Commercial contracts & insurance part 3: contractual liability and contracting out of proportionate liability

Loss attributable to liabilities assumed expressly under contract (that do not exist at common law) are commonly excluded under third party liability insurance policies. This article will focus on liability assumed by policyholders for contracting out of proportionate liability provisions and the effect of same on insurance coverage.

Proportionate liability is the name given to systems of allocating liability among multiple wrongdoers so that each wrongdoer is liable for no more than their relative share of fault. A court will determine whether each of the parties is liable, and then determine their relative ‘proportion’ of liability. The plaintiff can then recover from each of the wrongdoers but only in accordance with the Court’s assessed share.

The major ramification of proportionate liability is that the plaintiff rather than the defendant bears the risk of any uncollectable share of its loss. If a liable defendant becomes insolvent or otherwise unavailable after judgment, the plaintiff cannot look to the other liable defendants to pay the outstanding amount. Therefore, the relative liability of the wrongdoers becomes a matter of concern to the plaintiff, who will have an interest in ensuring that a greater proportion of the loss is allocated to wrongdoers who are likely to be able to satisfy the judgment.

Legislation to this effect has been passed in all states in Australia.[1] In some states including NSW, WA and Tasmania, parties may expressly contract out of proportionate liability regimes’ provisions so that the default general law position will apply i.e. joint and several liability coupled with the law of contribution (as explained below). There are types of claims in which the regime does not apply, for instance, personal injury matters.

Under most liability insurance policies, insurers will maintain an ‘assumed’ or ‘contractual’ liability exclusion. A sample assumed liability exclusion reads:

“liability assumed under any contract, agreement or warranty except to the extent that such liability would have been implied by law in the absence of such contract, agreement or warranty.” [is excluded]

The point of such a clause is to exclude liability which is voluntarily assumed by the insured as opposed to liability arising as a matter of general law. But liability will only be assumed under a contract, agreement or warranty if the only reason the insured is liable is that contractual assumption of liability. That is to say, the words “unless the Insured would have been liable in the absence of such terms or warranty” are to be read with the word “assumed” and confirm that the exclusion is directed to liability which only rests with the insured because of its voluntary act of assumption.[2]

Such a clause is not intended to exclude the contractual obligations of the parties in their entirety. It does not apply where the liability is an ordinary legal incident of the relationship of the parties. For example, if a builder and home-owner contract to build a house, the builder has assumed responsibility and is accountable to the homeowner to build the house. If the house that is built is defective and collapses, the owner will seek a remedy. But the builder did not agree to build a defective house and further did not agree to pay damages for that defective house. All of that results from something the builder did not agree to—defective construction. The builder has not assumed liability, within the meaning of the assumed liability exclusion, for anything. To hold otherwise would defeat the purpose of the insurance.

Increasingly principals (particularly across the construction industry) have required in their contracts that the application of the proportionate liability regime is excluded in the event of any claim related to  works performed under contract. This is because it is easier for a principal to pursue one defendant for the entirety of the loss and let the defendants sort out any cross-claims and assume the risk of non-payment.  Such a clause may read:

“The operation of the Civil Liability Act 2002 (NSW) is excluded to the extent necessary for the Consultant to be liable, in accordance with the terms of this contract, for any loss suffered by the principal arising out of, or in connection with, the services performed under this agreement.”[3]

Such clauses have the effect of re-establishing the general common law position (see below). Clauses that extend the insured’s liability beyond that which the law would normally impose, such as accepting liability without proof of fault rather than requiring the plaintiff to prove that the defendant has failed to exercise the ordinary duty at law to take reasonable care are likely to be excluded by an assumed liability clause.

An example is a contract that includes a clause that has the effect of not only contracting out of the proportionate liability regime but also an agreement that the contractor will be entirely and solely responsible for any failure to take reasonable care on the part of its subcontractors.

Another clear example is where a party agrees to provide an indemnity or “hold harmless”. The effect of same is ordinarily that one party promises the other to reimburse, and in some cases defend, claims or suits brought against the indemnitee by a third party. This includes, in some cases where a liability arises out of the indemnitee’s sole negligence.

