The main purpose of commercial general liability insurance policies ("CGL policies") is to provide protection to an insured party against financial losses which may be incurred if the insured is sued by a third party. The relationship between an insurer and an insured party is dependent on the wording of the relevant insurance contract. Typically though, CGL policies, similar to other liability insurance policies, require an insurer to fulfill two distinct, but related duties. The first obligation is referred to as the "duty to defend". This entails the insurer paying for, and instructing, legal counsel in the defence of a claim brought against its insured by a third party. The second obligation is called the "duty to indemnify". This duty requires the insurer to pay for any judgment awarded to the third party against its insured, or any settlement that the parties have reached in lieu of judgment.1
The duty to defend when properly understood from the insurer's point of view is both a contractual obligation and a contractual right. The duty to defend acts as an obligation on an insurer for the obvious reason that it is invoked by its insured to shield the insured from the significant costs associated with defending an action. However, given that a typical CGL policy creates a duty on an insurer to indemnify its insured, having control of the defence of the lawsuit is advantageous for the insurer. Even if it is clear that the insured is liable, the insurer can attempt to minimize the damages attributable to its insured, thereby reducing the financial impact of the insurer's obligation to indemnify its insured. Having control of the defence then can be seen as a benefit to the insurer thus making the duty to defend a contractual right of the insurer as well.2
An insurer's duty to indemnify its insured will only be triggered after the merits of the law suit have been determined by a court or after a settlement agreement has been reached.
An insurer's duty to indemnify its insured will only be triggered after the merits of the law suit have been determined by a court or after a settlement agreement has been reached. This is non-controversial as the determination of liability and the quantum of damages must be resolved in order to determine if, and to what extent, they fall within the indemnity coverage provided by the liability insurance policy. This is not the case with an insurer's obligation to defend an insured against a lawsuit from a third party. Although the duty to defend is triggered well before the merits of the lawsuit are determined, when exactly the duty arises is a question courts have grappled with.3
The Pleadings Rule
The Supreme Court of Canada has dealt with the question of when the duty to defend will arise, in a series of decisions. In 1990, the Court ruled in Nichols v. American Home Assurance Co., that an insurer's duty to defend arises only if, assuming that the facts as alleged in the pleadings were proven true, an insurer would have an obligation to indemnify its insured.4 This decision cites a judgment from the British Columbia Superior Court that held, "the pleadings govern the duty to defend".5 Nichols stands for the proposition that in order for the duty to defend to arise, it is not necessary to prove that the duty to indemnify will certainly arise. Rather the "mere possibility that a claim within the policy may succeed" is enough to trigger the duty to defend.6 This decision clarified one of the distinctions between the two duties, by stating that "in a senseâ€¦the duty to defend is broader than the duty to indemnify." 7 Essentially then it can be said that an insurer cannot owe a duty to indemnify if they do not owe a duty to defend, but an insurer can owe a duty to defend but ultimately be found not to owe a duty to indemnify.
The True Nature of the Claim
Ten years after the decision in Nichols, a problem developed. It was thought that the ruling in Nichols incentivized plaintiffs issuing claims against defendants who were insured, to draft their pleadings in as broad a manner as possible to capture at least one allegation that would be covered by the 'four corners' of the defendant's insurance policy. In doing so, plaintiffs were thought to be intentionally triggering the duty to defend on the part of the defendant's insurer and presumably hoping that the insurer would settle the claim before the merits of the action could be decided by a judge.8 Therefore in order to address this concern, the Supreme Court of Canada in Non-Marine Underwriters, Lloyd's of London v. Scalera, clarified what the analysis should be when determining whether an insurer's duty to defend is triggered.9
The facts of the Scalera decision are illustrative. Mr. Scalera was sued for damages arising from a series of sexual assaults that were allegedly perpetrated by him against a young woman over a period of several years.10 The pleadings raised numerous allegations including an allegation of negligent battery.11 Mr. Scalera sought coverage for the defence of this claim pursuant to his homeowner's insurance policy, as some of the allegations dealt with negligence, which he argued fell within the ambit of the policy.12 He was essentially arguing that similar to the conclusion in Nichols, the pleadings in this action created a possibility that a claim covered by his insurance policy could succeed and therefore his insurer's duty to defend should be triggered. The insurer requested a declaration that it not be required to defend Mr. Scalera against the plaintiff's claims because the policy specifically excluded coverage for bodily injury caused by intentional or criminal acts. The insurer maintained that sexual assault is always intentional.13 The Court sided with the insurer and found that all of the allegations that were in the pleadings were based on the same set of facts and were "derivative of the claim for sexual battery" and therefore were also covered by the exclusion for injuries intentionally caused.14 The Court in Scalera clarified the Nichols ruling by stating that the connection between the duty to defend and the pleadings is not determined solely with regards to the language of the pleadings. Instead, the determination is based on what the pleadings reveal to be the "true nature of the claim".15 After the ruling in Scalera, the decision in Nichols can be said to stand for the proposition that, "having determined the nature of the claim, an insured need not further prove that the claim would succeed" in order for the duty to defend to be triggered.16
