Severing Bad Faith Claims From First Party Property Losses

A property insurer denies coverage for a loss; the insured responds with a suit claiming not only what it considers to be its contractual entitlement under the policy, but also punitive damages for bad faith. Aside from the increased exposure to damages this scenario presents to the insurer, the existence of the bad faith claim may have the effect of colouring the court’s view of the insurer’s position with respect to the contractual claim. It may also create opportunity for the insured to gain access to the insurer’s privileged communications and work product, giving the insured an advantage in respect to the contractual claim the insured would not have but for the existence of the bad faith claim. Additionally, the bad faith claim may require the insurer’s legal counsel to become a witness and thereby preclude him or her from continuing as counsel for the insurer.

Where these possibilities exist, the insurer may want to consider applying to the court to have the bad faith claim severed from, and stayed pending, the determination of the contractual dispute. This process is otherwise known as bifurcation. To date, the Canadian courts have been divided on the matter, with courts in Eastern Canada having been less willing to grant such applications than have been courts in Western Canada.

Generally speaking, Canadian courts have been reluctant to sever issues for preliminary determination. At least two appellate courts1 have held that it is a “basic right” of a litigant to have all issues in dispute in a case to be tried in one trial, and that a split trial should be ordered only “in the clearest of cases.” Exceptional circumstances must exist. As a rule, the issue to be tried first must have the potential to end the litigation. There must then be a compelling case made that the delay that will be experienced if the subsequent issue(s) needs to be determined is justified and is more than off-set by the expenses that may be avoided if it develops that the subsequent issue(s) does not need to proceed. Even then, the court reserves its discretion to direct that all issues be tried together.

So, for example, leave of the court to sever and stay quantum determinations pending a trial as to whether there is liability on the defendant’s part is rarely granted. While the courts appreciate that a favourable determination of liability for the defendant would end the litigation, thereby making the time and expense of trying quantum unnecessary, the possibility that liability will be determined in favour of the plaintiff and quantum will therefore have to be addressed, is usually enough to militate against splitting the trial of the two issues.

Why, then, should the situation be any different where a bad faith claim has been conjoined with an insurance contractual claim? There are two features that can be used to support bifurcating the two claims that are not present in other situations where severance is being sought. First, the severing of the insurance contractual claim for initial determination will result in a judgment for or against the insured. If the determination on the contractual claim is against the insured, then the action ends there and there is no need to consider the bad faith claim. On the other hand, if the determination of the contractual claim is favourable to the insured, then the insured will have a judgment for the amount payable under the policy, and what remains is a determination of whether it is also entitled to punitive or exemplary damages arising from the insurer’s conduct in respect to the handling of the contractual claim. In the meantime, the insured has, by the judgment on the contractual claim, been made whole for its loss.

Contrast the foregoing situation with one where the issue of quantum in a personal injury claim is stayed pending determination of the issue of liability. There, the action will end if liability is resolved in favour of the defendant; however, a finding in favour of the plaintiff still leaves the plaintiff without a judgment until the stayed quantum determination has been made.

The second distinguishing feature often involved where bad faith claims have been conjoined with a contractual claim on an insurance policy that is not present in other situations where bifurcation is being sought, is the possibility that the insurer may be required to waive legal privilege in order to defend itself with respect to the bad faith claim. If the insurer would not have been required to waive legal privilege over communications, but for the existence of the bad faith claim, then the insurer will have been prejudiced by the bad faith claim being conjoined with the contractual claim.

Where the alleged bad faith conduct of the insurer occurred at a time when litigation was contemplated and/or the insurer was seeking legal advice with as to the course it should steer in respect to the first party property loss, the insurer will likely be required to divulge communications and/or work product in order to defend itself in respect to the allegations. As the insurer would not have to do so in the ordinary course of defending the contractual claim, the insured gains an advantage by having access to information that it would not otherwise have but for the bad faith allegations. It is likely fair to suggest some bad faith claims are motivated more by the desire to access such information, than by any real hope a case for bad faith can be made out. The allegations allow the insured an opportunity to gain insight into the strengths and weaknesses of the insurer’s position by becoming privy to legal opinions and other communications that would be protected from required disclosure in the defence of the contractual claim, but are relevant to the bad faith claim, and therefore open to examination by the insured.

Moreover, and possibly equally damaging, the insurer’s legal counsel may be required to be a witness in the proceedings in respect to the bad faith claims. In such circumstances, the Professional Codes of Conduct in most, if not all, of the Canadian provinces would require the legal counsel step down from their representation of the insurer. This, too, can be the primary purpose of the insured’s bad faith allegations.

