A “Twist” to Allocation of Defence Costs

A recent Ontario Court of Appeal decision, Tedford v. TD Insurance Meloche Monnex (2012), potentially injects uncertainty into how defence costs can or should be allocated before an action has been concluded. We believe the decision is helpful to insurers, but it may raise more questions than it answers. This could result in more litigation seeking guidance in respect of these unanswered questions.

The Tedford case addressed circumstances that did not arise in a previous case on the subject, Hanis v. Teevan, [2008]. In that case, the court ruled that allocation of defence costs will likely have to be determined at the end of the underlying action after an insurer provides a full defence if one or more of the claims are covered under a liability policy.

In Tedford, the primary differences were that (1) the insured was seeking a defence at the outset, while in Hanis defence costs were addressed after the matter was completed, and (2) in Teevan, “the covered claims represent a small portion of the total damages claimed.”

It remains to be seen which of the court’s rulings, whether in Tedford or Hanis, will be the proper determination for allocation of defence costs.

Facts and Motion Judge’s Decision

In the underlying action, it was alleged that the insured, Damon Tedford, made negligent misrepresentations in the Seller Property Information Statement completed in connection with the sale of his home. In that action, the plaintiff purchaser pleaded that as a result of the misrepresentations she incurred and will continue to incur repair costs, and has suffered anxiety, sleep disturbances, fatigue, stress, headaches and symptoms of depression, (the “Health Consequences”).

Tedford held a homeowner’s policy which provided coverage for damages due to “Bodily Injury” or “Property Damage.” The application judge concluded that as the Health Consequences amounted to Bodily Injury, a duty to defend therefore arose, and that duty extended to the entire action.

It was common ground that the damages the insured may have to pay with respect to the repair costs did not constitute property damage under the policy. Accordingly, but for the alleged bodily injury, a duty to defend would not have arisen.

The Court of Appeal’s Reasons

The Court of Appeal upheld the application judge’s finding that there was a duty to defend the misrepresentations under the Bodily Injury coverage. The Court found that the claim for alleged Health Consequences arising from the misrepresentations were not “derivative”, as submitted by the insurer, which argued that the true nature of the Plaintiff’s claim was one for economic loss arising out of a commercial transaction and the claim for Health Consequences was derivative of that loss. The Court disagreed, noting that only one cause of action was being advanced, that of negligent misrepresentation, and this is not a derivative claim as contemplated by the Supreme Court of Canada’s decision in Non-Marine Underwriters, Lloyd’s of London v. Scalera, [2000].

In respect of the allocation of defence costs issue, the Court noted that the policy did not provide for “allocation of defence costs where an insured is subject to both covered and uncovered claims and the same costs are incurred in the defence of both covered and uncovered claims”.

It found that the application judge erred in requiring the insurer to defend the entire action without making provision for apportionment of the defence costs.

Justice Hoy, speaking on behalf of a three-member panel which included Lang and Epstein JJ.A., noted that in Hanis Justice Doherty held that “where there is an unqualified obligation to pay for the defence of claims covered by the policy…the insurer is required to pay all reasonable costs associated with the defence of those claims even if those costs furthered the defence of uncovered claims. The insurer is not obligated to pay costs related solely to the defence of uncovered claims.”

Her Honour also noted that the apportionment of defence costs was determined following the underlying trial in Hanis. In the case at hand, the insured is seeking to have the insurer “assume the conduct of the defence, and the covered claims represent a small portion of the total damages claimed”, so “considerations not addressed in Hanis arise”.

Her Honour also noted that the insurer argued it would be unfair for it to have to defend the entire action because “of the plaintiff’s $185,000 damages claim, at least $150,000 relate to repair costs, and [t]he plaintiff seeks damages of approximately $25,000 for Health Consequences.”

Her Honour found that a decision relied upon by the insured, Riocan Real Estate Investment Trust v. Lombard General Insurance (2008), where the insurer was ordered to defend the entire action, even though not all the claims were covered by the policy, and no order was made with respect to the allocation of costs, was not of assistance because it was decided before Hanis. Moreover, the facts in Riocan are different because multiple theories of liability were advanced to support a claim for the same damages. The potential liability in respect of the covered claim was the same as that in respect of the uncovered claims.

