INSUR ANCE L AW
Background,
Nuances, Notable
Errors in Application
and a Proposal for
Future Cases
The Incorporation
Theory of Property
Damage
By James F. Baffa
The incorporation
doctrine continues to
vex parties and confuse
courts despite decades of
litigation. In this article,
the doctrine and its
nuances are explained,
and a proposal for future
application is offered
that remains faithful
to the plain language
of the CGL policy.
Countless amounts of disputed insurance proceeds have
involved, to varying degrees, the incorporation doctrine,
defined by the International Risk Management Institute
(IRMI) as the “legal principle that holds that the
incorporation of a defective product into
real property constitutes ‘property damage’ (PD) as defined in the commercial
general liability (CGL) policy.” IRMI also
states that the incorporation doctrine “has
been argued, mostly unsuccessfully, in
pursuit of liability coverage for construction defects that have not produced actual
physical damage.” IRMI’s definition and
commentary, while generally correct, is
too limited. In particular, the incorporation doctrine has been central to a wide
variety of coverage disputes, not only construction defect disputes involving real
property. This article explores the origins
of the doctrine; its application to several
common scenarios; noteworthy errors that
courts have made in providing, and sometimes barring, coverage; and a summary of
how and when the doctrine should apply.
Background and History
The incorporation doctrine concerns the
commercial general liability (CGL) policy’s
grant of coverage for “damages because
of ‘property damage’” to which the policy applies. “Property damage” is defined
as “physical injury to tangible property,
including all resulting loss of use of that
property” and “loss of use of tangible property that is not physically injured.” The
incorporation doctrine focuses on the first
prong of the “property damage” definition;
specifically, what is “physical injury to tangible property,” and when does such “physical injury” occur?
The focus, however, has not always been
on “physical injury.” Earlier versions of
the CGL policy, which used forms before
the language was changed in 1973, generally defined “property damage” as “injury
James F. Baffa is counsel with Sedgwick LLP in Chicago. Mr. Baffa focuses his practice on insurance coverage litigation,
counseling, and appeals. He has assisted domestic and international insurers in coverage and claim-­handling disputes, including
matters arising from underlying claims of construction defects, product liability, asbestos, environmental liability, professional
liability, and personal and advertising injury, among others. Mr. Baffa’s nationwide coverage practice regularly involves new or
novel issues and matters of first impression.
■ 54 For The Defense May 2017
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© 2017 DRI. All rights reserved.
to tangible property,” with no “physical”
modifier for “injury.” Wisconsin Label
Corp. v. Northbrook Prop. & Cas. Ins. Co.,
233 Wis. 2d 314, 335–39, 607 N.W.2d 276,
286–88 (2000); Aetna Life & Cas. v. Patrick
Industries, Inc., 645 N.E.2d 656, 659–62
(Ind. App. 1995). When only “injury to tangible property” was required, courts held
that the mere diminution in value of the
whole final product caused by the defective component was sufficient to implicate property damage coverage. See, e.g.,
Patrick Industries, 645 N.E.2d at 659 fn.
2. In 1973, however, a CGL form was promulgated that changed the first part of the
“property damage” definition to require
“physical injury.” The addition of the modifier “physical” is significant; diminution in
value by itself is no longer sufficient to satisfy the first prong of the “property damage” definition. Wisconsin Label, 233 Wis.
2d at 338-39, 607 N.W.2d at 287–88; Patrick Industries, 645 N.E.2d at 660. Decisions interpreting the pre-1973 definition,
therefore, provide little guidance in modern incorporation doctrine analysis.
Other decisions have provided additional
color to the “physical injury” definition. In
particular, a California court pointed out
that the adjective “material” qualifies “dimension,” not the scope of the required alteration. Valley Casework, Inc. v. Lexington
Ins. Co., No. D060837, 2013 WL 3470530, at
*13 (Cal. App. July 10, 2013) (unpublished).
In other words, slight detrimental alterations usually suffice for “physical injury”
as long as such alteration is the basis for
imposition of liability on the insured. See
Zurich American Ins. Co. v. Cutrale Citrus Juices USA, Inc., No. 5:00-CV-149-OC10GRJ, 2002 WL 1433728, at *3 (M.D. Fla.
Feb. 11, 2002) (“the fact that the adulteration [of the claimant’s juice product by the
introduction of the insured’s product] does
not make the resulting blend totally unfit for
human consumption (so that the blended
juice might still be marketed under different labeling), does not alter the conclusion
that damage has occurred.”). This nuance
in incorporation doctrine analysis has had
the greatest effect in food contamination
cases, discussed further below.
Formulations of “Physical Injury”
Once it was determined that diminution in
value alone was insufficient to constitute
“physical injury,” courts were left to craft a
sensible definition of the phrase. The main
formulation of “physical injury” is generally stated as “an alteration in appearance,
shape, color or in other material dimension.” See, e.g., National Union Fire Ins.
Co. of Pittsburgh, Pa. v. Terra Industries,
Inc., 216 F. Supp. 2d 899, 917–18 (N.D. Iowa
2002), aff’d, 346 F.3d 1160 (8th Cir. 2003);
Fidelity & Deposit Co. of Maryland v. Hartford Cas. Ins. Co., 215 F. Supp. 2d 1171, 1183
(D. Kan. 2002); Capstone Building Corp.
v. American Motorists Ins. Co., 308 Conn.
