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Tossing Pharmacal Out With the Poolwater: Wisconsin Supreme Court Overturns Only Seven-Year-Old Precedent

7/6/23

By: Jonathan Schwartz and Glenn A. Klinger

In a surprising decision, the Wisconsin Supreme Court sua sponte overturned Wisconsin Pharmacal Co., LLC v. Nebraska Cultures of California, Inc., 2016 WI 14, admitting that the Court erred in “incorporating the integrated system into insurance policy disputes,” and specifically rejecting Pharmacal’s “incorporation of an ‘other property’ analysis into the initial determination of whether an occurrence has caused ‘property damage’ under an insurance policy.” While Pharmacal had limited precedential value to begin with, it is odd to see a seven-year-old decision overturned.   

This pronouncement occurred in 5 Walworth, LLC v. Engerman Contracting, Inc., 2023 WI 51, where the Court was reviewing the propriety of summary judgment granted in favor of three insurers. This case arose from damage allegedly caused by defective construction of an in-ground pool, which cracked and caused water to leak into surrounding soil. The general contractor had hired a subcontractor to construct a pool complex, including a main pool and children’s pool. The subcontractor then hired a sub-subcontractor to supply ready-mixed concrete used for pool construction, known as “shotcrete.” Soon after the project was finished, the property owner started noticing leaks from the pools. It commissioned a report, which found that the pool walls had cracked due to improper installation, moist conditions, and erroneous placement of steel reinforcing bars. The report also found soil from neighboring properties to be unsuitable due to excessive water infiltration. The property owner subsequently had the pool complex demolished and rebuilt by another contractor.   

The property owner sued the general contractor and subcontractor, which filed a third-party complaint against the shotcrete provider. In accordance with civil procedure particular to Wisconsin, the liability insurers for the contractors/subcontractors were made a part of the lawsuit, and they moved for summary judgment on coverage under their respective policies. The circuit court granted the insurers’ motions, citing Pharmacal. The Court of Appeals reversed.   

The Wisconsin Supreme Court accepted the appeal and began its decision by noting that commercial general liability (“CGL”) policies are designed to protect insureds “against liability for damages the insured’s negligence causes to third parties.” It also explained that these policies are supposed to cover damage to property other than the insured’s own product or work. The Court cited with approval American Family Mutual Insurance Co. v. American Girl, Inc., 2004 WI 2, which also involved a faulty workmanship dispute. Nonetheless, the Court focused on the reasoning in American Girl that CGL policies’ limitation to damage to other property emanates from the policies’ “business risk exclusions” and not their insuring agreement. This is the source of the Court’s criticism of Pharmacal, where it had held that for a CGL policy to afford coverage for “property damage,” there must be damage to “other property.” 

“Pointing to this holding, the Supreme Court characterized Pharmacal as “a departure from our well-established law” and a decision that “flatly contradicted,” among other precedent, American Girl. The Court emphasized that a CGL policy’s insuring agreement “ma[kes] no mention of an ‘other property’ requirement.” Based on this erroneous predicate, the Court identified Pharmacal’s equally, if not more serious, error as the incorporation of tort law’s “integrated systems analysis,” i.e., an assessment of whether damage to a defective component of an integrated system constitutes damage to other property, into insurance law. According to the Court, Pharmacal “runs headlong into the fundamental principle running through our insurance cases that policy interpretation should focus on the language of the insurance policy.” Therefore, the Court expressly and affirmatively overturned Pharmacal’s incorporation of the integrated systems analysis into insurance policy disputes, as well as its grafting of an “other property” requirement onto the determination of whether there has been “property damage” caused by an “occurrence.” 

Based on its adherence to American Girl, the Court concluded that the water leakage, cracks in the pool, and damage to surrounding soil may together constitute “property damage” caused by an “occurrence,” at least for purposes of evaluating the insurers’ duty to defend. The Court made a point to note that “faulty workmanship is not an occurrence, but faulty workmanship can lead to an occurrence that causes property damage.” Accordingly, since cracks in the pool (which were the product of, among other things, “less-than-optimal installation of the shotcrete and poor placement of steel reinforcing bars”) caused water to lead into the surrounding soil, damaging and destabilizing it, there were unexpected and unforeseen events caused by improper construction, which caused property damage and necessitated demolition and rebuilding of the pool complex. Therefore, the insurers were not entitled to summary judgment on the absence of “property damage” caused by an “occurrence.”  

While Pharmacal, a case about probiotic supplement tablets, could have survived with limited precedential value if it had not been applied in a way that caused so much friction with American Girl, apparently the effects of the decision caused the Supreme Court to abandon it so soon after it was issued. In that same vein, the impact of 5 Walworth should not be great because American Girl was, and remains, the seminal Wisconsin precedent on construction defect coverage. 

For more information, please contact Jonathan Schwartz at Jonathan.Schwartz@fmglaw.com, Glenn A. Klinger at glenn.klinger@fmglaw.com, or your local FMG attorney.