The question that arises when assessing coverage under a third party liability policy is that if a party contracts out of proportional liability legislation (excluding the case where a party has accepted sole responsibility for another’s negligence), does it “assume a liability under contract” to the principal so as to trigger the relevant exclusion in the policy and exclude the claim?

At general law, in absence of a statutory proportionality regime, where multiple parties are responsible for damage to a plaintiff for an indivisible loss each will be jointly and severally liable for the whole amount of the loss to the plaintiff. Wrongdoers will only be jointly and severally liable where they have each been found to have caused the same loss or damage. The allocation of liability for the loss as between defendants in such a case is determined via the rules of contribution.

However, a wrongdoer who is liable for only part of a divisible loss will not be jointly and severally liable with other wrongdoers who are liable for the total loss but only in respect to that part of the loss that was caused by that wrongdoer.

In NSW pursuant to the Law Reform (Miscellaneous Provisions) Act (NSW) where damage is suffered by a person in tort (e.g. negligence) a defendant found liable for that damage can seek contribution from another person who is also liable for that damage and such persons may be joined to the proceedings. The amount recoverable as a contribution to the loss shall be such as may be found by the court to be just and equitable having regard to the extent of that person’s responsibility for the damage.[4]

In the ordinary course, the plaintiff will claim against one or more defendants, each of whom may then join third parties and bring crossclaims against them for contribution to the loss. The court will first determine whether each defendant is liable. Then the court must decide whether the loss is single and indivisible, or whether different aspects of the loss should be attributed to different liable defendants. The court will then assess respective contributions of the liable defendants.

The combined effect of joint and several liability and contribution means that each defendant found jointly and severally liable for the indivisible loss can be called upon by the plaintiff to pay in full, but can hope to receive sufficient contribution from other liable defendants to reduce their net exposure to their “share” of responsibility. Where the loss is divisible, the liable defendant will only be liable for that proportion of the total divisible loss that they caused.

Accordingly, under the general law, a wrongdoer may not always be liable for 100% of the total loss to the plaintiff if the loss is a divisible loss. An example is where there are multiple causes of loss that result in separate damage.  This can commonly occur in a building defects case. For example, a plaintiff may sue an architect, a builder and a tiling subcontractor for building defects. The court finds that the architect and the builder were negligent and that their negligence caused damage to the whole building and therefore they are jointly and severally liable for a total loss of $1,000,000, but the tiler who was contracted to waterproof a deck, who was also negligent, was only responsible for the repairs to the deck, which would cost $20,000 to fix. The subcontractor is only jointly and severally liable for the repairs to the deck, while the architect and the builder are jointly and severally liable for the entire amount (i.e $980,000 plus $20,000). The subcontractor is not liable at all for the total loss but only $20,000 because he or she didn’t cause the remainder of the loss. The tiler’s insurer would only have to pay $20,000 or 2% of the total loss.

A general liability policy’s insuring clause will often provide indemnity for “all sums which the Insured shall become legally liable to pay by way of compensation…in respect of personal injury and or property damage….” Such a clause is broad enough to capture both tort and contractual claims, but will, ordinarily be subject to a contractual liability exclusion.

The view commonly argued by insurers is that if an agreement to contract out of proportionate liability causes it to pay more (in indemnity for a claim) than it would have, had there be no contracting out, then the monetary value of same will be excluded by a standard contractual liability exclusion.

The argument runs that the effect of contracting out results in a “liability assumed under any contract” that would otherwise not have existed but for the contract. The insurer will argue that if the proportionate liability rules applied then such liability to the principal would have been limited to only the proportion of the loss that it would have been liable to pay to the principal rather than being liable to the principal for 100% of the loss. For example, if a contractor was held to be legally liable for 20% of the loss due to its negligence and the subcontractor was liable for 80%, the proportionate liability regime would apply to limit the contractor’s liability to the principal for the total loss to 20%. The insurer would pay the principal that 20% as compensation and the principal could not seek to recover any shortfall not paid by other defendants for the total of the loss from the insured defendant. The principal must pursue the other defendants.

The argument is that parties are exposing themselves to greater liability than they otherwise would have been exposed to at law as they are assuming liability that would have been apportioned to another wrongdoer.

