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An Unambiguous Exclusion Clause with an Ambiguous Exception: The Latest from the Court of Appeal on the Duty to Defend

6 minute read

Introduction

In Panasonic Eco Solutions Canada Inc. v XL Specialty Insurance Company, 2021 ONCA 612, the Court of Appeal for Ontario provided the latest appellate guidance on an insurers’ duty to defend. The application judge held that the insurer had a duty to defend one of the claims against the insured, but not the other. However, the Court of Appeal allowed the insurer’s appeal, dismissed the insured’s cross appeal, and held that there was no duty to defend either claim.

Panasonic had two agreements with a collection of companies (“Solar”) called the Engineering Agreement, and the Proceeds Agreement. Solar initiated two claims for breach of contract against Panasonic in an arbitration proceeding, and Panasonic sought defence coverage from its insurer, XL Specialty. The applicable insurance policy was a professional errors and omissions policy that excluded contractual liability unless the insured would have had the liability in the absence of the contract. The applicable exclusion read:

This Policy does not apply to any Claim…

B. Contractual Liability arising from the Insured’s:

  1. assumption of liability in a contract or agreement; or
  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…

Analysis

The court began by outlining the applicable general legal principles:

  • The determination of whether the duty to defend is triggered rests on the pleading by the claimant against the insurer. If the facts alleged in the pleading would, if true, require the insurer to indemnify, then the duty to defend is triggered. That is, the duty to defend is triggered by the mere possibility of coverage.
  • When interpreting an insurance policy, a court is to give effect to the clear language of the policy, provided that the wording of the policy is unambiguous. If the wording of the policy is ambiguous, the general rules of contractual interpretation apply including that courts should prefer interpretations that give effect to the reasonable expectations of the parties, and that provide a realistic result that is consistent with the interpretation given to similar policies.

Applying these principles, the court found that the contractual exclusion was unambiguous. Its plain language made it clear that claims arising from the insured’s assumption of liability in contract or the insured’s breach of contract would not be covered.

The court noted that if the contractual exclusion did not contain the exception contained in subsection (i), then the exclusion may not have been given any effect by the court as it would have made any coverage under the policy illusory, because the insured always provided its professional services under a contract.

The court did find that the exception to the exclusion in subsection (i) was ambiguous because the insured would have no relationship with the claimant if there was no contract between them under which the insured provided services to the claimant, and therefore nothing to insure.

However, applying the principles of contractual interpretation, the meaning of the exception was clear: the policy covers losses caused by the insured in its relationship with the claimant that arise in law aside from the terms of their contract. This would include coverage for liability for losses suffered by third parties as a result of the insured’s negligence in performing the contract, and coverage for liability to the claimant for the insured’s negligence in performing its contractual obligations under the doctrine of concurrent contractual and tort liability.

This interpretation gave effect to the parties reasonable expectations in light of the purpose of an errors and omissions insurance policy, which is to hold an insurer responsible for the losses caused by the insured’s negligent performance of its professional obligations, but not to provide indemnity for extra obligations that an insured undertakes in a contract.

Application to the Agreements

Under the Engineering Agreement between Panasonic and Solar, Panasonic was to construct solar electricity generating systems and achieve substantial completion by a specific date, which it failed to do.

Article 13 of the Engineering Agreement stipulated that Panasonic would pay liquidated damages if a system had not reached substantial completion by the due date due to its acts or omissions, and that the “amounts payable under this Article 13 shall be [Solar]’s sole and exclusive remedy for [Panasonic]’s failure to achieve Substantial Completion….”

Therefore, while Panasonic’s delay would ordinarily have triggered coverage, it effectively contracted out of the coverage by agreeing to the liquidated damages clause, as the obligation to pay liquidated damages is contractual and would not have otherwise arisen.. The clause also had the effect of Solar contracting out of any claim against Panasonic for negligence, as the claim for liquidated damages became the “sole and exclusive remedy.”

Under the “Proceeds Agreement,” Panasonic agreed that if it completed construction of some of the solar electricity generating systems pursuant to agreements with Ontario’s Independent Electricity System Operator (“IESO”), it would pay Solar a portion of the sale proceeds. Panasonic completed and sold the projects but refused to pay Solar any portion of the proceeds of sale.

The court held that the claim under the Proceeds Agreement triggered the exclusion clause in the insurance policy because this claim represented a debt owing as a result of a contract. The claim could not come within the exception to the exclusion because Panasonic would not have any liability to pay Solar in the absence of the Proceeds Agreement. In other words, there would be no claim without the contract.

Finally, Solar’s claims for unjust enrichment and negligent misrepresentation did not trigger coverage. The unjust enrichment claim was barred as the policy explicitly excluded indemnity for equitable relief. The negligent misrepresentation claim was based solely on Panasonic’s breach of contract in failing to pay Solar under the Proceeds Agreement. As the negligent misrepresentation claim depended on the breach of contract claim, the contractual liability exclusion was triggered and the exception to the exclusion did not apply.

Conclusion

This decision reiterates the importance for insurers to draft the exclusionary terms of their policies carefully so that courts will not find ambiguity and resort to interpretive principles beyond the plain language of the contract.

It also provides guidance on how courts will interpret similarly worded exclusions that preclude coverage for contractual liability unless the insured would have had the liability in the absence of the contract. This type of contractual liability exclusion clause is common in errors and omissions policies across a number of industries.

The decision also acts as a warning to insureds to carefully consider the agreements that they enter into as the terms of those contracts may lead them to unwittingly contract out of their insurance coverage. Further, claims for relief other than breach of contract may not trigger coverage if those claims necessarily depend on the existence of and breach of a contract.

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