The Court held that, unless the parties otherwise agree, insurers’ counsel “should be instructed to defend both the covered and the uncovered claims, in a manner commensurate with the aggregate amount claimed, and that the insureds [should] bear the costs of the defence, to the extent they exceed the reasonable costs associated with the defence of the covered claims. In determining the reasonable costs associated with the defence of the covered claims, it is appropriate to consider the quantum of the covered claims. It would be unfair to the insured to fix it with defence costs that are disproportionate to the extent of its potential liability for the covered claim.” The Court went on to say that if the parties are unable to agree on an allocation of the costs, the insurer will be entitled to apply to the Superior Court of Justice for a determination of the allocation, in accordance with Hanis, after the matter is concluded or at such other time as the parties agree.

Comment

While, as indicated, this formulation is helpful to insurers, it also introduces some potential uncertainty into how defence costs can or should be allocated before an action has been concluded. It leaves a number of unanswered questions, some of which are as follows:

1. Is the court’s intention, as appears to be the case, to provide that when damages are either covered or uncovered under a liability policy, this is when allocation is appropriate, as opposed to when there are multiple theories of liability that will require a defence to be provided with respect to one or more of them that will overlap to some extent? As we had understood the Hanis decision, it was not a matter of whether mixed claims, i.e., covered and uncovered claims, are so intermingled or intertwined that creates the defence obligation; rather, it is the obligation to defend the covered claims that also incidentally encompasses the uncovered claims, unless it can be shown the defence costs relate exclusively to uncovered claims. Otherwise, it would be difficult if not impossible to determine what costs were solely attributable to uncovered claims insofar as a liability defence is concerned.

Arguably, the court in Tedford appears to be saying this is less of an issue insofar as covered or uncovered damages are concerned, if it is an issue at all.

In terms of the liability defence in Tedford, the Hanis considerations do not arise since the court finds only one covered cause of action is being asserted. The question is whether, applying Hanis to a covered versus uncovered damages analysis, the court is implicitly saying that if the damages are not covered, and there are identifiable costs associated with their defence, then those are the costs the insured must bear? That que
ry posed, this does not appear to fully be the case because the court has suggested it is appropriate to consider the quantum of the covered versus uncovered claims in determining what the reasonable costs are for defending the covered claims.

2. How often can it be determined, with any certainty, what the breakdown is between the damages that are said to be covered as opposed to uncovered? For example, unless it is specifically pleaded that uncovered repair costs are a certain amount while covered damage claims are another specific amount, are the parties to simply rely upon the amounts claimed in the statement of claim? And, if those amounts are equivalent, share defence costs equally? Or, does this mean that allocation is not truly possible at the pleadings stage, but that once discoveries are held where damages may be more specifically determined, then this would be the appropriate time to determine allocation? If so, would that allocation then be applied retrospectively?

3. If the insured refuses to be reasonable, and does not agree to allocation at the outset of the matter in circumstances such as these, will a court when deciding the point after the fact penalize the insured in some fashion?

4. If the parties will not agree to a determination of allocation, is the Court saying that there is a continuing obligation on the part of the insurer to fully defend and seek reimbursement at a later date? It appears this is the case when it says that “appellant’s counsel,” whom we take to mean defence counsel, is to be instructed to defend both the covered and uncovered claims, “in a manner commensurate with the aggregate amount claimed.” However, it would have been helpful to have received more elaboration and guidance in this respect.

5. It appears that the Court is laudably attempting to pursue fairness for both insureds and insurers through this judgment by noting that an insurer should not have to pay defence costs that are “disproportionate to the extent of its potential liability for the covered claim.” This is a welcome development. That said, the mechanics and procedure for achieving this were not specifically addressed and we anticipate this may become necessary in future decisions.

Thus, at the moment, unless insureds and insurers take a reasonable approach to situations like that spelled out in Tedford, all parties are ultimately left with what we perceive to be the current status quo – the insurer will be obliged to fully defend, but can seek reimbursement after the action is concluded. _

Michael S. Teitelbaum is a partner with Hughes Amys LLP. Hughes Amys is a member firm of The Arc Group Canada.