United States of America
110 I turn now to the position in the United States. It suffices for present purposes to discuss appellate decisions in the influential commercial centre of Illinois, where the highest federal and state courts have reached conflicting conclusions on substantially the same facts. In doing so, I have borne in mind that there is not one common law of the United States of America: Erie Railroad Co v Tompkins 30 US 64 (1938), reversing Swift v Tyson 41 US 1 (1842).
111 The divergence in Illinois arises out of two decisions: Eljer Manufacturing Inc v Liberty Mutual Insurance Co 972 F 2d 805 (1992) (United States Court of Appeals, Seventh Circuit) and Traveler's Insurance Co v Eljer Manufacturing Inc 197 Ill 2d 278; 757 NE 2d 481 (2001) (Supreme Court of Illinois). Both cases concerned suits brought against the United States Brass Corporation in respect of plumbing systems. Contractors installed the systems in construction sites, usually behind walls or between floors and ceilings. Defects in the systems caused them to leak. 95% had not failed, but were viewed as defective from their alleged tendency to fail. The insurance claims included liability for removing systems from their locations in constructed buildings and for diminution of value of the buildings from the presence of allegedly defective plumbing, even if not yet leaking. Many of the policies provided coverage for "damages because of property damage", with "property damage" defined as "physical injury to tangible property". The contracts were governed by the law of Illinois.
112 In Eljer Manufacturing Inc v Liberty Mutual Insurance Co, a majority of the Seventh Circuit Court of Appeals found in favour of the insureds. The owners of the construction sites had suffered property damage from the moment that the defective plumbing systems were installed, even before the systems had failed.
113 Circuit Judge Posner began by considering the interaction between the ordinary meaning of "physical injury" and the objectives of insurance contracts. The judge explained at 808-10 that:
The central issue in this case - when if ever the incorporation of one product into another can be said to cause physical injury - pivots on a conflict between the connotations of the term "physical injury" and the objective of insurance. The central meaning of the term as it is used in everyday English - the image it will conjure up in the mind of a person unschooled in the subtleties of insurance law - is of a harmful change in appearance, shape, composition, or some other physical dimension of the 'injured' person or thing. If water leaks from a pipe and discolours a carpet or rots a beam, that is physical injury, perhaps beginning with the very earliest sign of rot - the initial contamination (an important question in asbestos cases as we shall see). The ticking time bomb, in contrast, does not injure the structure in which it is placed, in the sense of altering the structure in a harmful, or for that matter in any way - until it explodes. But these nice, physicalist, 'realistic' (in the philosophical sense) distinctions have little to do with the objectives of parties to insurance contracts. The purpose of insurance is to spread risks and by spreading cancel them. …
Nor are literal interpretations, which assume that words or phrases are always used in their ordinary-language sense, regardless of context, the only plausible interpretation of contractual language, especially when the contract is between sophisticated business entities. We should at least ask what function "physical injury" might have been intended to perform in a comprehensive general liability policy beyond just drawing a commonsensical, lay person's, ordinary-language distinction between physical injury and physical non-injury.
Apparently the term was intended to distinguish between physical and non-physical injuries rather than to distinguish between injuries and non-injuries.
114 The last proposition in this passage was substantiated with reference to the drafting history of the CGL policy. The judge then said at 810 that:
We can now see more clearly that two senses of "physical injury" are competing for our support. One, which the insurers want us to adopt, is an injury that causes a harmful physical alteration in the thing injured. The other, which is what the draftsmen of the Comprehensive General Liability policy apparently intended and what rational parties to such a policy would intend in order to make the policy's coverage real and not illusory, is a loss that results from physical contact, physical linkage, as when a potentially dangerous product is incorporated into another and, because it is incorporated and not merely contained (as a piece of furniture is contained in a house but can be removed without damage to the house), must be removed, at some cost, in order to prevent the danger from materializing. There is an analogy to fixtures in the law of real and personal property - improvements to property that cannot be removed without damaging it. In effect we are being asked to choose between "physical injury" and "physical injury".
115 Judge Posner preferred the latter sense, justifying the distinction at 810-11 as follows (omitting citations):
Human beings give structure to their experience - cut the world of perception up into usable slices - through language, in accordance with the needs and interests of the moment. For many purposes the distinction between touching and altering is important; if two automobiles collide, it makes a big difference whether they merely touch each other or dent each other. For other purposes, other distinctions are more important, such as that between harms from touching, whether or not some harmful physical change ensues, and harms from other interferences with valued interests.
