Court: Court of Appeals for the Seventh Circuit; August 8, 2017; Federal Appellate Court
In 2014, Mary Haley and others initiated a putative class action against Kolbe Millwork Company, alleging that defective windows sold by Kolbe caused air and water leaks, damaging their homes. Kolbe sought defense from its insurers, specifically United States Fire Insurance Company and Fireman’s Fund Insurance Company, both of which intervened in the case. United States Fire later moved for summary judgment, citing a Wisconsin Supreme Court decision that it claimed absolved the insurers of the duty to defend Kolbe. The district court granted this motion and awarded judgment to Fireman’s Fund, prompting Kolbe to appeal. United States Fire also appealed the court's refusal to require Kolbe to reimburse post-Pharmacal defense fees and requested a remand for a review of pre-Pharmacal defense costs.
In a related case, plaintiffs alleged two categories of damages: direct losses from window replacement and consequential losses from damage to their homes. Kolbe's insurers initially agreed to defend under a reservation of rights, but disputes arose over defense counsel. United States Fire and Fireman’s Fund sought to intervene and compel Kolbe to change attorneys while also moving to bifurcate insurance and liability issues. The district court permitted intervention but declined to stay the case and ruled that the insurers could not force a change in counsel.
The insurers argued they had no duty to defend Kolbe based on the insurance policies, which they claimed did not cover damages resulting from Kolbe's own products, both for direct replacements and for consequential damages to the homes. The district court initially accepted the argument regarding direct costs but rejected the one on consequential damages. However, after United States Fire renewed its summary judgment motion in light of the Wisconsin Supreme Court ruling, the court awarded judgment to both insurers, concluding that neither policy covered the plaintiffs' consequential damage claims. United States Fire's request for reimbursement of defense fees incurred after the Pharmacal decision was denied due to a failure to raise the issue earlier in the litigation.
Kolbe appeals a district court ruling that insurers do not have a duty to defend him in a lawsuit concerning defective windows. Concurrently, United States Fire appeals the court’s decision not to compel reimbursement for post-Pharmacal defense fees and requests a remand for the evaluation of the reasonableness of other defense fees incurred by Kolbe.
In reviewing Kolbe's appeal, the court applies a de novo standard to the district court’s summary judgment, favoring the non-moving party, Kolbe. Summary judgment is warranted when there are no genuine issues of material fact and the moving party is entitled to judgment as a matter of law.
Central to the insurance coverage dispute is the integrated-system rule, part of the economic-loss doctrine, which prevents a product purchaser from recovering purely economic losses through tort law. This doctrine encourages parties in commercial transactions to assess and allocate risks associated with economic loss through negotiation, as it limits recovery options for purely economic injuries. Notably, it does not restrict tort actions for bodily injury or damage to property other than the defective product.
However, if a defective product is part of a larger integrated system, damage caused by that defect is treated as damage to the defective component itself, thus not qualifying as damage to other property. This principle was illustrated in Wausau Tile, where a concrete manufacturer's claims against its cement supplier were barred because the defective cement was deemed an integral part of the paving blocks.
The economic-loss doctrine's application generally excludes insurance disputes, but the Wisconsin Supreme Court, in the 2016 Pharmacal case, extended the integrated-system analysis to a scenario involving a general-liability insurance policy. In Pharmacal, a retailer of dietary supplements faced litigation after recalling products due to incorrect bacteria in the tablets, leading to a summary judgment motion by the bacteria supplier’s insurance company regarding coverage issues.
The trial court ruled in favor of the insurer, concluding there was no coverage due to a lack of property damage as defined by the insurance policy. The court of appeals reversed this decision, prompting a review by the Wisconsin Supreme Court. The supreme court outlined the procedure for assessing insurance coverage: first, determining if the claim falls within the policy's coverage; second, checking for any exclusions; and third, evaluating if any exceptions to exclusions apply. The policy in question required coverage for damages stemming from property damage, defined as physical injury to tangible property, which the court had previously interpreted to exclude injuries to the insured's own product.
In examining whether the incorporation of defective bacteria into supplement tablets constituted physical injury to property other than the bacteria, the court applied an integrated-system analysis. It concluded that the supplement tablets, as an integrated system, meant that damage to the tablets was not damage to external property, thus resulting in no initial coverage grant.