760, 782–87, 67 A.3d 961, 979–82 (2013);
F & H Construction v. ITT Hartford Ins.
Co. of the Midwest, 118 Cal. App. 4th 364,
376–77, 12 Cal. Rptr. 3d 896, 905 (2004).
In addition, although the term “alteration” is repeatedly used, courts employing
that term required detrimental alterations
to constitute “physical injury.” See Phibro
Animal Health Corp. v. National Union Fire
Ins. Co. of Pittsburgh, Pa., 446 N.J. Super.
419, 437–38, 142 A.3d 761, 771–72 (N.J.
App. Div. 2016) (summarizing “physical
injury” decisions).
Construction Defect and
Product Liability Cases
As IRMI’s definition suggests, the incorporation doctrine has been addressed most
frequently in the construction defect context, or when underlying allegations of
product liability result in defective or non-­
conforming construction. And every discussion of the incorporation doctrine and
construction defects begins with the Eljer
decisions and the product liability claims
resulting from the Qest plumbing system.
Eljer Mfg., Inc. v. Liberty Mutual Ins. Co.,
972 F.2d 805 (7th Cir. 1992); Travelers Ins.
Co. v. Eljer Mfg., Inc., 197 Ill. 2d 278, 757
N.E.2d 481 (2001).
The Qest plumbing system was sold to
plumbing contractors all over the United
States in the late-1970s and 1980s. The
Qest systems were installed behind walls,
below floors, or above ceilings in houses
and apartments. As a result of alleged
defects in the Qest systems, thousands
of claims were brought, and it was estimated that just under five percent of the
systems had experienced failures. Some
of the claims sought damages for water
damage to the residences and associated
personal property. Some of the claims,
however, involved buildings that had not
yet experienced leaks but in which the
homeowners, as a preventive measure,
removed the systems.
In 1992, the United States Court of
Appeals for the Seventh Circuit, in an opinion by Judge Posner, considered insurance
coverage for the Qest system claims, summarizing the issue as follows:
Once it was determined
that diminution in value
alone was insufficient
to constitute “physical
injury,” courts were left to
craft a sensible definition
of the phrase. The main
formulation of “physical
injury” is generally stated as
“an alteration in appearance,
shape, color or in other
material dimension.”
If a manufacturer sells a defective product or component for installation in the
real or personal property of the buyer,
but the defect does not cause any tangible change in the buyer’s property
until years later, can the installation
itself nonetheless be considered “physical injury” to that property? The defective product or component in such a case
is like a time bomb placed in an airplane luggage compartment: harmless
until it explodes. Or like a silicone breast
implant that is harmless until it leaks.
Or like a defective pacemaker, which is
working fine now, but will stop working
in an hour. Is the person or property in
which the defective product is implanted
or installed physically injured at the
moment of implantation or installaFor The Defense May 2017 55
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tion—in a word, incorporation—or not
until the latent harm becomes actual?
972 F.2d at 807.
To ask the question is to answer it
because if “the defect does not cause any
tangible change in the buyer’s property,”
there should be no “physical injury.”
The Seventh Circuit, however, concluded
otherwise. According to the court, CGL in-
physical touching, as where a defective
water system is installed in a house.
Id. at 810 (internal citations omitted).
The court therefore cast the issue as
whether the loss resulted from physical
contact or physical linkage. Id. Because the
plumbing system was incorporated into,
not merely contained in, the residences, the
court found the allegedly requisite contact
or linkage, thereby holding that “physical
injury” resulted.
Judge Cudahy dissented from the majoriWhile the Seventh
ty’s conclusion. With respect to the economics of insurance, Judge Cudahy noted that
Circuit’s Eljer decision
policyholders may purchase performance
bonds or other comparable types of covhas been influential,
erage that may cover risks associated with
installation. 972 F.2d at 814–15 (Cudahy, J.,
the vast majority of
dissenting). In addition, in connection with
the majority’s assertion that policyholders
courts have rejected the
would be unable to afford insurance, Judge
Cudahy noted that the problem may be the
incorporation doctrine in
structure of insurance markets. Id. at 815.
Regardless, problems with market structure
the construction defect or
do not “support an argument that ‘physical
injury’ occurs at the point of installation inproduct liability setting.
stead of the point of physical failure.” Id.
At its most persuasive, however, Judge
Cudahy’s dissent grounded its conclusion
surance would be rendered “largely though on the plain language of the term “physinot completely illusory” if coverage was lim- cal injury”:
ited only to the time when a leak occurred.
