Contractual Liability Exclusions: How Far do they Reach?

By: Avi Sharabi and Lujza Csanyi

Commercial operations by nature often involve contracts, whether written or verbal. The commercial general liability (“CGL”) policy’s standard form wording contains a contractual liability exclusion. The exclusion is, on the one hand, often broadly worded. However, on the other hand, it contains exceptions which carve back the exclusion in scope. In particular, the clause often contains an exception for “liability that the insured would have in absence of the contract”. This exception raises questions of the applicability of the exclusion to certain claims where both breach of contract and torts are alleged against the insured. After all, a single wrongful act (so to speak) of an insured can constitute a breach in tort and a breach in contract.[1] Liability can be concurrent. As a result, an insurer may ask, where a claim for breach of contract is advanced against the insured concurrently with tort claims, is the insurer still required to provide coverage, or does the contractual liability exclusion apply? In the 2021 decision by the Ontario Court of Appeal in Panasonic Eco Solutions Canada Inc. v XL Speciality Insurance Company[2] (“Panasonic”), the Court attempted to answer this question. This decision can help insurers better understand the practical effects of this exclusion, and when to apply it. This paper is meant for information purposes only, and is not to be taken as legal advice.

Interpreting CGL Policies

Prior to delving into the contractual liability exclusion and the Panasonic case, it is important to understand or refresh our memories as to how insurance contracts are to be interpreted. The CGL policy insures against, among other things, third party liability for bodily injury and property damage that arises out of the course of the insured’s business operations. CGL insurance is particularly important because a business owner comes into contact with many third parties, including clients, vendors, other businesses and the general public. Without CGL insurance coverage, the business owner would be personally liable for losses sustained by these third parties as a result of their business operations.

Each insurer drafts CGL policies to their liking. However, some CGL insurers use standard wording adopted by the Insurance Bureau of Canada (“IBC”). Regardless, the primary interpretive principle in insurance law is to give effect to the clear, unambiguous wording of the policy. That is why each policy’s wordings should be carefully reviewed, regardless of whether they appear to conform with standard form wording or not.

The body of IBC Form 2100 generally has five main sections:

1. 1. Coverages;
2. 2. Who is an Insured;
3. 3. Limits of Insurance;
4. 4. Commercial General Liability Conditions; and
5. 5. Definitions

Coverage analysis should always begin with the policy Declarations. This page details the insured party’s name, the nature of their business, the amount and type of coverage purchased, and the policy year. The party seeking the benefit of coverage generally relies on the Declarations to show that it is an insured, that an event triggering coverage happened during the policy period, and the claim engages the Insuring Agreement. If the insured fails to show that the underlying claim falls within the Insuring Agreement, there is no entitlement to coverage.

Insuring Agreements are generally interpreted broadly. Exclusions are generally narrowly construed. Insurers have the onus of demonstrating that an exclusion, or any other limitation to coverage, applies. If an insurer is successful in showing that an exclusion exists,  the policyholder may argue that an exception to the exclusion brings the otherwise excluded claim back under coverage.

As Justice Rothstein held in Progressive Homes Ltd. v Lombard General Insurance Co. of Canada, [2010] 2 SCR 245, 2010 SCC 33 (“Progressive Homes”) (at para. 22):

[22] The primary interpretive principle is that when the language of the policy is unambiguous, the court should give effect to clear language, reading the contract as a whole.

[23] Where the language of the insurance policy is ambiguous, the courts rely on general rules of contract construction. For example, courts should prefer interpretations that are consistent with the reasonable expectations of the parties, so long as such an interpretation can be supported by the text of the policy. Courts should avoid interpretations that would give rise to an unrealistic result or that would not have been in the contemplation of the parties at the time the policy was concluded. Courts should also strive to ensure that similar insurance policies are construed consistently. These rules of construction are applied to resolve ambiguity. They do not operate to create ambiguity where there is none in the first place.

With that in mind, the remaining focus shall be on the contractual liability exclusion.