The insurers argued that the ruling in Pharmacal set a precedent for applying an integrated-system analysis in all general liability insurance disputes. They pointed to a previous case where windows were deemed part of an integrated system with surrounding structures, claiming that any damage to the structures caused by defective windows constituted damage to the windows themselves. Consequently, without injury to other property, the insurers contended that no insurance coverage was available.
The argument presented extends the interpretation of Pharmacal unduly. The determination of insurance policy coverage hinges on the nature of the plaintiffs' alleged loss. In Pharmacal, the plaintiff's claim was solely based on the inability to utilize supplement tablets as a whole, without seeking reimbursement for the non-defective components, which were indistinguishable from one another and the product itself. In contrast, the current case involves homeowners seeking compensation for the repair or replacement of specific elements within a larger structure, a scenario not addressed in Pharmacal.
Kolbe's insurers contend that even if the insurance policies initially cover the homeowners’ claims regarding leaky windows, the "your product" exclusion negates such coverage. This exclusion is interpreted from the perspective of a reasonable insured, adhering to principles that unambiguous terms carry their common meaning, while ambiguous ones favor coverage. Specifically, the United States Fire policy excludes damage to "your product," defined as goods or products associated with the insured or others trading under their name, as well as certain containers and materials related to those products. The Fireman’s Fund policy has a similar definition but excludes coverage for any goods other than real property.
Both parties agree that Kolbe’s manufactured windows qualify as Kolbe's goods under the exclusion, meaning the insurers are not liable for replacing defective windows. However, there is a dispute regarding whether walls and other components of the homes fall under Kolbe’s product definition. Kolbe asserts they do not, as it did not provide the drywall, wood framing, stucco, or bricks. Conversely, the insurers argue that the second part of the definition does not impose the same limitations, potentially excluding coverage for damages to all materials furnished in connection with the windows.
A reasonable insured, in this context, would interpret the phrase "furnished in connection with" to indicate that the items referenced are provided by the insured, Kolbe, or someone acting on its behalf. The term "in connection with" varies in meaning based on context, which can imply a relationship of causation or similarity in timing. Kolbe’s insurance policies define its product to include both the goods it produces and the associated materials. Thus, an insured could reasonably conclude that materials furnished in connection with the goods must originate from Kolbe or an associated party. The risk covered by the insured pertains to physical injury to tangible property, excluding damage to Kolbe’s own products. Since the drywall and other materials allegedly damaged were not supplied by Kolbe, the damage, while related to Kolbe's product, does not fall under the exclusion for "your product." The ambiguity in the definition of "your product" necessitates a construction favoring coverage. Therefore, as there appears to be potential coverage for at least one claim in the underlying suit, the insurer is obligated to defend against all claims. The judgment stating that the insurers had no duty to defend is reversed and remanded for vacatur.
United States Fire's cross-appeal arose from a pending motion for summary judgment regarding its duty to defend Kolbe, which was filed while the district court dismissed all remaining claims from the underlying suit. The court requested United States Fire to justify why the motion should not be deemed moot due to the dismissal. United States Fire contended that, should plaintiffs appeal, it would still have a duty to defend Kolbe until the district court ruled otherwise. If the duty to defend was found to have ended, United States Fire sought reimbursement from Kolbe for defense costs incurred since that point and indicated plans to contest the reasonableness of the defense fees charged by Kolbe’s counsel. The district court agreed that the duty to defend had ceased but denied the reimbursement request, citing that it was not included in United States Fire's pleadings and it was too late to amend. The court ultimately ruled in favor of the insurers regarding their duty-to-defend claims and closed the case. United States Fire appealed the reimbursement denial; however, the issue was rendered moot as it was determined that a continuing duty to defend existed. The insurer also did not formally request recoupment of excessive charges. The court's termination of the case was deemed appropriate given the resolution of all motions. On appeal, the judgment that the insurers did not have a duty to defend was reversed, and the case was remanded with instructions to vacate that judgment. The affirmance regarding reimbursement and case termination stood. Although Kolbe requested certification of questions to the Wisconsin Supreme Court, the court found no need for certification, concluding that the integrated-system approach from Pharmacal did not apply in this dispute, which involved warranties, representations, and warnings regarding the insured product.