There is immediately something counId. at 809. Insurance would purportedly not
terintuitive about saying that physical inbe available because after a leak occurred,
jury has been done to a house in which a
the risk of loss would have become a cerfunctioning plumbing system has been
tainty, thereby allegedly thwarting the risk-­
installed. Of course when we determine
spreading purpose of insurance. Id.
later (years later) that a good number of
The court also based its decision on the
the systems will fail—five percent in this
purported drafting history of the CGL polcase—then perhaps there is a sense in
icy. According to the court, when the 1973
which the “injury” was present from the
version of the CGL policy was drafted,
moment of installation: this is the majorthe addition of the modifier “physical” to
ity’s “ticking time bomb” metaphor. But
“injury” was designed to contrast the first
is there physical injury? The majority beprong of the “property damage” definition
lieves that interpreting the phrase is all
(“physical injury to tangible property”)
a matter of emphasis—“physical injury”
with the newly added second part (“loss of
versus “physical injury.” In my view, the
use of tangible property that is not physiphrase must be interpreted as “physical
cally injured”):
injury,” with both words given effect.
The first part of the new definition is
The majority’s account cannot give both
the old definition with “physical” prewords meaning at the same time. Somefixed to “injury” to distinguish the two
thing physical occurs when the plumbing
parts. Both cover injury, but the second
is installed—but it is not injury; and we
part covers injury that is not “physical”
might say that there is injury (of a sort)
because there is no physical touching of
when the plumbing is installed—but it
the tort victim’s property. *** There was
is not physical.
no intent to curtail liability in a case of Id. at 814.
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As a federal court predicting Illinois law,
the Seventh Circuit majority’s interpretation of “physical injury” was not binding authority. Nine years later, however,
the Illinois Supreme Court addressed the
same coverage issues arising from the Qest
plumbing system and provided the definitive interpretation of “physical injury”
under Illinois law. The Illinois Supreme
Court found no ambiguity in the phrase
“physical injury to tangible property,” and
therefore, the court refused to consider
extrinsic evidence of the phrase’s purported meaning. 197 Ill. 2d at 301, 757
N.E.2d at 496. The court held that the Seventh Circuit’s Eljer decision “erred when it
set aside the ‘central,’ plain, and ordinary
meaning of the term ‘physical injury,’ and
instead employed an admittedly ‘conjectured’ analysis with respect to the function
that the phrase was intended to perform
in a CGL policy.” Id. at 304, 757 N.E.2d at
497. As a result, the Illinois Supreme Court
determined that the plain and ordinary
meaning of “physical injury” unambiguously connotes damage to tangible property causing an alteration in appearance,
shape, color or other material dimension.
Id. at 312, 757 N.E.2d at 502.
The Illinois Supreme Court ultimately
held that the installation of the defective
Qest system was not itself “physical injury”
to the structure and that “physical injury”
was water damage due to leaks from the
Qest system. Id. at 314, 757 N.E.2d at 503.
Therefore, coverage under a CGL policy was
not triggered if the water damage occurred
after the policy period, even if installation
occurred within the policy period. Id.
While the Illinois Supreme Court
soundly rejected the Seventh Circuit’s Eljer
decision, there were several decisions rendered in the interim that heavily relied
on the Seventh Circuit’s reasoning to find
“physical injury” in the construction context. In Helm v. Board of County Commissioners, for example, the Supreme Court of
Wyoming cited the Seventh Circuit’s Eljer
decision for the proposition that it is “well
recognized that the installation of a defect
into a building is physical injury as defined
in insurance policies.” 989 P.2d 1273, 1276
(Wyo. 1999). Similarly, in another case
involving defective plumbing materials,
Hoechst Celanese, the Supreme Court of
Delaware determined that property dam-
age sufficient to trigger coverage may occur
as early as installation of the plumbing systems into housing units. Hoechst Celanese
Corp. v. Certain Underwriters at Lloyd’s
London, 673 A.2d 164, 169 (Del. 1996)
(applying New York law). Hoechst Celanese,
moreover, also made the error of relying on
decisions interpreting pre-1973 CGL policies in support of its conclusion adopting
the incorporation doctrine. Id. at 169 (citing Sturges Mfg. Co. v. Utica Mut. Ins. Co.,
37 N.Y.2d 69, 332 N.E.2d 319 (1975) (finding
“injury to tangible property” when defective ski straps were used to manufacture ski
bindings)). Other decisions have also relied
on the Seventh Circuit’s Eljer decision, to
varying degrees, and many of those rulings
will be discussed below.
While the Seventh Circuit’s Eljer decision
has been influential, the vast majority of
courts have rejected the incorporation doctrine in the construction defect or product
liability setting. See U. S. Metals, Inc. v. Liberty Mutual Group, Inc., 490 S.W.3d 20, 26–
28 (Tex. 2015) (concluding that 12 state high
courts have considered the incorporation
doctrine, with five expressly rejecting it,
five implicitly rejecting it, and two following
it). Faulty workmanship that merely diminishes the value of the whole is not “property
damage” as “physical injury” under the CGL
policy. The notion of physical injury at the
moment of incorporation or manufacture,
however, has not been cast aside so easily;
there are other contexts in which immediate physical injury may occur.
Hazardous Materials or
Contaminants Decisions
One of the largest categories of incorporation doctrine cases, and arguably a subset
of the construction defect and product liability cases discussed above, involves the
use of hazardous materials or contaminants. While the incorporation doctrine
has generally been rejected in situations
involving “normal” (i.e., non-­hazardous)
products, it has been more widely adopted
when the subject products are hazardous.
