an update on current issues in the dutyto...

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AN UPDATE ON CURRENT ISSUESIN THE DUTY TO DEFEND

These materials were prepared by Gary Zabos of Gauley & Co., Saskatoon, Sask. for the SaskatchewanLegal Education Society Inc. seminar, Insurance Law Update, March 1999.

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TABLE OF CONTENTS

1. INTRODUCTION 1

2. THE GENERAL PRINCIPLES 2

3. WHAT CAN THE COURT CONSIDER IN DETERMININGWHETHER THE ALLEGATIONS AGAINST THE INSUREDMIGHT POSSIBLY FALL WITHIN COVERAGE 4

4. CONFLICTS, APPOINTMENT OF COUNSEL, ANDAPPORTIONMENT OF DEFENCE COSTS IN MULTIPLEALLEGATION CLAIMS 7

5. THE DUTY TO DEFEND WHERE THERE IS A BREACHOF CONDITION 17

6. DEFENCE COSTS IN MULTIPLE INSURER CASES 20

7. PRACTICAL CONSIDERATIONS IN RESOLVING DUTYTO DEFEND ISSUES 23

(a) Applications to Determine Rights 23(b) Reservation of Rights and Non-waiver Agreements 24(c) Conflicts Arising during Defence 25

AN UPD~TE ON CURRENT ISSUES IN THE DUTY TO DEFEND

GARY ZABOS *

1. INTRODUCTION

The obligation undertaken by a liability insurer to defend its insured against claims by third

parties is a feature of almost any third party liability policy in use in Canada today. The

obligation is contractual, and the contract wording creating the obligation and rights of the parties

in regard to the defence of actions will vary from policy to policy. The Commercial General

Liability Policyl, for example, simply states:

duty to defend any lIactionll seeking those

We may investigate and settle any claim or IIaction" at ourdiscretion; andOur right and duty to defend ends when we have used upthe applicable limit of insurance in the payment ofjudgments or settlements ... II

3)

IIWe will have the right andcompensatory damages[2] but:

1)2)

Understanding and complying with the requirements of the duty to defend has important

implications for insurance practitioners, insurers and insureds. There are conflict considerations

of which the insurer must be aware, and lIinsurer bad faithll implications from decisions regarding

denying or accepting coverage. Expanding tort liability for defendants, a generally more litigious

society, and high costs of litigation, experts, etc., make a determination of whether an insurer is

bound to defend a claim one which can have significant economic implications for the insurer

and insured. Ethical concerns arising in the "tripartite relationshipll, greater expectations on the

legal profession in terms of avoidance of appearances of conflict, and liability risks for

IBC Form 2100

2 Damages for bodily injury or property damage to which the insurance applies.

* of Gauley & Co., Saskatoon. I would like to thank our student Norma Oshynko for her assistance in the researchof this paper. Any errors or omissions remain mine.

practitioners advising insurers on coverage issues, makes keeping up on developments in this area

of law important to practitioners.

A decision on the duty to defend is also something which must be dealt with at the earliest stages

of the claim. There is case authority that holds that at least where the insured can be said to be

prejudiced by actions of the insurer in taking steps. in the action before denying coverage, the

insurer may be deemed to have waived the right to deny the obligation to defend or to

indemnifY. It may not later be entitled to withdraw from the defence or refuse to indemnify,

even if there plainly is no coverage.

Many of the principles relating to the duty to defend are well established in Canadian law and

well known to insurance practitioners. However, there are areas in which the principles are not

clear, or are in the process of development in Canada. The purpose of this paper is to discuss

some of these issues.

A word of caution. While this paper is intended to provide a general discussion of the issues,

it must always must be borne in mind that the wording of the particular policy may (and probably

will) effect the outcome of any particular case. While there is general uniformity in liability

insurance policy wording in use in Canada, as with any insurance problem, consideration should

begin with the wording of the particular policy.

2. THE GENERAL PRINCIPLES

The Supreme Court of Canacia decision in Nichols v. American Home Assurance Co. et al4

provides the leading modem authority on the duty to defend in Canada. American Home

Assurance was sued by Nichols under a lawyer's professional liability policy. The policy

3 See example Schell v. Co-operative Farming Casualty Co. (1978),91 D.L.R. 3rd 230 (Sask. Q.B.).

4 [1990], 1 S.C.R. 801.

required the insurer to defend any action against the insured seeking damages which were or

might be payable under the terms of the policy, even if the allegations in the suit were

groundless, false or fraudulent. The allegation against the lawyer involved fraudulent acts or

omissions, and the insurer denied the obligation to defend. The insured sued American Home

for a declaration that he was entitled to a defence under the policy, and an order that the insurer

pay the defence costs. The trial judge awarded the relief requested5, based on the view that the

policy required a defence be provided even if the claim contained allegations of fraudulent

conduct. The Ontario Court of Appeal affIrmed the judgment6• The matter went to the

Supreme Court.

The Supreme Court reversed the decisions of the lower courts and held that the insurer was under

no duty to defend. In so doing, McLauchlin, J. for the unanimous Court provided the following

principles:

1. The duty to defend is broader than, and independent of, the duty to indemnify. the duty

to defend arises where the claim against the insured alleges acts or omissions falling

within the policy coverage, while the duty to indemnify arises only where such allegations

are proven at trial to be within the coverage: p. 808.

2. It follows that the duty to' defend is triggered when the allegations against the insured are

allegations which (if proven) might fall within those claims for which the insurer is

obligated to indemnify: p. 808-810. It is not necessary to prove that the obligation to

indemnify will in fact arise in order to trigger the duty to defend. "The mere possibility

that a claim within the policy may succeed suffices."7.

5 (1988), 63 O.R. (2d) 693.

6 (1989), 68 O.R. (2d) 1.

7 At p. 810. See also Prudential Life Insurance Co. v. Manitoba Public Insurance Corp. (1976),67 D.L.R.3rd 521 (Man. C.A.) quoted with approval in Nicholls.

