Publication

Dissecting the Duty to Defend: 3 Steps

Published:

October 4, 2023

Author(s):

• Jillian M. Kean
• Catherine Hirbour

Share

Print

Insureds aren’t automatically entitled to a defence from their insurers. Liability policies generally provide two types of coverage: coverage for indemnity to third parties for wrongful acts committed by the insured and coverage for legal fees incurred in the defence of those claims. The insurer’s duty to defend therefore arises at the outset of a legal proceeding – and puts the merits of the claim under scrutiny before the insurer has obtained any information through the discovery process. Insurers must understand both:

• How to determine whether it owes its insured a duty to defend a particular claim.
• When to raise with the insured coverage issues – and a denial that it owes the insured a duty to defend.

The starting point for an insurer in receipt of a claim is to determine whether it owes the insured a duty to defend that claim on the insured’s behalf. This determination can, in some circumstances, be a challenging one. The Supreme Court of Canada most recently reinforced the legal principles of the duty to defend in its 2010 decision in Progressive Homes Ltd. v. Lombard General Insurance Co. of Canada.  But the Court’s 2000 decision in Non-Marine Underwriters, Lloyd’s of London v. Scalera, in which the Court outlined three steps for determining whether there is a duty to defend, is of particular assistance to insurers in assessing the duty to defend.

Step 1: The Pleadings Rule

“Without attempting to determine the merits of the claim, and assuming all the claimant’s factual allegations are true, determine which of the legal assertions contained in the pleadings “could potentially be supported by those factual allegations”. When assessing whether the insurer owes a duty to defend, the first step in the analysis is to carefully review the pleadings, and in particular the Statement(s) of Claim against the insured.

“Any possibility”. The duty to defend is based on the substance of the allegations contained in the pleadings, particularly the Statement of Claim. In general, the alleged facts are assumed to be true for the purposes of determining if there is a duty to defend. To some degree, the insurer must embark in an exercise of crystal ball gazing to determine whether there is (hypothetically) “any possibility” the insurer will be liable to indemnify the insured for the claims of the third parties. If there’s a possibility of coverage for indemnity, the insurer must provide a defence – even if it’s later determined that there’s no duty to provide indemnity to the insured. This is often referred to as the “pleadings rule”.

The Facts. Since courts are limited to the allegations in the pleadings, they can struggle with the facts on which they can rely on in their duty to defend decisions. If a court strictly followed the pleadings rule, it would refer only to the facts as alleged in the pleadings and nothing extrinsic to them. In its 2001 decision in Monenco Ltd. v. Commonwealth Insurance Co. the Supreme Court of Canada confirmed that at a minimum, a court can consider evidence of facts expressly referred to in the pleadings to determine the true substance and nature of the allegations – but warned courts should not use this rule to prematurely resolve the underlying tort or contract (as the case may be) litigation.

Borderline Cases. Consideration of the material facts stated in the pleadings, requires the insurer to simultaneously weigh multiple potential factual matrices. If the pleadings allege even a single factual scenario that would be covered, a court could find coverage – and the duty to defend – is triggered.

Step 2: Derivative Claims

“Where multiple claims are properly pleaded, the court must determine whether any of the claims are entirely derivative of another. A claim is derivative of another if it arises from the same actions and causes the same harm. If the underlying elements of the negligence and the intentional tort are sufficiently disparate to render the two unrelated, they are not derivative of one another.” It doesn’t matter how the parties label a claim – what matters for the purposes of a coverage analysis is the true nature or substance of the conduct that gave rise to the claim. A claim that’s derivative of one that’s not covered isn’t covered either.

Step 3: Coverage Analysis

“Having identified the properly pleaded, non-derivative claims, a court must then determine whether any of these claims, if proven, would require the insurer to provide indemnity. If the claim satisfies this final step, it will give rise to the duty to defend.” The allegations against the insured in the pleadings will ground the ensuing coverage analysis. The pleadings rule’s threshold of “any possibility” of coverage makes an analysis of the insurer’s duty to defend inextricable from an analysis of coverage for third party claim indemnity. Coverage analysis is, in turn, an exercise in applying the principles of insurance contract interpretation, most recently outlined by the Supreme Court of Canada in its 2016 decision in Ledcor Construction Ltd. v. Northbridge Indemnity Insurance Co. and its 2017 decision in Sabean v. Portage La Prairie Mutual Insurance Company:

• Courts should give effect to clear language, reading the contract as a whole.
• If the policy language is ambiguous, general contract construction rules come into play and interpretations consistent with the parties’ reasonable expectations are to be preferred.
• Courts should avoid interpretations that would give rise to an unrealistic result.
• If these rules don’t resolve the ambiguity, the contra proferentemrule applies:  in brief, where there’s doubt about the meaning of a contract, the court will construe the contract’s words against the party that drafted the contract – in this case, the insurer.

Common Coverage Issues. In the context of liability insurance, watch for these common coverage issues that could impact the insurer’s duty to defend:

• For claims made policies (for example, typical professional liability insurance), whether the claim arose during the policy period.
• For occurrence-based policies, whether the alleged negligent act, error or omission arose during the policy period.
• Issues around notice and disclosure of claims when a policy is placed, subject, in some cases, to relief from forfeiture.
• For professional liability insurance, whether the insured was acting in their capacity as a professional at the time of the loss.
• Various forms of bodily or personal injury exclusions, depending on the policy wording.
• Intentional acts exclusions, where the insurer is only liable for negligence and mistakes and not deliberate acts such as fraud.

Substance Over Form. When assessing whether a particular claim does or does not fall within coverage, examine the pleadings carefully and focus on the true nature or substance of the conduct on which the claim is based – not on the labels assigned to the conduct in the pleadings. In the 2001 Supreme Court of Canada decision in Non-Marine Underwriters, Lloyd’s of London v. Scalera, the insured bus driver faced a civil claim arising from an alleged sexual assault against a passenger. However, his homeowner’s liability policy excluded coverage for intentional or criminal acts. To try to trigger the “pleadings rule” and the duty to defend, the insured’s pleadings alleged battery, “negligent battery”, negligent misrepresentation and breach of fiduciary duty. But the Court didn’t bite. Emphasizing parties aren’t bound by the labels the insured chose in the pleadings, the Court decided the alleged intentional acts of battery clearly didn’t fall within coverage despite the statement of claim’s allegations of both negligent and intentional acts. The true character and substance of the alleged conduct was an intentional act; there can be no such thing as “negligent battery”.

Please contact your McInnes Cooper lawyer or any member of our Insurance Defence Team @ McInnes Cooper to discuss whether you have a duty to defend in your case.

Share

Print