.7, 1983).
Given the split in authority on whether an incorporated defective product causes property damage to the insured’s own product or work, the same issue is likely to arise again in Ohio courts – and likely with a different result.
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