Regular readers know that a recurring topic I have explored on this site is the scope of the contractual liability exclusion found in many professional liability and management liability insurance policies. In prior posts I have argued that insurers sometimes apply the exclusion over-broadly so as to exclude matters that I believe should otherwise be covered under the policy. However, in a recent appellate ruling, in which the Ontario Court of Appeal concluded that as a result of the application of the contractual liability exclusion, a solar panel engineering company’s E&O insurer did not have a duty to defend the company in an underlying arbitration proceeding. As discussed below, I believe the appellate court’s reasoning is sound and that the case represents an example not only of when the exclusion may be applied appropriately but also of the appropriate limits of the exclusion’s reach. A copy of the Ontario court’s September 10. 2021 opinion can be found here.
Panasonic Eco Solutions Canada manufactures and installs solar panels. Panasonic entered two agreements with Solar Flow-Through Fund. Under the first of the two agreements (the Engineering Agreement), Panasonic agreed to construct and install roof top solar electricity systems for Solar Flow-Through. Solar Flow-Through intended to sell the electricity generated by the panels to Ontario’s Electricity System Operator (IESO). Panasonic failed to complete the solar panel installations pursuant to the agreed timeline in the Engineering Agreement.
Thereafter, Panasonic, Solar Flow-Through, and the IESO entered into negotiations that resulted in revised agreement (the Proceeds Agreement) with respect to certain of the originally intended solar panel installations. Of critical importance, under the Proceeds Agreement, Panasonic was to complete the planned installation and pass through a portion of the installation proceeds to Solar Flow-Through. Solar Flow-Through later claimed that Panasonic failed to remit to Solar Flow-Through the proceeds that Panasonic allegedly agreed to pay to Solar Flow-Through under the Proceeds Agreement.
Solar Flow-Through initiated arbitration proceedings against Panasonic. In the arbitration, Solar Flow-Through asserted two claims against Panasonic: first, for liquidated damages under the Engineering Agreement, based on Panasonic’s failure to complete the planned solar panel installations within the agreed timetable; and second, for the payment of the proceeds that Solar Flow-Through claimed that Panasonic agreed to pay under the Proceeds Agreement.
Panasonic submitted the arbitration proceeding to its E&O insurer as a claim under the policy. The insurer denied that it had a duty to defend Panasonic in the claim, in reliance, among other things, on the policy’s contractual liability exclusion. Panasonic initiated legal proceedings against the insurer, seeking a judicial declaration that the insurer had a duty to defend Panasonic in the arbitration proceeding. The lower court (referred to by the appellate court as “the application judge”) ruled that the insurer had a duty to defend Solar Flow-Through’s arbitration claim for liquidated damages under the Engineering Agreement but that the insurer had no duty to defend Panasonic for Solar Flow-Through’s arbitration claim for remittance of the proceeds under the Proceeds Agreement. Panasonic and the insurer both filed appeals of the application judge’s rulings.
The Contractual Liability Exclusion
The policy’s contractual liability exclusion provides that “This policy does not apply to any Claim … 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.”
The September 10, 2021 Opinion
In a unanimous September 10, 2021 opinion written for a three-judge panel of the Ontario Court of Appeal by Justice Kathryn Feldman, the appellate court held that the insurer had no duty to defend either claim.
The appellate court first addressed Panasonic’s argument that the exclusion was ambiguous. Panasonic argued that the effect of the exclusion, if read literally, would be to “nullify the coverage under the policy, because the insurer always provides its professional services under a contract, as it did here.” In making this argument, Panasonic relied on the Seventh Circuit’s 2019 opinion in Crum & Forster Specialty Insurance Company v. DVO (discussed in a prior post here), in which the Seventh Circuit has said that the contractual liability exclusion at issue in that case was so broad that it rendered coverage under the policy “illusory.”
The Ontario court rejected the argument that the exclusion itself was ambiguous, noting, among other things, that the policy at issue in the DVO case, unlike Panasonic’s policy, did not contain the exception to the exclusion. However, the appellate court went on to hold that the exception to the exclusion, was in fact, ambiguous because, the court said, “the insured would have no relationship with the claimant if there had been no contract or agreement between them under which the insured provided professional service.” If there had been no contractual relationship, “no services would have been performed and there would be nothing to insure.” That, the court said, “clearly was not what was intended.”
