May 1, 2020
Two Files or One – Conflict with Insured
TWO FILES OR ONE: WHEN DO YOU HAVE A CONFLICT WITH YOUR INSURED?
Mike Libby and Tom S. Newnham
updated May 2020
A. Introduction / Historical Approach
The insurer’s exclusive right to appoint and instruct defence counsel is one of the cornerstones of insurance law. However, the courts have shown a clear willingness to interfere with this standard in cases where a conflict exists between the insurer and the insured. As with coverage disputes generally, the issue of conflicts between insurers and insureds, is an area which has traditionally been greatly influenced by U.S. jurisprudence.
The approach adopted by U.S. courts has gone through cycles with the pendulum swinging in favour of insureds and then back towards insurers. For example, in San Diego Navy Federal Credit Union et al. v. Cumis Insurance Society Inc. 208 Cal. Rptr. 494 (1984) [“Cumis”], the California Court of Appeal held that an insurer which defended a claim but reserved its rights based on possible noncoverage must give up control of the defence and must pay for counsel chosen by the insured.
Fortunately for insurers, the California Court of Appeal later moved away from this broad basis for shifting control of the defence to the insured. In Foremost Insurance Co. v. Wilks, 253 Cal. Rptr. 596, (1988) [“Foremost”], the California Court of Appeal made clear that not every case in which the insurer elects to defend the insured under a reservation of rights will create a conflict of interest requiring the insurer to fund the insured’s choice of counsel. If the reservation of rights arises because of coverage questions which depend upon an aspect of the insured’s own conduct that is in issue in the underlying litigation, a conflict will clearly exist. On the other hand, where the reservation of rights is based on coverage disputes which have nothing to do with the issues being litigated in the underlying action, there is no conflict of interest justifying interference with the insurer’s basic right to appoint and instruct counsel.
This paper will highlight the development of the Canadian jurisprudence with an emphasis on recent cases. However, the primary focus will be on addressing the practical implications for insurers, including a discussion of situations in which an insured can assume conduct of the defence at the insurer’s expense, as well as and practice points for insurers to avoid bad faith/breach of contract claims.
B. Development of Canadian Jurisprudence
a) The Cumis Approach Followed
During the 1980s, Canadian courts favoured an approach which was very protective of insureds. In Laurencine v. Jardine, (1988), 64 O.R. (2d) 336 (Ont. H.C.), the Supreme Court of Ontario introduced the Cumis principles in Canadian law. In Laurencine, the underlying action was brought against the insured following a motorcycle accident. Mr. Jardine’s motor vehicle insurer proceeded to defend the action under a non-waiver agreement on the grounds that the accident did not arise from the ownership, use or
operation of the motorcycle, but the insured refused to sign it. There were a number of contentious issues in the underlying action including whether the plaintiff had consent to ride the insured’s motorcycle, what instruction was provided by the insured before the plaintiff rode to his injuries, and whether the insured had offered a helmet to the plaintiff.
The insured brought an application to permit him to appoint his own choice of defence counsel, at the insurer’s expense, on the basis that there was a conflict of interest since the insurer had not agreed to indemnify Jardine if the plaintiff succeeded, and consequently this would affect how the insurer-appointed defence counsel would conduct the case. In granting the insured’s application, the Court found that if the insurer was permitted control the defence, the insured would be obliged to disclose details of the accident to the insurer-appointed counsel, some of which may be material to the coverage dispute. According to the Court, the appropriate test to establish whether a conflict of interest existed was the “appearance of impropriety” or the “possibility of real mischief or prejudice” test. The Court also relied on American authorities in concluding that where a conflict of interest exists between an insurer and insured due to a coverage dispute, the insurer may be required to reimburse the insured for retaining his own independent legal counsel.
b) A Move Towards Foremost
Fortunately for insurers, the Laurencine principles have not been consistently applied. Moreover, Canadian courts have been more foregiving of insurers following the Foremost decision in the U.S.
i. Zurich of Canada v. Renaud & Jacob
In Zurich of Canada v. Renaud & Jacob,  R.J.Q. 2160 (Que. C.A.) [“Zurich”], the insurer provided professional liability insurance to a chartered accountancy firm. When the accounting firm was sued, the insurer appointed defence counsel but reserved its rights because the pleadings included claims for fraud, conflict of interest and breach of trust which were excluded under the policy. The question considered by the Quebec Court of Appeal was whether the insurer, by reserving its rights in this way, had given up its right to control the defence and entitled the insured to retain its own counsel at the insurer’s expense. The Court concluded that this alone, without more, was not a conflict of interest which would result in the insurer giving up its right to control the defence.
