Declines to apply an “integrated system” property damage analysis and finds “Your Products” exclusion ambiguous 

 The Seventh Circuit, applying Wisconsin law, reversed a district court’s ruling and held that claims arising from defective windows triggered the insurers’ duty to defend.  The Seventh Circuit found that, because the defective window claims sought compensation for the repair or replacement of individual elements of a larger structure, an integrated system analysis was not required.  The court also found the applicable “your products” policy exclusions to be ambiguous, and thus, the exclusions were construed in favor of coverage.

A putative class action was filed against Kolbe & Kolbe Millwork Company (“Kolbe”) alleging that Kolbe windows were defective because they allowed air and water to damage homes.   Kolbe tendered the defense of the class action defective product suit to its general liability insurers.  The insurers agreed to defend Kolbe under a reservation of rights.  The insurers intervened in the class action suit and filed a motion for summary judgment arguing that the Wisconsin Supreme Court decision of Wisconsin Pharmacal Co., LLC v. Nebraska Cultures of California, Inc., 876 N.W.2d 72 (Wis. 2016) relieved them of their duty to defend Kolbe for the defective window claims.

The class action suit alleged two general categories of damages:  (1) direct loss of replacing the windows and (2) consequential losses from damage to the claimants’ homes.  The insurers argued that their policies did not cover the direct cost of replacing any faulty windows because the policies do not cover damage to Kolbe’s own product.  Likewise, the insurers argued that the policies do not cover the consequential damages because each home formed an “integrated system” with Kolbe’s windows; thus, the entire house was to be treated as Kolbe’s “product” for insurance coverage purposes.  The district court agreed and entered summary judgment in favor of the insurers.

On appeal, the Seventh Circuit noted that, under Wisconsin law, the economic loss doctrine bars a purchaser of a product from using tort law to recover from the manufacturer any purely economic injuries arising from that product’s failure to work as expected.  Moreover, if the defective product is a component of a larger “integrated system,” damage by that component to the other elements of the system, or the system as a whole, is likewise considered damage to the defective component itself, and does not qualify as damage to “other property.”  Even though the economic loss doctrine generally is not applied in insurance coverage disputes, the Wisconsin Supreme Court in Pharmacal applied an integrated-system analysis to a case involving coverage under a general liability policy for claims relating to the recall of a dietary supplement due to the incorporation of the wrong kind of bacteria.  In the instant case, the Seventh Circuit held that the integrated-system analysis in Pharmacal was not required, because, here, the homeowners sought compensation for the repair or replacement of individual elements of a larger structure.  In contrast, in Pharmacal, the only loss alleged was to the plaintiff’s products as a whole because the components of the products were indistinguishable from each other and from the larger product.

While the parties agreed that Kolbe’s windows were excluded from coverage under the policies “your product” exclusion, the parties disputed whether the walls and other elements of the plaintiffs’ homes constituted Kolbe’s “product” as defined by the policies.   The Seventh Circuit found that the policies’ “your product” exclusions were at the very least ambiguous and, therefore, the exclusions were construed in favor of coverage. Thus, the Seventh Circuit held that, because there may be coverage for at least one of the claims in the underlying suit, the insurers had the duty to defend Kolbe against all of the alleged claims. Haley v. Kolbe & Kolbe Millwork Co., No. 14-cv-99-bbs (7th Cir. Aug. 8, 2017).