An alternative view to that put forward by insurers is that “liability assumed under contract” clauses are inapplicable to any agreement to contract out of the proportionality regime. The insurers argument that contracting out the proportionate liability regime is a form of “assuming liability under contract” can be criticised as it misconstrues what is meant by an “assumed” “liability” at law.

As with all contracts of insurance the words used should be given their plain and ordinary meaning. “Assume” means “to undertake” and “liability”, according to Black’s Law Dictionary, means “the state or quality of being legally obligated or accountable”.

Whether or not a “liability” exists is determined by reference to whether or not somebody has breached a legal duty or obligation to another and caused a loss to the plaintiff. In an ordinary negligence case that requires the plaintiff to establish that the defendant failed to exercise reasonable care and that such lack of care caused the plaintiff’s reasonably foreseeable loss. Quantification of the loss and relative responsibility for a total loss is a question for the Court to determine under either the proportionate liability regime or at common law.

In any case the court must still determine which proportion of responsibility for the loss lies with the insured defendant and which lies with co-defendants or third parties if any. The insured defendant has not “assumed liability” for anything.

The insurers argument that an insured, by excluding the proportionate liability regime has “assumed a liability” that would otherwise not exist at law suffers from the same problem that arises in the builder/homeowner example given above. By entering into an agreement which excludes the proportionate liability regime the builder has not voluntarily “undertaken” to do anything or “assumed” an obligation to do anything or assumed any liability for anything. The builder has not undertaken to pay the principal 100% of the loss and it has not contractually assumed liability to do so if a loss occurs. At general law the Court must still determine which defendant is liable if at all and which proportions of the loss is attributable to any particular defendant.

That is quite a different scenario from, for example, a hold harmless clause which gives the principal a contractual right to claim from the contractor for the damages caused, even if the sole liability lies with a subcontractor or another third party and the contractor is not liable at all. In that case the contractor has positively agreed to pay the principal for any loss sustained – in that case the contractor has assumed the liability for the subcontractor’s negligence but it has nothing to do with contracting out of the proportionate liability regime.

The maximum loss that a particular defendant may be held liable is of course 100% if the co-defendants are not found to be liable at all. Whether or not the proportionate liability regime applies or not, the result will be the same in that case. And the insured defendant must defend the proceedings brought against it to determine whether it is liable at all or not.

As noted above, in the case of a divisible loss there is no difference in the proportion of liability for the subcontractor whether a proportionate liability regime applies or it does not. In such a case it would be wrong for the tiling subcontractor’s insurer to refuse to meet all of the subcontractor’s defence costs (or contend that it is only required to meet 2% of them) or to refuse to pay all of the tiling subcontractor’s liability on the basis that the contract excluded the proportionate liability regime and that the subcontractor had therefore “assumed a liability” that would not otherwise have existed. The subcontractor was contracted to do particular work, it was completed negligently and is ordered to make good the work but is not obligated to pay 100% of the total loss claimed by the plaintiff against all defendants.

In the absence of the proportional liability regime, if an insured defendant is held to be jointly and severally liable as the loss is an indivisible loss, the insurer of the insured defendant and each of the other liable defendants will be obligated by court order to pay 100% of the loss to the principal but will also obtain contribution orders from the court (ordinarily at the same time) that the other liable cross defendants are liable to pay their proportion of the loss to the insured defendant.

If the liable cross defendants pay up (which is likely if they are also insured), then the insurer’s financial position is no different than it would have been under the proportionate liability regime. Assuming the cross-defendants were responsible for 80% of the loss, the insured defendant’s responsibility for the loss is 20% and that is what the insurer will pay to the principal. If the liable co-defendants do not pay, then the insured defendant is required to pay any part of the loss that is left unpaid by the other defendants to the plaintiff at first instance, but it may initiate recovery action based on the judgment against the liable cross-defendants or initiate separate proceedings against third parties who were not joined. The subrogated insurer faces the risk of non-recovery rather than the plaintiff.

However, the contractor’s liability to a principal (in tort) has not been contractually “assumed” by the contractor because the parties have contracted out of the proportionate liability regime. The principal must still prove and the court must find that the contractor or any other party is liable for the loss according to the general law.