The Court concluded that the potential tension inherent in the relationship between the insurer and the insured and which is manifested by the reservation of rights by the insurer is not in itself sufficient to require the insurer to surrender control of the defence. Rather, the focus must be on the mandate given by the insurer to the counsel it appoints to conduct the defence. The focus must be on whether the circumstances of the particular case create a reasonable apprehension of conflict of interest if that counsel were to act for both the insurer and the insured. If the insurer puts counsel in a position of having conflicting mandates, it must not only surrender control of the defence to an insured who wishes to retain its own counsel, but also pay for cost of that defence.
In coming to this conclusion, the Court noted that American jurisprudence had moved towards a similar position and away from the broader basis for shifting control of the defence to the insured, as articulated in Cumis, based on the more recent Foremost decision. Since the reservation of rights at issue was based on coverage disputes which had nothing to do with the issues being litigated in the underlying action, there was no conflict of interest requiring independent counsel paid for by the insurer.
ii. Brockton (Municipality) v. Frank Cowan Co. Ltd.
In Brockton (Municipality) v. Frank Cowan Co. Ltd., 2002 CanLII 7392 (ON CA), the Ontario Court of Appeal approved of the approach taken in Zurich. In Brockton, the Town of Walkerton in the Municipality of Brockton had faced an outbreak of E. coli bacteria contamination in the local water system resulting in several deaths and illness for hundreds of residents. Brockton was named in a $100 million class action lawsuit and sought assistance from its general liability insurers subscribing through Frank Cowan Co. After delivering a reservation of rights letter for claims in excess of the limits and non-covered punitive or exemplary damages, Cowan appointed defence counsel to advise Brockton.
After the initial meeting with Cowan’s representatives and defence counsel, Brockton was dissatisfied with the strategy proposed by defence counsel. Brockton felt the recommended strategy failed to address Brockton’s need to respond meaningfully to the myriad of ongoing criminal, coroner’s and environmental investigations. Brockton therefore retained its own counsel, without the consent or approval of Cowan, and with a broad mandate to deal with “any and all suits, claims, actions and inquiries.” At a second meeting, Brockton made it clear to Cowan that it wanted its own firm responding to all matters arising out of the E. coli outbreak and took the position that Cowan should pay for these services.
Brockton applied for a declaration that, amongst other things: (a) Brockton had the right to control the defence of the civil actions and appoint counsel at Cowan’s expense and (b) such expenses should include the costs incurred in responding to the criminal, environmental and coroner’s investigations as well as the public inquiry. Cowan brought a counter-application for a declaration that it was entitled to control the defence and appoint counsel.
The application judge held that Brockton was not entitled to control or appoint counsel at Cowan’s expense. The judge also ruled that Cowan’s duty to defend did not extend beyond the civil action and concluded the insurers were within their rights to appoint and instruct a firm of their choice. After the class action was settled the only issue on appeal was whether the past legal fees incurred by Brockton must be paid by Cowan. Brockton argued that “an appearance of impropriety” existed because of the clear divergence between original defence counsel’s defence strategy and what Brockton believed would be an effective defence. Brockton also referenced Cowan’s reservation of rights letter as evidence of a conflict of interest.
The Court of Appeal noted that the original defence counsel’s advice did not arise from conflicting mandates. Nor did the reservation of rights imply conduct by that counsel might unfairly prejudice Brockton’s defence. The Court of Appeal further noted that Cowan had appointed separate coverage counsel with notice to Brockton, “thereby removing any conflict that could have arisen from the reservation of rights in this case.”
Citing Foremost and Zurich with approval, the Ontario Court of Appeal characterized the issue in this manner at paragraph 43:
I agree with the approach taken in Zurich and Foremost. The issue is the degree of divergence of interest that must exist before the insurer can be required to surrender control of the defence and pay for counsel retained by the insured. The balance is between the insured’s right to a full and fair defence of the civil action against it and the insurer’s right to control that defence because of its potential ultimate obligation to indemnify. In my view, that balance is appropriately struck by requiring that there be, in the circumstances of the particular case, a reasonable apprehension of conflict of interest on the part of counsel appointed by the insurer before the insured is entitled to independent counsel at the insurer’s expense. The question is whether counsel’s mandate from the insurer can reasonably be said to conflict with his mandate to defend the insured in the civil action. Until that point is reached, the insured’s right to a defence and the insurer’s right to control that defence can satisfactorily co-exist.
The Court of Appeal concluded that in order for Brockton’s application to succeed it required proof of a clear conflict of interest. Absent a reasonable apprehension that the insurer-appointed defence counsel is faced with a conflict of interest, an insured has no inherent right to an insurer-funded counsel of choice.
c) A Return to Cumis in Canadian Insurance Law?
