Wisconsin Case Law Year in Review 2023

Every year, Quarles & Brady LLP's Insurance Recovery Team compiles a list of important decisions by Wisconsin state and federal courts addressing insurance issues. Our goal is to keep you informed of developments and help you anticipate what the future may bring. For additional information, please reach out to any member of Quarles' Insurance Recovery Team.

5 Walworth, LLC v. Engerman Contracting, Inc., 2023 WI 51, 408 Wis. 2d 39, 992 N.W.2d 31

5 Walworth clarifies an issue that had become muddled since the Wisconsin Supreme Court’s 2016 decision in Wisconsin Pharmacal Co. v. Nebraska Cultures of California. Namely, 5 Walworth overturns Pharmacal’s introduction of two concepts to Wisconsin insurance law. Following 5 Walworth, Wisconsin no longer (1) requires that damage occur to “other property” in order to trigger an initial grant of coverage under general liability policies; or (2) uses the integrated systems analysis to determine whether damage to “other property” occurred.

5 Walworth owns lakeshore property in Lake Geneva, Wisconsin, and hired Engerman in 2012 to serve as the general contractor for construction of an in-ground swimming pool complex. Engerman subcontracted the work to a subcontractor that completed the project using shotcrete purchased from a supplier. Shortly after construction finished, 5 Walworth discovered leaks in the pools. Following several years of failed attempts to repair the leaks, an engineering firm investigated and concluded that the pool walls cracked because of incorrect installation of the shotcrete and placement of steel reinforcing bars. It determined that the cracking and resulting leaks would continue. In 2018, 5 Walworth sued Engerman, the subcontractor, and their insurers for the costs to demolish and reconstruct the pool complex. The subcontractor added claims against the shotcrete supplier and its insurer. The liability insurers for Engerman, the subcontractor, and the shotcrete supplier filed motions seeking a ruling that their respective general liability policies do not cover 5 Walworth’s claim. The trial court granted the insurers’ motions, relying largely on the precedent established in Pharmacal. The Wisconsin Court of Appeals reversed that decision in 2021, which set the stage for one of the most significant insurance-related decisions from the Wisconsin Supreme Court in recent years.

To understand 5 Walworth, it is helpful to revisit Pharmacal. There, dietary supplement pills included a wrong ingredient and had to be destroyed because of that ingredient. Litigation ensued, including as to whether the liability insurer for the company that supplied the wrong ingredient owed coverage. The Wisconsin Supreme Court held the insurer did not owe coverage because (1) to trigger an initial grant of coverage under a general liability policy, there must be damage to “other property” than the insured’s own property/product; and (2) the integrated systems analysis used in other areas of the law shows that there is no damage to “other property” when an insured’s product is part of an integrated system like a supplement pill.

Based on Pharmacal, the insurers in 5 Walworth argued there was no initial grant of coverage under their policies because there was no damage to “other property” beyond the contractors’ own products, especially once those products were incorporated in an integrated system like a pool complex. The Wisconsin Supreme Court disagreed, noting that the standard language for general liability policies’ initial grant of coverage references only “property damage,” not damage to “other property.” The Court therefore overruled the requirement in Pharmacal that damage occur to “other property” in order to trigger general liability coverage. The Court also overruled Pharmacal’s holding that the “integrated systems analysis” can or should be used to decide insurance coverage disputes. Notably, none of the parties asked the Court to overrule Pharmacal—the policyholders had merely argued that even under Pharmacal, coverage applies. However, the Court concluded that Pharmacal was wrongly decided and introduced too much inconsistency and murkiness to coverage disputes, including construction defect claims.

So what does 5 Walworth mean for future general liability claims? Wisconsin law will continue to use the three-step process outlined below for determining insurance coverage, but whether damage occurred to “other property” is no longer relevant in the first step. 

First, is there an initial grant of coverage? In the context of general liability claims, an initial grant of coverage typically requires bodily injury or property damage caused by an occurrence (i.e., an accident). Pharmacal’s requirement that damage be to “other property” no longer applies and is irrelevant to determining the initial grant of coverage.

Second, if there is an initial grant of coverage, do any exclusions apply? This step can reintroduce the “other property” issue because most, if not all, general liability policies include business risk exclusions for damage to “your work” or “your product.” Still, moving the “other property” analysis to the second step of a coverage analysis is significant because exclusionary language is construed narrowly (i.e., in favor of coverage). 