Contractual Liability Exclusion Clauses

The current IBC Form provides the following example of a contractual liability exclusion:

This insurance does not apply to:

“Bodily injury” or “property damage” for which the insured is obligated to pay compensatory damages by reason of the assumption of liability in a contract or agreement. 

There are two exceptions to the exclusion:

This exclusion does not apply to liability for compensatory damages:

(1) assumed in a contract or agreement that is an “insured contract”; or

(2) That the insured would have in the absence of the contract or agreement (emphasis added)

Contracts that fall within the “Insured contract” exception are defined and enumerated. The IBC Form 2100 wording defines an “Insured contract” as[3]:

1. 1. A lease of premises;
2. 2. A sidetrack agreement;
3. 3. An easement or license agreement in connection with vehicle or pedestrian private railroad crossings at grade;
4. 4. Any other easement agreement;
5. 5. An indemnification of a municipality as required by ordinance, except in connection with work for a municipality;
6. 6. An elevator maintenance agreement; or
7. 7. That part of any contract or agreement pertaining to your business under which you assume the tort  liability of another to pay compensatory damages because of “bodily injury” or “property damage” to a third person or organization, if the contract or agreement is made prior to the “bodily injury” or “property  damage”. Tort liability means a liability that would be imposed by law in the absence of any contract or agreement.

An “insured contract” does not include that part of any contract or agreement that indemnifies an architect, engineer or surveyor for injury or damage arising out of:

1. 1) Preparing, approving or failing to prepare or approve maps, drawings, opinions, reports, surveys, change orders, designs or specifications; or
2. 2) Giving directions or instructions, or failing to give them, if that is the primary cause of the injury or damage.

The remaining focus will be on the second exception to the contractual liability exclusion: liability for compensatory damages that the insured would have in the absence of the contract or agreement.

The intent of a liability insurance policy such as the CGL, is to cover certain types of unintentional torts, but not purely contractual liability. The second exception to the exclusion is an acknowledgement that contract and tort exposure sometimes overlap. This overlap often creates a grey area where it can become unclear as to whether the exclusion should be applied or not. The key issue appears to be whether the concurrent tort liability is viewed as derivative of, or independent of, the claims in breach of contract.

The tension created by concurrent liability exposure was considered by the Court in Canalta Construction Co. v Dominion of Canada General Insurance Co[4]. The Court of Queen’s Bench of Alberta considered whether an insurer had a duty to defend. The lawsuit alleged both breach of contract and negligence. The insured, Canalta, was a general contractor and developer that was retained to design and construct a number of condominium units. The condominium corporation alleged that Canalta’s design and construction work was faulty, resulting in failure of a water main and failure of a roof system to repel water vapour and to provide insulation to the premises.[5] Canalta sought a declaration that its insurer, the Dominion of Canada General Insurance Company (“Dominion”) was required to defend it in the action commenced against it by the condominium corporation. The subject CGL policy contained the same contractual liability exclusion as the sample IBC exclusion noted above. Dominion argued that this exclusion precluded a duty to defend. The Court disagreed.

The Court held that there were construction deficiencies alleged that were independent, and not derivative of, certain alleged breaches of contract. In particular, the Court was of the view that the negligent design/construction allegations as pleaded could not be said to have been simply redundant of the breach of contract claims. There was, therefore, a mere possibility that the second exception to the exclusion could apply. The Court ordered Dominion to defend Canalta.[6] If that is the case, one wonders when this exclusion could be applied in a similar context. After all, construction contractors do not simply show up to do work out of the kindness of their hearts. There has to be an agreement in place to perform the work for a specified price. A failure to properly carry out that work should be a breach of that agreement. One wonders, why would the exclusion not apply to such claims. On the other hand, one could argue that such an application would result in the over-denial of claims; thus, rendering coverage under a CGL policy illusory in many circumstances.

