First presented at a Client Subrogation Seminar.
Subrogation is the mechanism by which an insurer can recover monies that it has paid to its insured by bringing an action in the name of the insured as against a third party who is responsible for the loss.
The right of subrogation is established contractually, at common law, and in section 278(1) of the Insurance Act. Most insurance policies contain language which broadens the right of subrogation beyond that granted by statute and common law.
When can the Insurer Pursue Subrogation?
At law, the insurer's right of subrogation arises only when the insurer has paid the insured for some portion of its loss. Moreover, until the insured is completely indemnified for all insured and uninsured losses, the insured has the right to control the action.1 In order to give the insurer command over a subrogation action, standard terms of the insurance policy will often contain language that stipulates that the right of subrogation is triggered as soon as the insurer assumes liability for a loss, rather than once the insurer has paid any portion of the loss. This wording will also often give the insurer the sole right to control the action, and settle claims without the insured's instructions.
Occasionally, the insured may also initiate an action against the same third party. If both the insurer and the insured commence separate actions, the rule against multiplicity of actions may prevent one of the actions from proceeding. Insurers need to be mindful of this possibility and alert the insured of their intent to pursue a claim in order to prevent the failure of their action.
Where the insured does pursue its own claim, it has an obligation to protect the subrogated interest of the insurer. Likewise, the insurer is obligated to protect any uninsured interest of the insured in its subrogated actions.
What Claims are Suitable for Subrogation?
Some subrogation opportunities are not obvious and will require investigation and creative thinking.
Not all payouts by an insurer for insured losses are fit for litigation and determining what claims are appropriate to pursue is not always a quick or easy task. Some subrogation opportunities are not obvious and will require investigation and creative thinking.
The insurer's first step, after determining the cause of the loss, is to determine who the potential wrongdoers are. In simple terms, the insurer should consider what, if any, third party could be responsible for the wrongdoing. In legal terms, this party would be liable for the loss. Liability describes the state of being actually or potentially subject to a legal obligation.
Some questions to consider in the determination of liability include:
- Who had last access to the area or the product?
- Who manufactured the product?
- Who was the supplier?
- Who did the installation? Was it a contractor, or a subcontractor?
- Who was responsible for maintenance?
- Was there a contract?
Beyond this, the insurer should then examine if and how the loss could have been prevented entirely. One consideration is if the parties could have foreseen the problem prior to the loss. This involves further questions, including:
- Could the problem have been noticed during movement through the supply chain from the manufacturer to the retailer?
- Was there something that could have been done during the design, installation, inspection, and/or maintenance steps that could have identified a deficiency or prevented the loss?
- Was municipal and/or administrative approval obtained?
The insurer should then consider whether parties may have been able to mitigate the loss. These parties would not be responsible for the entire loss, but may be responsible for some portion of it, as they could have prevented the damage being as significant as it was. Among the questions to ask include:
- Was the emergency response adequate?
- Was the suppression/alarm system designed and/or functioning properly?
- Was there adequate security present in the area?
Example: Sprinkler Systems
Sprinkler system failure is a relatively common cause of water damage, and nearly always yields subrogation potential. Failure of the system is almost always due to freezing and bursting of the lines. However, the insurer should not rush to blame cold weather for these freeze-ups.
Wet sprinkler systems are only permitted for use in heated spaces. They should therefore not be able to freeze. There are a number of reasons why a sprinkler system may fail, including inappropriate heating levels, improper design and/or construction of the building envelope, an improperly designed, built, and/or inspected sprinkler system, and the failure to conduct annual inspections. Simply put, wet sprinkler systems should be protected from freeze-ups. If one does freeze, someone has likely done something improper, leading to the failure.
The same holds true for dry sprinkler systems. These systems are intended for unheated spaces, so they contain pressurized air instead of water. If one of these systems fails as a result of a freeze-up, the insurer should consider how the water got into the system, whether the sprinkler was designed and/or constructed with a proper slope, whether the sprinkler system was properly inspected, and whether annual inspections were completed in order to determine what led to the failure. The answers to these questions could identify one or more parties liable for the failure of the sprinkler system.
To establish liability at law, the insurer must prove that the third party breached a responsibility they owed to the insured.
To establish liability at law, the insurer must prove that the third party breached a responsibility they owed to the insured. The most common way to establish this breach is to pursue a claim in negligence.
To succeed in a negligence claim, the insurer must show, on a balance of probabilities, that:
- The wrongdoer had a duty of care/responsibility to the insured;
- There was a breach of the standard of care;
- The wrongdoer caused that breach; and
- The insured suffered damages.