Asbestos is the most common example. In Armstrong World, for example, the
court determined that contamination of
buildings and their contents from released
asbestos fibers constitutes a physical injury
under a CGL policy. Armstrong World
Industries, Inc. v. Aetna Cas. & Surety Co.,
45 Cal. App. 4th 1, 90–91, 52 Cal. Rptr.
2d 690, 732–33 (1996). While this conclusion may be unremarkable, the Armstrong
World court took it one step further, holding that the mere presence of asbestos-­
containing materials was physical injury to
the buildings. 45 Cal. App. 4th at 91–94, 52
Cal. Rptr. 2d at 733–35. Armstrong World
explicitly adopted a different formulation
of “physical injury” from that of the majority of courts, but which was inspired by the
Seventh Circuit’s discussion in Eljer:
a loss that results from physical contact, physical linkage, as when a potentially dangerous product is incorporated
into another and, because it is incorporated and not merely contained (as
a piece of furniture is contained in a
house but can be removed without damage to the house), must be removed, at
some cost, in order to prevent the danger from materializing.
45 Cal. App. 4th at 91–92, 52 Cal. Rptr. 2d
at 733 (citing Eljer, 972 F.2d at 810).
The latter conclusion—that physical
injury results from the mere presence of
asbestos in a building without any accompanying release of fibers—rests on a shaky
foundation. In particular, as noted above, it
relied on the generally rejected formulation
of “physical injury” set forth in Eljer, and
the court also cited older decisions interpreting “injury,” not “physical injury,” in
support. 45 Cal. App. 4th at 93–100, 52 Cal.
Rptr. 2d at 734–39 (citing, inter alia, Maryland Cas. Co. v. W. R. Grace & Co., 23 F.3d
617, 626–28 (2d Cir. 1993)). It is difficult,
moreover, to meaningfully distinguish the
defective Qest plumbing system from the
installed asbestos-­containing materials.
Both have arguably “injured” the building, but without water damage caused by
a leak or dispersal of asbestos throughout
the structure, it may be a bridge too far to
consider the injury physical.
The Armstrong World court also recognized the rule that physical incorporation
of a defective product into another does not
constitute property damage unless there is
physical harm to the whole. 45 Cal. App.
4th at 92, 52 Cal. Rptr. 2d at 734. In rejecting the rule, however, the court deemed relevant the fact that the insured was “facing
liability not as a contractor but as a manufacturer or supplier” of asbestos-­containing
materials. 45 Cal. App. 4th at 92–93, 52 Cal.
Rptr. 2d at 734. The court therefore limited
the rule to situations involving contractors and allegations of defective materials
or poor workmanship. But it is not clear
why the distinction between contractors
and manufacturers or suppliers would be
relevant because what constitutes “physical injury” to the product or work of something other than the insured’s product or
work itself should be the proper inquiry.
Other decisions applying the incorporation doctrine in the context of hazardous
materials or contaminants stand on firmer
ground because they addressed the actual
or alleged release of asbestos or other contaminants within a building, not the mere
presence of the substances. See, e.g., Colonial Gas Co. v. Aetna Cas. & Sur. Co., 823 F.
Supp. 975, 981 (D. Mass. 1993) (“As soon as
[urea-­formaldehyde foamed-­in-place insulation] has been installed, by definition
a hazardous substance has been released
into the home.”); United States Fidelity &
Guar. Co. v. Wilkin Insulation Co., 144 Ill.
2d 64, 74–76, 578 N.E.2d 926, 931–32 (1991)
(finding a duty to defend due to allegations
of “physical injury to tangible property”
when pleadings alleged that the buildings
and the contents therein were contaminated by toxic asbestos fibers). Similarly,
in Watts Industries, the insured manufactured waterworks parts that allegedly
leached lead and other metals into the
water supply. Watts Industries Inc. v. Zurich
American Ins. Co., 121 Cal. App. 4th 1029,
18 Cal. Rptr. 3d 61 (2004). The court determined that the insurer had a duty to defend
because “damages because of property
damage” was alleged. The court held that
there was a sufficient showing of physical
injury to tangible property insofar as the
defective waterworks parts were hazardous
products that immediately damaged the
water systems. 121 Cal. App. 4th at 1045–
46, 18 Cal. Rptr. 3d at 71–72. The Watts
Industries plaintiffs alleged that “increased
leaching of lead caused by [the insureds’
faulty parts] already has caused, and is still
causing, serious health-­endangering harm
to their water.” 121 Cal. App. 4th at 1042,
18 Cal. Rptr. 3d at 69. Under the circumstances, the holding in Watts Industries
appears correct: the insurer had a duty to
defend because allegations of immediate
lead contamination of the water systems
caused by the insured’s products is potenFor The Defense May 2017 57
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tially covered “physical injury” to those
water systems.
Because the presence of hazardous
materials or contaminants is more likely
to result in a finding of “physical injury”
upon incorporation or installation, many
policyholders have tried to fit their facts
within the hazardous contaminant category. For example, in Silgan Contain-
Unlike plumbing parts
installed in buildings,
defective or hazardous food
components simply cannot
be extracted from the whole
in many circumstances.
Terra Industries is illustrative.
ers, the insured manufactured “pull-top”
cans for use in packaging ready-to-go fruit
cups. Silgan Containers Corp. v. National
Union Fire Ins. Co. of Pittsburgh, Pa., No. C
08-2246 PJH, 2010 WL 1267127 (N.D. Cal.
