Duty in Excess

In February 2013, Justice Luc Lefebvre of the Superior Court of Quebec dismissed Tembec’s claim against its excess insurer, AIG, pursuant to settlement payments made by Tembec to third parties. The judgment, Tembec v. AIG, was initially appealed and – unfortunately for interested readers – recently settled out of court. Interestingly, the case dealt with the scarcely discussed topic of an excess insurer’s duty to defend and its prerogatives pursuant to same.

UNDERLYING FACTS

Tembec sells resin to its client Uniscope, Inc., which in turn resells it to Cargill. In 2007, an inspection by the U.S. Food and Drug Administration (FDA) revealed the presence of melamine in Tembec’s resin, which prompted a product recall by both Tembec and Uniscope. Cargill and Uniscope later sued Tembec for losses incurred in connection with the product recall. 

THE INSURANCE COVERAGE

Tembec was insured pursuant to policies issued by Zurich, with a $5-million cap per occurrence. Further, Tembec was covered by an excess policy issued by AIG for any claim in excess of the Zurich policies’ coverage, up to $50 million.

TEMBEC’S CLAIM AGAINST AIG

In June 2007, Tembec informed its broker that it had received a demand letter from Cargill related to the recall. The broker, in turn, notified Zurich and AIG of the demand letter.

Uniscope also put Tembec on notice and filed a lawsuit in October of that year. Shortly thereafter, Cargill also filed a claim against Tembec and Uniscope. Neither Uniscope nor Cargill had quantified their damages at the time of filing their claims.

In May 2008, Zurich undertook to defend Tembec under reserve of the $5-million policy cap. A few weeks later, Cargill and Uniscope quantified their claims against Tembec in excess of $7 million.

In June 2008, all parties agreed to participate in mediation. Tembec’s broker then informed AIG that according to Zurich, the total amount of the claims could possibly exceed $5 million.

In November of that year, Cargill provided Tembec with documents establishing its hard recall costs at $6.7 million. That December, Tembec’s broker requested that AIG become involved in the management of the claims and participate in the upcoming mediation session scheduled in January 2009.

Shortly thereafter, Tembec provided AIG with a file summary prepared by its counsel, as well as Zurich’s reservation of rights (ROR) letter regarding Cargill’s claim. It also provided AIG with 4,000 documents pertaining to Cargill’s claim.

On December 24, 2008, AIG informed Tembec it would attend the next mediation session. Although no settlement was reached regarding Cargill and Uniscope’s claims at the January 8, 2009 session, the parties nonetheless continued the mediation process.

On January 16, 2009, AIG received a chart prepared by Tembec’s paralegal regarding Cargill’s claim for hard recall costs. On January 26, AIG issued Tembec an ROR letter stating that coverage would begin only once Zurich’s coverage was exhausted.

On February 5, AIG directed its own expert to prepare a report for the next mediation scheduled a week later. AIG received its expert’s report, which evaluated Cargill’s claim at $3.3 million, 48 hours prior to the meeting.

During the mediation session, the parties agreed to settle Cargill’s claim for $6.1 million, of which Zurich agreed to pay $3.6 million. Tembec’s coverage under the Zurich policies was thereby exhausted considering prior ancillary settlement payments. AIG, however, only agreed to contribute $560,000 to the settlement, leaving Tembec $1.5 million out of pocket. As for Uniscope’s claim, it was settled for $1.7 million, with the entire amount paid by Tembec.

Tembec responded by suing AIG on the basis that the latter failed to properly defend Tembec and acted in bad faith by failing to diligently investigate the claims. Tembec further argued that the settlements reached with Cargill and Uniscope were reasonable and, therefore, could be set up against AIG.

FINDINGS OF THE COURT

Justice Lefebvre reviewed the principles applicable to an excess insurer’s obligation to defend. First, the judge found that AIG’s obligation to defend under the excess policy was only triggered once Zurich’s coverage was exhausted. He pinpointed that moment as February 12, 2009, when Zurich agreed to contribute to the Cargill settlement, thereby exhausting the $5 million coverage. In addition, the judge noted that until December 2008, both Zurich and Tembec were under the impression that the claims would settle for less than $5 million.

Second, having established when AIG’s obligation to defend was triggered, Justice Lefebvre strongly disagreed with Tembec’s assertion that its excess insurer acted in bad faith. AIG reviewed an important amount of documentation in a very short period of time and adequately co-operated with Tembec. On the other hand, the judge found that Tembec failed to provide AIG with all the necessary information in a timely fashion to allow it to determine its position regarding coverage, liability and quantum.

He also reminded Tembec that the excess insurer’s duty to defend entitles it to dictate the conduct of the defence. Justice Lefebvre noted that during the February 12, 2009 mediation session, Tembec’s in-house counsel refused to follow the strategy of AIG’s representatives, which was to contest the damages based on AIG’s expert report.

The judge was very critical of the work performed by Tembec and Zurich, which tasked a paralegal without the necessary skills to evaluate the Cargill and Uniscope claim. He equally disapproved of Zurich and Tembec’s decision not to depose any Cargill representatives and not to prepare an expert report to contradict Cargill’s alleged damages.

Finally, Justice Lefebvre analyzed the settlements reached by Tembec to determine whether or not they were reasonable and could be set up against AIG. He found that AIG’s report established that Tembec overpaid to settle the claims.

He speculated Tembec may have done so to maintain good business dealings with Uniscope and to avoid the risk of paying uncovered punitive damages.

AIG’s contribution to the settlement was, therefore, deemed sufficient and, in fact, in excess of what it was obliged to pay. However, AIG’s claim for reimbursement was dismissed since the insurer paid without any reserve.

CONCLUSION

Justice Lefebvre’s ruling confirms that under Quebec law, an excess insurer’s obligation to defend is only triggered by the exhaustion of the primary coverage. This principle was reaffirmed by the Quebec Court of Appeal in the 2013 decision, Canadian National Railway Company v. Chartis Insurance of Canada.

Justice Lefebvre’s judgment further serves as a stern reminder to insureds that where the excess insurer’s duty to defend is triggered, the insurer is entitled to dictate the defence strategy. Considering their different exposures to risk, the excess insurer should understandably not be bound by the primary insurer’s litigation strategy.

As such, an insured would be well-advised to keep in line with its excess insurer’s defence strategy, even where it may somewhat deviate from the one previously established by the primary insurer, such as in Tembec v. AIG.

This case also suggests an insured should be mindful of keeping its excess insurer fully informed and up to date with respect to all material facts, especially where it expects the latter to step into its primary insurer’s shoes on short notice in a complex case.