The maximum exposure of an insurer is always 100% of the loss unless and until the court determines that another party is also responsible for the same loss (or agreement is reached between the parties as to their respective liabilities for the claimed loss). The extent and proportioning of responsibility for the loss in terms of quantum is a separate question but it does not turn on any assumed liability to the principal by the contractor that would not have existed but for the contract. It does not alter the standard that must be met in order to establish liability or relieve any other defendant or third party from liability. The thing that has changed is that the risk of any inability to recover a share of the loss from one or other of the defendants has moved from the plaintiff to the defendant.

Accordingly, if insurers wish to protect themselves against risk of non-recovery that can be accounted for in the premium, but the claim should not automatically be excluded if an insured has contracted out of the proportional liability regime because of the “contractually assumed liability” exclusion clause; and the insurer should be obligated to defend the claim.

Whether the “orthodox” or “alternative” view is correct has not been considered nor determined by courts in Australia.

It is clearly to an insured defendant and insurers advantage if the proportional liability regime applies. However, in some sectors, particularly construction, principals often insist on contracting out of the regime.

If an insured contracts out and extends its own liability by assuming liability for a third party’s negligence; and a contractual assumption of liability clause is included in the policy, it is highly likely that an insurer will attempt to refuse to pay the plaintiff for any loss claimed that is over and above the insured’s relatively proportion of responsibility for the loss.

For the reasons outlined above, whether it is legitimate for the insurer to do so will depend on the particular terms of the contractual provision between the parties and the assumed liability exclusion in the policy. It will not depend on a blanket mantra that if the proportional liability regime is excluded by contract, then the insurer is not liable to indemnify or defend the insured in the proceedings. The insurer can initiate a subrogated action for recovery against any liable cross-defendants or other third parties.

Some insurers will agree to ‘waive’ any prejudice suffered as a result of “contracting out” via a “proportionate liability “writeback”” and will adjust the premium to account for that increased risk of non-recovery accordingly. Provision of such a term in the insurance policy is more preferable than leaving the question open as it reduces the risk of any dispute about this difficult issue when an insured event occurs.

If a contractual indemnity or “hold harmless” clause is insisted upon, it is likely that the insurer can exclude cover pursuant to the contractual assumption of liability exclusion and the insured will be required to pay the principal and seek recovery at its own cost from those at fault. This is so whether the proportionate liability regime applies or not – and in fact it is preferable that the regime does not apply if the insured becomes the plaintiff against its subcontractors or third parties, who must in turn crossclaim against others that they consider to be responsible. In that case, it may be to the advantage of a contractor to also contract out of the proportionate liability regime with its subcontractors as the liable subcontractor will be required to pay and seek contribution from other liable parties.

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[1] Civil Liability Act 2002 (NSW) Pt 4, Wrongs Act 1958 (Vic) Pt IVAA, Civil Liability Act 2002 (WA) Pt 1F, Civil Liability Act 2003 (Qld) Pt 2, Civil Law (Wrongs) Act 2002 (ACT) Ch 7A, Proportionate Liability Act 2005 (NT), Civil Liability Act 2002 (Tas) Part 9A, Law Reform (Contributory Negligence and Apportionment of Liability) Act 2001 (SA) Pt 3, Competition and Consumer Act 2010 (Cth), Development Act 1993 (SA) s72, Building Act 2004 (ACT) s141 and Building Act 2000 (Tas) s252, and any similar legislation, all as amended from time to time.

[2] QBE Underwriting Ltd as managing agent for Lloyds Syndicate 386 v Southern Colliery Maintenance Pty Ltd [2018] NSWCA 55 (28 March 2018) at [50]; See also Karenlee Nominees Pty Ltd v ACN 004 312 234 Ltd (1994) 8 ANZ Ins Cas 61-236 at p 13, referring to Derrington and Ashton.

[3]Such an express “contracting out” provision is not required and if language is used in the contract that in effect contradicts the proportionate liability regime, then a party may be deemed to have contracted out of the legislation. Tasmania in Aquagenics Pty Ltd v Break O-Day Council [2010] TASFC 3 Perpetual Trustee Company Ltd v CTC Group Pty Ltd (No 2) [2013] NSWCA 58.

[4] Absent tort claims covered by that statute, defendants may rely on the doctrine of equitable contribution to achieve a similar result.  For there to be equitable contribution, liability need not be predicated on the nature of the cause of action. The focus is on the parties’ liability for the same damage.