The Exclusion Migration

Ontario’s Superior Court of Justice in April 2007 released Boliden Limited v Liberty Mutual Insurance Company, which contains some interesting lessons for brokers and underwriters in its consideration of environmental pollution exclusions in D&O policies.

For underwriters, Boliden reiterates the need for underwriters to be absolutely clear and specific in the language they are using to include pollution exclusions in D&O coverage.

The case can also help brokers to manage their errors and omissions exposures. For example, when clients indicate a desire to purchase D&O insurance, brokers can explore up-front the need for Environmental Impairment Liability (EIL).

CGL POLLUTION EXCLUSION

Boliden fits at the tail end of 20 years’ worth of litigation around the Commercial General Liability (CGL) pollution exclusion. There have been two different versions of this exclusion over the years.

The first version emerged when the insurance industry reacted to concern over industrial polluters as early as 1978. At that time, the Insurance Bureau of Canada (IBC) amended the CGL to include the Pollution Exclusion. This first version of the clause would come to be known as the “sudden-and-accidental” exclusion.

The “sudden-and-accidental” emphasis related to the fact that the first version was itself an exception to an exclusion. Pollution losses were excluded except if they were as a result of a “sudden-and-accidental” release of toxins, discovered within 120 hours of the event. There was little agreement about the exact application of “sudden and accidental”. The central issue in litigation therefore became: What amounts to a “sudden and accidental” release of a pollutant? One United States court held that each pinprick leak in a pipe leaking pollution amounted to a separate, “sudden and accidental” release.

In the United States, the sudden-and-accidental version of the Pollution Exclusion was widely litigated; in Canada, however, the exclusion received relatively little judicial review. By 1986, it became clear to insurance industry that the sudden-and-accidental clause did not exclude gradual pollution.

IBC in 1986 replaced the sudden and accidental Pollution Exclusion with the so-called Absolute Pollution Exclusion. The intent was to exclude any loss “arising out of actual, alleged or threatened discharge, dispersal, release or escape of pollutants.”

Canadian courts reviewed litigation surrounding the 1986 clause, culminating in the Ontario’s Court of Appeal’s 2002 decision in Zurich Insurance Company v 686234 Ontario Ltd.

The Appeal Court in Zurich rejected the argument that the Pollution Exclusion applied to indoor carbon monoxide. Zurich argued that carbon monoxide was a “pollutant” as defined in the CGL, but Ontario Court of Appeal Justice Stephen Borins rejected that argument. He reviewed the history of the pollution clause, observing that the clause was aimed at damage to the natural outdoor environment. Borins also introduced a new interpretive concept in writing: “[I]n construing contracts of insurance,” he wrote, “dictionary literalism is often a poor substitute for connotative contextual construction.”

Insurance lawyers have widely commented on the phrase “connotative contextual construction.” The commentary left the reader with the sense that Zurich would have a lasting impact on the pollution exclusion. Borins had hinted at the gauntlet the pollution exclusion would have to run in the courts “[w]hen the full panoply of insurance contract construction tools is brought to bear on the pollution exclusion …”.

D&O POLLUTION EXCLUSION

The Ontario Superior Court of Justice released Boliden on Apr. 3, 2007. The case represented the first time a Canadian court had been asked to apply the pollution exclusion to a D&O policy. Ontario Superior Court Justice Frank Newbould’s well-written judgement provides some much-needed guidance for brokers and underwriters — especially if you read between the lines.

In Boliden, the directors and officers of Boliden Limited faced lawsuits for misrepresentation. The plaintiffs (shareholders) sought damages as a result of Boliden’s initial public share offering.

The facts of the case are as follows: Boliden Limited owned a mine in Spain. A tailings (the waste rock produced in the mining process) dam failed. Court evidence showed 7 million cubic metres of toxic waste had been released, reportedly contaminating 10,000 hectares of land. As a result of this pollution event, the company’s initial share price of $16 fell to $5.35.

The shareholders’ class actions were started and settled. Boliden Limited looked to their D&O Insurer, Liberty Mutual, for recovery of defence costs, which were in excess of $3 million. Liberty Mutual denied the claim.

