Case comment: Sky Clean Energy Ltd. v. Economical Mutual Insurance Co. 2020 ONCA 558

By Damon Stoddard, LL.B., LL.M., Heal & Co. LLP

Construction cases are often complicated. Disputes between a contractor and an owner often have an overlay of insurance and indemnity provisions that may be engaged in a particular case.

The inclusion of an owner as an “additional insured” under a contractor’s commercial general liability (CGL) policy is used allocate risks that arise during a contractor’s work under its contract. Being an additional insured allows an owner to make a direct claim under its contractor’s CGL policy, where properly engaged.

In this case, the owner Sky Clean Energy, sued Economical, its contractor’s insurer, after losing an arbitration claim against its contractor (Marnoch) that arose following a transformer loss.1 Sky made a direct claim on the insurance on the basis that it was an “additional insured” (which it was) under its contractor’s commercial general liability (CGL) policy.

The Ontario Court of Appeal considered whether Sky’s liability for remediation costs and lost revenue due to the failure of transformers at two projects fell within the grant of coverage under the additional insured endorsement in the CGL policy.

The Court of Appeal held that since Sky chose the transformers that its contractor installed, and decided to continue to use replacement transformers from the same manufacturer after a fire, that Sky’s liability did not “arise out of the operations” of its contractor, and therefore was not covered under the additional insured endorsement in its contractor’s CGL policy.

“…the scope of coverage under a contractor’s CGL policy and additional insured endorsements are a frequent source of litigation…”

This case is worth discussing since the scope of coverage under a contractor’s CGL policy and additional insured endorsements are a frequent source of litigation between owners, contractors and their insurers.

Brief Facts:
Sky Clean Energy (“Sky”) is a developer of rooftop solar energy systems that supply electricity to the power grid.2 Sky entered into CCDC2 contracts with Marnoch Electrical Services (“Marnoch”), to supply and install rooftop solar projects at two buildings, based on Sky’s specifications. Marnoch was the Contractor under the CCDC2 contracts, which contained both standard form insurance and indemnification clauses.

There was a fire at one of the solar projects, which originated in the transformer selected by Sky, that Marnoch ordered and installed. Sky decided to replace that transformer with another one from the same manufacturer, which Marnoch ordered and installed. Upon completion, Sky sold both projects to a third party. Shortly thereafter, a fire occurred at the second project which also involved the transformer.3 Sky incurred liabilities to the third-party owner, and ultimately paid the third-party owner $591,596 for remediation costs and lost revenue.

Sky commenced an arbitration against Marnoch seeking $591,596, under both the warranty and indemnity clauses in their CCDC2 contracts. Following the unsuccessful arbitration, Sky sued the insurer for coverage, and it was agreed that the facts found by the arbitrator would bind the trial parties (Sky, the CGL insurer Economical, and the insurance broker).

Hence, the coverage action issues were contractual interpretation questions centering around the meaning and applicability of the indemnification and warranty clauses of the construction contract, GC 12.1.1 and GC 11.1, and the Additional Insured Endorsement.

The standard indemnification clause, GC 12.1.1, was slightly amended to provide that:

“Contractor shall defend, indemnify and hold harmless the Owner … against any suits, claims, damages, losses, liabilities … caused by (i) the Contractor’s failure to perform its obligations under this Agreement or (ii) the negligent acts or omissions of Contractor, its employees, agents … or suppliers or any other party for whom the Contractor may be liable, in the Contractor’s performance of the Work…”4

The insurance clause, GC 11.1, required Marnoch to “provide, maintain and pay for” various types of insurance, including:

“General liability insurance in the name of the Contractor and include, or in the case of a single, blanket policy, be endorsed to name, the Owner … as insureds, but only with respect to liability, other than legal liability arising out of [Owner’s] sole negligence, arising out of the operations of the Contractor with regard to the Work”.5

Marnoch was required to name Sky as an additional insured under its CGL policy with Economical, and it provided certificates that named Sky as an additional insured.

Marnoch’s CGL policy included an “Additional Insured Endorsement” which provided that “This insurance applies to … Additional Insureds, “but only with respect to liability arising out of the operations of the Named Insured [Marnoch]”.6

The arbitration between Sky and Marnoch:
The arbitrator, Clifford Lax, found that “Marnoch played no role in the decision to initially purchase” the transformers, or in Sky’s subsequent decision to use transformers from the same manufacturer after the first fire.7 Marnoch’s role was simply to implement Sky’s decisions, which did not make the transformer manufacturer a “supplier” of Marnoch within the meaning of the indemnification clause in the CCDC2 contract.

The arbitrator dismissed Sky’s claims and held that Marnoch “could not be liable to Sky under the warranty provisions because Sky did not rely on Marnoch’s skill and judgment with respect to the suitability of the transformers”.8 Sky’s appeal to Superior Court from the arbitration award was dismissed by Justice Hainey.9 In effect, the suitability of the transformers for their intended purpose was not warranted by Marnoch.

Sky’s action against Economical:
Sky commenced an action against Economical and claimed that its liability to the third-party arose out of Marnoch’s operations, and therefore, fell within the grant of coverage under the Additional Insured Endorsement of Marnoch’s CGL policy.

The parties agreed that the arbitrator’s findings of fact would be binding on the trial judge.

The trial judge found that Sky’s decision to select the transformers was “not part of Marnoch’s operations”.10 The fact that the ‘but for’ test of causation was satisfied, because the [second] fire would not have occurred ‘but for’ Marnoch’s installation of the transformer was not, in itself, sufficient to establish that Sky’s liability to the third party was “liability arising out of the operations of Marnoch”.11

The trial judge held that there was “insufficient proximity” between Sky’s decisions, and Marnoch’s actions to order and install the transformers to conclude that Sky’s liability “arose out of Marnoch’s operations”.12 Hence, Sky did not prove its liability arose out of the operations of Marnoch, and Sky’s liability did not fall within the initial grant of coverage under the additional insured endorsement in Marnoch’s CGL policy.