3. Because the duty depends on the nature of the claim made against the insured, the

pleadings in the action against the insured govern the duty to defend. Where it is clear

from the pleadings that the suit falls outside the coverage of the policy, the duty does not

arise. On the other hand, there is an obligation to defend any claim which, if proven,

would fall within the scope of the coverage: p. 810-811.

4. The widest latitude should be given to the allegations in the pleadings in determining

whether they raise a claim that may be covered by the indemnity obligation in the policy:

p. 812. The insurer's view of the validity or nature of the claim or possible outcome of

the litigation are not considerations8•

5. In determining whether the claim may fall within the indemnity obligation, the entire

policy is to be looked at. It is not sufficient to look at the insuring agreement but, as

illustrated by Nichols, the exclusions to coverage are also to be examined.

The Nichols case provides a general summary of the main principles in the duty to defend in

Canada. However, the application of these principles can raise some significant collateral issues,

to some of which we will now turn.

3. WHAT CAN THE COURT CONSIDER IN DETERMINING WHETHER THEALLEGATIONS AGAINST THE INSURED MIGHT POSSffiLY FALL WITHINCOVERAGE

As noted above, Nichols and the other cases which defme the scope of the duty to defend say that

"the pleadings" govern the duty. But what is meant by "pleadings"? And are there any

circumstances under which the Court can go beyond the pleadings? A review of the cases shows

there is some authority to suggest that only the statement of claim may be examined, some to

suggest all "pleadings" may be looked at, and some that have held that extrinsic evidence of

underlying facts may also be looked at.

8 See also Bacon v. McBride (1984),60 D.L.R. 4th 96 (RC.S.C.).

In Kerr v. Law Profession Indemnity Co. 9, the insured was insured under a lawyers professional

liability policy. The third party's claim against the insured made no mention of him acting in

his capacity as a solicitor. Rather, the claims were based on alleged acts of the insured in the

capacity of secretary of a company. The insured filed a statement of defence alleging that he was

acting in his capacity as solicitor, and then called on his professional liability insurer to defend.

On the application for a declaration of a right to a defence, the insured also filed an affidavit

setting out some underlying facts, including that he had acted as secretary as part of the solicitor

client relationship with the company. The Court held that he was not entitled to a declaration

of an obligation to defend. In so ruling, the court was of the view that neither the affidavit or

the statement of defence could effect the issues. At paragraph 40 Mandel J. said:

"If the claim, as in the case at bar, is not in respect of such services but arisesotherwise, there is no duty to defend ... and allegations in the. Statement ofDefence which are not the claim put forward but may give rise to a different andpotential claim on the part of the claimant and which as yet has not been putforward, does not in my view trigger the obligation of the insurer to defend theclaim that is the subject matter of the action. The operative phrase is the claimput forward." (emphasis added)

In essence, the Court held that the obligation to defend was in regard to claims actually raised(

by the third party in the claim, not allegations that potentially could be raised by the plaintiff.

In John Picken Ltd. v. Guardian Insurance Co. of Canada lo, the court refused to look beyond

the pleadings to underlying facts, stating that:

"...the duty to defend must be determined on the basis of a claim made against theinsured not on a basis of what has on occasion been referred to as the 'underlyingfacts exception'."11

9 (1994),22 C.C.L.I. (2d) 28 (Ont.Gen.Div.).

10 [1993], 17 CCLl 2d 167 (ant. C.A.).

II Page 170.

But in western Canada, the Courts seem more willing to consider underlying fact evidence. In

Cansulex Ltd. v. Reed Stenhouse Ltd. 12, the British Columbia Supreme Court discussed what was

referred to in John Picken as "the underlying facts exception". McEachern C.J. said at 8061:

"If a claim is pleaded which is covered, then the insured is unquestionably entitledto succeed on this narrow ground. Most cases are not so simple, but I have theview that neither the insured nor the insurer are always in the hands of the thirdparty pleader, and it is open to an insured to show he is covered for the claimeven if it is not correctly pleaded, and it is equally open to an insurer to show thata claim, however pleaded, is not one for which indemnity is furnished or, ifcovered, is excluded by another provision in the policy. This was the view ofDevlin J. in West Wake Price & Co. v. Ching [1957] 1 W.L.R. 45, [1956] 3 AllE.R. 821 (Q.B.), as stated in the headnote at p. 822, which appears accurately tostate His Lordship's views. It states:

'PER CURIAM: underwriters were not bound by the way in which a claimantchose to formulate his claim, but could properly invite the Court to ascertain thetrue nature of the claim and to make such inquiry as might be necessary for thatpurpose.'

In this respect, see also Fidelity & Casualty Co. of New York v. EnvirodyneEngineers Inc., 461 N.E. 2d 471, 122 Ill. App. 3d 301, 77 Ill. Dec. 848 (1983),although I think the declaratory action has mercifully fallen into disuse in Canada.I have the view that it is always open to an insured or an insurer to show that aclaim is or is not covered or excluded, subject, of course, to situations such asBacon, supra, and other circumstances following a denial of coverage such asoccurred in this case..." (emphasis added)

While similar reasoning has been applied in other cases to hold that all pleadings, including the

defences and third party proceedings could be examined13, in Simcoe & Erie, extrinsic evidence

sought to be filed by an insurer for the purpose of "clarifying the nature of the plaintiffs claims"

was disallowed. In Privest, the Court held that extrinsic evidence was admissible, as long as it

was non-contentious. Arguing Cansulex, the insurer in Privest sought to adduce a transcript,

12 [1986] I.L.R. 1-2090 (B.C.S.C.).