Subsequent decisions, both from the Supreme Court of Canada and from the lower courts, have elaborated on how exactly to determine what the "true nature" of the claim is where pleadings are not framed with sufficient precision to determine whether the claim is covered by a policy or not. Courts have been encouraged to "look behind the literal terms of the pleadings" in order to assess which of the legal claims put forward by a plaintiff could be supported by the factual allegations.17 The purpose of the analysis is to discern the true "substance" of the allegation. The analysis should be framed by assuming the truth of the plaintiff's factual allegations and asking whether the pleadings could possibly support the plaintiff's allegations.18 In undertaking this analysis, courts are allowed to look at any extrinsic evidence that has been explicitly referred to within the pleadings to assist in determining "the substance and true nature of the allegations".19More recently the Court of Appeal confirmed further that for the purpose of determining what the "true nature" of the claim is and whether a duty to defend arises from it, the term "pleadings" includes any cross claims or third party claims, in so far as they are relevant in defining the substance of the allegations.20
After a court has analyzed the pleadings and after it has made a determination as to what the true nature of the allegations being pled are, the next step that a court will take in order to assess the scope and nature of the duty to defend is to scrutinize the actual contract of insurance to explore whether the policy is triggered by the allegations or not. It is at this step of the process where the value of precise and unambiguous language in a CGL policy truly becomes apparent. The manner in which the CGL policy is drafted can have important implications in terms of whether an insurer will have to defend their insured or not.
The Importance of Good Contract Drafting
In Ontario Society for the Prevention of Cruelty to Animals v. Sovereign General Insurance Co. the Ontario Court of Appeal dealt with an insurer's duty to defend under a CGL policy of insurance. In that case, three separate actions for malicious prosecution were brought against the Ontario Society for the Prevention of Cruelty to Animals (the "OSPCA") who had charged three individuals with animal cruelty offences. After those charges were ultimately withdrawn, the three individuals launched a civil suit against the OSPCA. The OSPCA reported the claims to its insurer and requested that it provide a defence. The insurer refused to defend the actions as they relied on, among other things, an exclusion clause in the policy that stated no coverage would be granted when there are allegations of willfully violating a penal statute. The insurer's position was based on an allegation in the pleadings that the OSPCA violated an order of the Animal Care Review Board, which is an offence under the OSPCA Act. The insurer further argued that the OSPCA Act was a penal statue and therefore the exclusion clause is triggered.
At the court of first instance the insurer was ordered to defend the actions.21 The Court of Appeal upheld that decision and dismissed the insurer's appeal. The Court found that the interpretation of insurance contracts involves a unique blend of the general principles of interpretation applicable to all contracts and the unique principles applicable in the insurance setting.22 While courts have found that the "language of the policy" is the most important factor in determining whether coverage is granted or excluded, courts have found that where there is genuine ambiguity or doubt, the duty to defend ought to be resolved in favour of the insured.23 Similarly other insurance law principles should be considered, such as the principle that coverage provisions should be construed broadly and exclusion clauses should be construed narrowly.24 It was this last principle that the Court looked to in making a decision in this case.
The Court determined that, notwithstanding the prohibitions that the OSPCA Act creates, the object of the legislation taken as a whole is not to punish behaviour that is morally blameworthy, but rather to prevent cruelty to animals. The Court therefore found that the statute was not penal in nature but rather was remedial and therefore the exclusionary clause in the insurance policy was not triggered.25 One of the key lessons about careful policy drafting is the importance of considering the implications of the language being used in the policy, in light of who the insured is and what risks they may face in the course of carrying out their functions. If the OSPCA's insurer had drafted the policy in a broader manner, to include the willful violation of, for instance "any and all statutes", the insurer, ceteris paribus would have been able to rely on the exclusionary clause and would have avoided the steep costs associated with assuming the OSPCA's defence.
Although courts have established that where there is genuine ambiguity or doubt, the duty to defend ought to be resolved in favor of the insured....