Mar. 29, 2010), aff’d, 434 Fed. Appx. 709
(9th Cir. 2011). The fruit inside the cans
was not injured; the cans simply could not
be opened reliably and effectively, which
rendered the fruit cup products essentially
useless. 2010 WL 1267127, at *5. The court
rejected the notion that “physical injury”
occurred and the insured’s reliance on the
Seventh Circuit’s Eljer decision. Id. at *5–6.
The insured also argued that the cans
were dangerous because there was a “clear
potential to cause bodily injury” due to consumer’s attempts to open the cans in an unintended manner and the potential for the
cans’ sharp edges to cause injury. Id. at *6.
The court rejected the insured’s argument,
noting that complaints of potential injury
do not render a product inherently dangerous and that the fruit products were
not “contaminated” by the pull-tops. Id.
See also Semtech Corp. v. Royal Ins. Co. of
America, No. CV 03-2460 GAF (PJWx),
2005 WL 6192907, at *6–7 (C.D. Cal. Oct.
11, 2005) (finding no physical injury when
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defective computer chips were incorporated into motherboards used in servers because “defective computer parts cannot be
considered inherently dangerous products
like asbestos”).
Food Contamination Cases
Notwithstanding Silgan Containers (which
involved a food product), insureds have
had better luck asserting that immediate
“physical injury” has occurred in connection with cases involving food contamination. Such success is likely attributable to
two characteristics of many food contamination cases. First, the final food product is
fully integrated, meaning that the “defective” component product simply cannot be
removed or distinguished from the whole.
Second, food products, unlike construction
projects, have a low threshold for determining when a component product may be
inherently dangerous or hazardous.
Unlike plumbing parts installed in buildings, defective or hazardous food components simply cannot be extracted from the
whole in many circumstances. Terra Industries is illustrative. National Union Fire
Ins. Co. of Pittsburgh, Pa. v. Terra Industries, Inc., 216 F. Supp. 2d 899 (N.D. Iowa
2002), aff’d, 346 F.3d 1160 (8th Cir. 2003).
In Terra Industries, the insured sold carbon
dioxide, a by-product in its manufacturing
process, which was ultimately incorporated
into carbonated beverages during the bottling process. 216 F. Supp. 2d at 902–03. Due
to problems at the insured’s manufacturing
facility, benzene ended up in the carbon dioxide sold by the insured. While the levels
of benzene did not pose a threat to human
life, many bottlers and beverage sellers recalled the products containing the benzene.
The court noted that the contaminated carbon dioxide could not be removed from the
beverages, and as a result, the entire beverage was rendered unsuitable for human
consumption. Id. at 914.
The court determined that the beverages had suffered “physical injury.” The
court rested its conclusion, in part, on the
fact that the benzene was fully integrated
into the physical composition of the beverages. Id. at 915–16. See also Shade Foods,
Inc. v. Innovative Products Sales & Marketing, Inc., 78 Cal. App. 4th 847, 865–66,
93 Cal. Rptr. 2d 364, 376–77 (2000) (finding physical injury to cereal containing nut
clusters composed mainly of diced almonds
and congealed syrup when wood was found
in the nut clusters; wood splinters were integrated into the final product). The resulting beverage, in which benzene could not
be extracted or differentiated, experienced
physical injury at the time of benzene contamination. Id. See also Sethness-­Greenleaf,
Inc. v. CIGNA Property & Cas. Ins. Co., No.
94 C 6002, 1995 WL 571866, at *3 (N.D. Ill.
Sept. 22, 1995) (“We believe the ‘contamination’ of a liquid beverage constitutes as
much injury as contamination of a building, given that the contaminating agent is
both pervasive in and inseparable from the
beverage.”). The degree of integration or assimilation of the problematic product with
the end product, therefore, is a relevant factor when addressing the incorporation doctrine in food contamination cases and other
contexts. See Int’l Paper Co. v. Agricultural
Excess & Surplus Ins. Co., No. A089102,
2001 WL 641781, at *15–17 (Cal. App. Apr.
12, 2001) (unpublished) (rejecting the incorporation doctrine in connection with
claims involving use of hardboard siding
in home construction, noting that for “the
incorporation doctrine to apply at all, there
must be a physical linkage or integration of
the two products such that separation is not
reasonably possible”).
The Terra Industries court also examined
the most common formulation of “physical injury”—damage to tangible property
causing an alteration in appearance, shape,
color or other material dimension. 216 F.
Supp. 2d at 917–18 (citing Travelers Ins. Co.
v. Eljer Mfg.,197 Ill. 2d at 312, 757 N.E.2d
at 502). The insurer argued that there was
no “physical injury” because the resulting
beverage had not experienced an alteration
in appearance, shape, or color. In finding
an alteration in “other material dimension,” however, the court concluded that a
known carcinogen, benzene, had rendered
the beverages useless for their intended
purpose, human consumption, and the removal of the benzene was impossible. Id.
at 917–18. While other courts have not focused on the “other material dimension” aspect of potential “physical injury,” similar
holdings have been rendered in food contamination cases despite the lack of a detrimental alteration in appearance, shape,
or color. See, e.g., Thruway Produce, Inc. v.