However, should a successful claim in negligence be unavailable, liability can also be established through breach of contract. The insurer should consider whether a party was required to complete work under a contract, including general contractors, property managers, security providers, or other work falling under the Sale of Goods Act.
A third potential avenue to establish liability is through a nuisance claim. Nuisance is the unreasonable interference with the use and enjoyment of land in possession of another. Some examples of nuisance are: smoke damage to an insured's property caused by fire on a neighbour's property, sewage backup caused by a contactor performing work on the public sewage system, and the leaking of a neighbour's fuel tank onto the insured's property. However, not all parties can be legally pursued for nuisance. Nuisance claims against a municipality related to water and sewage damage, for example, are prohibited by s. 449 of the Municipal Act.
It is not enough for the insurer to claim that the third party was negligent. The insurer must establish, on a balance of probabilities, that the injury would not have occurred "but for" the negligence of the defendant.
In most cases, it is critical to obtain an expert opinion on the cause of the loss, as it represents an objective, detailed assessment which will guide the subrogation investigation. Some simple cases will not necessarily require an expert opinion, but most of them will.
While the legal or ultimate burden remains with the plaintiff, there are cases where the evidence will justify an inference of causation in the absence of evidence to the contrary provided by the wrongdoer. For example, it has been held that an inference of negligence against a manufacturer is compelling where the defect arose during the manufacturing process, which was controlled by the wrongdoer.
It is not always necessary to prove that a third party caused the loss in a specific way. Liability can be established if one can eliminate all reasonable possibilities other than the third party's liability. This is known as inferred liability, and can include cases where there is only one supplier and installer, where the third party had sole access to origin of the loss, or where the third party was the sole entity doing work on an element that caused the loss.
In addition to establishing legal liability, the insurer must also prove damages...
In addition to establishing legal liability, the insurer must also prove damages, including the quantum of damages being claimed, in order to be successful in their action against the wrongdoer. Depreciation of the value of the goods may reduce the quantum that is recoverable. The insured may also have to prove that there was an attempt to mitigate their damages.
Certain items will likely not be recoverable in the claim. Expert reports and investigation expenses, for example, might not be included in the quantum of damages; however, they may be recoverable as disbursements and/or in a costs award.
Once the insurer has determined the amount that can be reasonably recovered, the insurer should assess whether the quantum is worth pursing in comparison to the anticipated costs of investigating, negotiating, and litigating the claim. It may be that the damages are not significant enough to warrant the costs associated with pursuing the claim.
Early Investigation Steps
There are a number of steps an insurer should take early in an investigation to determine whether a claim is appropriate for subrogation.
While not all subrogation claims are easily established, the insurer can determine the viability of a claim by conducting a quick and effective investigation.
It is in the insurer's best interests to retain a well-respected expert as early as possible to assess the cause of the loss. However, it is not always beneficial to obtain a written report immediately. Once the expert has completed his investigation, the insurer or adjuster should obtain a verbal report as to the cause of the loss. This may identify other areas that the expert should investigate further, or may make it clear that there is no prospect of subrogation.
In the former case, the investigation can be completed without a report having already been prepared, and in the latter case, the insurer can save the cost of having such a report prepared.
It is vital that the site of the loss and any potential evidence be secured immediately.
It is vital that the site of the loss and any potential evidence be secured immediately. The insurer should also collect witness reports and any public investigation records, such as those from the Ministry of Labour, the TSSA, or the Office the Fire Marshal. The insurer may also consider inviting potential third parties to participate in the investigation and even conduct joint inspections for efficiency and expediency.
Where relevant evidence is in the possession of others, they should be put on notice immediately and be requested to preserve and produce the relevant evidence.
Another important step is to obtain all relevant documents from the insured, such as any contracts, leases, maintenance records, or design drawings associated with the loss.
While mitigating damages is important, all relevant evidence must be secured. This includes any pipes, plumbing fittings, sump pumps, tanks, sprinkler heads, or any other items linked to the loss. If an item failed, or worked improperly, and caused the loss, it should be preserved for testing. It is imperative that the insurer does not let repair contractors destroy the evidence.
Being aware of the best practices regarding subrogation will allow insurers to pursue all viable subrogation claims and to maintain the maximum amount of evidence to aid in any future litigation.
1 Zurich Insurance Company Ltd v Ison TH Auto Sales Inc, 2011 ONSC 1870 (CanLII).
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.