At trial, both Boliden and Liberty Mutual agreed the insuring clause covered the defence costs for this litigation. According to Liberty, however, the pollution exclusion removed coverage. Boliden Ltd countered that the pollution exclusion should not apply. In Boliden’s view, the wrongful acts cited in the statement of claim were identified as misrepresentations. The resultant damages were for the depreciation in the value of the shares and not over a pollution event. Liberty disagreed, saying the proximate cause of the share depreciation was the pollution event in Spain.

Justice Newbould found the pollution clause applied to some of the claim for misrepresentation; but some of the claim was a direct result of the pollution event. Since some of the claim was covered and some of the claim was not, the allocation clause applied. The clause stated that if part of the loss is covered but not all of it, then 80% of defence costs were insured. Liberty was ordered to pay 80% of Boliden’s defence costs.

LESSONS FROM BOLIDEN

Brokers

Brokers can use the result in Boliden to help manage errors and omissions exposures. One example is in the interplay between the D&O and an environmental impairment liability policy. If a policyholder requires directors and officer coverage, for example, why not explore the need for Environmental Impairment Liability (EIL)?

In this post-Walkerton world, directors face increasing exposure from environmental laws and regulations. Media reports have highlighted how environmental risks are emerging as a major liability. And according to the headline of a recent report, an “avalanche” of environmental laws is in the works. It is therefore incumbent on brokers to gather relevant information about all of the exposures their clients face. Environmental exposures need to be added to the everyday checklist brokers use.

An EIL quote has a number of advantages: first of all, the client’s risks are being identified and insured. In addition, offering to quote EIL gives brokers an opportunity to review with their clients the pollution exclusion in the D&O — and the CGL, for that matter. In doing so, brokers will be taking a large step towards due diligence, and thus addressing concerns around broker errors and omission. Overlooking a client’s need for EIL may be inviting a future claim. Clients who discover only after a loss that they needed EIL coverage may consider legal action against their brokers.

The Insurance Marketer lists a number of specialty firms under the heading of pollution. These firms can guide the broker through all aspects of the EIL quote process.

Underwriting

Justice Newbould provides underwriters reading the Boliden decision a clear overview of insurance policy interpretation doctrines. By the end of the judgement, underwriters might conclude that few exclusions can withstand the onslaught of these doctrines. This would certainly be true if a judge doesn’t agree with the underwriting intent of the exclusion.

Aligned against the exclusions in the Liberty policy were three heavyweight doctrines Canadian courts currently employ. They are:

* “na
rrow versus broad,” meaning coverage sections are to be interpreted broadly and exclusions interpreted narrowly;

* “reasonable expectations doctrine,” meaning the terms of the policies are to be interpreted in such a way as to meet the reasonable expectations of the parties. Newbould referred in Boliden to the expectations as such: “[I]f the meaning of insurance provisions are to be construed in a way that takes into account the reasonable expectations of the parties, a slavish reference to somewhat antiquated dictionary definitions may not be appropriate;” and

* “contra proferentem doctrine,” which states that in the event of ambiguity, the contract will be decided against the party who drafted it — in other words, against the insurer.

Newbould’s decision reviews each of these insurance policy interpretation doctrines. He also provides underwriters with some direction regarding the degree of clarity the courts expect in the language of exclusions. He cites a 1942 English case in which Lord Greene states: “…if underwriters wish to limit some qualification a risk which, prima facie, they are undertaking in plain terms, they should make it perfectly clear what that qualification is.”

From there, Newbould dissects the phases “attributable to,” “in any way involving, directly or indirectly,” and “resulting from.” He noted that although the two sides in Boliden cited U.S. cases that had comparable wordings, none of the phrases at the centre of the U.S. litigation had language identical to that found in the Liberty D&O policy.

Newbould’s dissection of the three phases is a message to underwriters about the degree of precision upon which the courts insist when applying the facts of the individual loss to a generally worded exclusion. In fact, underwriters might interpret Boliden as a caution against using a one-size-fits-all pollution exclusion to be used for any client who happens to buy the policy. Boilerplate wording in exclusions are likely to face a rough ride in the courts.