Although courts have established that where there is genuine ambiguity or doubt, the duty to defend ought to be resolved in favor of the insured, the Ontario Court of Appeal has said that this principle of interpretation "has no application where the wording of the policy is plain on its face and capable of only one meaning. Trite though it may be, an insurer has the right to limit coverage in a policy issued by it and when it does so, the plain language of the limitation must be respected".26 Insurers should ensure that exclusionary clauses are drafted clearly, unambiguously and as broadly as possible in order for a court to uphold the clause and decide the issue in the insurer's favour, as occurred in the case detailed below.
In Kohanski v. St. Paul Guarantee Insurance Co. the Ontario Court of Appeal allowed an insurer's appeal of an order requiring it to defend its insured. In that case the insured party, Mr. Kohanski, was sued by an association, Master Insulators' Association of Ontario Inc. Mr. Kohanski formerly acted as a director of that association.27 The association claimed that he had breached his fiduciary duty and had committed the tort of conspiracy. The insurer took the position that the policy did not cover actions brought by the association against Mr. Kohanski, as the association was also an insured under the policy and the policy contained an exclusion clause for claims brought by other insured parties under the same policy. The key provision of the insurance policy was:
"Section IV(7) of the Policy provides: The Insurer shall not be liable to make any payment for loss in connection with any claim made against the Directors and Officers:
(7) which is brought by or at the behest of the Corporation, or any affiliate of the Corporation, or by any security holder of the Corporation whether directly or derivatively except where such security holder bringing such claim is acting totally independently of, and totally without the solicitation of, or assistance of, or participation of, or intervention of, any Director or Officer, or the Corporation or any affiliate of the Corporation."28
The Court referred to this type of exclusion clause as "the insured versus insured exclusion"29 The Court agreed with earlier jurisprudence that found that the language of these clauses is "in no way ambiguous" and that this type of clause operates to exclude coverage when one insured sues another insured.30 The Court said that in such circumstances, its obligation is to give effect to the language of the contract unless to do so would "defeat the main object of the contract or virtually nullify the coverage".31 The Court ruled that since the claim was clearly excluded from coverage by reason of an unambiguous clause, the insurer did not have a duty to indemnify its insured, and therefore did not have a duty to defend him in the underlying action. The Court found that where the language of the contract is clear and unambiguous, it must give effect to that language.32
The precise language of an insurance policy can be the determinative factor as to whether an insurer owes a duty to defend to its insured or not....
The precise language of an insurance policy can be the determinative factor as to whether an insurer owes a duty to defend to its insured or not, as was the case in Jesuit Fathers of Upper Canada v. Guardian Insurance Co. of Canada, a 2006 decision of the Supreme Court of Canada.33 At issue in the appeal was whether an insurance policy issued by the Guardian Insurance Company of Canada ("Guardian") to the Jesuit Fathers of Upper Canada ("Jesuits") imposed on Guardian the duty to defend certain actions for damages arising out of the operation of the Jesuits residential school in Ontario. The allegations related to physical and sexual abuse of students at the school. The policy in question was a "claims-made" policy. At issue in this appeal was the scope of the coverage provided by the insurance agreement, which read in part:
"To pay on behalf of the Insured all sums which the Insured shall become legally obligated to pay as damages, because of injury arising out of the rendering of, or failure to render professional services in the practice of the Insured's profession, provided however, that coverage as provided herein shall apply only to claims which are first made against the Insured during the policy period as stated in the Declarations".34
In order to understand the decision in this case, it is important first to appreciate the various types of policies that are available when insuring against risks arising from the offering of professional services. The Court at paragraph 23 of their decision summarized this succinctly:
"Significant variation may be observed in the nature and structure of policies insuring against risks arising from the offering of professional services. Generally, the drafting of such policies reflects two main approaches for the determination of whether a claim is captured, from a temporal perspective. The first and more traditional approach, the occurrence-based approach, focuses on the occurrence of the negligent act. If the negligent act giving rise to the damages occurred during the policy period, the insurer is required to indemnify the insured for any damages arising from it regardless of when the actual claim is made. The second approach, the claims-made approach, focuses on the claim made by the third party. If a claim is made by a third party during the policy period, the insurer is required to indemnify regardless of when the negligent act giving rise to the claim occurred. Naturally, a particular policy may use the first or the second approach or a hybrid of both. The issue is always what a particular policy dictates".35
The policy at issue in this case, was crafted in such a way that in order to engage the insurer's duty to defend, it required the communication, during the policy period, by a third party, of an intention to hold the Jesuits responsible for damages.36 In this case, it was accepted by the parties, that if the claims were made within the temporal limits of the Policy, the duty to defend would have been engaged as the claims allege injuries that would fall within the policy.37 In fact the Court found one of the claims was made within the policy period and therefore did trigger the insurer's duty to defend.38 The rest of the claims however were found not to have been communicated during the policy period and, as a result, the insurer did not have a duty to defend the actions.39 The determination of whether a policy will be "claims-made" or "occurrence based" will depend on many factors. However, it clear that prior to drafting a particular CGL policy, an insurer should be fully cognizant of who the intended insured party is and what sort of potential claims they might face, before determining which type of policy should be drafted.