Given that ambiguity, the Court said, the correct way to interpret the policy under applicable contractual interpretation provisions was to “give the words the interpretation that accords with 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 to the parties’ insurance dispute the meaning of the exception to the exclusion “becomes clear.” The policy, the court said, “continues to cover professional losses caused by the insured in performing its professional functions in relationship with the claimant that arise in law, regardless of the term of their contract.”
Under this view, “the insurer will be responsible for the losses caused by the insured’s negligent performance of its professional obligations; but the insurer will not indemnify the insured for any extra obligations it undertakes in a contract, or for the breach of any extra obligations that it undertakes in a contract.”
In light of this interpretation of the contractual liability exclusion, the appellate court quickly concluded that the insurer had no duty to defend Panasonic with respect to either of the two claims in the underlying proceeding.
First, with respect to the claimant’s claim for liquidated damages under the Engineering Agreement, the appellate court said that while the delay for which the claimant was seeking damages was the result of an act or omission Panasonic’s performance obligations, “by agreeing to liquidated damages, Panasonic effectively contracted out of its insurance coverage.” The exception to the exclusion does not apply “because the obligation to pay liquidated damages is purely contractual and does not otherwise arise.” The court noted that this outcome “demonstrates the fairness of the contractual exclusion,” observing that Panasonic could have agreed to any amount of liquidated damages, but it could not thereby “bind its insurer to the bargain,” as the insurer is only obligated to cover liability that the insured would have had in the absence of the contract.”
Next, with respect to the claimant’s claim for remittance of a portion of the proceeds under the Proceeds Agreement, the appellate court concluded that the claimants’ claim arose out of the Proceeds Agreement, bringing the claim squarely within the exclusion. The court went on to note that the exception to exclusion did not apply because Panasonic would not have had the liability to remit the proceeds to the claimants except under the contract. The remittance, the courts said, “amounted to a debt.” The court went on to say that the fact that the claimant asserted, in addition to a breach of contract claim, claims for negligent misrepresentation and for unjust enrichment, did not change the analysis. Regardless of the claimant’s theory, the claims are based on Panasonic’s failure to make the payments required under the Proceeds Agreement.
I have reviewed the court’s analysis of the coverage issues at some length, because, along the way, the appellate court makes some observations that I think shed some important light on the contractual liability exclusion.
First, the court noted that the exclusion and the exception, if read literally, could swallow up the very reason for the insurance in the first place. Since the insured’s delivery of professional services in every instance arises out of contract, literal application of the exclusion could eliminate coverage on every occasion. It is this aspect of the exclusion’s reach that has always bothered me; at a minimum, insurers in some instances have relied on this attribute of the exclusion to try to apply it over broadly.
The second important point in the court’s analysis was its consideration of the exclusion’s reach in light of this potential for overbreadth. In effect, what the court said was, given this aspect of the exclusion, the exclusion has to be applied in a way that makes sense given the policy’s purposes. From this starting point, the court concluded that notwithstanding the exclusion, the policy “continues to cover professional losses caused by the insured in performing its professional functions in its relationship with the claimant that arise in law, regardless of the terms of their contract,” but the insurer is not obligated to indemnify the insured for any obligations that the insured specifically bound itself to in a contract.
Under this reading, it is clear that the liquidated damages to which Panasonic agreed in the Engineering Agreement and the payments to which Panasonic agreed in the Proceeds Agreement are voluntarily undertaken contractual obligations, as opposed to obligations imposed by law.
The court’s distinction between obligations imposed by law and obligations voluntarily undertaken in a contract is an important one and provides an important basis for distinguishing between claims that should be covered by the policy and claims that are precluded under the exclusion.
Thus, to return to where I started in this blog post, there are occasions on which I think insurers have tried to apply the exclusion overbroadly, to preclude coverage for claims that in my view appropriately should be covered under the policy. This application of the exclusion could, in my view, render coverage illusory. However, the fact that the exclusion can be applied overbroadly does not mean that every application of the exclusion is objectionable. Indeed, in this case, I think the appellate court got it right. More importantly, the court drew an important and even illuminating distinction between obligations imposed by law and obligations arising solely out of contractual undertakings. Even though this reading in the end resulted in the denial of coverage for this particularl insured, the reading does, in my view, reflect an important understanding of the exclusion’s meaning.
Special thanks to a loyal reader for providing me with a copy of the court’s opinion.