13 See ego Simcoe & Erie General Insurance Co. v. Kansa General Insurance Co., [1992] 6 W.W.R. 77(B.C.S.C.), Privest Properties Ltd. v. Foundation Co. afCanada, [1991] 6 CCLI 2nd 23 (additional reasonsat (1991) 6 C.C.L.I. 2d 15) (B.C.S.C.).

some documents, and affidavit evidence which it said went to the nature of the damages claimed

by the third party. Drost 1. held:

"I concluded that, as a matter of law, it is open to a court on an application of thisnature to go beyond the pleadings and to consider evidence. However, I alsoconcluded that in the circumstances of this case, one in which many complex andnovel issues arise and which, at that time, was still in its early stages, it would bewrong to admit evidence which counsel considered contentious and which wouldlikely require the court to trench upon the very issues to be resolved in the mainaction.

For those reasons, I held that on the duty to defend application I would allowcounsel to adduce only such evidence as they could all agree was not contentiousand would be of assistance ..." (emphasis added)

It is submitted that the reasoning in Cansulex and Privest makes sense. The parties should be

entitled, where appropriate, to show that the claim is (or is not) covered, despite poor or inexact

pleadings by the third partyl4.

4. CONFLICTS, APPOINTMENT OF COUNSEL, AND APPORTIONMENT OFDEFENCE COSTS IN MULTIPLE ALLEGATION CLAIMS

Complications can arise where the claim made against the insured raises multiple or alternative

allegations, some of which may be covered by the policy, and some not. A simple example of

a situation in which this often arises is in sports injury cases where the pleadings may allege an

intentional tort, and in the alternative, that the defendant player was negligent.

Generally speaking, the right and duty to defend carries with it the right to appoint defence

counsel to defend the claims against the insured. As some recent authorities show, however,

there are situations in which the Courts may require the insurer to fund a defence by counsel

selected by the insured, either as a replacement for, or to act in addition to, defence counsel

14 See also Hilliker, Liability Insurance Law in Canada (Butterworth's, 1991) p. 62-67 for further discussionon this issue.

appointed by the insurer. This can occur where the Court perceives a conflict between the

insured and insurer.

One way in which conflict can arise in multiple or alternative allegation claims was recognized

by the Supreme Court in Nichols. McLauchlin, J. described it as follows:

"Moreover conflicts of interest may result. The insurer's interest in defending aclaim is related to the possibility that it may ultimately be called upon toindemnify the insured under the policy. It is in the insurer's interest that ifliability is found, it be on a basis other than one falling under the policy.Requiring the insurer to defend claims which cannot fall within the policy puts theinsurer in the position of having to defend claims which in its interests shouldsucceed." 15

The Supreme Court in Nichols also provides some guidanceon how this conflict can be handled.

McLauchlin, J. stated at 812:

"For this reason, the practice is for the insurer to defend only those claims which.potentially fall under the policy, while calling upon the insured to obtainindependent counsel with respect to those which clearly fall outside its terms.

I conclude that considerations related to insurance law and practice, as well as theauthorities, overwhelmingly support the view that the duty to defend should, unlessthe contract of insurance indicates otherwise, be confined to the defence of claimswhich may be argued to fall under the policy."16

But as shown in the recent Alberta case PCS Investments Ltd. v. Dominion of Canada General

Insurance Co. 17, the resolution of such a conflict may not always be so simple. PCS

Investments involved a conflict where a pre-trial application was made by the insured for a

declaration as to the obligation to defend a claim against it. The insured was sued by a

competitor over a letter alleged to be defamatory which contained statements about the plaintiff

15 Nichols, supra, at 812.

16 Nicholls, supra, at 812.

17 [1996], I.L.R. 1-3308 (Alta. C.A.).

which were described in the statement of claim as being "libelous, defamatory, malicious,

irresponsible and calculated... to cause damage". The insured called on Dominion of Canada to

defend under a liability policy that required indemnification of the insured for claims for injury

arising out of the conduct of its business, including injury that arose from liable or slander, !f the

insured did not know that the defamatory statement was untrue. The insurer refused to defend.

The insured then sued for breach of the insurance contract and applied for an order requiring the

insurer to defend.

At the Chambers' level, it was decided that some, although not all, of the allegations in the claim

might possibly be claims for which the insurer would be required to indemnify under the policy.

The insurer was held to be obligated to defend those at its expense. But, because the claim

contained multiple and alternative allegations, some of which would be covered and some not,

the Court recognized a conflict of interest between the insured and insurer about possible lines

of defence. The insurer would not be required to indemnify if malice was proved, but would be

required to indemnify if defamation simpliciter was proved. The solution adopted by the

Chambers' Judge to resolve the conflict was to deny the insurer the usual right to name and

instruct counsel to defend. Instead, the insured was held entitled to appoint counsel of its choice

to defend all claims (both those covered and those not). The insurer was required to pay the

costs of the defence of the insured claims.

On appeal by the insurer, the Court of Appeal recognized that the Chambers' decision enforced

the duty of the insurer to defend the claims against the insured, but noted:

"... if offers no protection to the insurer, who also has a contractual right to defendand therefore a right to raise defences that best suit its interests. In the normalcourse, this right is exercised by naming and instructing counsel." 18

18 At 3961. Italics in original.

The solution adopted by the Court of Appeal "in the special circumstances"19 was to allow the

insurer also to have a right to name its own counsel to participate in the case. According to the

Court:

"This would solve the problem posed by Mr. McGillvray [counsel for the insurer],that, otherwise no party at the first trial would have any interest in a solutIon thatwould protect the insurer."

The insurer, the Court held, could participate in the defence by applying to be added as a party,

or by consolidating the third party action and the insured's suit against the insurer for indemnity.

As to the allocation of the legal costs for the insured's selected defence counsel, the Court of

Appeal held:

"It is correct, that in some cases, a close analysis of the statement of claim maybe needed to enable a fair division of the work of defence counsel between thoseclaims clearly not insured and those that may be. That is not needed here. Thetest calculation for costs assignable to the insurer is to ask how much would beexpended if only the insured risks were raised by the plaintiffs claim... Indeed,it would appear that the insured has hired separate counsel to defend the otherclaims. In our view that is unnecessarily expensive and cumbersome. We see noreason why Mr. Wachowich [counsel for the insured] cannot handle both, but billthe insurer only in accordance with the test just mentioned. If a problem arises,he can get further directions from Queen's Bench."20

In summary, the pes decision appears to hold that where there is a conflict such that the interests

of the insured and insurer are not the same21 and different lines of defence may benefit one or

the other, the following may occur:

1. . The insured, not the insurer is entitled to appoint counsel to the defend the claim.

