Canada: It's Not "All The Facts And Nothing But The Facts": Assessing An Insurer's Duty To Defend

In Optrics Inc. v Lloyd's Underwriters, 2022 ABCA 26 [Optrics] the Alberta Court of Appeal highlights the limits on summary applications by insureds seeking confirmation that an insurer must defend a claim against the insured. The Court provides an important reminder about the sharp distinction between factual determinations that are appropriate at the duty to defend stage and those that are properly left to be decided in the claim against the insured. The standard of review applied by the Court may also have implications for such proceedings, with the factual matrix playing a more significant role.

Background

In 2013, Optrics Inc. (Optrics) and Barracuda Networks Inc. (BNI) entered into a contract that granted Optrics rights to the "use and ownership of the CudaMail URL, CudaMail services and CudaMail trademark" (the CudaMail Rights). There was conflicting evidence about whether BNI asserted the agreement was breached in 2013, and whether sufficient notice of this was given to Optrics' insurers.

In 2017, Optrics commenced an action against BNI for various claims associated with the agreement. BNI counterclaimed against Optrics for breach of the agreement.

Optrics sought a declaration that its insurer, which had issued a series of consecutive claims-made policies, was required to defend the BNI counterclaim under the 2012-2013 and 2016-2017 policies. The 2016-2017 policy provided coverage for "breach of client contract" and defined "client" as:

The 2016-2017 policy also contained an intellectual property exclusion. The 2012-2013 policy was similarly worded, but did not contain the intellectual property exclusion.

At first instance, Optrics' application for a summary determination that the insurer had a duty to defend the counterclaim was dismissed in part. The Court held that under the 2016-2017 policy, the counterclaim was not covered as BNI was not an Optrics "client." The Court also found that there was insufficient evidence to resolve the question about the 2012-2013 policy on a summary basis.

The Court of Appeal Decision

The unanimous Court of Appeal set aside the determination that BNI was not a "client" under the 2016-2017 policy, but upheld the decision to dismiss the application.

Standard of Review

In this decision, the Court of Appeal revisits the standard of review applicable to insurance contracts. The key cases on this point are Sattvaand Ledcor:

1. Under Sattva, contractual interpretation is generally treated as a question of mixed fact and law reviewable on a deferential standard, largely because of the importance of the factual matrix in contractual interpretation; and
2. Under Ledcor, the interpretation of standard form contracts is generally treated as a question of law reviewable on the correctness standard. This is largely because factual matrix evidence plays a smaller role in the analysis.

In Optrics, the Court of Appeal rejected the argument that interpretation of the policies at issue was a question of law reviewable on a correctness standard. Instead, the Court found that the contractual interpretation exercise "in this case" turned on the words in the policies, considered in light of the factual matrix, bringing this appeal within the deferential standard of review under Sattva.

Under Optrics, lower Courts in Alberta may place more emphasis on factual matrix evidence in the interpretation of insurance policies, and the Court of Appeal may be expected to apply the deferential standard of review to the interpretation of such policies more often.

Duty to Defend

The Court concisely restates the legal principles applicable to preliminary applications about an insurer's duty to defend. The duty arises if there is a mere possibility that the facts alleged, if true, would trigger indemnity. Courts should only consider the pleadings and limited extrinsic evidence. Courts should not engage in unnecessary fact-finding and should avoid making findings "that can affect the issue of liability in the underlying action."

The Court of Appeal concluded that there had been errors on this point in the underlying decision.

First, the conclusion that BNI was not a "client" of the insured was premature. This issue would be informed by the outcome of the underlying litigation, and would properly be determined in a later assessment of indemnity obligations in relation to that outcome.

Second, in holding that the counterclaim was not covered, the chambers judge had interpreted the counterclaim as alleging that the agreement involved only the insured purchasing rights from BNI. However, the Court of Appeal considered the agreement and concluded the insured had also agreed to undertake activities on behalf of BNI in exchange for compensation. There was therefore a possibility that the insured would be found in "breach of [a] client contract."

Despite these errors, the Court of Appeal concluded the intellectual property exclusion applied, and thus upheld the lower court's ruling that the insurer had no duty to defend under the 2016-2017 policy.

Duty to Defend and Summary Disposition

For the 2012-2013 policy, there was conflicting evidence about whether the insurer had been adequately notified of a "claim" within the policy period, and the parties acknowledged the record was incomplete. No questioning on affidavit evidence had occurred. As a result, the chambers judge directed a trial on these points.

The Court of Appeal agreed, noting that if only portions of a claim may be covered, whether a declaration that an insurer is liable for a portion of the defence costs is warranted before the underlying litigation is resolved is a contextual assessment. One consideration in this assessment is whether an insured's breach of a policy condition is at issue. In such cases, it may not be appropriate to make a determination regarding duty to defend until the underlying issues between the parties have been decided.

Conclusion

Optrics provides a helpful and concise overview of the law on summary applications about an insurer's duty to defend. The decision highlights the low threshold for triggering an insurer's duty to defend and provides guidance as to the very limited scope of relevant factual findings. The decision also confirms the technical nature of these applications, which often arise in the course of complex litigation, and gives rise to nuanced strategic considerations for insureds.

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.