Two recent decisions suggest that Canadian courts may be reverting back towards the Cumis approach in adopting an “appearance of impropriety” test to assess whether a conflict of interest exists between insurer and insured.
i. Re Pope & Talbot
In Pope & Talbot Ltd. (Re), 2011 BCCA 326, Pope & Talbot Inc. (“PTI”) a forest products company, and its wholly owned subsidiary Pope & Talbot Ltd. (“PTL”), purchased primary and excess D&O insurance from the insurer, prior to becoming insolvent. The insurer had provided D&O coverage to directors and officers of the bankrupt companies when there was a gap in coverage. The underlying action was commenced by a group of former Pope & Talbot employees over unpaid wages and vacation pay owing. The former directors and officers of both PTI and PTL were each named as defendants.
The insurer brought an application to be added as a party or intervenor in an underlying action. The insurer also sought to defend itself and its insured company by retaining the law firm that had been acting as the insurer’s coverage counsel. The insurer argued that PTI was a bankrupt company with no assets other than insurance. The insurer took the position that it would not be a conflict to have its coverage counsel provide the insured’s defence in the underlying action because it was solely the insurer, not the insured, which faced exposure as a result of the underlying action.
The insurer’s application was dismissed. The B.C. Supreme Court held that a liability insurer should not be permitted to participate in the defence of an underlying action as a party, or through its coverage counsel, because this could permit the insurer to defend the case so as to ultimately officiate coverage. The Court did not rely on any conflict between the insurer and the insured but rather focused its reasoning on the impact that allowing the insurer’s choice of counsel to act in “dual” roles may have on the other parties in the litigation. The Court expressed concern that the insurer’s counsel would have an incentive to “sculpt” findings of fact and prejudice the liability proceedings in a manner that would be advantageous to the insurer’s coverage position and to the detriment of the other defendants. The court concluded that the only practical reason for the insurer to have its coverage counsel to defend PTI would be to “sway” the outcome of the liability proceedings to vitiate coverage and to save the expense of paying for two sets of counsel. The court reasoned that the defence of PTI must be conducted in a “coverage neutral” manner to prevent any prejudice to the other parties in the litigation.
The insurer was granted leave to appeal the lower court decision by the BC Court of Appeal. The Court of Appeal noted the issue raised by the insurer – whether a liability insurer should be permitted to participate in underlying litigation when it is affording coverage to its bankrupt insured on a reservation of rights basis – is of clear “significance” to the practice generally. Unfortunately, the appeal was abandoned during early 2012 so this issue has yet to be addressed at the appellate level.
ii. B.C. Medical Association v. Aviva
In B.C. Medical Association v. Aviva Insurance Company of Canada, 2011 BCSC 1399, the B.C. Medical Association (BCMA) was insured with the insurer under several CGL policies containing coverage for claims alleging libel or slander. The policies also contained exclusions for knowingly violating the rights of another and publication with knowledge of falsity.
The BCMA sought coverage for an action brought by a physician against the BCMA in which the physician alleged the BCMA had defamed her as part of a “campaign of vilification” with the intent to disqualify her from practicing medicine and the with full knowledge of the falsity of their statements.
The insurer took the position that there was no coverage under the policy based on the allegations of intentional falsehood and the related exclusions. The BCMA claimed the pleadings also supported a claim against them in defamation, even without a finding of intentional wrongdoing, which could therefore give rise to coverage.
The B.C. Supreme Court concluded that in order to determine if there is a possibility of coverage, the court should consider the prospect that some but not all of the plaintiff’s allegations will succeed at trial. Ultimately, the Court held that the defamation plea was a properly plead non-derivative claim that could potentially trigger indemnity if it were to succeed at trial. Accordingly, the insurer had a duty to defend the underlying action.
With regard to the conduct of the defence, the Court concluded that a conflict existed because the coverage questions would depend on certain aspects of the BCMA’s conduct at issue in the underlying action, specifically the intention, knowledge and purpose of the defendants. Given that this would be a central issue at the trial in the underlying action, the Court concluded that the conflict which arose between the interests of the insurer and the BCMA was “too substantial to ignore” and concluded that the insurer was not entitled to exercise any right to control the defence of the BCMA. The Court made an order permitting the BCMA to conduct the defence to the underlying action with legal counsel of its choosing, to be paid for by the insurer, and further ordered that counsel chosen by the BCMA was not required to report to the insurer with respect to any matters bearing on the issue of liability.
At the time of writing this paper the insurer had abandoned its appeal of the lower court judgment.
C. Implications for Insurers
Although the jurisprudence in this area is continually evolving, there are several emergent principles which provide guidance for insurers that wish to avoid the appointment of what is often called “Cumis counsel”. The following discussion offers some basis practice points for insurers facing such potential issues.
a) When do you need two files?