The Ontario Court of Appeal tried to resolve this tension in Panasonic. This decision concerned a declaration for a duty to defend pursuant to a professional errors and omissions (“E&O”) policy for an arbitration commenced against the insured, Panasonic by Solar Flow-Through Fund (“Solar Flow”). Note that other liability policies, such as E&O and D&O policies, often contain similarly worded contractual liability exclusions. As such, while this decision did not concern the interpretation of a CGL policy, it is relevant to the CGL policy, because the subject exclusion contained the following relevant language:[7]

This Policy does not apply to any Claim … arising from the Insured’s:

1. 1. assumption of liability in a contract or agreement; or
2. 2. breach of contract or agreement.

This exclusion does not apply to: (i) liability that the Insured would have in the absence of the contract or agreement… (emphasis added)

Solar Flow alleged that Panasonic breached its contractual obligations pursuant to two agreements. Under the first agreement (“the engineering agreement”), Panasonic was required to procure, construct, and install roof-mounted solar electricity generating systems. Solar Flow entered into a number of 20 year-contracts with Ontario’s Independent Electricity System Operator (IESO), under which it planned to sell the electricity generated by Panasonic. The engineering agreement required Panasonic to achieve substantial completion by a guaranteed date. The engineering agreement stipulated that if Panasonic failed to complete the project by this date, it would be required to pay liquidated damages. Importantly, the engineering agreement stipulated that the payment of liquidated damages would be Solar Flow’s only remedy for delay.[8] As a result, if Panasonic delayed the project, Solar Flow could not bring a claim in tort, or any other cause of action for damages.

Panasonic failed to achieve substantial completion by the agreed upon date, which resulted in the IESO cancelling seven of its contracts with Solar Flow. Consequently, Solar Flow sought $92,309.62 in liquidated damages pursuant to the engineering agreement.

Following the cancellation of the contracts, the IESO reissued five contracts to Panasonic. These re-issued contracts became the subject of the second agreement  between Solar Flow and Panasonic (“the proceeds agreement”). Under the proceeds agreement, Panasonic was required to pay Solar Flow a portion of the proceeds from its sale of the projects to the IESO. Solar Flow anticipated that it could recover a minimum of $1.3 million in sunk costs. Panasonic failed to pay Solar Flow under this agreement. As a result, Solar Flow sought damages for Panasonic’s breach.

At first instance, the application judge found that the insurer only had a duty to defend the claim arising from the engineering agreement. In particular, Koehnen J. found that Panasonic’s delay was not simply a breach of contract. Rather, the delay could have been caused by Panasonic’s negligence, which would bring Solar Flow’s claim within coverage.[9] Moreover, it was inconsequential that Solar Flow did not plead negligence in its statement of claim, as it pled facts that were capable of supporting the tort of negligence.[10] However, based on the record before him, the application judge was not able to determine whether the delay was actually caused by Panasonic’s negligence. Thus, the application judge held that the insurer had a duty to defend the allegations of delay under the engineering agreement, unless the delay later turned out to be due to deliberate acts or omissions.[11]

In contrast, the claim for a share of subsequent proceeds under the proceeds agreement was found to be a debt claim, which fell squarely under the contractual exclusions exception. As a result, the insurer was ordered to defend and retained the right to appoint counsel to address the delay claim while Panasonic was given carriage of and defence funding responsibility for the non-covered subsequent proceeds claim.

The Ontario Court of Appeal reversed the application judge’s decision and held that liability arising from Panasonic’s breach of both the engineering agreement and proceeds agreement was excluded by the contractual liability exclusion.

The Court of Appeal first considered when the duty to defend is engaged. It explained that the duty to defend is triggered in instances where the facts alleged in the pleading would, if true, require the insurer to indemnify. Therefore, the duty to defend is broader than the duty to indemnify because it is triggered by the mere possibility of indemnity. As a result, if the claim, read broadly, alleges facts that might fall within coverage, the duty to defend arises. It is important to note that this analysis considers the substance of the claim, rather than the cause of action selected by the claimant. Therefore, if the substance of the claim fell within coverage, then the insurer would have a duty to defend Panasonic in the arbitration proceedings.[12]

To investigate whether the claim fell within coverage, the Court applied the principles of interpretation as summarized by the Supreme Court in Progressive Homes. The Court found that the contractual liability exclusion was unambiguous: the policy did not cover a claim that arises from an insured’s assumption of liability in a contract or from an insured’s breach of contract. Next, the Court considered the meaning and effect of the exception “liability that the insured would have in the absence of the contract or agreement”.

