It is common for liability insurance policies to exclude liability arising under a contract unless such liability would have attached in the absence of such contract. In Omega Proteins Ltd v Aspen Insurance UK Ltd  EWHC 2280, Christopher Clarke J found that an underlying judgment that the insured had a liability to a third party in contract did not conclusively determine the basis of liability for the purposes of a claim under its product liability insurance policy which contained a contractual liability exclusion. Thus it was open to the insured to argue that any finding in the underlying judgment was not correct, or to contend that it was also liable on other grounds.
The claimant, Omega Proteins Ltd, was in the business of processing by-products from animal carcasses which it supplied to customers, such as pet food manufacturers. Omega was supplied with animal carcasses by Northern Counties Meat Ltd. Northern Counties failed to act promptly to comply with a new statutory regulation, introduced following the BSE crisis, which classified (any mixture containing) vertebral columns from animals over 24 months old as specified risk material fit for disposal only. As a result, Northern Counties supplied Omega with over 220 tonnes of animal material which, unknown to Omega, was specified risk material. Omega mixed this material with other material, thereby contaminating the whole bulk of the resulting mixture which it supplied to its customers (and they, in turn, to others). The State Veterinary Service (an agency of DEFRA) discovered this contravention of the law and required the relevant material to be disposed of.
A company which had ultimately purchased some of the contaminated material began an action for damages against one of Omega's customers which joined Omega as a third party. Omega in turn joined Northern Counties as a fourth party. On 18 May 2009, HH Judge Mackie QC (sitting as a judge in the Commercial Court) held that Omega was liable to pay damages to its customer for breach of contract and that Northern Counties was liable to indemnify Omega in respect of such liability. No claim in or allegation of negligence had been made against Northern Counties.
The policy claim
Northern Counties was in liquidation and unable to satisfy the underlying judgment against it. Omega therefore commenced an action pursuant to the Third Parties (Rights Against Insurers) Act 1930 against Aspen which insured Northern Counties under a combined liability policy seeking a declaration that Aspen was liable to indemnify it under the policy in respect of its liability resulting from the underlying judgment.
The product liability section of the policy provided cover against "all sums which the Insured becomes legally liable to pay for damages and claimants' costs and expenses arising out of or in connection with … accidental loss of or damage to property". However, the exclusions to this section included an exclusion of "any liability arising … under any contract or agreement unless such liability would have attached in the absence of such contract or agreement".
Aspen contended that the policy claim fell within this contractual liability exclusion since the underlying judgment definitely and conclusively determined that Northern Counties was liable to Omega in contract. Omega accepted that the liability for which it sought insurance coverage arose under a contract but contended that whether or not there was cover depended on whether such liability would have attached in the absence of the contract.
By judgment dated 10 September 2010, Christopher Clarke J found in favour of Omega.
The Judge found that the contractual liability exclusion invites consideration as to what liability would have attached in the absence of a contract (but the facts were otherwise as they were), not what (if any) liability in tort would have attached in the presence of a contract.
The Judge did not accept that the underlying judgment foreclosed any question as to whether Northern Counties' liability was within the scope of coverage under the policy. In this regard, he agreed with Omega's reasons for contending that the basis of its liability was not fixed by the underlying judgment for the purposes of the policy claim. In particular:-
- Aspen's construction would mean re-writing the second part of the exclusion to read "unless the judge in the trial which established liability had expressed the view that liability would arise in the absence of contract".
- The question posed by the exclusion is a hypothetical one on which Judge Mackie could not have reached a binding or dispositive decision. Thus, it did not make sense, and the parties cannot have intended, that his failure to make such a decision should conclusively determine whether or not Omega can recover.
- Since ordinarily the third party claimant elects what claims it makes, or does not make, against the insured, it cannot be right, and the parties cannot have intended, that the question of policy coverage is determined by the choice of such third party.
- Aspen's proposition did not address the position if the underlying claim is compromised by the parties, in which case the terms of the settlement cannot be determinative of policy coverage. If that is so there is no reason why there should be a distinction between settlement and judgment.
Moreover, the Judge doubted the reasoning of Tomlinson J in London Borough of Redbridge v Municipal Mutual Insurance Limited  Lloyd's Rep IR 545, at 550 (upon which Aspen had placed reliance) who had commented in respect of liability insurance that "one would expect the enquiry whether insurers are liable to begin and end with the question of what liability has been established. … In my judgment it is normally neither permissible nor possible to look beyond or outside the four corners of the determination itself for the basis of liability to which the insured has become subject. … [I]n liability insurance one is concerned, as between insured and insurers, with established liability and thus with the basis on which liability was in fact established."