The Canadian courts have clarified that the test for when an insurer must maintain two separate files, one for coverage and one for defence counsel, is the same as the test which is used to determine whether an insured is entitled to its own counsel – in either case there must be an actual conflict of interest. The mere “appearance of impropriety” is not enough to require that an insurer “split” its files.
In The Co-operators General Insurance Company v. Morrison, 2004 NBCA 62, the plaintiffs in the underlying action claimed for damages arising from a motor vehicle collision and subsequent assault at the hands of the insured defendant. The original statement of claim alleged that both acts were intentional and that the defendant drove his vehicle into their vehicle with such force that the vehicle flipped on its side causing injuries to the occupants. The plaintiffs further alleged that the defendant then exited his vehicle and assaulted two of the plaintiffs. The original statement of claim did not raise any claims which would be payable under the insurance policy and the insurer accordingly took the position that there was no duty to defend.
The plaintiffs then astutely proceeded to file an amended statement of claim alleging the collision was the result of negligence and therefore raised the possibility that some or all of the damages sustained were caused by negligent, as opposed to intentional acts. The insurer maintained that the insured had deliberately and intentionally rammed into the plaintiffs’ vehicle and then proceeded to assault the plaintiffs. The insurer took the position that the insured had therefore forfeited his right to be indemnified under the policy since he had intentionally committed a criminal act with the intent to cause loss or damage.
The insured applied for a declaration that the insurer was under a duty to defend. The insurer alleged that the plaintiffs had manipulated their Statement of Claim by amending it to circumvent the exclusions for intentional acts, in an attempt to give rise to coverage and to permit them to recover under the insurance policy if successful at trial.
The Court of Appeal concluded there was a duty to defend, rejecting the insurer’s submission that the negligence claim was purely derivative. The Court of Appeal considered the possible outcomes at trial in the course of its analysis at paragraph 29:
Having said all this, I am not convinced that, in a case such as this, a plaintiff could not claim that Mr. Morrison intentionally caused the collision in an attempt to stop the Dedam vehicle from leaving his property or, in the alternative, that he caused the injuries by driving his vehicle in a negligent manner. It is arguable, in my view, that the two torts involve different acts or conduct based upon Mr. Morrison’s state of mind, one being an intentional tort and the other a non-intentional tort. The Statement of Claim would obviously contain a claim potentially within coverage. At trial, the claim based upon the intentional tort could fail and the negligence claim succeed. This is different from the allegations in Scalera where it was alleged in the Statement of Claim that the defendant had caused damages to the plaintiff by engaging in non-consensual sexual intercourse. In that case, the negligence claim was not legally viable because on the facts as alleged, there was no possibility that a claim within coverage could succeed. That is so because “[e]ither there was consensual sexual intercourse, in which case the claim would be dismissed, or there was non-consensual intercourse, in which case the claim in battery would succeed.” In the latter case, the claim would not be within the coverage provided by the policy…
The Court of Appeal upheld the lower court’s order that the insured was entitled to separate legal counsel, to be paid for by the insurer, with no obligation to report to the insurer on issues of coverage.
b) How severe can the consequences be if there is a Conflict?
The courts in some Canadian provinces have addressed conflicts between insurers and insured in a “creative” manner resulting in clearly undesirable results to insurers.
In PCL Constructors Canada v. Lumbermens Casualty Company Kemper Canada, 2009 CanLII 32915 (ON SC), the insured had provided construction services for a hospital and was later sued after water ingress resulted in damage to the hospital’s roof system. The insurer denied coverage and refused to defend or indemnify on the basis that the allegations in the statement of claim against PCL were for damages caused in the course of PCL’s own work, or at least that of one of its subcontractors (i.e. an “own work”
After analyzing the insuring agreement, exclusions and exceptions, the court concluded that there might be coverage for the claim, depending on whether the damage to the roof had arisen before or after PCL’s work had been completed. Since there was a possibility that the claim might ultimately be covered, the duty to defend was triggered.
The insured argued that to allow the insurer to appoint defence counsel may give rise to an incentive for that defence counsel to demonstrate that the allegations against PCL fell within policy exclusions, as this would be consistent with their stated “no indemnity” position.
The Ontario Superior Court resolved this dispute in a most unusual manner, holding that while the insurer must pay for the defence of the insured in the underlying action, defence counsel must be counsel who had not acted for either the insurer or the insured for the last 5 years such that there would be no appearance of a conflict of interest.
The court also held that defence counsel must be different from coverage counsel (which is not unusual), and must refrain from discussing the case with coverage counsel. The court further ordered that the insurer assign both a new coverage examiner and a new defence examiner to the file that would not have any communication with any individuals who dealt with the claim up until that point in time. The insurer’s file was also to be purged of any references to the coverage issue. Lastly, the court ordered the coverage examiner and counsel not to discuss the case with defence counsel, which is a most unusual order in the writer’s respectful opinion.