Third, if an exclusion applies, do any exceptions to the exclusion reinstate coverage? For example, “your work” exclusions often include exceptions for work performed by subcontractors. 

In 5 Walworth, all of these issues will go back to the trial court because the Supreme Court simply ruled that the insurers’ motions should not have been granted based on the factual record developed to that point. Even the first step of the coverage analysis remains to be decided because of the occurrence requirement—the Supreme Court in 5 Walworth reiterated that faulty workmanship is not itself an occurrence, but the Court also suggested that the cracks and leaks that occurred after construction could be an occurrence. Ultimately, the judge or jury at the trial court will have to determine which, if any, of the insurers owe coverage for 5 Walworth’s claim based on the full factual record and the law as clarified in 5 Walworth.

Riverback Farms, LLC v. Saukville Food Supplies, Inc., 2023 WI App 40, 409 Wis. 2d 14, 995 N.W.2d 257

In Riverback Farms, the Wisconsin Court of Appeals, District 2, further clarified when coverage might accrue for a property damage claim, caused at least in part by an underlying intentional act. At issue in Riverback Farms was alleged damage to dairy cattle that their owner asserted was caused by a feed supplier intentionally using a particular substitute ingredient in their cattle feed. The cattle owner did not know about or authorize the particular substitute. After a lengthy period during which the cattle were progressively getting sicker and less productive, the owner discovered the change and sued the supplier. While the evidence suggests that the feed supplier arguably made the change in good faith, the change turned out to be ill-advised and caused cattle to suffer various nutrition-related harms, including lost milk production. At issue before the Court was whether the feed supplier’s general liability policy provided coverage for this type of property damage. 

The supplier’s liability insurer argued that the cattle owner’s claim did not trigger coverage because the property damage was not caused by an accident, but rather by the feed supplier’s intentional conduct in changing the cattle feed. The Court of Appeals held that notwithstanding that the cattle feed supplier intentionally changed the feed which had the ultimate effect of damaging the cattle, the supplier did not intend to harm the cattle and therefore covered property damage had occurred: “an initial intentional act by the insured—the provision of goods, products or work—can set in motion a chain of events that includes an accident, a covered occurrence, causing property damage. The focus is on whether the injury or damages was foreseeable or expected, not on whether the action that caused the property damage was intended.”

This decision is notable because it relied on 5 Walworth and arguably challenged a long and conceptually-confusing line of cases in which Wisconsin courts have held that if a loss is caused by a volitional act, notwithstanding the ultimate intent of the actor, there would be no trigger of coverage. 

As a secondary question, the Riverback Farms court addressed whether property damage had occurred to the dairy cattle due to use of the nutrition substitute. The Court looked at the record to conclude that the substitute caused a magnesium deficiency in the cattle that caused harmful changes to their digestive tract. Based upon this fact, the Court concluded that the cattle owner had alleged a physical injury to tangible property – in other words, there had been a physical alteration to the cattle.

Finally, the Court of Appeals rejected application of a standard impaired property exclusion to bar the claim. The impaired property exclusion is triggered when property that is not physically injured cannot be used or is made less useful because it incorporates a product that is defective, deficient, inadequate, or dangerous. The exclusion also requires that the impaired property can be restored to use by repair, replacement, adjustment, or removal of the incorporated defective product. The Court of Appeals held that the exclusion did not apply because the cattle were indeed physically injured, that there was no actual incorporation of a product into the cattle, and the feed substitute at issue could not be repaired, replaced, adjusted or removed. 

Dostal v. Strand, 2023 WI 6, 405 Wis. 2d 572, 984 N.W.2d 382

In Dostal, the Wisconsin Supreme Court answered a question of first impression under Wisconsin law: “whether being aware of the risk that something might happen necessarily means that when that thing happens, it is not an ‘accident’” as that undefined term is used in an insurance policy when determining whether there has been an occurrence.

Curtis Strand was charged and convicted of second-degree reckless homicide and resisting or obstructing an officer in connection with the death of his infant daughter, Haeven, in his home due to head trauma he inflicted. Haeven’s mother, Lindsey Dostal, brought a civil action against Strand, asserting claims for negligence and wrongful death. Strand subsequently tendered a claim to State Farm, his homeowner insurer. State Farm intervened, bifurcated the coverage proceeding, and sought a determination that Strand was not entitled to coverage because there was no “occurrence,” which is defined as an “accident,” triggering coverage.