19 Presumably meaning that the fact situation involving a potential conflict of interests: See p. 3961.

20 At p. 3960. Emphasis added.

21 As the Court described it at 309 "there is not, in the special circumstances here, the usual complete identityof interest between the insured and insurer vis a vis the third party claim."

2. Costs of this counsel will be apportioned in accordance with the test noted above.

3. The insurer has a right to appoint its own separate counsel to participate in the trial and

advance the insurer's position that the act or omission is not covered by the policy.

The pes Investments case does not appear to have been followed elsewhere to date.

Another case dealing with a similar issue is Laurencine v. Jardfne22• There the insured sued for

damages for personal injury arising from an accident involving a motorcycle that Jardine owned.

Halifax Insurance Company provided third party liability insurance for the motorcycle. There

was some dispute over how the injured party obtained possession of Mr. Jardine's motorcycle and

rode to his injuries. Halifax sought to obtain a non-waiver agreement from Jardine but this was

refused. Halifax denied coverage. Jardine applied for an order that Halifax was required to

defend, which Halifax opposed, unsuccessfully. Jardine then sought an order that Halifax was

in a conflict and that he should be entitled to appoint his own solicitors, at the cost of Halifax,

to defend the claim. His argument was that because Halifax had denied coverage under the

policy, therefore (as summarized by the court):

"... the situation is open to conflict as to the manner in which counsel for Halifaxconducts the case, ie., what is good for Halifax is not necessarily good forJardine"23.

Citing American authorities, the court held that an "appearance of impropriety" did exist. The

court quoted from 44 American Jurisprudence, 2d (1985) at 359:

"It has also been held that a conflict of interest on the coverage question does notrelieve the insurer of its duty to defend, but rather transforms that duty into thatof reimbursing the insured for the expense of retaining his own counsel. Theinsurer retains the right to have its own counsel present at trial to establish factsregarding the coverage issue."

22 (1988),64 O.R. 2d 336 (H.C.).

23 At p. 338.

In the end, the court held that Mr. Jardine was entitled to appoint his own counsel to defend the

claim, and that the legal fees and disbursements of the solicitors should be paid by Halifax. The

court further directed that counsel so appointed were not required to report to Halifax with

respect to any matter bearing on coverage. Halifax was entitled to participate in the defence of

the action with a solicitor it appointed, "subject to the control of the solicitors appointed by

Jardine".

Another situation in which conflicts may arise and which can have serious implications for the

control of the defence of a claim is where the insurer wishes to defend a claim under reservation

of rights or non-waiver agreement. There are many cases in which the insurer may consider that

it is likely that there will be no coverage, or where a determination on that, even with a legal

opinion, cannot be made, until the facts and evidence develop. The insurer has a dilemma,

because as already noted, proceeding with the defence may in some circumstances be taken to

prevent the insurer from subsequently denying coverage24• On the other hand, denying coverage

can be perilous. Should the decision on coverage turn out to be wrong, the insurer may find

itselfhaving given up the control of the defence and settlement and may be bound by the findings

in the third party's action25, as well as be obligated to pay the solicitor/client defence costs of

the insured in defending it. The solution to this dilemma is often to ask the insured to enter into

a non-waiver agreement, or for the insurer to send a "reservation of rights" letter.

In Ontario v. Kansa General Insurance Co. 26, the main action involved a claim by a property

owner for damages caused by contamination from pollutants migrating from the defendants'

property. One of the defendants brought a third party action for contribution and. indemnity

against the Crown in right of Ontario for alleged negligence of the Crown's servants in

24 See ego Schell, supra, footnote 3.

25 See ego Cansulex Ltd Y. Reed Stenhouse Ltd, supra, footnote 12, Murphy Oil Co. Ltd Y. The ContinentalInsurance Co. [1981], I.L.R. 1-1409 (Ont. Co. Ct.), McMurachyy. Red River Valley Mutual Insurance Co.[1994], I.L.R. 1-3093 (Man. C.A.).

26 (1991), 2 O.R. 3d 269 (Ont. Gen. Diy.) and (1991), 3 O.R. 3rd 543 (Ont. Gen. Diy.).

monitoring. Kansa was the Crown's liability insurer. It initially agreed to defend pursuant to

a reservation of rights letter, which its appointed defence counsel drafted and delivered. Defence

counsel also provided an initial coverage opinion to Kansa.

When costs of the defence, became a concern, Kansa requested the Crown to take over the

conduct of the defence and pay the costs on its own. The Crown brought an application to

. detennine whether it was obliged to do so. The Crown also applied for an order that as a result

of Kansa's actions, it was entitled to select and instruct counsel of its choice and control the

defence and other proceedings at the expense of Kansa. The Crown also requested an order

providing that counsel chosen by it not be required to report to Kansa respecting any matter

touching on coverage.

The Crown's argument was based on the position that by wrongfully refusing to defend the third

party claim, Kansa had repudiated the insurance contract and lost its right to control the defence.

Second, it argued that defence counsel appointed by Kansa was in a conflict of interese7 and

that this conflict gave the Crown the right to choose its own lawyer and control the defence, but

at Kansa's expense.

The Crown in Kansa relied on Laurencine v. Jardine28• There, as already noted, the Court had

held that an insurer had initially refused a defence on the basis that the claim was not covered,

could not then appoint defence counsel, and the insured was entitled to an order pennitting him

to appoint counsel at the insurer's expense and with a requirement that counsel not report to the

insurer on any matters touching coverage.

