A third-party insurance policy provides coverage for an insured’s liability to third parties for personal injury or property damage. This is in contrast to a first-party insurance policy, which provides coverage for damage to the insured’s own property. An insurer generally has two obligations under a third-party policy: (1) it must defend its insured in connection with potentially covered claims asserted against the insured; and (2) it must pay any judgments entered against its insured in connection with covered claims.
Most third-party insurance policies exclude coverage for damage to the insured’s own products or work performed by the insured. “The consequences of not performing well is part of every business venture; the replacement or repair of faulty goods and works is a business expense, to be borne by the insured-contractor in order to satisfy customers.” See Weedo v. Stone-E-Brick, Inc., 81 N.J. 233, 239, 405 A.2d 788 (1979). Consequently, if the insured manufacturers a defective product, there will be no coverage for costs incurred to repair or replace the defective product. Coverage may exist, however, if the defective product causes personal injury or damage to other property not manufactured by the insured.
Thus, whether coverage exists in connection with faulty work performed, or a defective product supplied, by the insured, depends on whether the damage at issue occurred to something other than the insured’s own work or product. There is no coverage if the damages at issue consists solely of economic damages resulting from the failure of the insured to properly perform its obligations.
Titanium Indus., Inc. v. Federal Ins. Co., No. L-1043-11, 2014 WL 4428324 (App. Div. Sept. 10, 2014), involved a claim by an insured, Titanium Industries, Inc. (“Titanium”), seeking coverage under a third-party liability policy for costs incurred in connection with the sale by it of defective titanium bars to one of its customers. It was determined that the defect in the titanium bars existed at the time they were purchased by the insured from one of its suppliers.
The insured’s customer, Biomet Manufacturing Corp. (“Biomet”), used the titanium to manufacture screws that were used in connection with orthopedic products. Biomet recalled the screws after learning that they were defective. With the exception of a piece of stainless steel that may have been inserted at the top of the screws, the screws were made entirely of the titanium it purchased from the insured. The insured incurred $963,000 to settle the claims asserted against it by Biomet.
The defect in the titanium was described as “alloy separation,” which is caused by “the failure of alloys in a metal to completely melt causing the alloy to separate and undermine the strength of the finished product.” Id. at 1.
The insured sought coverage for its losses from its insurer, Federal Insurance Company (“Federal”). Federal denied coverage and Titanium commenced a declaratory judgment action against it. Federal denied coverage on the basis that “the titanium was already defective when Biomet received it, and the titanium was not added to any product which then caused property damage.” Id. at *2. Federal also denied coverage on the basis that the defective titanium did not cause damage to any other property. Id.
The policy at issue provided that there was no coverage for “property damage to your product arising out of it or any part of it.” The policy defined “your product” as “goods or products . . . manufactured, sold, handled, distributed or disposed of by” the insured. Id. at *3.
The policy also contained an “impaired property” exclusion. An “impaired property” exclusion comes in to play when a third-party claims that its property was impaired (i.e., it could not be used or was less useful) because it incorporated the insured’s defective product or work. Id.
Both exclusions apply only if the insured’s product or work does not result in bodily injury or property damage to a third-party’s property.
Federal moved for summary judgment on the basis that the titanium was already defective when Biomet received it, that it was not added to any product which then caused property damage, and that the defective titanium did not cause damage to any other property. The trial judge granted summary judgment in favor of Federal, concluding that even if coverage existed, the “your product” exclusion applied. According to the court:
[P]laintiff’s product is not simply the titanium bars. Your product is defined in pertinent part under the policy . . . as goods, products, manufactured, sold or distributed, and includes representations regarding . . . the quality of use of your product.
By that definition, plaintiff’s product here was titanium bars of a particular grade for use as pins and screws for orthopedic devices, and it was, in fact, the pins and screws that were in issue here.
To be sure, if the pins and screws were comprised of components other than plaintiff’s titanium, the screws and pins would be a different product and the inability to replace the titanium without destroying the other components of the screws and pins would alter the analysis.
Id. at 4. The trial judge further concluded that the impaired property exclusion applied “because the titanium supplied by plaintiff is the only component of Biomet[’s] screws [and the] screws can be restored to use by supplying Biomet with the proper grade of titanium for use in [orthopedic] pins and screws.” Id.
On appeal, the Appellate Division affirmed “for reasons slightly different than those expressed by the motion judge.” Id. The court concluded that there was no coverage under the policy as a matter of law because the only damage was to the defective product itself. The court went on to note that it was not necessary to even consider (as the trial court did) whether the loss fell within one of the policy exclusions. Nonetheless, the court indicated, albeit in dictum, that the “your product” exclusion would also bar coverage.
The court distinguished the case before it from one in which an insured faces tort liability arising out of personal injury or property damage to other property. In Titanium, the insured’s liability was essentially contractual in nature. The court specifically rejected the insured’s argument that the damage was to Biomet’s screws and not to the titanium bars sold by the insured.
The court noted that “[i]mplicit in [the insured’s] argument is the assertion that plaintiff’s property—the titanium bar material—has been sufficiently transformed so that it is something else, that is, some other property that was damaged.” Id. at *7. However, as noted by the court:
Here, plaintiff’s product—raw titanium—was fashioned into screws, a process anticipated by the parties’ relationship and the terms of the long-term supply agreement. Plaintiff’s titanium was otherwise unaltered and was not appended to other property that was itself, damaged.
Id. at *8. The court went on to note:
Biomet’s claims were for breach of plaintiff’s warranties regarding the intended use of its titanium, and the risk of any replacement or repair of plaintiff’s faulty goods was a risk assumed by plaintiff as a cost of doing business, not a risk passed onto [plaintiff’s insurer] via the policy.
Thus, under New Jersey law, in order for a loss arising out of the sale of a defective product manufactured by an insured to be covered, it must be shown that the defective product caused personal injury or damage to the property of others. There must be something other than a purely economic loss resulting from the insured’s failure to properly perform its obligations. In other words, coverage depends on whether the damage at issue is of a type typically recoverable in a breach of contract action or whether the insured’s actions also caused tort liability.
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