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Bright Wood: Has the Sister Ship Come In for CGL Insurers?

to accept review because of the potential statewide impact and need for a single rule. But the second reason for caution is less obvious but we feel it is noteworthy.  While the case interprets and applies stock CGL exclusions, some of the case law support is not based upon insurance cases but instead applies "economic loss doctrine." 

What happened in this case? Scherer Brothers Lumber Company contracted with Bright Wood to provide it with treated wood components to be used to produce windows which Scherer Brothers would then sell.  Treated wood means treated with a wood preservative to prevent rot. For reasons not clear in the case, Bright Wood provided untreated wood to Scherer during a 13 month period. When Bright Wood discovered its failure to treat the wood it began treating future shipments but neither notified Scherer nor its CGL insurer of its failure to treat the previous shipments.

Roughly a year later when inspecting windows for hail damage after a bad storm, Scherer noticed windows with discolored sashes (a sash is the frame that holds the panes of a window in a window frame). About that time Scherer began receiving numerous complaints. Scherer notified Bright Wood that "there appeared to be a problem with Bright Wood's preservative process." Roughly a year after that, Bright Wood met with Scherer but once again did not disclose its preservative process was not used (although at about the same time Bright Wood put its CGL insurer on notice of a "possible claim.") A few months later Bright Wood notified Scherer of its 13 month lapse in treatment of the wood.

The case eventually deals with the cost of repair and replacement. Scherer started out handling claims one by one. But when Scherer could not predict which window sashes would fail, it resolved to replace all components manufactured during the time untreated wood had been used. To replace the wood sash components Scherer had to remove weather stripping, hardware and aluminum cladding and then refinish the window.

The scope of the problem grew; Scherer decided it would be more efficient to replace the entire window with a new unit. The materials were more costly but labor expense was lower. This meant the window had to be refinished.

There was never any damage or defect noted in any part of the window except the wood sash components provided by Bright Wood.

Scherer sued Bright Wood for breach of contract and warranty. Bright Wood settled for $8.2 million and then pursued its CGL insurers to reimburse them for their settlement.

The CGL policy contained business risk exclusions for damage to the product "arising out of it or any part of it" and the "sister ship" exclusion (which eliminates from coverage costs incurred for withdrawal, recall, repair or replacement of the insured's product or impaired product.)

Why would the exclusions not eliminate coverage? Bright Wood argued that because the repair and replacement damaged non-Bright Wood components to the window, neither exclusion ought apply. The court of appeals did not agree; the court ruled that there was no coverage.

As to the first exclusion (insured's own product) that text had already been interpreted in Minnesota to deny coverage for cost of repairs necessitated by a defective product including anticipated future repair costs. Here the damage, said the court, was based solely on Bright Wood's defective product. Damage to the finish, hardware and stripping were incidental and incurred only to make repairs. Significantly there was no damage to any other product. (That is a classic delineation of the business risk doctrine.)

As to the sister ship (recall) exclusion the dispute centered around whether the exclusion applied because "impaired property" means that the product into which the insured's deficient product is incorporated may be restored by simply removing the insured's product and that "other property" must be undamaged...except for the inclusion of the insured's deficient product. Because, argued Bright Wood, the rest of the window could not be restored to use simply by removal, because the rest of the window was damaged during replacement of weather stripping, cladding and finishing, the exclusion was not applicable and Bright Wood's CGL insurer should pay to replace the untreated "treated" wood. The court did not see it that way. While recognizing that the repair process required stripping and refinishing, "these components are so integral to each window unit that they cannot be considered as other property." Therein a key: had "other property" been damaged, the Business Risk doctrine would not usually prevent coverage.

It is there that the court imports economic loss doctrine case law for the proposition that "economic losses to the product as a whole were not losses to 'other property'" quoting Minneapolis Soc'y of Fine Arts v. Parker-Klein Assocs. Architects Inc., 354 N.W.2d 816 (Minn. 1984).

Certainly the business risk doctrine remains alive and well in Minnesota no matter what happens to this case on appeal. Right now it seems to stand for the proposition that when the component is incorporated into another separable, distinct component (the window) the damage to the larger component is not "other property." It does not stand for the proposition that damage to the wall or to the entire house is so related to the lack of preservative; at some point, there can be damage to "other property."

About the Author: Ted has practiced Minnesota insurance law for over a quarter century.  With a concentration in insurance coverage he advises and counsels insurance companies and self-insured entities, including writing policies and self-insured undertakings as well as operations/compliance.  As a prolific writer and teacher, he has written extensively on general insurance law subjects, bad faith, ADR, complex settlement devices (such as Drake v. Ryan and Miller Shugart) and a wide range of subjects.  Ted has authored and co-authored seven books on Minnesota motor vehicle insurance law and practice. He and the Minnesota Motor Vehicle Insurance Manual are regarded as primary authorities by the legal and insurance communities.  Ted and Rich Besonen are working with a friend and colleague from the insurance industry to publish a Minnesota guide to CGL insurance coverage.

© 2003 Arthur, Chapman, Kettering, Smetak & Pikala, P.A.

This publication is intended as a report on legal developments in the insurance coverage area. It is not intended as legal advice. Readers of this publication are encouraged to contact Arthur, Chapman, Kettering, Smetak & Pikala, P.A. with any questions or concerns.