A decision of the Ontario Court of Appeal, shows why clearly drafted exclusion clauses are crucial to the determination of whether a duty to defend will be triggered or not. In D.E v. Unifund Assurance Co. the Court was tasked with determining whether an insurer had a duty to defend its insured under a homeowner's policy against a claim alleging that the insured's Grade 8 daughter had bullied her classmate, causing physical and psychological injuries.40 The claim alleged that the insured was negligent in their failure to control their daughter. The insured requested that their insurer defend and indemnify them under the policy. The insurer refused on the basis that the claims fell outside of the policy's scope of coverage, due to exclusionary clauses with respect to intentional assault. The motion judge rejected the insurer's position and granted the insured a declaration that the insurer had a duty to defend and indemnify them. The insurer appealed that decision and the Ontario Court of Appeal allowed the appeal, siding with the insurer. The key provisions of the insurance policy were:
"SECTION II -- Liability Coverage
Coverage E -- Personal LiabilityThis is the part of the policy you look to for protection if you are sued. We will pay all sums which you become legally liable to pay as compensatory damages because of unintentional bodily injury or property damage arising out of:
1. your personal actions anywhere in the world...
Exclusions -- SECTION IIWe do not insure claims arising from:
6. bodily injury or property damage caused by an intentional or criminal act or failure to act by:
(a) any person insured by this policy; or(b) any other person at the direction of any person insured by this policy;
7.(a) sexual, physical, psychological or emotional abuse, molestation or harassment, including corporal punishment by, at the direction of, or with the knowledge of any person insured by this policy; or(b) failure of any person insured by this policy to take steps to prevent sexual, physical, psychological or emotional abuse, molestation or harassment or corporal punishment".41
The Court first looked to the pleadings to assess what the nature of the allegations was. The claim had several allegations, including that the parents "failed to investigate", "failed to take steps to remedy", and "failed to take disciplinary action" with regards to their daughter. The court found that the language of the plaintiff's claim made it obvious that the claim was a negligence claim.42 The Court then compared the language in the claim to the language in exclusionary clause 7(b) cited above. MacPherson JA, writing for the unanimous court, stated, "I see no ambiguity in the wording of this clause. The first word of the clause is 'failure' whichâ€¦is also the centrepiece of the Amended Statement of Claim".43 The court concluded that "exclusion clause 7(b) is clear on its face and it applies to the lawsuit".44 The insurer therefore did not owe a duty to defend in this circumstance.
The Ontario Superior Court released a decision that shows the importance of clearly drafted exclusionary clauses and how the courts will dissect each word of the contract to determine whether the duty to defend is triggered or not. Borthwick v. Lombard Insurance was an application for a determination on whether a duty to defend was owed to an insured.45 Mr. Douglas and Mr. Borthwick went to Fox Hollow Farm to cut down trees. While doing so, one of the trees fell on Mr. Douglas, who became paraplegic. Mr. Douglas and his family sued the farm and Mr. Borthwick for damages. Two insurance policies were potentially in force in relation to Mr. Borthwick; a homeowner's policy issued by Northbridge and a business insurance policy issued by Economical.
The Northbridge policy included liability coverage and stipulated a promise to pay compensatory damages awarded against Mr. Borthwick if he unintentionally caused bodily injury to another. However, the policy excluded claims arising from any "full time, part-time or occasional pursuit undertaken for financial gain".46 Northbridge submitted that the action involved claims for damages for bodily injury arising from an activity (tree cutting) that was undertaken with a view to making a profit. This, it argued, constituted a "business" within the meaning of the Northbridge policy and triggered the exclusion.47 Mr. Borthwick argued it was a one-time event which did not fit within the definition of business. Justice Grace found that the Northbridge policy was unique in comparison to policies analyzed in other cases, as it defined the term "business" in the clause to include the term "occasional pursuit".48 The judge found that the pleadings indicate that Mr. Borthwick was harvesting trees with a view to making a profit.49 Even if this was only a 'one-time' event, the exclusion clause was very clear that even an occasional pursuit would be excluded from coverage and therefore "effect should be given to unambiguous language appearing in the Northbridge policy".50 Northbridge was therefore found not to owe a duty to defend the claim on behalf of its insured.
