Under The Umbrella: Quebec Superior Court Examines Excess Insurer’s Obligation To Defend

I. Introduction

On February 18, 2013, the Honourable Luc Lefebvre of the Quebec Superior Court rendered an interesting judgment regarding the excess insurer's obligation to defend under an umbrella policy. Said judgement is currently in appeal. The facts are the following.

II. The Underlying Facts

From 2004 to 2007, Tembec Industries Inc., a Canadian company, and its American subsidiary (collectively "Tembec") sold resin to client Uniscope, Inc. ("Uniscope"). In turn, Uniscope resold the resin, and the products integrated thereto, to Cargill, Inc. ("Cargill"). However, in 2007, an FDA inspection revealed the presence of melamine in Tembec's resin. In June of that year, Tembec and Uniscope recalled the resin and the products integrated thereto. Cargill and Uniscope later sued Tembec in relation to same.

III. The Insurance Coverage

Tembec was covered pursuant to policies issued by Zurich Insurance ("Zurich") in Canada and in the United States. The limit of the Zurich policies was C$5 million per occurrence. Tembec and its subsidiary were equally covered by an umbrella policy for any claim in excess of the Zurich policies' coverage, and thus up to C$50 million (the "Umbrella Policy").

IV. Tembec's Claim Against AIG

• On June 14, 2007, Tembec informed its broker that it had received a letter of demand from Cargill in relation to the recalls. Tembec's broker in turn informed Zurich and AIG Commercial Insurance Company of Canada ("AIG") of same a week later. On June 27, 2007, Uniscope also put Tembec on notice and filed a claim in Colorado in October 2007. In November 2007, Cargill filed suit against Tembec and Uniscope in Idaho. Neither Uniscope nor Cargill had quantified their damages at that point.
• On May 13, 2008, Zurich accepted to defend Tembec's Canadian entity under certain conditions, namely that the coverage would be covered under the Canadian Master Policy and that the combined limit of the policies was C$5 million. In June 2008, Cargill and Uniscope finally quantified their claims against Tembec at in excess of C$7 million.
• On June 11, 2008, all parties accepted participation in mediation. A week later, Tembec's broker informed AIG that according to Zurich the total claims would possibly exceed C$5 million and that the parties would reconvene in September 2008. In July 2008, Zurich agreed to defend Tembec's American entity with some reservations, namely as to the extent of the damages claimed which were covered by the policy.
• A few months later, Cargill sent Tembec the documents establishing its hard recall costs at C$6,669,912.47. On December 3, 2008, Tembec's broker requested from AIG that it get involved in the management of the claims and participate in the next mediation session scheduled for January 8, 2009. In the following days, Tembec provided AIG with a file summary prepared by its lawyers as well as Zurich's reservation of rights ("ROR") letter regarding Cargill's claim. On December 16, 2008, Tembec sent AIG 4,000 documents pertaining to Cargill's claim. On December 24, AIG informed Tembec that it would be present at the next mediation session which allowed for the settlement of some ancillary claims by other companies, but not Cargill and Uniscope's.
• On January 16, 2009, AIG received a chart prepared by Tembec's paralegal regarding Cargill's claim for hard recall lost. On January 26, 2009, AIG issued Tembec an ROR letter stating namely that coverage would only begin once Zurich's coverage was exhausted.
• On February 5, 2009, AIG mandated its own expert in preparation for the next mediation session on February 12, 2009. AIG received its expert's report two days before the mediation, which evaluated Cargill's claim at C$3.3 million.
• On February 12, 2009, the parties agreed to settle Cargill's claim for C$6.1 million, of which AIG would pay C$560, 000 and Tembec C$1.5 million. Zurich agreed to pay C$3.6 million, which constituted the maximum amount payable under the C$5 million coverage after settlement of the ancillary claims. Uniscope's claim was settled for C$1.7 million, all payable by Tembec.

Subsequent to the settlement, Tembec sued AIG on the basis that:

• AIG failed to defend Tembec pursuant to its obligations under the Umbrella Policy;
• AIG acted in bad faith and failed to diligently investigate the claim; and
• The settlements reached by Tembec with Cargill and Uniscope were reasonable and opposable to AIG.

V. Justice's Lefebvre's Findings

Justice Lefebvre's ruling is interesting in that it reviewed the principles applicable to an excess insurer's obligation to defend.

After reviewing case law, Justice Lefebvre ruled that an excess insurer's obligation to defend is only triggered once the primary insurer's coverage is exhausted. More specifically, he found that AIG's obligation to defend Tembec arose on February 12, 2009, when Zurich agreed to contribute to the Cargill settlement and thereby exhausted the C$5 million coverage. The judge noted that AIG's position in this regard was consistent with Zurich's and previous case law. More so, he underlined that on January 8, 2009, both Zurich and Tembec were under the impression that the claims would be settled for less than C$5 million.

Justice Lefebvre also strongly disagreed with Tembec's contention that AIG acted in bad faith. AIG reviewed a large amount of documentation in a very short period of time and adequately cooperated with its insured. On the other hand, he noted that corollary to the insurer's obligation to defend is its right to dictate the conduct of the defense. In this regard, the judge noted that during the February 12, 2009 mediation session, Tembec refused to follow AIG's representative's strategy to contest the damages based on its expert report.

The judge nonetheless evaluated the settlements reached by Tembec to determine whether they were reasonable and could be opposed to AIG. His analysis was very critical of the work performed by Tembec who entrusted a paralegal without the necessary skill set to evaluate Cargill and Uniscope's claims. In addition, he criticized the fact that Cargill representatives were not discovered and that no expert report was previously prepared to contradict or verify Cargill's contentions. In his opinion, AIG's report established that Tembec overpaid to settle the claim. He concluded that Tembec possibly overpaid to maintain good relations with its client, Uniscope, and avoid the risk of paying other damages not covered by either the Zurich or the AIG policies. Further to his evaluation of Cargill and Uniscope's claims, the judge was of the opinion that AIG's contribution to the settlement was sufficient and, in fact, in excess of what it was obliged to contribute. He nonetheless dismissed AIG's claim for reimbursement since its payment was made without any reserves.

Obviously, each case must be decided upon its own set of facts and the wording of the policies will always play a determining role. Yet, Justice Lefebvre's ruling is interesting in that it confirms that a secondary's insurer's obligation to defend is triggered by the exhaustion of primary coverage. It also constitutes a stern warning to the insured as to its obligation to cooperate with its insurer's defense strategy.

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.