It does not appear that the reasoning in the PCL decision has been applied in other cases to-date. However this case further illustrates the potential risks that insurers face if a court determines that a conflict of interest exists.
c) Do limits claims create an automatic conflict?
An insured will often perceive a conflict of interest in cases where there is a risk that an award of damages will exceed the limits of its insurance policy. However, a claim which will exceed limits does not automatically create a conflict. In Fredrickson v. I.C.B.C., 1990 CanLII 3814 (BC SC), the Court acknowledged that while an exposure in excess of policy limits sets up a potential conflict between the insurer and insured, such potential does not, in and of itself, give rise to a requirement that the insurer retain independent counsel for its insured.
However, insurers should be always keep in mind the obligation of good faith in defending and settling third party claims which may exceed the policy limits. Shea v. Manitoba Public Insurance Corp., 1991 CanLII 616 (BC SC), stands for the proposition that an insurers obligation of good faith require that the insurer take affirmative steps to settle a third party claim for the policy limits in cases where a finding of liability is highly probable and where the judgment to be awarded will probably exceed the policy limits. If an insurer fails to do so, a court is may find the insurer liable for the portions of the damages that exceed the policy limits and the insurer may be exposed to aggravated or punitive damages.
Markham v. AIG raises a further interesting point. In that case, an injured plaintiff had named both the City of Markham, who owned and operated an arena, and Hockey Canada, who oversaw some aspects of hockey programs. The plaintiff was injured while watching a minor ice hockey game in the City’s arena. The City held a liability policy which could respond to the claim, but the City was also an additional insured under a policy issued to Hockey Canada. The two insurers disputed whether the City’s insurer had a concurrent duty to defend the claim. The City and its insurer contended that Hockey Canada’s insurer was conflicted and sought control of the City’s defence at the expense of Hockey Canada’s insurer.
The insured City’s deductible ($100,000) in Markham v. AIG represented the lion’s share of the plaintiff’s claim ($150,000). Nevertheless, as that dispute was, at its heart, a dispute between insurers, this potential burden on the insured did not tip the scales against the insurer’s right to conduct the defence.
A contrasting example can be found in Temple Insurance Company v. Sazwan. The insureds in Sazwan were covered for a combined $12 Million of indemnity and defence costs for commercial claims in a pair of actions. Between the actions, damages in excess of $237 Million were sought against the insureds. The actions included both covered and uncovered claims, and the insured and insurer had a history of disagreement over defence strategy.
In Sazwan, the Court denied the insurer conduct of the defence on three grounds: the conflict between covered and uncovered losses, the history of disagreement, and the significant extent to which the insureds’ exposure exceeded policy limits.
The contrast between these two cases is interesting. The insured’s share of exposure in Sazwan was greater and the amounts in dispute were significantly greater, but the insured’s exposure in Markham v. AIG was more certain, as it had to be paid before the insurer’s contribution came into play.
These two cases offer little ground for conclusion, but three general principles can be fairly summarized:
- An insured is not entitled to control the defence simply because its share of exposure will exceed its insurer’s;
- If the insured’s exposure is high enough in absolute terms, it will likely tip the balance towards the insured’s control;
- The insured’s exposure will receive less attention where the case involves a dispute between insurers than where it involves a dispute between insurer and insured.
The City’s exposure to a deductible in the Markham v. AIG case was likely less significant because a corresponding exposure applied to Hockey Canada. Each insured would be faced with the prospect of a deductible, depending on whether claims fell within or outside of Hockey Canada’s coverage. Although the Court did not address this point explicitly, that balance may explain why the City’s exposure bore little weight. Had the City’s exposure in Markham v. AIG been for claims in excess of limits, it seems likely that the Court of Appeal would have considered it more closely.
d) Does a ROR for future coverage issues create a conflict?
In some cases, an insurer’s best intentions, and desire to bring potential future coverage issues to the attention of an insured in advance of a conflict actually arising, have led to insureds alleging that a conflict of interest exists. Fortunately for insurers, the Ontario Superior Court has provided some helpful guidance in this regard.
In 137328 Canada Inc. v. Economical Mutual Insurance Company, 2011 ONSC 1085, the insured, a company providing security and alarm services, was named as a defendant in a lawsuit by one of its clients arising out of a roof collapse that caused extensive structural and water damage. The insured had a CGL policy with limits of $2 million. The lawsuit claimed damages well in excess of those limits. Upon notice of the claim, the insurer advised the insured that it would provide coverage and defend the lawsuit. However, in light of the likely exposure in excess of limits, the insurer further advised the insured that it may wish to retain its own counsel to advise it with respect to its excess exposure.