The policy issued by Economical was a CGL specifically designed to insure business operations. Economical did not dispute that Mr. Borthwick was involved in a "business" on the day in question, however they argued that the tree cutting operation was not the business that they had agreed to insure. Economical stated that they only agreed to insure Mr. Borthwick's wood shaving manufacturing operation. To support their argument they pointed to the name of the insured found on the declarations page, "L.B Wood Shavings and Farm Supplies operated by Larry Borthwick".51 Tree cutting they maintained involved a greater risk than the one that was contemplated by the policy. The Court found that the insurer's assertion was not supported by the language of the policy.52 Specifically the policy read in part:
Section II: Who is an Insured:"If you are designated in the Declarations as:
(a) An individual, you and your spouse are insureds, but only with respect to the conduct of a business of which you are the sole owner."
The Court focused on the fact that the clause above did not refer to and was not limited to any particular business activity. Further the clause did not refer to or limit itself to what was described in the declarations.53 Economical was unable to claim that Mr. Borthwick was not an insured and therefore they were found to owe a duty to defend Mr. Borthwick as "there is a possibility the claim, if proven, fits within the coverage afforded by the policy".54
When a court is tasked to determine whether an insurer owes its insured a duty to defend them against a claim brought by a third party, the court will first look to the pleadings to assist them in making a determination of what the true nature of the allegations are. Once the nature of the claim being made against the insured has been identified, courts will then turn their attention to the insurance policy wording to assess whether the allegations against the insured are covered by the policy or not. Insurers should be very careful as to how they word the policies they underwrite since as demonstrated by the cases we have discussed, all it takes is the presence or omission of just one word from the policy, to result in the Â insurer having to incur the costs of defending the claim. Prior to drafting a policy or even determining what the nature of the policy will be (claims based or occurrence based), insurers should be cognizant of who the potential insured party is and what the anticipated risks are, that they are seeking to insure against. Exclusionary clauses should be drafted broadly, but at the same time insurers should be wary of making the clauses ambiguous, since ambiguity is resolved in favor of the insured. Although there is no way to predict precisely how a court will view each fact situation, hopefully some of the above considerations will be of assistance.
Footnotes1 Barbara Billingsley, General Principles of Canadian Insurance Law, 1st ed, Student ed, Lexis Nexis, at 233.
2 Supra note 1 at 234
4 Nichols v. American Home Assurance Co  1 SCR 801at para 16-17.
5 Ibid at 16 citing Bacon v. McBride (1984), 6 DLR (4th) 96.
6 Ibid at 17.
8 Supra note 1 at 236.
9 Non-Marine Underwriters, Lloyd's of London v. Scalera  1 SCR 551.
10 Ibid at 56.
11 Ibid at 57-58.
12 Ibid at 79.
13 Ibid at 59.
14 Ibid at 54.
15 Ibid at 79.
16 Ibid at 81.
17 Monenco Ltd. v. Commonwealth Insurance Co.  2 SCR 699 a par 34.
19 Ibid at 36.
20 Virani v. Intact Insurance Co. 2015 ONCA 400 at para 6.
21 Ontario Society for the Prevention of Cruelty to Animals v. Sovereign General Insurance Co. 2014 ONSC 3345 at para 113.
22 Ontario Society for the Prevention of Cruelty to Animals v. Sovereign General Insurance Co. 2015 ONCA 702 at para 39.
23 Ibid at 42.
24 Ibid citing Reid Crowther & Partners Ltd. v Simcoe & Erie General Insurance Co, 1993 1 SCR 252.
25 Supra note 21 at 78-86.
26 Kohanski v. St. Paul Guarantee Insurance Co  OJ No. 157 (ONCA) at para 41 citing Stuart v. Hutchins  OJ No. 3672 at paras 29-30.
28 Ibid at 5.
29 Ibid at 13.
30 Ibid at 14,37.
31 Ibid at 38.
32 Ibid at 42.
33 Jesuit Fathers of Upper Canada v. Guardian Insurance Co. of Canada  1 SCR 744.
34 Ibid at 36.
35 Ibid at 23.
36 Ibid at 1.
37 Ibid at 55.
38 Ibid at 14.
39 Ibid at 1.
40 D.E v. Unifund Assurance Co. 2015 ONCA 423.
41 Ibid at 11.
42 Ibid at 22-23.
43 Ibid at 25-26.
44 Ibid at 28.
45 Borthwick v. Lombard Insurance 2015 ONSC 4845.
46 Ibid at 36-37.
47 Ibid at 38.
48 Ibid at 41-42.
49 Ibid at 47.
50 Ibid at 49.
51 Ibid at 57.
52 Ibid at 71.
53 Ibid at 68-71.
54 Ibid at 91.
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.