Sky’s appeal to the Ontario Court of Appeal:
The Court of Appeal stated that the issue on appeal was whether the trial judge erred in interpreting the words “arising out of the operations” in the additional insured endorsement in Economical’s policy.13

This language is a common feature of insurance arrangements in construction and other businesses. Such contracts are usually in the insurer’s standard form and are generally not negotiated. In this case, the contractual matrix between Sky and Marnoch did not play a role in the formation of the insurance contract.

The Court of Appeal held that the interpretation of the standard form contract was a question of law and subject to a correctness standard of review.14

The Court of Appeal largely agreed with the trial judge’s decision, and adopted the approach taken by the B.C. Court of Appeal in Vernon Vipers Hockey Club v. Canadian Recreation Excellence (Vernon) Corp.15 where it was held that “arising out of” requires more than a “but for” connection between the liability of the additional insured and the operations of the named insured. While a “but for” test is necessary, it is not sufficient. Specifically, there must be “an unbroken chain of causation”, and a connection that is more than “merely incidental or fortuitous”.16

The Court of Appeal held that the word “operations” includes “the creation of a situation, or circumstance, that is connected in some way to the alleged liability. It does not necessarily imply an active role by the named insured in creation of the liability event”.17

The Court of Appeal agreed with the trial judge that the fire was caused by the failure of the transformers and Marnoch’s connection to that failure was “merely incidental”. The fire would not have occurred ‘but for’ the fact that Marnoch ordered and installed the transformers, but Vernon requires a stronger connection.18 Since Marnoch did not select the transformers, “it was effectively a bystander to the decisions of the additional insured [Sky]. Its operations had a ‘but for’ connection to Sky’s liability, but nothing more”.19

The Court of Appeal also held that Economical did not breach its duty of good faith by initially denying coverage without an investigation. Sky’s appeal was dismissed.

Takeaways from the Court of Appeal decision:

In Sky, the Court of Appeal clarified the required degree of connection between the liability incurred by an owner, and the words “arising out of the operations” of a contractor, in the additional insured endorsement of a contractor’s CGL policy.

In light of the Sky decision, owners ought to make sure that their contractors have contractually agreed to take responsibility for key equipment and materials being installed, so that if repair or replacement costs are incurred in the applicable timeframe, there is an ‘unbroken chain of causation’ between an owner’s liability (as an additional insured) and a contractor’s operations. This is particularly important if the intent is to make a performing contractor responsible for warranting the performance of key equipment.

Further, an owner that seeks to be an additional insured under its contractor’s CGL policy should obtain a copy of that policy and endorsement before construction begins, to ensure that the appropriate coverage has been obtained, and that the language of the policy mirrors the language in its contract with the contractor. Otherwise, an owner may not be covered as an additional insured, since the policy language will prevail over the contractual language.

  1. For added complexity this second claim followed after an unsuccessful appeal of that arbitration finding to the Superior Court, in Sky Solar (Canada) Ltd. v. Marnoch Electrical Services Inc., 2016 ONSC 1295 (SCJ)
  2. Sky Clean Energy Ltd. v. Economical Mutual Insurance Company, 2020 ONCA 558 at para. 3
  3. The failed electrical transformers were manufactured by Marcus Transformer of Canada, who was not a party to the arbitration.
  4. 2020 ONCA 558 at para. 35
  5. 2020 ONCA 558 at para.58
  6. 2020 ONCA 558 at para. 4
  7. 2020 ONCA 558 at para. 32, referring to the arbitrator’s decision.
  8. Sky Solar (Canada) Ltd. v. Marnoch Electrical Services Inc., 2016 ONSC 1295 (SCJ) at para. 24
  9. 2016 ONSC 1295 (SCJ) at paras. 28 and 32.
  10. Sky Solar (Canada) Ltd. v. Economical Mutual Insurance Company, 2019 ONSC 4165 at para. 78.
  11. 2019 ONSC 4165 at para. 78
  12. 2019 ONSC 4165 at para. 80. The trial judge also held that “if Marnoch had contractually agreed with Sky Solar to undertake responsibility for the selection of a suitable transformer for the solar projects …. and if, following the first fire, Marnoch had undertaken its own investigations, relied upon its own professional advisors, and decided to continue to use the Marcus transformers, which later failed, this would affect the analysis because, in such circumstances, there would be much closer proximity between Marnoch’s operations and the event which gave rise to Sky’s liability.” [Ibid at para 82]
  13. 2020 ONCA 558 at para 52
  14. Citing Ledcor Construction Ltd. v. Northbridge Indemnity Insurance Co., 2016 SCC 37, [2016] 2 S.C.R. 23, at para. 4. The interests of certainty and predictability require that such policies be interpreted consistently: Co-operators Life Insurance Co. v. Gibbens, 2009 SCC 59, [2009] 3 S.C.R. 605, at para. 27; Progressive Homes Ltd. v. Lombard General Insurance Co. of Canada, 2010 SCC 33, [2010] 2 S.C.R. 245, at para. 23.
  15. 2012 BCCA 291
  16. 2020 ONCA 558 at para. 78
  17. 2012 BCCA 291 at para. 54 and 2020 ONCA 558 at para. 101
  18. 2020 ONCA 558 at para 102
  19. 2020 ONCA 558 at para. 102

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