The Court found that this exception was ambiguous, because the insured would have had no relationship with Solar Flow in the absence of a contract. If there was no contract, no services would be performed, and there would be nothing to insure. What the Court appears to have been concerned about was that a literal reading would effectively nullify the coverage the parties reasonably intended. As noted above, in order to resolve an ambiguity, one ought to give effect to the reasonable expectations of the parties, in consideration of how similar wording has been previously interpreted. The Court concluded that the reasonable expectations of the parties would have been that the policy covered:

1. 1. liability for losses to third parties as a result of the insured’s negligence in performing its services under the contract with the plaintiff; and
2. 2. liability to the plaintiff because the insured negligently performed its contractual obligations, in accordance with the doctrine of concurrent liability in contract and in tort.

Therefore, the Court held that the contractual liability exclusion clause does not negate coverage simply because the parties are engaged in a contractual relationship with one another. However, the claim made under the engineering agreement was for liquidated damages. This was a claim for contractual relief, and was therefore excluded under the contractual liability exclusion.

In particular, the Court held[13]:

 A liquidated damages clause, such as this one, demonstrates the fairness of the contractual exclusion and exception clause of the insuring agreement, when it is interpreted in accordance with the reasonable expectations of the parties to that agreement. An insured is free to make whatever promises it wishes when it contracts to perform services, for example for remedies for its breach. Panasonic could have agreed to pay liquidated damages to Solar in any amount as part of the consideration for the contract. But it could not bind its insurer to that bargain. The insurer is only obligated to cover liability that the insured would have had without the contract.

Panasonic agreed to pay Solar Flow liquidated damages as the sole remedy in the event of delay. In doing so, Panasonic was found to have contracted out of coverage under its professional errors and omissions policy because it could not bind its insurer to this additional contractual obligation. The Court held that the exception did not apply because the obligation to pay liquidated damages was purely contractual.

As for the claim under the proceeds agreement, the Court of Appeal agreed with the application judge that it was a claim arising under the contract. Therefore, if the claim came within the coverage under the policy, it was excluded by the contractual liability exclusion clause, and was not saved by the exception to the exclusion.

As such, where the sole basis for relief lies in breach of contract, without independent tortious claims, coverage ought to be denied. Although coverage is to be interpreted broadly, and exclusion clauses narrowly, where the elements of the tort are not independently present, coverage is unlikely to exist. This accords with the reasonable expectations of parties, as it does not negate coverage entirely where breach of contract is involved. Where there is concurrent liability in tort and contract, coverage may exist. As a further matter, insureds are free to contract as they wish. However, if they choose to contract out of tort liability, the Court of Appeal appears to have affirmed that such agreements ought not to bind insurers.

Other Issues Considered

1. Liability vs Obligation

An issue that has been considered is the difference between liability and an obligation in contract, in the context of this exclusion.

For example, in Westaqua Commodity Group Ltd. v Sovereign General Insurance Co.[14], the insured supplied ammonia contaminated corn gluten meal product to a customer for use in the manufacture of fish food. The unusable product was destroyed by the third party who then made a claim against the plaintiff. The insured sought indemnification from its CGL insurer for disposal costs. The insurer argued that the claim was for an unpaid refund arrangement for disposal costs, creating an “obligation” within the scope of the contractual liability exclusion. Moreover, it argued that the unused product was not used for fish food, it did not cause any damage, and therefore did not give rise to any liability that would trigger coverage under the CGL.

The Court ultimately held that the exclusion applied to the insured’s assumption of “liability” and not the assumption of an obligation. There was no liability alleged in this case, therefore the exclusion did not apply.