Having considered the cases of West Wake Price v Ching  1 WLR 45 and MDIS v Swinbank  2 All ER (Comm) 722 CA, which preceded Redbridge, the Judge set out a series of propositions which he stated would generally apply to liability insurance. The starting point was that the insured must establish that it has suffered a loss which is covered by an insured peril. That may be demonstrated by judgment, arbitration award or agreement to pay. The loss must be within the scope of the cover provided by the policy. However, while as a matter of practicality the judgment, award or agreement may settle the question whether the loss is covered by the policy because the insurer will accept it as showing a basis of liability which is within the scope of coverage, such judgment, award or agreement is not determinative of whether the loss is covered. It is open to the insurer to dispute that the insured was in fact liable, or that it was liable on the basis specified in the judgment, or to show that the true basis of liability fell within an exception.
The Judge also agreed with and drew support from the obiter statements of Aikens J in Enterprise Oil Ltd v Strand Insurance Co Ltd  1 Lloyd's Rep 500 to the effect that an insurer always has the right to challenge whether the insured's right to indemnity under a liability policy has been established, whatever is stated in an underlying judgment, award or agreement, to which the insurer will not be a party unless specifically involved. The insured must equally be able to claim that any finding in the underlying judgment is not correct, or to claim that it was also liable on other grounds.
Turning to the question of whether in this case a liability would have attached in the absence of the contract, the Judge found that Northern Counties would have been liable in negligence for supplying the specified risk materials to Omega without a warning. In particular, Northern Counties had failed to take reasonable care to ensure that the product it was supplying to Omega was both something it could lawfully supply and safe in the sense that it could be used without unacceptable risk to human health and without damaging, by rendering unusable, any other product with which, as would foreseeably happen, it was mixed.
Finally, the Judge considered the incidence of the burden of proof in connection with the exclusion and held (obiter) that in order to bring itself within the exclusion, the insurer must show not only that the liability in question arose under a contract but also that the exception to the exclusion is inapplicable, i.e. that, absent a contract, no liability would have attached. The burden was not on the insured to demonstrate that there would have been such a liability.
In most circumstances, it will not be necessary for the parties to look beyond the four corners of the underlying judgment, award or agreement in order to determine whether the established liability falls within the scope of coverage. However, neither the insured nor the insurer are precluded from looking beyond the judgment, award or agreement to ascertain whether the insured was or would have been, in fact and law, liable to the third party and, if so, on what basis (or bases) and in what amount. In this regard, the Judge's decision is consistent with the obiter view expressed by Aikens J in Enterprise Oil that (contrary to the decision of Colman J in Lumbermens Mutual Casualty Co v Bovis Lend Lease Ltd  2 CLC 617) it was open to an insured in a claim on a liability policy to demonstrate, by reference to extrinsic evidence, that it was liable to a third party for a particular sum under a settlement agreement even where the agreement failed to identify the amount of that liability. The Judge did not see why there should be any distinction between a settlement and judgment. Whilst potentially this decision may be of considerable assistance to an insured in circumstances where a judgment, arbitration award or settlement does not on its face evidence an insured liability, equally it may assist insurers in challenging the basis or amount of the liability as determined.
The Judge's decision on the application of the contractual liability exclusion in liability insurance, is consistent with the general purpose of liability policies which (subject to the precise terms of cover) is to indemnify the insured against legal liabilities for damages arising in tort (or akin to tort). Thus a contractual liability exclusion will not apply in circumstances where the insured would also (co-extensively or absent the contract) have had a liability in tort. Rather than looking at the facts of the case and asking himself whether the insured would have had a co-extensive claim in tort, the Judge considered that (on this particular wording at least) he must consider hypothetically what the position would have been in the absence of a contract, were the facts otherwise the same. Such an analysis is perhaps somewhat artificial given that it would be unusual for a party to supply goods or services without a contract. The Judge's approach might also potentially cause some difficulties for the insured if the existence and terms of the contract might have assisted it in establishing a duty of care to the third party.
Finally, it is worth noting that while the question of whether there had been damage to property within the meaning of the policy was not in issue before the Judge, he indicated that the admixture of contaminated animal material fit only for disposal with other materials caused damage to, by rendering unusable, those other materials, which were Omega's property. That analysis is generally consistent with the line of cases on the meaning of damage within product liability insurance policies. However, there are some difficulties in reconciling this analysis with the decision of the Court of Appeal in Bacardi-Martini Beverages Ltd v Thomas Hardy Packaging Ltd  2 All E.R. (Comm) 335 where it was held that a final drinks product which had, during the manufacturing process, been contaminated with benzene, had not suffered "direct physical damage to property" within the meaning of a limitation of liability clause under a supply contract, but instead was merely defective from the moment of its creation. Indeed, the meaning of damage to property (where there is a close analogy between tort and product liability insurance) can sometimes be elusive and thus may well be a fertile area for further consideration by the Courts in the future.