Massachusetts Bay Ins. Co., 114 F. Supp. 3d
81, 94 (W.D.N.Y. 2015) (“physical damage to
tangible property” occurred when tainted
apples provided by insured were incorporated into claimant’s baby food and render
the food unusable); Cutrale Citrus, 2002
WL 1433728, at *3 (while juice may have
remained fit for consumption, damage occurred when food grade propylene glycol refrigerant was introduced into juice).
In addition to how much easier it is to
integrate defective components into food
products than into construction projects,
food products are also subject to greater
scrutiny. In short, food can arguably be
“damaged” with greater ease than a building. This point was illustrated in Main Street
Ingredients, where the insured sold dried
milk for use in instant oatmeal. The Netherlands Ins. Co. v. Main Street Ingredients,
LLC, 745 F.3d 909 (8th Cir. 2014). Significant amounts of instant oatmeal were recalled after authorities found salmonella
bacteria on surfaces and in areas used to
manufacture the dried milk. It was undisputed, however, that there was no finding
that either the dried milk or the instant oatmeal contained salmonella. Id. at 911, 914.
The court nevertheless found physical injury to the oatmeal because it was “adulterated,” defined as “prepared, packed, or held
under insanitary conditions whereby it may
have been rendered injurious to health.”
Id. at 916–17 (citing “adulterated” definition in 21 U.S.C. §342(a)(4)). Authorities
determined that the oatmeal could not be
lawfully sold, and the court held that this
constituted physical injury to the oatmeal.
Main Street Ingredients and other cases
finding “physical injury” absent an actual showing of contamination to food are
questionable. They appear to violate basic rules of contract interpretation by finding “physical injury” without a showing of
an actual detrimental alteration in appearance, shape, color or other material dimension. Food and drink, however, are subject
to regulations and conditions that are dissimilar to those of construction projects. In
other words, when pre-­physical injury repairs are made to buildings, it is for solely
commercial reasons (to prevent damage before it starts); when pre-­physical injury food
and drink recalls are put in place, it is due
to legal requirements imposed by the U. S.
Food and Drug Administration or comparable authorities. But it is debatable whether
this distinction is meaningful when interpreting “physical injury” in the CGL policy.
Notable Erroneous Applications
of the Incorporation Doctrine
As may be gleaned from the foregoing summary, most arguably incorrect decisions involving the incorporation doctrine have
(1) favored policyholders and (2) been influenced by the Seventh Circuit’s Eljer decision. In addition to those decisions discussed
above, the most prominent case that rested
upon the Seventh Circuit’s Eljer decision to
arrive at an arguably incorrect result is Newark Ins. Co. v. Acupac Packaging, Inc., 328 N.J.
Super 385, 746 A.2d 47 (2000). In Acupac, the
insured manufactured foil-­laminated pacquettes containing lotion, which were attached to advertising cards and bound into
magazines. Some pacquettes leaked after being bound into the magazines, and production was halted. Over two million pacquettes,
however, already had been attached to the
claimant’s advertising cards. The claimant
sought damages for, among other things, the
purported injury to the advertising cards to
which the pacquettes had been attached but
on which no lotion had leaked. 328 N.J. Super. at 388–91, 746 A.2d at 49–50.
The Acupac court specifically chose to
follow the Seventh Circuit’s Eljer decision,
finding physical injury despite no leak:
We hold that if [the insured] can establish that it was inevitable that all, or a
substantial portion, of the cards would
be destroyed once subjected to the binding process, those cards, which belonged
to [the claimant], were indeed damaged. [The insured] was not required
to subject the balance of the cards to
the binding process (which may have
increased the actual damages) in order
to insure coverage. *** We reiterate that
if [the insured] can establish its contention that all or a substantial portion
of the pacquettes would have leaked
onto the cards if subjected to the binding process, rendering the cards inutile
for their intended purpose, coverage
should be afforded because the cards
were, for all intents and purposes, physically damaged.
328 N.J. Super. at 400, 746 A.2d at 55.
The Acupac court thus found physical
injury by the mere attachment of defective
lotion pacquettes to the advertising cards.
The court found the potential for later physical injury or commercial uselessness—
evidenced by the use of phrases such as
“would be destroyed,” “would have leaked,”
and “for all intents and purposes”—to be
itself physical injury. The Acupac court,
therefore, did not give “physical injury”
its typical formulation; there was no detrimental alteration in appearance, shape,
color or other material dimension to those
cards that had not been bound into magazines and experienced leaking lotion.
Swank Enterprises represents another
decision reaching a questionable conclusion involving “physical injury.” Swank
Enterprises, Inc. v. All Purpose Services,
Ltd., 336 Mont. 197, 154 P.3d 52 (2007).
Unlike Acupac and other decisions cited
above, however, the Seventh Circuit’s Eljer
decision apparently played no role. The
Swank Enterprises court relied solely on
prior Montana case law to craft a modified definition of “physical injury”: “a
physical and material alteration resulting in a detriment.” 336 Mont. at 201–02,
154 P.3d at 55–56. The court found such
“physical injury” when the insured used an
improper type of paint on tanks and pipes
in a municipality’s water treatment plant.