Both the circuit court and the court of appeals agreed with State Farm, holding that because Strand’s conduct “created an unreasonable and substantial risk of harm,” the resulting death of Haeven was not an “accident,” and thus no “occurrence.”

The Wisconsin Supreme Court, relying on out-of-state law, reversed. The Court rejected State Farm’s issue preclusion argument based on Strand’s criminal conviction for second-degree reckless homicide. The Court held that the “issue of whether Strand’s conduct was an ‘accident’ was not actually litigated in the prior criminal proceeding.” In addition, the Court noted that “under a common understanding of ‘accident,’ it would seem that even if one engages in reckless conduct, a resulting injury can still be, in the common parlance of the word, ‘accidental.’” The Court also found that neither the resident relative nor intentional acts exclusions in the policy applied due to material disputes of fact.

Dostal should not be read as an invitation for insureds to partake in reckless behavior with impunity as the Court did not hold that reckless behavior would always be considered an accident, only that it is possible for reckless behavior to be considered such. Insureds should also read their policy carefully, because it may contain a definition for “accident” or “occurrence” which exempts reckless acts from coverage. Nonetheless, Dostal expands the scope of coverage for insureds to potentially include coverage for reckless behavior for “accident”-based “occurrence” policies.

Pepsi-Cola v. Employers Insurance, 2023 WI 42, 407 Wis. 2d 384, 990 N.W.2d 267 (per curiam)

The Wisconsin Supreme Court has now examined an important issue that frequently arises after corporate transactions where old liability policies are transferred from a predecessor company to a successor entity. These policies frequently come into play for long tail claims like environmental contamination or asbestos-related injuries, where it may take years or decades for a claimant to discover the covered property damage or bodily injury that occurred during the policy period. As part of a typical transaction, parties attempt to give the successor entity access to old policies to cover potential historical claims through an assignment. In 2022, the Wisconsin Court of Appeals decided the validity and enforceability of these assignments and reaffirmed long-standing precedent indicating an insured may assign its right to coverage for a loss after the loss has occurred and the rights under the policy have already accrued. The Court of Appeals adhered to the majority rule articulated in part by the California Supreme Court in Fluor v. Superior Court, 354 P.3d 302 (2015) which holds that the so-called “anti-assignment” clauses in insurance policies only preclude the assignment of rights under the policy for future or post-assignment losses that have yet to occur. The rationale for this holding is that the insurer has already underwritten past risks and once the loss occurs, the insurer is already obligated to cover the loss agreed to under its policy terms. This obligation should not change simply because the entity that later holds the liability and seeks insurance coverage is not the same party as originally insured. However, coverage for post-assignment losses are not covered because those are unforeseen by the carrier and never considered in its original underwriting of the policy.   

Pepsi involved coverage for an underlying asbestos suit. In the 1960s, Wausau issued policies covering the underlying suit to Waukesha Foundry Company (“Old Waukesha”) a predecessor of Pepsi. In 1968, after the claimant in the underlying suit already had been exposed to asbestos and begun to suffer undiagnosed bodily injury, Old Waukesha transferred and assigned its assets to Waukesha Foundry Company, Inc. (“New Waukesha”), as part of a corporate reorganization. New Waukesha later merged with and into Abex Corporation, which subsequently transferred and assigned its assets to PA Holdings Corporation (“PAH”). PAH later merged with and into Pneumo Abex, LLC, which assigned its rights under the Wausau policies to Pepsi.

Pepsi sought coverage for the underlying asbestos suit from Wausau. Wausau refused, arguing that Pepsi acquired no rights under the policies because the assignments at issue were made without Wausau’s written consent, which the policies expressly required. The Court of Appeals rejected Wausau’s argument, holding that, under well-established Wisconsin law, “anti-assignment” clauses are unenforceable to bar post-loss assignments of rights to insurance proceeds.

