Authored by industry thought leader and expert, Joe Bermudez
It should be straightforward. Incorporate a defective product into another and boom, property damage. Simple, no? No! Especially with respect to coverage under product contamination or product recall insurance (PCI/PRI) policies. U.S. courts’ handling of this perplexing and complex issue can have a significant impact on coverage for an incident or on the extent of coverage for a Loss.
Why Is Something So Simple, So Confusing?
In U.S. Metals, the Texas Supreme Court surveyed decisions rendered by the high courts of several other states and found only twelve had ruled on the adoption of the doctrine. The Court advised that five high courts had expressly rejected the doctrine, another five had impliedly rejected the doctrine, and 2 high courts adopted the doctrine. However, a closer review of the cited decisions established that only one addressed the doctrine in the context of a product, such as food, consumer goods, autos, etc. The remainder addressed the doctrine in the context of construction defects. And, while certain comparisons can be made, it’s a bit like comparing apples to oranges. A federal or lower state court in any of these same jurisdictions could very well distinguish a construction defect fact pattern and hold for the application of the doctrine in the context of a dispute over a product. Additionally, each of the cited decisions addressed the doctrine in the context of coverage under a commercial general liability issue. And, PCI/PRI policies, generally, define property damage differently.
Under PCI/PRI policies, issues involving the incorporation doctrine are raised in two instances – dramatic pause – whether an incident falls within the scope of coverage and other insurance.
As we have recently discussed, U.S. courts have found raw poultry and beef products contaminated (Can we say contaminated in this context?) with salmonella not to be defective. So, if a recall or withdrawal involves a product, which incorporated raw chicken or beef with salmonella, would property damage result under a PCI policy? (As for bodily injury, is it the product or failure to properly cook the product?) And, in the food context but outside of the raw chicken/beef salmonella issue, the relevant inquiry focuses on whether the defective ingredient, when incorporated, resulted in “physical damage”, “destruction”, or “physical injury”?
On the non-food side, the Texas Supreme Court advised in U.S. Metals, “[w]e agree with most courts to have considered the matter that the best reading of the standard-form CGL policy text is that physical injury requires tangible, manifest harm and does not result merely upon the installation of a defective component in a product or system. Our rejection of the incorporation theory is consistent with our other interpretations of CGL policies.”
“Start Spreading the News”
It’s the opening lyrics to New York New York. And, like a beacon of light on a foggy night, it is the one jurisdiction in which the high court has adopted the incorporation doctrine. And yes, in the products context. Fantastic from a scope of coverage standpoint, not as helpful with respect to other insurance – unless the CGL was also issued in New York. Also, keep in mind that the State of Washington does not allow the choice of any other law in insurance policies. Something about being against public policy. And, don’t get me started on the service of suit endorsement issue. Anyway, New York is favorable and the reason I didn’t commit copyright infringement, as I only had to refer to 49 shades of gray. Who says insurance isn’t sexy?
WOW = Watch Out for Wisconsin
This jurisdiction is a major U.S. hub for food production and transportation parts – so pay attention! As some will know, it’s a direct-action state, one of only two jurisdictions in the U.S (If you must ask, you’re either an underwriter or placement broker.). So, we can see where this is going. Wisconsin’s Supreme Court has developed the “Integrated System Analysis” (ISA), when addressing product incorporation issues. In the Court’s own words, as stated in Wisconsin Pharmacal, “[a]n 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.” “In short, ‘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’’”. In regard to coverage, no other state has adopted ISA. However, with respect to subrogation, ISA has attracted the attention of courts in other jurisdictions.
Critical Takeaways
Outside of New York, the handling of the incorporation doctrine is complex and can be perplexing, like WOW. In other words, certain relevant claim circumstances and policy wording are extremely important when analyzing coverage under PCI/PRI policies.
For claim professionals, this issue is critical as it could be determinative with respect to coverage under PCI/PRI policies and may significantly impact the quantum involved with a Loss.
Similarly, for brokers and underwriters, the issue raised is important. Differences in PCI/PRI wordings could be vital. Brokers and underwriters should review the Insured Product and Property Damage definitions as well as the wording contained in the Other Insurance Condition.