The treatment plant’s tanks and pipes were
stripped and repainted, and the treatment
plant was shut down during the repair
work. The court concluded that the application of improper paint caused “physical
injury” because it physically and materially altered the treatment center’s tanks
and pipes, resulting in a detriment to the
municipality. In so holding, the court noted
that the “detriment in fact” was that the
tanks and pipes had to be stripped and
repainted, and the court deemed it significant that the original paint would not
have sufficiently protected the tanks and
pipes. Id.
The court’s conclusion, however, appears
misguided. Even using the court’s own definition of “physical injury,” it is improbable
there was a “physical and material alteration” to the tanks and pipes through the
mere application of paint. No corrosion,
rusting, or other issues with the tanks
and pipes were reported. The stripping
and repainting occurred before any problems arose. The purported “detriment,”
moreover, was the repair itself, not any
pre-repair injury to the tanks and pipes.
For The Defense May 2017 59
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INSUR ANCE L AW
While the purportedly insufficient protection provided to the tanks and pipes by the
paint may have increased the likelihood of
future injury, it did not result in any present injury. For these reasons, Swank Enterprises represents a minority holding, which
provided coverage in an instance when it is
unlikely that “physical injury” took place.
While most questionable holdings have
Whatever the merits
of the integrated system
analysis in the context of
an underlying tort case, its
application to insurancepolicy interpretation
is indefensible.
resulted in an unjustifiable expansion of
coverage, one recent incorporation doctrine decision may have unduly restricted
coverage. In Wisconsin Pharmacal, the
insureds supplied probiotic bacteria used
by the claimant to manufacture dietary
supplement tablets. Wisconsin Pharmacal
Co., LLC v. Nebraska Cultures of California, Inc., 367 Wis. 2d 221, 876 N.W.2d 72
(2016). After the claimant compressed the
ingredients into tablet form, it was determined that the incorrect type of bacteria was provided, and the resulting tablets
were mislabeled and ultimately destroyed.
The insureds sought coverage in the ensuing litigation, arguing that the manufacture of the tablets containing the incorrect
bacteria was covered “property damage” in
the form of “physical injury” to the tablets.
367 Wis. 2d at 233–34, 876 N.W.2d at 77.
The Wisconsin Supreme Court rejected
the insureds’ argument under both Wisconsin and California law. Under Wisconsin law, the court determined that
the resulting products—the tablets—were
integrated systems, meaning that the tablets were deemed an integrated whole, not
a combination of their formerly separate,
constituent parts. Using the integrated
60 For The Defense May 2017
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system analysis, the court concluded that
“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.’” 367 Wis. 2d at
240–42, 876 N.W.2d at 80–81. In essence,
therefore, only the insureds’ products were
affected, not any third-party property.
And when only an insured’s products are
damaged, there is no covered “physical
injury.” 367 Wis. 2d at 243–45, 876 N.W.2d
at 81–83.
Whatever the merits of the integrated
system analysis in the context of an underlying tort case, its application to insurance-­
policy interpretation is indefensible. As
the Wisconsin Pharmacal dissent highlighted, reading elements of tort law into
the interpretation of insurance policies is
unwise and unwarranted. 367 Wis. 2d at
265–66, 876 N.W.2d at 92–93 (Abrahamson, J., dissenting). The integrated system analysis is not found in, or required
by, the language of the insurance policies,
nor is it justifiable to conclude that the
presence of an “integrated system” would
affect and diminish the well-known principle that policies provide coverage when an
insured’s work or product damages another’s work or product. Simply put, the integrated system analysis erroneously holds
that there is no “other property” when
there is, in fact, other property. There is
no reason to ignore the other party’s property, and the Wisconsin Pharmacal majority offered no compelling justification for
applying the integrated system analysis to
an insurance coverage dispute. See Haley v.
Kolbe & Kolbe Millwork Co., Inc., No. 14-cv99-bbc, 2016 WL 4487807, at *3 (W.D.
Wis. Aug. 25, 2016), appeal docketed, No.
16-3648 (7th Cir. Oct. 12, 2016) (criticizing
Wisconsin Pharmacal, though recognizing
that the court was bound by the Wisconsin
Supreme Court’s decision).
While the Wisconsin Pharmacal analysis under Wisconsin law is misguided, its
conclusion is defensible, though on different grounds. Specifically, the court also
examined the issue under California law
and concluded that there was no “physical
injury” to the claimant’s tablets because
the incorporated product, the probiotic
bacteria, was not hazardous. 367 Wis. 2d
at 253–55, 876 N.W.2d at 86–87. The court
determined that although the bacteria
rendered the tablets inadequate for the
intended purpose and essentially worthless, they were not hazardous. The mere
mislabeling was dissimilar to the wood
splinters in cereal (Shade Foods) and other
instances of hazardous product contamination, and therefore, the tablets had not
experienced “physical injury.” Id.
