Insurers risk hefty bill if they (erroneously) conclude they have no duty to defend

Insurance companies who conclude that they have no duty to defend an insurer facing an action, and by extension no obligation to indemnify, risk being surprised with a hefty bill, following a ruling by the Quebec Court of Appeal.

In a ruling that repeatedly hammers the distinction between a liability insurer’s duty to defend with its obligation to indemnify, the appeal court warns insurance companies that it cannot come to the hasty conclusion that it has no duty to indemnify simply because it has no duty to defend.

“What strikes me about this case is that in most cases the duty to defend is broader than the duty to indemnify,” said Domenic Naud, a partner with Nicholl Paskell-Mede. “Normally it is understood that when there is no obligation to defend there is necessarily no obligation to indemnify. But in this exceptional case, there was no duty to defend, which is normally broader, but the insurer may find itself with an obligation to indemnify.”

Informed by several Supreme Court of Canada rulings, including Nichols v. American home assurance co., [1990] 1 S.C.R. 801, and its own rulings, notably Boréal assurances inc. c. Réno-dépôt inc. [1996] R.J.Q. 46, the appeal court notes that the duty to defend is based on an analysis on the nature of the claims made by the third party while the obligation to indemnify is determined following the facts proven at a trial.

“I recognize that the outcome between the duty to defend and the duty to indemnify often coincides but as this case demonstrates there are exceptions,” noted Judge Marie-France Bich in Hoyos c. Chubb Insurance Company of Canada, 2008 QCCA 1296, who described the case as uncommon.

Hector Hoyos, an American citizen, was sued four years ago in New York State by a woman who had been injured during a visit to his secondary residence in Mont-Tremblant, which was insured by Chubb Insurance Company of Canada under a damage insurance policy covering property and liability. She alleged that suffered arm and hand injuries due to a sexual assault committed by Hoyos. Hoyos asked Chubb to defend him against the claim but the insurance company refused on the grounds that the policy excludes intentional fault, including sexual misconduct.

Hoyos incurred the costs of his defence, tabbed at $488,000, and then settled out-of-court for $427,000. The settlement agreement contains no admissions “by any party or as evidence of any liability or wrongdoing whatsoever on the part of any party.” The agreement adds that the settlement amount was paid solely in consideration of the physical injuries to the third party.

Hoyos then launched a suit against Chubb, seeking the reimbursement of his defence and out-of-court settlement costs. Chubb, in turn, filed a motion to dismiss Hoyos’ claim before Quebec Superior Court, arguing that the claims made by the third party were clearly actions that were excluded from the insurance policy and therefore it had no duty to defend, and consequently, no obligation to reimburse Hoyos for his defence and out-of-court costs, said Michel McMillan of Donati Maisonneuve who plead the case for Chubb.

“We plead that the two obligations were intimately linked and that under the circumstances of this case one could not dissociate one from the other,” said McMillan.

Quebec Superior Court granted Chubb’s motion but it was overturned by the Quebec Court of Appeal who concluded that the judge at first instance “confused the two obligations” and deprived Hoyos the possibility of establishing at trial that the third party’s injury was the result of an accident that was covered by the insurance policy.

“If it can be allowed that the duty to defend rests on a prima facie analysis of the obligation to indemnify, an analysis based only on the claims made by the injured third party, this process is not suitable when it is time to ask if, in the facts and according to the insurance contract, the insurer must indemnify the insured: to hold otherwise would put the insured and his right to insurance coverage at the mercy of allegations by a malicious third party,” said Justice Bich in her 10-page ruling.

By dismissing Chubb’s motion, and returning the issue to Superior Court, the appeal court has given Hoyos the possibility of eventually proving his case at trial and demonstrate that the injuries suffered by the third party were an accident, noted Sylvain Provencher of Heenan Blaikie. If the insured is able to make his case at trial that the suit should be covered by the insurance policy, then even if he is condemned to pay the injured third party damages, the insurer will end up having indemnify the insured.

While the appeal court did not address the impact of the settlement agreement between Hoyos and the third party, it “opened the door” to the possibility that the insurer may end up picking up the tab in spite of s.2505 of the Civil Code of Quebec, added Provencher. S.2504 states that no transaction made without the consent of the insurer may be set up against him.

“That is an interesting finding,” said Provencher. “Even though the insurer was not party to the settlement, the ruling opens the door by giving the insured the opportunity to make the demonstration that the indemnity given to the injured third party was reasonable and covered by the insurance policy.”

According to Naud, this finding is an insurer’s worst nightmare. It should prompt insurers to seriously consider in certain cases to defend an insured even after concluding that it has no obligation to defend after analyzing the claims made by the injured third party. Indeed, it might be in their interest to hire their own team of lawyers and experts in order to “control the defence and oversee the trial” in a bid to obtain a better result than could possibly be the case if left in the hands of the insured.

Provencher concurs. “Insurers are going to have to read in between the lines and there may be cases in which it may be to their advantage to defend the insurer in spite of the claims made by the third party.”

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