It is common in building contracts to include a term whereby the contractor agrees to add the project owner as an additional insured under its general liability insurance policy. Often the endorsement insures the added owner for any liability “arising out of the operations” of the contractor.
The appeal in this case concerns the interpretation of this insurance language and clarifies the requisite connection between the contractor’s operations and the owner’s liability as a “but for” test. However, unlike the “but for” test in negligence, the degree of connection in the insurance context requires an unbroken chain of causation between the liability event and the operations of the named insured.
In this case, the degree of connection between the contractor’s installation of the equipment and the equipment’s malfunctioning was insufficient.
The Appellant, Sky Clean Energy Ltd. (“Sky”) is a developer of solar energy projects and the project owner. Sky entered into CCDC2 contracts with Marnoch Electrical Services Inc. (“Marnoch”), an electrical contractor, to install two rooftop solar power systems that Sky designed, using equipment selected and sourced by Sky. Marnoch’s responsibility was limited to installing the solar system’s components.
Incorrect transformers were delivered to one of the project sites; a mistake that threatened to delay the construction schedules for both systems. Faced with a significant delay, Sky enlisted Marnoch’s help to source replacement transformers. Although not contractually obligated to do so, Marnoch helped Sky locate a replacement supplier. It was Sky’s decision whether or not to accept the supplier; Sky never asked Marnoch for its opinion on the suitability of the transformer, nor did Marnoch have the expertise to opine on such matters.
Upon completion of the construction of the solar systems, Sky transferred ownership of the systems to a solar energy partnership (“Firelight”). As part of the sale agreement, Sky provided Firelight with warranties and indemnities.
During the installation phase (connecting the solar systems to the power grid), the replacement transformers caught fire and burned. As a result, Sky incurred liabilities for remediation and loss of revenue to Firelight. Sky settled these liabilities with Firelight and then sought to recover those damages, first against Marnoch, then against Marnoch’s general liability insurer, Economical Mutual Insurance Company (“Economical Insurance”).
Under the contracts with Sky, Marnoch agreed to indemnify Sky for Marnoch’s failure to perform its contractual obligations and for its negligent acts. Marnoch also agreed to name Sky as an insured under its commercial general liability insurance policy, but “only with respect to liability, other than legal liability arising out of [Sky’s] sole negligence, arising out of the operations of [Marnoch] with regard to the Work.”
The insurance certificates issued to Sky by Marnoch’s insurance broker confirmed Sky’s entitlement to coverage under an endorsement “but only with respect to liability arising out of the operations of [Marnoch].”
Sky commenced various proceedings against Marnoch, Economical Insurance, Marnoch’s insurance broker and the manufacturer of the replacement transformers.
In the proceeding against Economical Insurance, the trial judge found that the design of the solar systems, including the wiring and the choice of equipment, were Sky’s responsibility. Marnoch played no role in the decisions to purchase or install the transformers, therefore Sky’s liability did not “arise out of the operations” of Marnoch. Sky appealed.
Strathy C.J.O., for a panel of the Court of Appeal, upheld the trial judge’s holding and dismissed Sky’s appeal.
“Arising Out of”
The Court dismissed Sky’s argument that the trial judge adopted an unduly narrow interpretation of the words “arising out of the operations.”
The Court agreed with the trial judge’s adoption of the British Columbia Court of Appeal’s reasoning in Vernon Vipers Hockey Club v. Canadian Recreation Excellence (Vernon) Corporation, 2012 BCCA 291 (“Vernon”). In particular, the Court confirmed that the correct interpretation of “arising out of” or “arising from” requires more than a “but for” connection between the liability of the additional insured and the operations of the named insured. In the insurance context, there must be an ”unbroken chain of causation” to satisfy the requisite connection and the connection must be more than “merely incidental or fortuitous.”
The court in Vernon went on to define “operations” to include the “creation of a situation, or circumstance, that is connected in some way to the alleged liability.” The court in Vernon qualified this interpretation as not requiring an “active” role by the named insured in creating the liability event.
In other words, pinning liability on a party in this context requires a clear and uninterrupted sequence of events from the party’s action(s) to the liability event. Further, the party’s action(s) need not directly cause the event, rather causing or contributing to the occurrence of the event can be sufficient.
Application to the Facts
The Court agreed with the trial judge and found that Marnoch’s connection to the failure of the replacement transformer and the resulting fire was “merely incidental.”
Although the fire would not have occurred “but for” Marnoch’s ordering and installing the transformers as part of Marnoch’s operations under its CCDC2 contracts with Sky, Vernon requires a stronger connection. In this case, there was a broken chain of causation. Marnoch’s “operations” under the contract were limited to installing the transformers, and did not require Marnoch to select the transformers. This was Sky’s decision.
The Court held that Sky’s attempts to hold Marnoch liable for the consequences of its own decisions were not justified. The Court dismissed Sky’s appeal with costs.
Conclusion and Takeaways
Sky argued that the language of the construction contract should inform the Court’s interpretation of the insurance policy. The Court noted that insurers are often not privy to the agreements entered into by its insureds and although insurers can (in theory) create custom language to underwrite the risks assumed into by its insureds, there was no evidence that Sky demanded Marnoch request its insurer to do so in this case. This is an important takeaway. When negotiating building contracts, be wary of executing agreements that contain indemnity language that does not track the language in the insurance policy. Not only will this create uncertainties over what risks are insurable, but it will devolve into unnecessarily costly disputes when an eventual claim does arise.
During the contract negotiation phase, specifically, when drafting indemnity language that covers a party’s liability arising out of the operations of another party, it is prudent to consider including “operations” as a defined term under the contract. Further, ensure the definition of “operations” is sufficiently broad and specific to cover most (if not all) liability events. Conversely, if representing the party whose operations are being defined, ensure that the language covers operations that are 1) insurable, 2) reasonable and 3) in line with the skill and expertise of the party.