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August 19, 2011

Clarifying pollution exclusions in commercial insurance policies

The Ontario Court of Appeal recently delivered a decision interpreting the pollution exclusion commonly found in commercial general liability (CGL) insurance policies. Such exclusions typically preclude coverage for the insured's liability for the release or escape of pollutants at or from the insured's premises.

In ING Insurance Co. of Canada v. Miracle (c.o.b. Mohawk Imperial Sales), [2011] O.J. No. 1837, the Court of Appeal held the exclusion applied to a liability claim for the escape of gasoline from a service station storage tank. This was opposite in result to its earlier decision in Zurich Insurance Co. v. 686234 Ontario Ltd., [2002] O.J. No. 4496, where it concluded the exclusion did not apply to the escape of carbon monoxide in a high-rise apartment. Why the difference in outcomes on substantially the same wordings?

In Zurich, the insurer provided CGL coverage to the owner of the apartment complex. The tenants sued for bodily injury from breathing carbon monoxide that inadvertently leaked into the units from the building's malfunctioning furnace system. Zurich cited the pollution exclusion to decline coverage and sought a declaration in support. The lower court dismissed Zurich's application, concluding that the exclusion was only "intended to vitiate coverage for injuries resulting from pollution of the natural environment and not the indoor environment."

The Ontario Court of Appeal upheld this result, but with expanded reasoning. Notwithstanding language that, on its face, supported broad application of the pollution exclusion, the court declined a "hyperliteral" reading in deference to a "connotative contextual construction" that drew on the exclusion's historical roots in industrial risks. The court concluded that "to apply an exclusion intended to bar coverage for claims arising from environmental pollution to carbon monoxide poisoning from a faulty furnace, is to deny the history of the exclusion, the purpose of CGL insurance, and the reasonable expectations of policyholders in acquiring the insurance."

The court further stated that "[t]here is nothing in this case to suggest that the respondent's regular business activities place it in the category of an active industrial polluter of the natural environment." Effectively, it considered the claim to be the very type of business tort that has been and should be covered by CGL insurance policies, which placed it beyond the traditional purpose of the pollution exclusion. The court further confirmed, "it is necessary to understand that the exclusion focuses on the act of pollution, rather than the resulting personal injury or property damage."

In the more recent Mohawk case, ING's insured operated a convenience store and gas bar with underground storage tanks that supplied the pumps. The government of Canada brought an action for damages caused by gasoline that escaped from the tanks and migrated to its adjacent lands. The claim alleged strict liability, nuisance and negligence, and sought the costs of an environmental assessment and remediation, together with the loss of land value.

In considering coverage for Mohawk against the claim, the lower court took the view that ING's pollution exclusion did not apply, as passive leakage of gasoline from a commercial business as a consequence of negligence did not satisfy Zurich's requirement of an "active industrial polluter."

On appeal, the Ontario Court of Appeal also relied on Zurich, but to support a different view of the facts and law. The court confirmed that the historical evolution of the pollution exclusion remained paramount to its interpretation. Such exclusions were initially incorporated into CGL policies as a result of insurer fears of the growing exposures of industrial insureds to regulators and other entities. Thereafter, variations of the exclusion proliferated in both insurance and reinsurance contracts, finding their way into virtually every CGL policy issued in Canada and the U.S.

The court also referenced the nature of the insured's business activities, together with its reasonable expectations, as two important factors in the factual analysis of such cases. Justice Sharpe, in promoting a "commercially sensible interpretation" of the wording, stated, "I do not accept the argument that the phrase 'active industrial polluter of the natural environment' used in Zurich should be read as restricting the reach of the pollution exclusion clause to situations where the insured is engaged in an activity that necessarily results in pollution."

He took the further view that the clause could not be meant to be restricted to "active industrial polluters" as such entities, by their nature, would not be covered by ordinary liability insurance coverage on the basis of the "fortuity" principle underlying all insurance products. To limit application of the exclusion to such insureds would effectively strip it of any meaning.

Instead, the court concluded that "the exclusion clearly extends to activities, such as storing gasoline in the ground for resale at a gas bar, that carry a known risk of pollution and environmental harm." In doing so, it cited with approval the statement of Justice Labrosse in Ontario v. Kansa, [1994] O.J. No. 177, that "the passive polluter who permits pollution to take place is just as much a polluter as the active polluter who discharges or causes the discharge of pollution." The result was a reversal of the lower court's ruling and a declaration of no coverage in favour of the insurer.

In Mohawk, the court referred to Zurich as the "starting point for interpreting the pollution exclusion." From there, it determined that the phrase "active industrial polluter of the natural environment" as it appears in Zurich should not be given a "hyperliteral" interpretation itself. Otherwise, the court would fall into the very interpretational trap the court in Zurich sought to avoid. Rather, the historical purpose of the exclusion, along with a "commercially sensible" reading of its language, supported the conclusion that the business of storing gasoline in underground tanks for resale entails a sufficient "known risk of pollution and environmental harm" to invoke the exclusion. In contrast, leakage of carbon monoxide in an apartment building does not.

Mohawk emphasizes that application of the pollution exclusion is deeply dependant on the actual business activities of the insured. While both the exclusion's wording and its historical roots remain relevant to a coverage analysis, the ultimate outcome will turn on the nature of the business that causes the pollution exposure. In this context, literal distinctions between "active industrial" and "passive commercial" polluters appears to be irrelevant.


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