A covenant to insure most often arises in a landlord-tenant situation but does have broader commercial application as was seen in the recent British Columbia Court of Appeal decision of Kruger Products Ltd. v. First Choice Logistics Inc., 2013 BCCA 3. There, the insurers of a paper warehouse brought a subrogated action to recover more than $16,000,000 paid out following a fire at the warehouse which destroyed not only the building but over 3,700 tonnes of unprocessed paper, and 236,000 cases of finished paper products. The fire began when paper debris came into contact with the exhaust system of a forklift being operated in the warehouse.
The stored paper products were owned by Kruger Products, formerly known as Scott Paper Ltd. ("Scott") and managed by First Choice Logistics ("First Choice") pursuant to a warehouse management agreement. Under the warehouse management agreement, Scott covenanted both to insure loss or damage to the inventory in the warehouse, and to name First Choice as an additional insured under such a policy. Specifically, the warehouse management agreement provided as follows:
A. Liability Insurance
The Contractor [First Choice] will maintain, throughout the Term of this Agreement, and any Extension Term, comprehensive general liability insurance and industry standard warehouseman's legal liability insurance. Scott will maintain general liability insurance, tenant's legal liability insurance, and insurance of its inventory and property within the warehouse.
All insurance shall name Scott or the Contractor as applicable as an additional insured against all liability for bodily and/or personal injury and property damage, arising from the insured's fault or negligence, or the fault or negligence of any of its or their shareholders, directors, officers, employees, servants and agents, its and their affiliated, related, parent and subsidiary companies, and its and their appointees, successors and assigns, in connection with the Management Services hereunder.
If the comprehensive general liability policy contains a general aggregate, that aggregate limit shall apply separately, per location, so that the Warehouse will have its own aggregate limit. All insurance policies contemplated hereunder shall constitute and respond as primary coverage to any insurance otherwise available to Scott and any of its shareholders, directors, officers, employees, servants and agents, its affiliated, related, parent and subsidiary companies, or its and their appointees, successors and assigns. [Emphasis added]
Scott failed to name First Choice as an insured under its policy. At trial First Choice argued that had Scott honoured its covenant to the insurer, the action would have been barred because it is trite law that an insurer may not subrogate against its own insured1.
The trial judge held that the "covenant to insure" defence did not apply in this instance, and purported to distinguish decisions by the Supreme Court of Canada and the British Columbia Court of Appeal about insurance covenants and bars to subrogation, on grounds that:
- First Choice did not have an insurable interest in the stored goods stating that "there is a critical distinction between leases and construction contracts on the one hand and contracts of bailment on the other hand regarding the insurable interest of the parties in the bailed property";
- To allow the tort immunity defence "would make meaningless the indemnification contained in the warehouse management agreement" and would impair the duty of care owed by First Choice to Scott; and
- There was no language in the warehouse management agreement indicating that the property insurance taken out by Scott was to benefit First Choice.
On appeal First Choice argued that the trial judge erred by failing to dismiss the action on the basis that Scott's covenant to name First Choice jointly with itself operated to bar claims for loss or damage to be covered by such joint insurance, and that Scott could not rely on its own breach to circumvent such bar2. First Choice further argued that the trial judge erred in distinguishing bailment situations from the landlord-tenant and complex construction situations discussed in the authorities.
The Court of Appeal allowed the appeal and did not agree with the trial judge that the circumstances of a bailor / bailee relationship, by itself, was sufficient grounds to distinguish the Supreme Court trilogy of covenant to insure / tort immunity case authority3.
The Court of Appeal found that the trial judge erred in holding that First Choice did not or could not be said to have an insurable interest in the property that was destroyed by the fire. The Court cited de Grandpre J. from the Supreme Court of Canada decision of Commonwealth Construction Co. Ltd. v Imperial Oil Ltd.4. It was observed that in the field of bailment "in the widest sense", persons other than the owner have been held to have insurable interests in the subject property "because of their special relationship with the property entailing [the] possibility of liability"5. Here, as First Choice was subject to "the possibility of liability" under the Warehouse Receipt Act6, an insurable interest in the paper products arose.
The Court of Appeal also disagreed with the trial judge's policy concerns regarding First Choice's obligation under the warehouse management agreement to indemnify Scott for negligent acts, stating that they did not see any conflict between a general covenant to indemnify given by a warehouser and covenants to insure. The Court noted that "one may see insurance covenants as a means of strengthening indemnification obligations, which alone are only as strong as the indemnifier's particular financial circumstances. Furthermore, the obligation of a negligent warehouser to indemnify its bailor for breaches of its duty of care arises even without a [covenant to insure] provision"7.
Finally, the Court of Appeal held that the covenant to insure in the warehouse management agreement was indeed to the benefit of First Choice. The Court noted that the trial judge had "acknowledged that the trilogy is generally recognized as standing for the proposition that in the context of a commercial lease, 'a covenant to insure by a landlord should flow to the benefit of a tenant unless that result would be inconsistent with something in the lease itself'"8. The Court of Appeal found no such inconsistency in the warehouse management agreement and held that "the insertion of a covenant to insure ... on the part of a bailor or landlord is generally regarded as intended for the benefit of the bailee or tenant".
As this decision illustrates, the complete defence afforded under the principle of tort immunity arising out of a covenant to insure can be a powerful weapon to defeat liability and underscores the importance of careful drafting of commercial agreements.
1 Commonwealth Construction v. Imperial Oil, 1976 CanLII 138 (SCC).
2 Active Fire Protection 2000 v. B.W.K. Construction, 2004 CanLII 47781 (ONSC); aff'd 2005 CanLII 24226 (ONCA).
3 Agnew-Surpass Shoe Stores Limited v. Cummer-Yonge Investments Ltd.  2 S.C.R. 221; Ross Southward Tire Ltd. v. Pyrotech Products Ltd.  2 S.C.R. 35; T. Eaton Company v. Smith  2 S.C.R. 749
4 Supra at footnote 1.
5 At Para. 52
6 RSBC 1996, c 481
7 At Para. 56
8 At Para. 59
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