27 The conflict was the same as that mentioned in connection with the pes Investments case: The interestsof the Crown at trial would be served by a defence that involved the claim falling within coverage, Kansa'sinterests would best be served by showing that the claim fell within a policy exclusion. Kansa did retainseparate "coverage counsel" to represent it on the application.

28 Supra, footnote 22.

Zelinski J. in Kansa held that Laurencine was distinguishable on the basis that Kansa had not

initially repudiated the contract by refusal to defend, as Halifax had done in Laurencine. Rather,

it had entered into an agreement with the Crown and had defended, under a reservation of rights.

Thus, it was held, Kansa had not placed itself in a position where it had lost the right to control

a defence solely by reason of a repudiation.

As to whether counsel was otherwise in a conflict giving rise to a right for the insured to appoint

counsel to control the defence at the expense of the insurer, Zelinski J. adopted an objective test:

"It is the nature of insurance contracts that absent conflict or other properobjection, the insured is consenting to the retainer of counsel appointed by theinsurer, and that information from the insured, unrelated to coverage, or otherwiseinappropriate, will be communicated to the insurer. In this instance, it is onlyproper for HMQ to insist upon new counsel, of its [own] choosing, under itscontrol, and at the expense of Kansa, if I conclude that a reasonable person.reasonably informed. would not be satisfied that [defence counsel] had not used.or will not use confidential information improperly. ,,29

Zelinski J. held that the test here was not met on the facts. His judgment provided some

interesting discussion on the effect of a reservation of rights letter on the right to appoint counsel.

He explained at 554-556:

"As previously noted, the fact of the delivery of the reservation of rights letter ofJuly 28, 1985 by Blaney [defence counsel] to HMQ indicates that, before Blaneywas retained to represent HMQ, Blaney counselled Kansa with respect to itsobligations to defend.

At p. 138 of his article (Ferguson on Conflict, supra[301, the learned authorsuggests:

'[I]f an insurer delivers a reservation of rights letter or proposes a non-waiveragreement this will give the insured the right to retain separate counsel at theinsurer's expense.'

29 At p. 557, emphasis added.

30 D.S. Ferguson, "Conflict Between Insured and Insurer: An analysis of Recent Canadian Cases" (1990), 12Advocate's Q. 129.

This is a right which must be acted upon when it arises. It is lost if the terms areaccepted. It is not restored unless, or until, a new situation arises which justifiesa similar election. The rights of HMQ herein differ from those of the insured inLaurencine, supra. In that case the insurer had repudiated the contract ofinsurance by its initial refusal to defend. I have already concluded that, here,Kansa did not repudiate its contract with HMQ.

When HMQ elected to accept the terms set out in Blaney's letter, and to use theservices of that firm in accordance with its letter, and to use the services of thatfirm in accordance with its letter, it lost its right to retain separate counsel atKansa's expense, at that stage. Issues of mountIng cots, uninsured periods, familyfeuds, claims which fell outside the coverage, etc., which troubled Kansa andwhich led to its efforts to renegotiate the terms of the defence, could only bebased upon the information passed to Kansa by Blaney. However, Blaney had anobligation to convey all relevant information concerning the conduct of the actionto Kansa. There was no evidence before me that, in doing so, Blaney resumedgiving advice to Kansa with respect to coverage.

At p. 139, the learned author [Ferguson, supra] excerpts the following passagefrom Foremost Insurance Co. v. Wilks, 253 Cal. Rptr. 596 (Cal. C.A., 1989) [atpp. 601-02]:

'The insurer's duty to defend the insured obligates it to furnish independentcounsel to represent the insured if a conflict of interest has arisen between theinsurer and the insured ." A conflict of interest between jointly-represented clientsexists "whenever their common lawver's representation of one is rendered lesseffective by reason of his representation of the other" ... "Such a conflict is likelyto arise in the insurance context in two situations: [1] where coverage under thepolicy is disputed ... and [2] where the claim against the insured is likely to resultin·a recovery in excess of the policy limits unless the insurer accepts a settlementoffer within the policy limits" .. , Moreover, if there is a coverage dispute and theinsurer elects to defend the insured under a reservation of rights. the conflictcreated thereby may require· the insurer to furnish independent counsel ...

.However. not every reservation of rights creates a conflict of interest; rather theexistence of a conflict depends upon the grounds on which the insurer is denyingcoverage ... If the reservation of rights arises because of coverage questions whlchdepend upon the insured's own conduct, a conflict exists.

On the other hand, where the reservations of rights is based on coverage disputeswhich have nothing to do with the issues being litigated in the underlying action.there is no conflict of interest requiring independent counsel.'

Adopting this test to the facts of this case indicates to me that there is no conflictof interest here. It must be remembered that it is only appropriate for the courtto find a conflict ofinterest which affects the rights of counsel to continue to actwhen the conflict arises in connection with counsel's obligation to his/her clients.It is the solicitor who must be in a conflict of interest. This arises either byhis/her actions or by virtue of the special nature of the dispute between the partiesthat he/she represents. Conflicts between the parties only become the problemsof the counsel when the problems between the clients put into question the abilityof counsel to be able to properly and obJectively represent the clients, in fact andin appearance." (emphasis added)

Finally, it should be noted that Zelinski 1. did not appear to necessarily accept the principle that

even if the Blaney firm had been put in a conflict (on the objective test) by its initial opinion on

coverage and reservation of rights letter, that this necessarily meant that the insured would be

entitled to counsel appointed by it. Zelinski 1. said at 557:

"If I am wrong in this(31) I am not satisfied that Blaney's error would justify thedenial to Kansa of the right to appoint new counsel under its control. My errorwould be in my conclusion about the circumstances which address what Blaneyhas done. This does not suggest new counsel appointed by Kansa would besimilarly tainted. It is not necessary for me to consider this further at this time inview of my conclusions. ,,32 (Emphasis added)

Following Laurencine, the New Brunswick Court of Queen's Bench in Desmond v. Guardian

Insurance Co. of Canada33, held that where there was a conflict of interest, the insured was

entitled to his own counsel at the insurer's request. Similarly, in Ware v. Robertson34, the court

declared the insured to have the exclusive right to select and instruct counsel of his choice to

defend the plaintiffs claim where the interests of the insured and insurer conflicted. The court

there further held that it would be "impractical and unworkable" to have two counsel represent

the insured. The conflict there arose in a case in which the insured was sued for fire damage to

31 On his conclusion that there was no conflict.

32 At p. 557.

33 [1995], N.B.J. 378.