The Wisconsin Pharmacal dissent disagreed with the majority’s conclusion
under California law as well. The dissent
found “physical injury” to result from
“the incorporation of a defective, faulty,
or inadequate part that renders the other
components or the whole unusable.” 367
Wis. 2d at 272–74, 876 N.W.2d at 96–97. In
concluding that “physical injury” occurs
when a final product is rendered unusable, however, the dissent was mischaracterizing California law. Mere inability to
use the final product has not been deemed
sufficient to constitute “physical injury”
because California courts have used the
typical formulation of “physical injury”
as meaning an alteration in appearance,
shape, color or other material dimension.
See, e.g., Silgan Containers, 434 Fed. Appx.
at 710–11, aff’g, Silgan Containers, 2010
WL 1267127, at *5–6; Semtech, 2005 WL
6192907, at *5–10. In support of its position, the Wisconsin Pharmacal dissent
relied on Shade Foods (78 Cal. App. 4th
at 865–66, 93 Cal. Rptr. 2d at 376-77), but
Shade Foods did not hold that an inability
to use the final product alone was “physical injury.” Portions of the discussion in
Shade Foods, moreover, may be questionable insofar as the court cited favorably
the Seventh Circuit’s Eljer decision, and
the court’s opinion was rendered prior to
the other California incorporation doctrine decisions cited here. In other words,
an inability to use the final product is not
“physical injury” in the absence of alteration in appearance, shape, color or other
material dimension. Wisconsin Pharmacal, therefore, likely reached a correct conclusion, despite its ill-advised foray into
an “integrated system analysis.”
Conclusion and Proposal
for Future Application
The most frequently cited definition of
“physical injury” is an alteration in
appearance, shape, color or other material
dimension, yet courts evaluating the incor-
poration doctrine have not always applied
that formulation. Courts have been influenced by the Seventh Circuit’s decision in
Eljer, which found “physical injury” despite
no tangible change in the affected property, and other arguably irrelevant considerations, such as the commercial utility of
the end product. The nature of the incorporated product and the integrated nature of
the final product, in contrast, are relevant
factors, although they should not automatically determine whether and when “physical injury” occurs. A different analysis
should be used, one that weighs the nature
of the defective component and the final
product to determine if, and when, the
final product was detrimentally altered in a
material dimension. (Presumably the final
product would be a product of the thirdparty claimant.)
Focus on whether the final product is
“inutile” or “unusable” is misguided. Cases
have erroneously relied on “uselessness”
grounds to find “physical injury,” but they
also reached the correct conclusion because
the final product did, in fact, suffer an
alteration in appearance, shape, color or
other material dimension. See, e.g., Thruway Produce, 114 F. Supp. 3d at 94 (where
the insured’s tainted apples rendered the
claimant’s baby food “unusable,” but baby
food contaminated with rodenticide has
likely suffered a detrimental alteration in a
material dimension); Terra Industries, 216
F. Supp. 2d at 915–17 (where the insured’s
benzene-­contaminated carbon dioxide rendered the claimant’s beverages “unsuitable
for human consumption” and “useless for
its intended purpose,” but beverages contaminated with benzene have also likely
suffered a detrimental alteration in a material dimension). And while “uselessness,”
standing alone, is insufficient for a finding
of “physical injury,” it is also unnecessary.
Several cases have reached correct conclusions, finding “physical injury” despite
the fact the end products were not rendered useless. See Cutrale Citrus, 2002 WL
1433728, at *3, (where the insured’s contaminated orange juice may have been
marketed as a different juice blend under
different labeling, but the claimant sought
damages due to the introduction of food
grade propylene glycol refrigerant into the
juice). See also Pepsico, Inc. v. Winterthur
Int’l America Ins. Co., 806 N.Y.S.2d 709,
711, 24 A.D.3d 743, 744 (2005), and 788
N.Y.S.2d 142, 13 A.D.3d 599 (2004) (finding “physical damage” despite the fact the
end product was fit for human consumption when “faulty ingredients resulted in
the finished product having an off-taste.” ).
“Physical injury,” therefore, may be present
regardless of any conclusion related to the
usability of the end product, and the commercial utility of the end product should
not be the focus of an incorporation doctrine analysis.
A similar conclusion generally follows
with respect to whether the defective component is fully integrated into or with the
final product. While the degree of integration may be relevant in determining when
a final product is physically injured (e.g.,
the food contamination cases), the degree
of integration alone is not determinative.
Wisconsin Pharmacal is a good example.
The final product was fully integrated, yet
the addition of the insured’s nonconforming bacteria caused no “physical injury”
to the product. The Wisconsin Supreme
Court correctly concluded that there was
no “physical injury” when the “tablets were
simply labeled as containing one probiotic
ingredient when they actually contained
another.” 367 Wis. 2d at 254, 876 N.W.2d
at 87. Full integration of the insured’s nonconforming product with the claimant’s
final product, therefore, is not automatically “physical injury.”
Incorporation doctrine analysis, in conclusion, has come a long way since Judge
Posner upset the applecart with the Eljer
decision in 1992, and it extends to a broader
range of situations than only to construction defect cases involving real property.
Courts, however, have yet to reach consensus regarding the application of the doctrine, and analytical errors continue to be
made. Given the virtually limitless situations in which the issue may arise, courts
should have numerous opportunities to
clarify and sharpen the analysis to ensure
that coverage is provided only in those situations when “physical injury” genuinely
took place.