Canada: SCC Refuses Leave To Appeal D&O Coverage Case

Last Updated: October 29 2013
Article by Casandra Drake

The Supreme Court of Canada recently refused leave to appeal the decision in Onex Corporation et al. v. American Home Assurance Company et al, 2013 ONCA 117, a case where the Ontario Court of Appeal had provided guidance on a number of important issues in the context of director and officer insurance policies. In particular, the court addressed the adequacy of notice of claims under a prior notice provision, the proper interpretation of an "insured vs. insured" exclusion clause and "reasonable expectations" in the context of a unique fact pattern.

The Onex Action

In this coverage dispute (the "Onex Action"), Onex Corporation claimed they were entitled to payment of (very substantial) defence costs pursuant to the primary and excess D&O policies for an action commenced against them (and others) in the state of Georgia in 2005 (the "Georgia Action"). Onex incorporated Magnatrax Corporation ("Magnatrax") as a subsidiary in 1999. The Georgia Action arose out of bankruptcy proceedings involving Magnatrax under Chapter 11 of the United States Bankruptcy Code. In the action, the trustee alleged that the plaintiffs had breached their fiduciary duty and were unjustly enriched by engaging in a series of transactions that benefitted Onex at the expense of Magnatrax. Two of the Onex directors had also been directors and officers of Magnatrax and other Onex directors were alleged to have acted as de facto directors and officers of Magnatrax.

On August 1, 2003, counsel for the Magnatrax Creditors' Committee provided a letter to Magnatrax's counsel (the "Notice"), asserting that Magnatrax had claims against Onex and its affiliates, and the directors and officers of both Onex and Magnatrax. The Notice included allegations of claims arising from breach of fiduciary duty, aiding and abetting breach of fiduciary duty, unjust enrichment "and possibly other claims to be identified". The insurance broker provided the letter as a "Notice of Circumstances" to American Home one day before the Onex 2002-2003 policy expired.

Damages and Expenses

The trustee sought damages of approximately US$600 million but settled for approximately US$9.25 million. In the course of defending the action, Onex spent approximately US$35 million and sought reimbursement for the defence costs under D&O policies issued by American Home Assurance Company ("American Home") and various excess insurers.

The D&O Policies

Onex had regularly purchased D&O liability insurance from American Home. The D&O policies were "claims made and reported policies" and each of them included a "notice of circumstances" clause which allowed the insured to report circumstances arising during a policy period which may give rise to a claim in the future.

At issue in the proceedings were three D&O policies purchased by Onex. The policies included a US$15 million 2002-2003 American Home D&O policy (the "Onex 2002-2003 Policy") purchased for the 2002-2003 policy year, a US$15 million 2004-2005 American Home D&O policy purchased for the 2004-2005 policy year (the "Onex 2004-2005 Policy"), and a D&O policy issued to Magnatrax (the "Magnatrax Run-Off Policy") on the eve of Magnatrax's insolvency.

Onex also purchased excess insurance policies for the years referenced above. American Home initially denied coverage under all three policies, but prior to the Onex Action, paid out US$15 million – the full limit of liability – under the Magnatrax Run-Off Policy.

The Onex Action was commenced in 2008 seeking coverage under the Onex 2004-2005 Policy, or, in the alternative, under the Onex 2002-2003 Policy, and coverage under the excess insurance policies. The plaintiffs brought a motion for summary judgment seeking payment of their defence costs pursuant to the Onex 2004-2005 Policy. American Home brought their own cross-summary judgment motion on the basis that the Georgia Action was a claim first noticed under the 2002-2003 D&O policy and was therefore excluded from coverage under the 2004-2005 D&O policy.

2004-2005 Onex Policy

American Home and the Excess Insurers argued Onex gave notice of circumstances under clause 7(c) of the 2002-2003 Onex Policy. Clause 4(d) of the 2004-2005 Onex Policy excluded coverage where the claim was covered by a prior policy, in this case, the 2002-2003 Onex Policy. Thus, so the argument went, the plaintiffs were not entitled to reimbursement for defence costs in connection with the Georgia Action.

The plaintiffs argued the Notice did not satisfy the specificity requirements of clause 7(c) of the 2002-2003 Onex Policy, and therefore, the 2004-2005 Onex Policy provided coverage to the plaintiffs.

2002-2003 Onex Policy

At issue with respect to the 2002-2003 Onex Policy was the proper interpretation of Endorsement #14, which stated that American Home would not be liable for:

... any Loss alleging, arising out of, based upon or attributable to or in connection with any Claim brought by or made against the Entity listed below and/or any Insureds thereof.

1. MAGNATRAX Corporation (including any subsidiary or affiliate thereof)

It is further understood and agreed that the Definition of Subsidiary shall not include MAGNATRAX Corporation. Further, the Insurer shall not be liable to make any payment for Loss in connection with any Claim made against an Insured alleging, arising out of, based upon or attributable to any breach of duty, act, error or omission of MAGNATRAX Corporation, or any director, officer, member of the board of managers or employee thereof.

American Home argued that Endorsement #14 excluded coverage because the Georgia Action was a claim by Magnatrax against Magnatrax directors and officers, based on their acts and omissions.