The protection of both the solicitor-client and litigation privileges has long been revered in Canada as being fundamental to the justice system. Central to the solicitor-client privilege is the concept that people must be able to speak candidly with their lawyers and so enable their interests to be fully represented. The purpose of the litigation privilege is to protect from disclosure the statements and documents which are obtained or created particularly to prepare one’s case for litigation or anticipated litigation. It is intended to permit a party to freely investigate the facts at issue and determine the optimum manner in which to prepare and present the case for litigation. Arguably, the sanctity given to these legal privileges ought not to disappear merely because an allegation of bad faith is advanced together with a claim on an insurance policy.2

As for requiring that an insurer’s legal counsel step down from a case, this will not only likely delay the trial of the action, but it violates the insurer’s right to counsel of choice. Generally, the courts are reluctant to deprive clients of their chosen counsel.3

The practice of an insured adding a bad faith claim whenever they are compelled to commence suit for the denial of a first party property loss is a fairly recent phenomena in Canada. The limited number of Canadian authorities on point is split with respect to whether there should be bifurcation of the bad faith and contractual claims. Interestingly, to date, the difference in opinion has been geographically based, with Western Canadian courts favouring the weight of American court decisions, which allow bifurcation, while courts in Eastern Canada have been less inclined to do so.

Concerns with respect to loss of legal privilege and right to counsel seem to have been at the heart of the d ecisions of the Western Canadian courts to allow the severing and staying of the bad faith claims.4

On the other hand, courts in Ontario and Newfoundland, relying upon the general principle that it is a “basic right” of a litigant to have all issues in the dispute tried in one trial, have taken a less protective approach when solicitor-client and litigation privileges applicable to the coverage claim are threatened by the presence of bad faith claims.5 However, while Ontario courts have been less inclined to order severance in such circumstances, they have acknowledged that on proper evidence, severance could occur.

Where are Canadian courts likely to go on this issue in the future? Comment made in the Supreme Court of Canada’s decision in Whiten v Pilot Insurance Co.6 may be impactive in this regard. There, the high court stated, where a trial judge is concerned the claim for punitive damages may affect the fairness of the liability trial, bifurcation may be appropriate. It is highly arguable that requiring an insurer to waive its solicitor-client and litigation privileges, and having to relinquish its choice of counsel, constitutes an unfairness sufficient to warrant the severing and staying of a bad faith claim pending determination of the contractual claim under the insurance policy.

With over 32 years of experience, Havlock Madill, Q.C. is Brownlee LLP’s most senior litigator. He has been counsel in some of the larger, more complex litigation that have come before the Courts, and is well regarded for his thorough and effective advocacy

References:

1. Elcano Acceptance v. Richmond, Richmond, Stambler & Mills (1986), 55 O.R. (2d) 56 (Ont. C.A.); Esso Resources Canada Ltd. v. Stearns Catalytic Ltd. (1991), 114 A.R. 27 (Alta. C.A.)

2. Davies v. American Home Assurance Co., [2002] O.J. No. 2696 at paras. 17 and 44

3. Alberta Treasury Branches v. Leahy, (1998), 223 A.R. 113 (Alta. C.A.); Michel v. Lafrenz (1992), 6 Alta. L.R. (3d) (Alta C.A.); Downham v. Wawanesa Mutual Insurance, (2005), 23 C.C.L.I. (4th) 33 (Alta. Q.B.)

4. Wonderful Ventures v. Maylam [2001] B.C. J. No. 1144; Lawrence v. Insurance Corp. of British Columbia [2001] B.C.J. No. 2516 (B.C.S.C.); Read v. Insurance Corp. of British Columbia, (2002) BCSC 1607; Stuart v. Manufactures Life Insurance Co., (2004), 10 C.C.L.I. (4th) 142; Stevens v. Sun Life Assurance Co. of Canada, (2004), 9 C.C.L.I (4th) 245; Sovereign General Insurance Company v. Tanar Industries Ltd., [2002] 3 W.W.R. 240

5. Sempecos v. State Farm and Casualty Co., [2001] O.J. No. 4887; affirmed [2002] O.J. No. 4498 (Ont. C.A.); Osborne v. Non-Marine Underwriter’s Lloyd’s London, (2003), 46 C.C.L.I. (3d) 157; Lundigran v. Non-Marine Underwriters, Lloyd’s, London, [2002] N.J. No. 30

6. [2002] S.C.J. No. 19