34 (1996), B.C.J. 1627.

the plaintiffs property. It was alleged by the insurer that the fire was caused by arson of the

insured. If this was so, there would be no coverage under the liability policy.

5. THE DUTY TO DEFEND WHERE THERE IS A BREACH OF CONDITION

As is clear from the Supreme Court decision in Nichols, supra, where the allegations made

against the insured do not fall within the coverage provided by the policy, there is no duty to

indemnify. However, what happens when the allegations made against the insured would fall

. within the policy, but the insurer alleges that the insured has breached a policy condition or

otherwise engaged in conduct (for example misrepresentation) which relieves the insurer of its

obligation to indemnify? The Canadian authorities on whether the insurer will be required to

defend despite alleging a breach of condition are conflicting.

Where the issue of whether the breach will result in voiding the policy, and if so whether the

insured should be relieved from forfeiture, can be determined by summary application, it is

expected that the duty to defend issue could be resolved in the same summary way as any the

other dispute on the obligations to defend. However, given the nature of the type of allegation

often involved in this type of situation, summary determination will not usually be possible.

Usually, to decide on a breach of policy condition or a relief from forfeiture, the court will need

to consider all of the circumstances, some of which may only be determined as the evidence is

developed in the main action.

The first line of authorities on this issue is represented by Agassiz Enterprises (1980) Ltd. v.

General Accident Assurance Co. 35. The insured operated a ski resort and was insured for

liability by General Accident under a policy which provided that prompt notice was to be given

of any accident or occurrence. The insured was sued by an injured skier, but failed to give notice

to General Accident for nearly two years. General Accident denied coverage for breach of the

policy condition, and the insured brought an interlocutory application for a declaration that

35 [1988], 3 W.W.R. 304 (Man. C.A.).

General Accident was required to defend. The issue was whether the insurer must conduct and

fund the defence, pending a final determination of the issue of whether the breach of condition

raised by the insurer disentitled the insured to a defence. The insured was successful at the first

level. General Accident appealed.

The Manitoba Court ofAppeal overturned the lower court decision. The Court held that the issue

of the insurer's duty to defend depended on whether there was a breach, whether there was an .

estoppel, and whether the insured may be entitled to relief from forfeiture, all matters which

should not be determined on a summary application, but way of an appropriate action with

pretrial discovery and trial. The court held that the insurer was not required to defend the action

against the insured in the interim. The Agassiz approach has been followed in British

Columbia36 and in Ontari037•

Cases from other jurisdictions have taken a different view. In the Nova Scotia Court of Appeal

decision in Dominion of Canada General Insurance Company v. MacCulloch38, the facts were

similar to Agassiz. The insured failed to give timely notice of the claim as required by a

condition of the policy. Referring to Nichols, supra, and other authority supporting the position

that the pleadings in the action against the insured· govern the duty to defend, the court held:

"It follows that if an insured has failed to notify the insurer of an occurrencebecause he has no reasonable apprehension that it put him at risk, he should notbe deprived of the right to be defended that does not arise until the insurer isaware of allegations in the statement of claim.

.... The policy itself therefore does not contemplate that the insurer may berelieved of the duty to defend because it considers the insured to be in breach ofa term of the policy.

36 Carter v. Kerr (1990), 69 D.L.R. 4th 542 (B.C.C.A.), Platz v. Sperling (1990), 43 C.C.L.I. 259 (B.C.C.A.),East Kootenay Realty Ltd v. Gestas Inc. (1986),21 C.C.L.I. 230 (B.C.S.C.).

37 Veillieux v. Chambers (1995), 25 OR 3d 538 (Gen.Div.), Societa Italiana Assicurazioni Trasporti v.Canadian Marine Underwriters Ltd (1994),26 C.C.L.I. 2d 274 (Gen.Div.).

38 (1991), 78 D.L.R. 4th 593 (N.S.C.A.).

... The allegations of liability against the insured in the statement of claim arewithin the coverage of the policy and trigger the duty to defend, whether or nota breach of terms of the contract may later be raised by the insurer to support arefusal to indemnify. 1139

The Alberta decision in SCS Western Corp. v. Dominion of Canada General Insurance42 and

the New Brunswick decision in Desmond v. Guardian Insurance Co. 43 also adopted this

approach.

While the Ontario position as recently as 1995 appeared to follow the Agassiz approach44, it

appears from more recent cases that the attitude of the Ontario courts may be changing. In 1996

Rosenberg J of the Ontario Court of Appeal, in obiter, noted that he was not accepting the

position that breach of a condition automatically disentitled the insured to a defence: Cummings

v. Budget Car Rentali5• And the very recent decision of the Ontario General Division in

39 At 597, emphasis added.

40 (1987), 27 C.C.L.I. 248.

41 At 36.

G ((1998), 59 Alta L.R. 3d 73 Q.B.).

43 (1995), 167 N.B.R. 2d 93 (Q.B.).

44 See ego Veillieux v. Chambers, supra, footnote 37.

45 (1996), 29 O.R. 3d 1 (C.A.).

Griffen v. Hopey Estate46 took a similar approach. There, the insurer alleged that the insured

had breached a condition of a motor vehicle liability policy by allowing an unlicensed driver to

operate the vehicle. On the basis of the pleadings in the liability action, a defence was clearly

owed. The insured argued that the pleadings must govern.

The court in Griffen adopted the MacCulloch judgment and held that, the insurer was obligated

to defend the claim. If at the end of the day, the insurer's position was upheld, it would be

entitled to reclaim expenses of the defence from the insured.