It is unclear how applicable this reasoning is. First, the Court had already decided that no occurrence had arisen; thus, there was no indemnity. The comments about exclusions were in obiter. Second, the Court took an approach that was arguably overly technical and relied on semantics to find that the exclusion did not apply. It is not clear whether such an approach would be applied in future cases.

2. Statutory Warranties

Canadian courts have also considered the interplay between statutory warranties and breach of contract as it applies to this exclusion. This issue often arises in the construction context, in relation to the Ontario New Homes Warranty Plan Act[15] (“ONHWP”). Canadian courts have generally held that liability arising from legislative requirements does not fall under the contractual liability exclusion clause. Liability arising from legislative requirements is wholly distinct from liability arising from contractual relationships, and therefore the exclusion does not apply. If insurers wish to exclude coverage from claims resulting from the ONHWP legislative scheme, clear and precise language must be used to effect that objective.[16]

3. Wrongful Dismissal Claims

Generally, wrongful dismissal claims should be excluded by contractual liability exclusions. For example, severance allowances and compensation in lieu of reasonable notice arise from the employment contract, and are therefore excluded from coverage. However, claims cleverly framed in tort may result in there being a duty to defend. For instance, certain tortious claims resulting from the manner of dismissal, such as cases involving dismissal where mental distress, loss of reputation or embarrassment is proved and is in some way linked to the termination of employment may invoke coverage.[17]

4. Equity vs Contract

Another interesting consideration is the distinction between claims in contract and claims based in equity.

Equitable claims may be covered by a liability insurance policy, as a claim by a beneficiary against his trustee is neither in contract, nor in tort but in equity. As a result, equitable claims may fall under the exception to the contractual liability exclusion.[18] However, note that some US courts have found that certain equitable claims, such as unjust enrichment and conversion, were inextricable from claims for breach of contract.[19] As noted above, the issue will often boil down to whether the non-contractual claims can be framed as derivative of the contractual claims or not.

Conclusions

The foregoing summary underscores that whether a claim will be caught by the contractual liability exclusion, or saved by one of its exceptions, depends on a careful reading of the applicable policy and the substance of the allegations being made. If the non-contract allegations in the claim can be framed as derivative of the contract claims, the exclusion will likely apply. Otherwise, courts may find it difficult to uphold a denial of coverage based upon the contractual liability exclusion. Further, where an insured has contracted out of tort liability, that insured may find that it has effectively contracted out of the “liability in absence of the agreement” exception to the exclusion. Insurers should consider these issues before seeking to apply this exclusion.

[1] Bg Checo International Ltd. v. British Columbia Hydro & Power Authority, [1993] 1 SCR 12 at para 21.

[2] 2021 ONCA 612 [Panasonic].

[3] Snowden & Lichty, Annotated Commercial General Liability Policy at 15-2 –15-3.

[4] [2013] I.L.R. I-5441 (Alta Q.B.) [Canalta].

[5] Canalta at para 3.

[6] Canalta at para 33.

[7] Panasonic at para 11.

[8] Panasonic at para 38.

[9] Panasonic at para 16.

[10] Panasonic at para 16.

[11] Panasonic at para 17.

[12] Panasonic at para 22.

[13] Panasonic at para 39.

[14] 2014 BCSC 263 (CanLii).

[15] R.S.O. 1990, c. O.31.

[16] Bridgewood Building Corp. (Riverfield) v Lombard General Insurance Co. of Canada, 2005 CanLII 63763 (ONSC) at para 39.

[17] Acklands Ltd. v Canadian Indemnity Company, 1984 CanLII 3655 (MB QB) at 767-768.

[18] Operating Engineers’ Pension Plan v Commercial Union Assurance Co. of Canada, 1989 CanLII 2719 (BC SC).

[19] Global Fitness Holdings, LLC v Navigators Management Co., Inc., et al. No. 20-5774, 2021 WL 1884593 (May 11, 2021)