In so holding, the Court of Appeals clarified its prior dicta in Red Arrow Products Co, Inc. v. Employers Insurance of Wausau, 2000 WI App 36, which Wausau read to mean that an anti-assignment provision precluded the assignee from acquiring rights under a policy. As the Court of Appeals explained, the parties in Red Arrow agreed and stipulated that the purported insured never had received any assignment from its predecessors. As a result, the Court never reached the issue of whether an insured can assign its rights post-loss under Wisconsin law—an issue that nevertheless had been repeatedly addressed in earlier decisions indicating an insured may do so. Wisconsin thus remains one of the majority of states that allow such post-loss transfers.

The Wisconsin Supreme Court agreed to review the decision but because not all members of the Court participated in the review, the Supreme Court deadlocked on whether to affirm or deny. Procedurally, this results in an affirmance of the Court of Appeals decision. While the Supreme Court could review once again when it is at full strength, for now this decision is a good one for policyholders and for corporate transactions because it adds Wisconsin to the group of states that follow the majority rule on assignability of liability insurance policies.

Komatsu Mining Corp. v. Columbia Casualty Co., 58 F.4th 305 (7th Cir. 2023)

The Seventh Circuit added to the slim body of appellate decisions when it found a “bump up” provision in a directors and officers policy excluded coverage for a shareholder settlement following a merger. The provision, also known as “inadequate consideration” clause, is intended to prevent an insurer from being required to supplement the sale price in a merger when selling shareholders later contend their shares were sold for less than market value.

In Komatsu, Joy Global Inc. shareholders, during the company’s 2016 merger with Komatsu America Corporation, alleged that Joy Global failed to disclose certain internal projections that should have enhanced its value and, in turn, the merger price benefiting shareholders. The type of claims varied, including some based on regulatory disclosures as apart from fiduciary duty breaches. The parties eventually settled the litigation, with Joy Global shareholders obtaining funds that, theoretically, could be considered the shortfall in the merger price they alleged was more proper.

Joy Global’s D&O insurer defended the company, along with its directors and officers, in the underlying litigation, but refused to indemnify them for the settlement. It based its denial on the “inadequate consideration” exclusion in the policy that advised it would not cover “any amount of any judgment or settlement of any Inadequate Consideration Claim other than Defense Costs.” This meant any claim “alleging that the price or consideration paid or proposed to be paid” in this situation “is inadequate.” Applying Wisconsin insurance law, the district court noted various allegations from shareholders but concluded they all came down to the same grievance sued over—the company and its leadership left money on the table.

The Seventh Circuit had seemingly no concerns in affirming the exclusion’s application. The court first contextualized why the exclusion exists, which is to avoid the pitfall of companies using a D&O carrier to knowingly cover a gap in a merger sale price. It then scrutinized the underlying claims from shareholders against the policy, reasoning that even if a claim arose under a disclosure regulation as opposed to a fiduciary duty claim more specifically alleging insufficient price, they all come back to the same act or harm—the inadequate consideration.

This decision is not remarkable and its conclusion is not a surprise. However, this area of policy interpretation is relatively young and sure to be growing, making the Seventh Circuit’s decision in Komatsu a material addition to the national case law. It reflects D&O policy language can vary in material ways, such as the indemnification language here precluding coverage for any of the claims here, and that courts may dig deep into the underlying litigation in determining the exact nature of each claim in interpreting that language.

In closing, the decision makes a fairly sweeping and suspect comment that Wisconsin courts do not construe “all conceivable ambiguities . . . against an insurer[,]” citing Danbeck v. American Family Mutual Ins. Co., 2001 WI 91, ¶ 10, 245 Wis. 2d 186, 629 N.W.2d 15. Although not central to the Komatsu decision, we would be remiss to not comment that this seems like an inaccurate characterization of both Danbeck and Wisconsin insurance decisions since then. Id. (“If the language is ambiguous, it is construed in favor of coverage.”); see also Acuity v. Est. of Shimeta, 2023 WI 28, ¶ 11, 406 Wis. 2d 730, 737, 987 N.W.2d 689, 692 (“We interpret the policy language as a reasonable insured would understand it, and if the language is ambiguous, we construe it in favor of the insured.”).

For more information, contact your Quarles attorney or a member of our Insurance Recovery Team:

• Patrick Nolan / 414-277-5465 / patrick.nolan@quarles.com

• Brandon Gutschow / 414-277-5745 / brandon.gutschow@quarles.com
• Joe Poehlmann / 414-277-5763 / joseph.poehlmann@quarles.com
• Nathan Oesch / 414-277-5120 / nathan.oesch@quarles.com