The insured did retain counsel and immediately instructed the insurer’s chosen defence counsel to cease taking further steps in the litigation on its behalf. The insured also demanded that the insurer fund its chosen counsel alleging that the potential exposure in excess of limits created a reasonable apprehension of a conflict of interest between itself and the insurer. The insurer objected, emphasizing that it had not raised any coverage concerns, except for the quantum of the claim. The insurer confirmed its willingness to provide coverage and defend the underlying action on behalf of the insured.
In spite of these assurances from the insurer, the insured brought an application seeking declarations that it could choose and instruct its own counsel, and that the insurer should be required to pay for its legal costs, including independent counsel.
The Court rejected the insured’s argument that exposure in excess of limits was sufficient, in itself, to create a conflict of interest requiring the insurer to fund independent counsel. The Court noted that while facts could later emerge that may raise concerns about a conflict of interest on the part of the insurer, in the absence of any present divergence of interest there was no basis at law to deviate from the normal course and require the insurer to fund independent counsel for its insured.
The Court noted the coverage concern raised by the insurer with respect to the claim had nothing to do with the conduct of the insured and related solely to the quantum of the claim. There was no reasonable apprehension of conflict of interest on the part of counsel appointed by the insurer to defend the civil action, and no divergence of interest at that point in time, and the Court dismissed the application by the insured as it related to payment of its legal costs by the insurer. The Court also found that the possibility of an unknown coverage issue arising in the future was speculative and insufficient to raise a reasonable apprehension of a conflict of interest.
e) When can the insured’s choice of counsel have a conflict?
It is worth emphasizing that conflicts are not always due to the acts of an insurer. In many cases it is the counsel for the insured that is placed in a position of conflict and cannot act.
In Chan v. St. James (King-Jarvis) Inc., 2005 CanLII 3206 (ON SC), the insured condominium corporation was sued by the plaintiff. Some of the allegations pled in the amended statement of claim, if proven, would be covered under the insured’s policy, while others would be excluded. Before the pleadings were tendered to the insurer for a defence, the lawyer for the insured entered a defence in the underlying action. The insured’s lawyer then issued a third party claim against the insurer alleging breach of the contract and failure or refusal to offer a defence or indemnity because the insurer had suggested that
matter be referred to an insurer previously on risk.
The insurer elected to defend the underlying action and brought an application to replace the insured’s lawyer with solicitors of its own choosing to defend the underlying action, relying on its right to retain counsel and to control the defence. In addition, the insurer argued that the insured’s lawyer, having commenced the third party claim against the insurer alleging bad faith, was in a position of conflict of interest. The insured opposed the application arguing that any counsel appointed by the insurer would be placed in a conflict of interest with the condominium corporation because of the fact that some of the allegations in the statement of claim were not subject to coverage.
The court allowed the insurer to appoint its counsel of choice to defend the underlying action. The insured’s lawyer was in a position of conflict given that he had made an allegation of bad faith against the insurer in the third party proceeding which gave rise to a reasonable apprehension of conflict on the part of the insurer.
f) When can you disqualify the insured’s counsel of choice?
Where an insured’s choice of counsel commences and maintains a separate action against the insurer alleging bad faith, that counsel will be prohibited from acting as defence counsel for the insured in the underlying action.
In Svishchov v. Corol, 2003 CanLII 4521 (ON SC), the underlying action involved a fatal accident. The defendant was the owner of the car in which the plaintiff’s wife had died after the vehicle came to a sudden stop on the road and was struck by another vehicle.
The defendant’s insurer initially denied coverage. The insured retained independent counsel who brought a third party action against the insurer alleging bad faith. The insurer later acknowledged that it had an obligation to defend the underlying action but objected to the insured’s choice of counsel and sought to appoint its own choice of counsel to represent the insured in the underlying action.
The Court held that “but for” the bad faith allegation asserted by the insured in the ongoing third party proceeding, the insurer would have been obliged to surrender conduct of the defence to the insured since it had placed the insured’s conduct in issue by contesting the insured’s version of events rather than merely reserving legal rights to later deny coverage. However, in the continued presence of the bad faith allegation against Economical, the counsel retained by the insured was clearly in a position of conflict and independent counsel should be appointed to defend the underlying action.
g) What if only part of a claim is covered – is there a conflict?
A conflict will often arise in cases where liability against an insured can be grounded in either an intentional tort or negligence. In such cases, a conflict will often be found where the court concludes that defence counsel will have an incentive to pursue a defence theory of liability that would support an off-coverage position.
In Coakley v. Allstate Insurance Company of Canada, 2009 CanLII 22549 (ON SC), the insured was being sued after he allegedly pushed the plaintiff through a door and slammed him to the ground causing him injuries. Allstate refused to defend the action under the insured’s homeowner’s policy on the basis that the underlying action alleged intentional conduct, although negligence had also been pled. The insured brought a third party claim against Allstate seeking a declaration that it had a duty to defend in the underlying action. A major issue at trial in the underlying action was expected to be whether the insured’s impugned conduct had been in self-defence.