6. DEFENCE COSTS IN MULTIPLE INSURER CASES

Not infrequently, especially with commercial enterprises, more than one insurance policy may

respond to an incident. There may be multiple primary insurers, primary and excess insurers, or

in the case of a continuing or progressive loss, different insurers on risk at different times.

Where the facts are such that more than one insurer is obligated to defend, issues can arise over

which insurer is to pay defence costs, and if more than one, how the costs should be apportioned.

American authorities discussing these issues conflict. It has been pointed out by some that each

insurer has an obligation to the insured to defend, but that there is no privity of contract between

insurers which would give a contractual right or obligation to contribute for the costs of the

defence. And if there is an obligation to contribute, on what basis are costs to be shared?

Should it be equal, or on some pro rata basis, perhaps based on exposure, or on policy limits?

Canadian authorities which have considered these issues appear to accept that the principle of

"equitable subrogation" requires insurers to contribute, and favour an equal contribution to

46 (1998) 0.1. 3012.

defence costs despite unequal exposures, although perhaps with provision for adjustment between

the insurers at the end of the case47•

. In Broadhurst & Ball v. American Home Assurance Co. 48, the insured law firm had professional

liability insurance from American Home, with a limit of $500,000.00 per occurrence. It had

excess coverage from Guardian Insurance to a limit of $9.5 million per loss. An action was

brought against the firm for $20 million. The court held that both insurers were obligated to

defend and, even though there was no contract between them, as a matter of equity, both should

pay the defence costs. On the issue of the apportionment of the defence costs, the court declined

to follow a number of American authorities which have held that there should be a pro rata

sharing of defence costs in proportion to the amount of the claim each is required to pay. The

court held that the defence costs were to be shared equally:

"On the facts of the present case, it appears to me that, as a simple matter offairness between insurers under concurrent obligations to defend, and, as well, infairness to the insured, Guardian should pay a proper share of the costs of defence.It follows that American Home should be able to compel such payment. Sincethese insurers have no agreement between themselves with respect to the defence,their respective obligations cannot be a matter of contract. None the less, theirobligations should be subject to and governed by principles of equity and goodconscience, which, in my opinion, dictate that the costs of litigation should beequitably distributed between them.

To require a primary insurer, whose financial exposure is significantly less thanthat of the excess insurer, to bear the entire burden of defending an action of thisnature is, in my view, patently inconsistent with those principles. By the sametoken, a result which allows an excess insurer to deny any responsibility for costswhich it ought in good conscience to pay, is likewise inconsistent with thoseprinciples. As a matter of equity, the burden that these insurers assumed ininsuring the same insured against the same risks should fall on both of them andthe costs accordingly be shared by them. In so· far as it is necessary to provideAmerican Home with a remedy to achieve this result, and without purporting to

47 It should be noted that at least between primary and excess insurers, issues of responsibility for defence andcosts may be provided for by the 1984 "Agreement of Guiding Principles Between Primary and ExcessLiability Insurers Respecting Claims", to which many insurers are signatory. See Brown and Menzies,Insurance Law in Canada (Carswell 1991), p. 362.

48 (1990), 76 D.L.R. 4th 80 (Ont.C.A.).

formulate any rule of general application to all cases involving claims exceedingthe limits of the primary policy, I would adopt the approach taken in the line ofauthority to which I have made reference and recognize the equitable subrogationrights of American Home to compel Guardian to pay a fair share of the costs ofdefence.

On what basis, then, should the costs of defending the Lumsden Building actionbe, apportioned between these insurers? In American Home's submission, theyshould be shared pro rata in proportion to the coverages afforded by each insurer,that is, 95% of costs should be borne by Guardian and 5% by American Home.I cannot accept that submission. The underlying action here, unlike the situationin most of the American cases, has not yet been tried or settled; it remainsoutstanding and its final outcome will not likely be known for some time. In thissituation. I do not think it appropriate to allocate costs simply by reference to therespective policy limits. although I would add. in other situations. this may wellbe a fitting basis for the allocation. The costs of providing the defence here areclearly not necessarily related to the monetary limits of the policies. It seems tome, in viewing the 'matter broadly and as best I can, that the fairest, mostreasonable and most equitable allocation of costs that can be made in the overallcircumstances of this case is to apportion them equally between the insurer."49

The court in Broadhurst & Ball made reference to an earlier decision of the Ontario High Court

in General Accident Assurance Co. ofCanada v. Commissioner ofthe Ontario Provincial Police

Force et aZSo. In that case the insured was sued for equipment damage and allegations of both

automobile negligence and negligence not related to the operation of a motor vehicle were made.

A question arose as to whether the CGL insurer or auto liability insurer should defend. The court

held that both were obligated to defend. On the issue of the apportionment of costs, the court

held that an equal contribution should be made in first instance, but with a right of adjustment

at the end of the day:

"The Prudential51 case did not decide the issue of relative costs of defencebecause it was not asked to do so. However, it did infer, at p. 527, that if theinsurers could not agree on a solicitor to defend the action, they would both beliable for reasonable costs of a solicitor appointed by the insured. In my opinion,

49 At 95-96, emphasis added.

50 (1988),64 O.R. 2d 321 (H.C.).

51 Prudential Life Insurance Co. Ltd. v. Manitoba Public Insurance Corp. (1976), 67 D.L.R. 3d 521.

on the pleadings in the present case, the insurers should bear the cost of thedefence equally, subject to the right of either to apply for a differentawortionment after the facts have been determined at the conclusion of trial.There may be other cases where the pleadings disclose claims that are so nebulouswith respect to the obligation of one or the other of the insurers that it would beinequitable to grant an interim order for the second insurer to defend or for theequal division of the costs of the defence. n52

Accordingly, it would appear where there are multiple insurers and the issue of liability and

quantum in the action against the insured has not been resolved, the general rule appears to be

that the insurers will be required to contribute on principles of equitable subrogation, and to

contribute equally to the defence costs. This may be subject to a different apportionment after

the case has been determined as suggested by the Court in General Accident Assurance Co. of

Canada v. Commissioner of the Ontario Provincial Police Force et al. The theory behind this

approach appears to be that where an insurer owes a duty to defend, the duty is owed regardless

of the amount of the claim, and not only in proportion to its exposure.