Motion Judge's Decision

The motion judge found that the Georgia Action was not covered under the 2004-2005 Onex Policy. Specifically, he held that the Notice constituted sufficient notice of a claim or notice of circumstances giving rise to a claim pursuant to s.7(c). Further, the motion judge confirmed that in determining whether a notice by an insured to an insurer is sufficient, an objective test should be applied having regard to the wording of the policy. Specifically, the test is whether the insured objectively complied with the notice provision of the policy.

With respect to the 2002-2003 Onex Policy, the motion judge held that coverage was not excluded under Endorsement #14 because the claims asserted in the Georgia Action, although initially belonging to Magnatrax, were not brought by Magnatrax, but by the trustee in bankruptcy.

Specifics of Notice Requirement Met

With respect to the issue of whether the Notice complied with the requirements of clause 7(c) of the Onex 2002-2003 Policy, Onex argued that the motion judge erred in concluding that the Onex 2004-2005 Policy did not provide coverage.

Clause 7(c) of the Onex 2002-2003 Policy provided that the period of coverage could be extended beyond the policy period if an insured provided notice during the policy period of circumstances that may lead to a future claim. Clause 7(c) applied in combination with clause 4(d) of the standard exclusions in the Onex 2004-2005 Policy, which excluded from coverage loss from any claim arising out of wrongful acts of which notice had been given under a previous policy.

The Court of Appeal rejected Onex's arguments that the Notice did not satisfy the requirements of clause 7(c) in that it did not set out full particulars as to dates, persons and entities involved. The Court refused to interfere with the motion judge's decision, finding that the notice contained sufficient particulars to meet the requirements of clause 7(c). Further, the Court of Appeal endorsed the motion judge's application of an objective test to determine whether the insured objectively complied with the notice provision in the policy. The court noted that Onex provided American Home with the specifics of threatened litigation as those specifics were provided to it. The insured was not required to speculate about the names of the individual directors or officers who might be named in the threatened litigation.

Narrow Interpretation of Insured vs. Insured Exclusion

The Court of Appeal affirmed the motion judge's narrow interpretation of the exclusion, finding that it did not exclude coverage for derivative actions such as the one brought by the trustee in bankruptcy. The context of the Endorsement was also considered, as the reason for the negotiations that resulted in Endorsement #14 was the impending bankruptcy of Magnatrax. The context of the bankruptcy in addition to the sophistication of the parties convinced the court that the omission was not an oversight.

However, with respect to the two additional exclusions included in Endorsement #14, the Court of Appeal held that there was ambiguity, making it necessary to turn to extrinsic evidence to assist with the interpretation. Having found Endorsement #14 was unambiguous, the motion judge did not make findings of fact with respect to the issues of extrinsic evidence. Thus, the Court of Appeal determined that the evidence necessary to determine the reasonable expectations or intentions of the parties with respect to the endorsement was not entirely before it, and therefore, the court refused to resolve the ambiguity de novo.

Intentions and Negotiations Relevant to Policy Interpretation

In considering whether the exclusions in Endorsement #14 applied, the Court of Appeal reviewed the principles for interpreting the terms of an insurance policy. The court noted that the very exercise of determining whether or not the language is ambiguous must include an assessment of "...the words of a contract in light of the factual matrix in which the agreement was written". The court held that "[i]t is important to distinguish what is meant by the factual matrix from extrinsic evidence that it is admissible to resolve an ambiguity". The factual matrix is gleaned from the context of the transaction, and, as set out by Doherty J.A. in Dumbrell v. The Regional Group of Companies Inc., 2007 ONCA 59, the factual matrix "clearly extends to the genesis of the agreement, its purpose, and the commercial context in which the agreement was made".

Providing further guidance, the Court of Appeal observed that "...the admission of extrinsic evidence does not mean that the parties' subjective views of what was intended by the agreement will be used to resolve the ambiguity". Rather, it was held that the courts must look for the interpretation that gives effect to the reasonable expectations or intentions of the parties at the time the contract or policy was obtained.

Finally, before turning to the specific arguments, the court noted that Endorsement #14 to the Onex 2002-2003 Policy was one part of an individually negotiated set of insurance agreements between Onex, American Home and Magnatrax. Further, the positions of both parties in approaching the interpretation dispute were commercially reasonable.

Importance of the Decision

This case is of particular importance to Canadian insureds and insurers as it appears to be the first time an appellate court has considered the scope and application of a prior notice provision included in a D&O insurance policy. The court endorsed the use of an objective test, requiring less specificity than may have been expected. Thus, even where the insureds do not have the specifics required to satisfy the notice requirement, as long as adequate notice has been provided, an insurer should not deny coverage.

The Court of Appeal also provided guidance with respect to the interpretation of exclusion clauses in D&O policies and, in particular, insured vs. insured clauses. The decision suggests that exclusion clauses will be interpreted narrowly and negotiations that result in the exclusion may be considered in determining whether the exclusion was to apply to the claim in question.

Finally, this case demonstrates that where an ambiguity in a policy is found, a consideration of the factual matrix, the negotiations surrounding the insurance arrangements and the parties' reasonable expectations will be important to resolve the interpretation dispute. Accordingly, parties should keep in mind the communications of intentions and expectations when a policy is being negotiated. Where there are two commercially reasonable interpretations of a clause, the extrinsic evidence of the parties' communications may determine which applies.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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