The court concluded that there would be an appearance of conflict if Allstate were permitted to conduct the defence through its choice of counsel, and ordered that the insured be permitted to continue with his own lawyer, with all past and future defence costs to be paid by Allstate:
… the question of whether Mr. Oakley will be indemnified by the insurance policy depends on a determination and characterization of his conduct in the litigation. There is an ongoing dispute between Mr. Oakley and Allied as to whether he is excluded from coverage. Mr. Oakley is concerned that the insurer may steer the defence of the action in order to obtain a result in its favour, that is, a result that would exclude him from coverage. In my opinion, a reasonable person would perceive a conflict of interest.
Clearly, the court’s concern in these types of cases is that defence counsel will “sculpt” the conduct of the defence to the detriment of the insured in respect of the coverage issues. In such cases, a clear conflict of interest arises and the insured will be entitled to its own choice of counsel, but, as seen below, that conflict of interest may not disqualify the insurer from controlling the defence where the issue is overlayed on a conflict between insurers.
h) Two Overlapping Policies
There is limited authority in Canada and the Commonwealth to assist us in determining what happens when two separate insurance companies are bound to defend one insured from a claim where there is no question that one insurer will provide primary coverage and the other excess coverage.
In Prudential Assurance Co. v. Manitoba Public Insurance Corp.,  M.J. No. 71, two insurance policies, issued by separate insurers, were potentially triggered by the allegations in the underlying action. The plaintiff had alleged that he was injured while walking beside the insured’s vehicle in his garage when he was struck by a piece of metal protruding out from the side of the vehicle. Both insurers agreed that the insured was entitled indemnity from one of them but each sought to cast the primary responsibility onto the other policy.
The Court of Appeal concluded that both insurers were bound to defend the action on behalf of the insured and noted that it was also possible, and in fact likely, that both insurers would be bound to indemnify the insured against any judgment to be obtained by the plaintiff. The Court acknowledged the clear conflict between the insurers noting that the personal lines insurer would seek to establish that the sole cause of the accident was the Automobile while the auto insurer would take the position that the sole cause of the accident was the insured’s negligence as an occupier. The Court ordered that the insurers agree upon a “neutral” counsel, and in further ordered that if the insurers were unable to agree the insured could then select the counsel of his choosing.
The same result obtained in Markham v. AIG Insurance Co. of Canada. A young boy was injured by a flying puck while watching a hockey game at a community centre. The Plaintiff sued both the City of Markham, who ran the community centre, and Hockey Canada, who oversaw the hockey league program. The Plaintiff claimed $150,000 in damages.
The City was insured under its own CGL policy, but was also an additional insured under Hockey Canada’s policy. The City’s policy provided that it would be excess if other insurance applied to a covered occurrence. Hockey Canada’s policy had no such provision. Each insurer brought a competing application to determine their respective duties to defend and entitlements to participate in the defence.
The City of Markham and its CGL insurer were represented by the same counsel. Their counsel took the position that the City was entitled to appoint and instruct counsel without having to report to or take instructions from Hockey Canada’s insurer. Hockey Canada’s insurer took the position that defence counsel should be jointly appointed and instructed.
In support of its position, the City’s insurer argued that:
1) Hockey Canada’s insurer was conflicted because some claims advanced against the City were not covered under Hockey Canada’s policy, incentivizing Hockey Canada’s insurer to “sway” the proceeding to impose liability on the City;
2) The City had brought a third-party claim against Hockey Canada; and
3) A separation between coverage and defence counsel and adjusters at Hockey Canada’s insurer (a “split file”) would not address the conflict because:
a. there was no mechanism in place to detect whether one adjuster had improperly “peeked” at the other’s materials; and
b. Hockey Canada’s insurer had not produced a written policy setting out
how such conflicts were to be managed.
The Application Judge accepted these arguments, and concluded that there was an “irremediable conflict of interest”. As a result, she ordered that the City could appoint and direct its own counsel without having to report to Hockey Canada’s insurer.
The Court of Appeal disagreed. The Court upheld the “reasonable apprehension of conflict of interest” test, but reached a different conclusion based on two points:
- the case was not one where an insurer’s conflict would sway the defence towards uncovered losses to the insured’s detriment – its focus was on which of two insurers would be responsible for the loss. Therefore, cases where an insurer’s conduct of the defence would place its insured at greater risk were distinguishable; and
- in the absence of evidence that appointed defence counsel or an insurer’s file handlers had or would breach their obligations or misuse confidential information, the Application Judge erred in concluding that a “split file” would not address the potential conflict of interest.