Within the class of unintentional torts, too, the distinction between touching and not touching is often made. Under traditional tort law, if you hit a bridge and put it out of commission, you are liable to the owner of the bridge but not to merchants who lose business because customers cannot reach them with the bridge down. You have not touched the merchants or their property. The doctrine of "economic loss," illustrated by the Rickards case, makes touching a prerequisite to tort liability for damage to property and thus rules out loss-of-use claims by persons with whose property the tortfeasor had made no physical contact.
116 The majority's conclusion was provided at 814:
[T]he drafting history of the property-damage clause, and the probable understanding of the parties to liability insurance contracts, persuade us that the incorporation of a defective product into another product inflicts physical injury in the relevant sense on the latter at the moment of incorporation - here, the moment when the defective Qest systems were installed in homes.
117 That conclusion should be read in light of what was said earlier at 812, where Judge Posner clarified that:
We do not think that every time a component part fails, the resulting injury can be backdated to the date of installation or incorporation. The expected failure rate must be sufficiently high to mark the product as defective - sufficiently high, as is alleged to be the case regarding the Qest plumbing system, to induce a rational owner to replace it before it fails, so likely is it to fail. That condition was satisfied.
118 Circuit Judge Cudahy dissented. He explained at 814 that:
There is immediately something counter-intuitive about saying that physical injury has been done to a house in which a functioning plumbing system has been installed. Of course, when we determine later (years later) that a good number of the systems will fail - five percent in this case - then perhaps there is a sense in which the "injury" was present from the moment of installation: this is the majority's "ticking time bomb" metaphor. But is there physical injury? The majority believes that interpreting the phrase is all a matter of emphasis - "physical injury" versus "physical injury." In my view, the phrase must be interpreted as "physical injury" with both words given effect. The majority's account cannot give both words meaning at the same time. Something physical occurs when the plumbing is installed - but it is not injury; and we might say that there is injury (of a sort) when the plumbing is installed - but it is not physical.
119 Judge Cudahy's dissenting position was preferred by the Supreme Court of Illinois in Traveler's Insurance Co v Eljer Manufacturing Inc (2001). On substantially the same facts as those considered by the Seventh Circuit, the Supreme Court concluded at 502 that:
under its plain and ordinary meaning, the term "physical injury" unambiguously connotes damage to tangible property causing an alteration in appearance, shape, color or in other material dimension. We reject the policyholders' assertion that, under the post-1981 excess CGL policies, the very installation of a functional Qest system into a structure constitutes "property damage." Insurance coverage is not triggered where the Qest system does not cause any physical injury to tangible property during the policy period and performs as intended. The plain language of the policies unambiguously states that the insurable event which gives rise to the insurers' obligation to provide coverage is the physical damage to tangible property. The term "physical" limits the word "injury" in the policies' definition of "property damage."
We also conclude that under its plain and ordinary meaning, the phrase "physical injury" does not include intangible damage to property, such as economic loss. We agree … that the diminution in value of a whole, resulting from the failure of a component to perform as promised, does not constitute a physical injury.
120 The Supreme Court of Illinois went on to endorse the thrust of CGU's argument in the present case, pointing out at 503 that:
if we were to interpret the post-1981 excess CGL policies as urged by the policyholders, "the policy would not only provide insurance against tort liability, but would function as a performance bond as well." As explained more fully in Qualls:
"[C]omprehensive general liability policies … are intended to protect the insured from liability for injury or damage to the persons or property of others; they are not intended to pay the costs associated with repairing or replacing the insured's defective work and products, which are purely economic loss. Finding coverage for the cost of replacing or repairing defective work would transform the policy into something akin to a performance bond."
121 Somewhat ironically in light of the federal-state divide just identified, the only American authority which CGU specifically drew to my attention in the context of question 1(a) was a decision of the Seventh Circuit Court of Appeals: Hamilton Die Cast Inc v United States Fidelity and Guaranty Co 508 F 2 d 417 (1975). That case concerned an insured who had supplied tennis rackets with defective frames. The incorporation of a defective part (the frame) was said to be property damage (relevantly defined as "injury to … tangible property"). The Seventh Circuit Court of Appeals rejected the claim, stating at 419 that (emphasis added):
We do not think that the mere inclusion of a defective component, where no physical harm to the other parts results therefrom, constitutes "property damage" within the meaning of the policy.
122 Hamilton Die Cast was discussed in Carwald at 65, but ultimately distinguished. On the facts of Carwald, the pouring of the defective concrete did damage other property. As explained above, the pouring of the concrete physically injured the rebars, reinforcing steel and other equipment.