7. PRACTICAL CONSIDERATIONS IN RESOLVING DUTY TO DEFEND ISSUES

(a) Applications to Determine Rights

When faced with a dispute over the duty to defend, it is in the interests of both the insured and

the insurer to have the matter resolved expeditiously, as the decision will have an impact on who

will have the right and responsibility for the control of and costs of the defence of the action

against the insured. If it is at risk to indemnify, the insurer will want to know this early, so that

it can control the defence. On the other hand, if it is not required to defend, then the insured will

want to know this early, as it will be responsible for the defence and costs. While these issues

may be resolved by trial between the insurer and insured after (or concurrent with) the trial in

the action against the insured, this is not a satisfactory solution as it leaves the obligations

52 At p. 95-96, emphasis added.

uncertain in the meantime. There are also, as already mentioned issues of estoppel and bad faith

that can be impacted by failure to resolve such disputes early, or by making the wrong call.

In the reported cases from other jurisdictions, issues on the duty to defend are routinely

determined by summary applications to chambers to determine a point of law. A reading of

many of the decisions indicates that an agreed statement of facts was filed. There are cases in

which the courts have held that it is impossible in a summary application to determine the

coverage issues in dispute53, but these cases appear primarily to deal with situations where the

allegation is that the insured has breached a policy condition. As discussed above, for those types

of cases, there may be no method to summarily dispose of the dispute.

For the more straight-forward disputes, it is submitted that under our Rules the appropriate

approach to obtain a ruling would have to bring an application under rule 188 for determination

of a point of law. This would require an agreed statement of facts. The suggested approach to

have the .matter determined is:

1. issue a claim requesting a declaration that there either is or is not coverage (depending

on who brings the action) or to otherwise determine the dispute;

2. agree between the parties as to a statement of facts on which the coverage issue can be

determined;

3. make a rule 188 application for determination· of the point of law.

(b) Resenration of Rights and Non-waiver Agreements

Although clearly the principles are in the process ofdevelopment, the Kansa and pes Investments

cases provide some guidance to counsel for dealing with situations in which there is uncertainty

aboutthe obligation to indemnify. It is suggested that counsel and insurers involved in claims

which may involve an uncertainty about coverage consider at least the following steps:

53 See discussion under section 5 above.

1.

2.

3.

4.

(c)

Page 25

On receiving the assignment, counsel should be sure of his/her role. If being retained as

defence counsel, then no advice on coverage should be given, and counsel should

communicate no information to the insurer which may impact on coverage.

Any reservation of rights letter or request for a non-waiver agreement should be made by

the insurer directly or by coverage counsel. The insurer should be aware that a request

for a non-waiver agreement or a reservation of rights letter may have an impact on the

right to appoint defense counsel.

An insurer issuing a reservation of rights letter should seek the consent of the insured to

the arrangement being proposed, and should not deny coverage, at least until this is

resolved. If Kansa and Laurencine are correct, failing to use caution here could, in some

circumstances at least, result in the insurer losing its right to appoint counsel and control

the defence.

While insurers generally are becoming more aware and sophisticated regarding conflicts

and the duty of counsel to the insured, there are still some insurers (and counsel) who

appear to consider it appropriate to defend and to advise on coverage. It is submitted that

ethical considerations require defence counsel to insist that an insurer who has a coverage

issue retain coverage counsel and avoid expressing opinions or giving advice on such

matters to the insurer.

Conflicts Arising during Defence

Finally, a difficult situation can arise where counsel appointed to defend, learns information

during the course of his/her defence, which may have an impact on coverage. Counsel is placed

in a conflict situation because of the divergent interests of two clients represented.

In Kifarkis v. Blatchfortf4, the insured admitted to counsel appointed by the insurer that the car

accident which was the subject of the claim by the plaintiff had been staged. Counsel made an

54 [1992], O.J. 621 (Ont.Gen.Div.).

application to court for an order removing himself as the insured's solicitor, and to add the

insurer as a third party. He proposed he would continue to act for the insurer.

The court held that as a result of the information revealed by the insured to him, it was clear

counsel could no longer act for the insured, and he was removed as counsel for the insured

defendant. But the court declined to allow the Economical Mutual to be joined as it requested,

questioning the propriety of counsel to continue to act for the insurer. The court held:

"I question whether Mr. Ledroit should continue to act for the Economical Mutualas he will inevitably come into conflict with Mr. Blatchford, his former client. Asa result I am dismissing his application to add the Economical Mutual as a thirdparty pursuant to The Insurance Act without prejudice to the company's right torenew the application."

It is submitted that this is the appropriate approach to take. Counsel appointed by the insurer to

defend the insured clearly is acting for two clients. If a situation develops which places the

lawyer in conflict, Rule 5 of the Code ofConduct would require counsel to withdraw completely

if the conflict cannot be resolved. The concern of the court in Kifarkis about whether counsel

could continue to act for the insurer also appears well founded. The commentary to the same

rule makes it clear that a lawyer who has acted for a client in a matter should not thereafter act

against him in the same or any related matter. In Canadian Southern Railway v. Kingsmill,

Jenning~5, Southey J. stated at 122:

"It will be seen that the authorities emphasize the unfairness arising out of asolicitor acting against a former client where the solicitor might have receivedconfidential information from the former client."

It would appear that the proper approach, should this type of conflict arise, is for counsel to .

withdraw entirely and require the insurer to appoint new counsel on the coverage issue, and for

the defence (subject of course as discussed above, to any right the insured may have to determine

counsel in a conflict situation).

Gary Zabos17/02/99

55 (1978),4 B.L.R. 257 (B.C.S.C.).

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