The Court recognized that each party to the application had a conflicting interest:
- the City would prefer Hockey Canada to bear liability so that it would not have to pay the deductible under its policy and potentially bear future premium increases;
- the City’s insurer would prefer that Hockey Canada bear liability to minimize its exposure; and
- Hockey Canada’s insurer would prefer that the City bear liability to minimize its exposure.
The objective remained the same: striking a balance between the insured’s right to a full and fair defence with the insurer’s right to control the defence. In the circumstances, the Court of Appeal overturned the Application Judge’s findings and adopted Hockey Canada’s insurer’s proposal for a “split file” with some minor additions. The insurers were to jointly appoint and instruct counsel and share defence costs equally, subject to reallocation at a later date.
Markham v. AIG makes a number of important points. First, it establishes that an inter-insurer conflict will not be treated the same way as an insurer-insured conflict. Second, it suggests that future misconduct should not be presumed – parties should be expected to conduct themselves in accordance with professional obligations and the requirements of a “split file” scenario. Any challenge to that proposition will require more than the existence of a conflict.
i) Push it outside of coverage
A clear conflict will exist if the insurer has an incentive to defend the underlying action in a manner which would push the claim outside of the coverage afforded under the policy of insurance.
This type of conflict is illustrated by the case of Schwartz v. Kuszko Estate,  O.J. No. 611. The plaintiff in the underlying action was a hearing aid technician who attended the insured’s home in regard to complaints made by the insured related to a hearing aid he had purchased from the plaintiff’s employer. The meeting reportedly became somewhat “unfriendly” and the plaintiff elected to depart from the insured’s residence. Unfortunately, before he was able to enter his car the plaintiff was shot by the insured and seriously wounded.
The plaintiff brought an action for damages pleading alternate theories of liability: he alleged that he was either shot intentionally or through the negligent use of a firearm. The insured died shortly after the commencement of litigation but had previously maintained that the rifle was discharged by accident. The insured’s estate defended the action and sought an order requiring the insurer to provide a defence. The insurer claimed that the plaintiff’s injuries were caused by an intentional act of the insured, and that it was not required to indemnify the insured since coverage for intentional acts was excluded by the policy.
In concluding that the insurer was obligated to defend the insured, the Court stated that there were two contractual obligations which arose from the policy (to indemnify and to defend) and the intentional acts exclusion did not necessarily excuse the insurer from its obligation to defend. The Court made an order requiring the insurer to defend the underlying action. However, the insurer was not permitted to defend the action with its own choice of counsel since that would result in a clear conflict in terms of which defence “theory” should be proven.
The case of Donovan Estate v. Patricia Fly-In Camps,  O.J. No. 1394, illustrates another example of a clear conflict. In Donovan, the late plaintiff’s estate brought an action against the insured’s fly-in fishing camp. The plaintiff had attended a wilderness fly-in fishing trip to Coles Lake, a remote location near Kenora, Ontario when a fire destroyed the cabin his group was staying in. The plaintiff later left the campsite to search for help and was never seen again until his body was discovered in the brush several days later a short distance from the burned cabin. Interestingly, the insured has increased its liability limits from $200,000 to $1,000,000 in the days prior to the discovery of the plaintiff’s body. The plaintiff’s body was discovered at a time when the insurance coverage was admittedly $1,000,000 but it was unclear which policy limits were in effect at the time of the plaintiff’s demise.
The court concluded that the precise time of death was a matter of “obvious dispute” between the insured and the insurer. On that basis the court held that there was both a “probability of real mischief” and “appearance of impropriety” existed and the insured was allowed to retain independent counsel at the expense of the insurer.
Canadian courts have recently shown an increased willingness, particularly in B.C., to interfere with the insurer’s right to appoint counsel of its choosing. The result, as illustrated in cases such as B.C. Medical Association v. Aviva Insurance Company of Canada is that insurers which have mistakenly proceeded as if no conflict had existed, have been penalized by the courts. In such cases, courts have ordered that the insured be allowed to appoint its own choice of defence counsel, with extremely limited reporting requirements to the insurer, and perhaps equally important, no ability to control that counsel’s hourly billing rate and defence strategy.
An issue for insurers is how important their choice of counsel is to them. Many preferred counsel are specifically retained by insurers for their specific expertise and a proven track record. Insurers can avoid the appointment of “Cumis” counsel by maintaining separate files for coverage and defence counsel with separate examiners for each file. Clearly not every claim will justify such an expense. However, the writers respectfully suggest that claims which suggest that insurers, faced with a claim which may likely generate a conflict as the litigation progresses, would be well served by adopting the two file system. The risk to insurers if they proceed otherwise is clear: insurers risk losing its choice of counsel, it control of the defence, its access to file materials. Perhaps most importantly, insurers in such cases risk becoming reduced to a “cheque writer”.