Decisions, Decisions…

As litigation becomes more elaborate and trials increase in duration, the cost of defending an action has increased significantly. At the outset of a defence file, most insurers now expect their counsel to provide liability assessments, quantum assessments and defence cost assessments. The weight placed on the role of defence costs varies from one insurer to another. On one hand, some take the position that defence fees are a necessary cost of doing business. In other words, assuming that care has been taken in selecting the defence firm, “the costs are what they are.”As such, when compared to issues of liability and quantum, defence costs have little bearing on the resolution of matters. On the other hand, many take the position that all three are equally important when making decisions that affect negotiations, settlement and trial exposure. Regardless of which position an insurer takes, under the current regime, the cost of defending a superior court action through to trial is certainly significant.

As a result of the high stakes, both insurers and their clients are now having second thoughts about issues of coverage.

The coverage provisions found in most liability policies provide two basic benefits to the insured. First, the insured can expect to be indemnified by the insurer to the limits of the policy. Second, from a claim’s infancy through to resolution, the insurer agrees to defend the insured. Not surprisingly, this latter benefit is termed the “duty to defend.”

The duty to defend is broader than the duty to indemnify. In this context, we note the often-cited decision of Manitoba Court of Appeal Justice Joseph Francis O’Sullivan (as he was at the time), who wrote in Prudential Life Ins. Co. v. Manitoba Public Ins. Corp.: “the duty to defend depends on the nature of the claim made, not on the judgment that results from the claim.”

In a perfect world, the duty to indemnify should be determined at the beginning of a claim. That said, we do not live in a perfect world and an insurer can wait until after a trial to make a decision regarding their obligation to indemnify. To the extent that they have any questions regarding their obligation to indemnify, they should proceed under a “Reservation of Rights Letter” or a “Non-Waiver Agreement.” Such a process allows an insurer to investigate, defend, negotiate and even pay out a claim without prejudice to a later denial of coverage on the part of the insurer.

Unlike decisions regarding the duty to indemnify, an insurer’s decision regarding its duty to defend must be made at the inception of a claim. In doing so, an insurer finds guidance in the “Pleadings Rule.” The Pleadings Rule was pronounced by the Supreme Court of Canada in the seminal case of Monenco Ltd. v. Commonwealth Insurance Co., in which Supreme Court of Canada Justice Frank Iacobucci (as he was at the time) stated: “[w]hether an insurer is bound to defend a particular claim has been conventionally addressed by relying on the allegations made in the pleadings filed against the insured… If the pleadings allege facts [that], if true, would require the insurer to indemnify the insured for the claim, then the insurer is obliged to provide a defence. This remains so even though the actual facts may differ from the allegations pleaded.” As stated by Supreme Court of Canada Justice Beverley McLachlin (as she was at the time) in Nichols v. American Home Assurance Co.:”[t]he mere possibility that an obligation to indemnify exists is sufficient to trigger the duty to defend.”

THREE STEPS TO DETERMINE DUTY

The Supreme Court of Canada also provides guidance in Non-Marine Underwriters, Lloyd’s of London v. Scalera regarding an application of the duty to defend. In Scalera, Iacobucci identified a three-step process. The first step is for the court to determine whether the allegations are properly pleaded. In short, the court will not be bound by the terms but will examine the substance of the pleadings. The second step is to determine whether any of the claims are derivative. In other words, if the claim has been drafted with a reference to a covered loss (such as negligence) and a non-covered loss (such as an intentional tort), both of which relate to the same subject matter, the court may find such claims as derivative and thus excluded. Third, the court will then apply the Pleadings Rule to determine whether the properly framed, non-derivative claims exist within the terms of the policy. If so, a duty to defend will be established.

Although the Pleadings Rule has been around for quite some time, the envelope is being pushed. Initially, the court would analyze only the originating document as framed by the plaintiff. Scalera expanded the scope of the rule. Now, in an effort to service their clients, counsel argue that the court can go beyond the originating document and analyze the duty with reference to a filed defence and any affidavits sworn in the litigation.

The scope of the documents that may be examined through the Pleadings Rule has yet to bear settled jurisprudence, But the Court of Appeal of Alberta has addressed the issue in Wi-Lan Inc. v. St. Paul Guarantee Insurance Co., in which Alberta Court of Appeal Justice J. E. L. Ct took issue with an interpretation that allowed analysis beyond the originating document. Simply put, he said that if one makes use of the filed defence, a duty to defend can appear or disappear depending on whether or not a plaintiff demands a defence. He further reiterated the trite principle that insurance contracts are agreements of the utmost good faith. He envisioned a potential conflict in which counsel representing an insured, but paid by the insurer, may not place all viable defences forward. If the duty to defend is analyzed referencing only the originating document, then there can be no potential for conflict, Justice Ct found.

Using the principles discussed herein, one must decide whether or not a duty to defend exists. In a grey area, an insurer may be tempted to deny a defence and save significant defence costs. Such mentality could, however, be considered “penny-wise and pound-foolish.” Simply put, if you are an insurer, there are many benefits to defending an action. First, you get to select defence counsel. As such, you can hand-pick counsel because of their recognized specialties. Second, you get to instruct defence counsel and guide the direction of the defence. Such day-to-day decisions ultimately define the case and often lead to a litigant’s success or failure. The importance of this cannot be overstated. Third, through the defence and the terms of the policy, an insurer has the power to settle the claim within policy limits.

Perhaps the most important reason for assuming the defence is to avoid the risk of an indemnity finding after a trial. As noted above, an obligation to indemnify is often only revealed after trial. If an insurer refuses to defend, the litigation will proceed under the direction of the insured. Under such scenario, it is possible that after trial, the insured “loses” the case but succeeds in establishing indemnity. Thereafter, the insurer must pay out both the loss and the defence costs, but will have had no say in the direction of the file — a tough one to explain to management back home.

DUTY VERSUS RIGHT TO DEFEND

Once the decision has been made to defend an action, one must be careful not to “lose” the right to do so. Case law has established that the quickest way to lose conduct of the defence occurs when there is an appearance of impropriety. Thus, if the insurer does anything to prejudice the rights of the insured — for example, acting in bad faith or failing to settle a clearly-defined claim within the policy limits — then the insurer’s right to defend the action may be terminated. Further, the insured will be able to select counsel and have the defence costs paid by the insurer. Finally , the courts have held that under such circumstances, counsel retained by the insured may not need to report to the insurer. This makes it very difficult to assess the risk and manage a claim until after a trial decision is rendered. Problematic indeed.

In the end, an obligation to defend may be considered by some to be a “duty,” but others will see it as a “right.” Regardless of your view, it is undeniable that much rides on choices that must be made at the outset of the claim. To ensure that the best choices are made, consideration must be given to the pleadings, the law, the anticipated costs and the predicted outcome. Good luck.

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Perhaps the most important reason for assuming the defence is to avoid the risk of an indemnity finding after a trial.