Subrogation Rights

Farmers’ Mutual Insurance Company v. Pinder is a recent Ontario Court of Appeal decision dealing with the question of subrogation rights of an insurer under the standard mortgage clause in a policy of insurance. It is an important case in terms of clarifying the right of an insurer to subrogate in a situation where it has paid a loss award to a mortgagee without establishing that it has no liability to the insured mortgagor.

The Court found that there are two preconditions before the insurer can subrogate: The insurer must make payment of all or part of the mortgage, and it must establish that it has no liability to the insured mortgagor.

The issue on the appeal was whether the motion judge erred by finding there were no genuine issues for trial and granting the insurer summary judgment based on its claimed right of subrogation under the standard mortgage clause. In particular, the issue was whether the payment made by the insurer to the mortgagee of any part of the loss award under the insurance policy was the only precondition for the insurer to claim a right of subrogation under the standard mortgage clause.

Prior to delving into the facts and principles of subrogation in play in the present case, a few words on the function and importance of standard mortgage clauses in relation to contracts of insurance and mortgages. A major concern for lenders is protection against the possibility that the borrower will do something that would result in nullifying coverage under an insurance policy. In essence, the standard mortgage clause constitutes a separate contract between the insurer and a mortgagee that provides a mortgagee can collect payment even if the policy is void or voidable with regard to the insured. The lender will therefore maintain coverage and receive payment regardless of any potential breach of the policy that would otherwise result in a denial of coverage.

Royal Bank of Canada v. State Farm and Casualty Co.

Accordingly, standard mortgage clauses constitute vital terms in policies of insurance relating to mortgaged properties, and this importance has been recognized by the courts. For instance, the paramountcy of the standard mortgage clause in a policy of insurance is outlined in the case of Royal Bank of Canada v. State Farm Fire and Casualty Co., which stands for the proposition that a mortgagee’s coverage would remain in force despite any act or omission of the mortgagor, including one which may cause a material change in the risk. In State Farm, the insurer argued that a material change in the policy — i.e., that the property had been vacated by the mortgagor prior to the loss -vitiated the policy of insurance. The court disagreed, holding instead that the standard mortgage clause superseded all other conflicting terms, including the one that apparently required the mortgagee to give notice of the vacancy to the insurer.

The protection a standard mortgage clause affords a mortgagee results in ramifications for the insurer, who, despite having paid in some instances on a policy of insurance where alleged policy breaches have occurred, will now have to consider how to recoup losses it deems wrongful. The insurer in such instances may wish to pursue the insured in a subrogated action.

In the present case, there was a fire at the home of the appellants, Joyce and Cindy Pinder, who held a policy of insurance with the respondent, Farmers’ Mutual Insurance Company. There was a five-year mortgage with the Bank of Montreal. The Pinders submitted a claim to Farmers as a result of the damage caused by the fire, which was denied on two grounds: That the Pinders voided the policy through their failure to notify the insurer of a material change in the risk, and they willfully made a false statement with respect to their claim. The Bank of Montreal submitted a proof of loss to Farmers, seeking payment of the mortgage under the standard mortgage clause of the policy. Farmers paid the principal balance. The Pinders initiated a claim against Farmers seeking an Order declaring that their insurance policy was valid and binding, which has yet to be tried. Farmers in turn commenced an action against the Pinders, relying on its right of subrogation under the standard mortgage clause.

The standard mortgage clause provides in part: “Whenever the insurer pays the mortgagee any loss award under this policy and claims that — as to the mortgagor or owner, no liability therefore existed, it shall be legally subrogated to all rights of the mortgagee against the insured . . . or the insurer may at its option, pay the mortgagee all amounts due or to become due under the mortgage or on the security thereof, and shall thereupon receive a full assignment and transfer of the mortgage together with all securities held as collateral to the mortgage debt.”

Two preconditions

The Pinders took the position that the standard mortgage clause is triggered only by Farmers not being liable to the Pinders for the fire loss. The insurer argued that the clause provides that the insurer’s payment of the mortgage debt to the mortgagee is the only precondition for the insurer’s right of subrogation.

Justice Juriansz, on behalf of a three-member panel, found the insurer’s interpretation was incompatible with the language of the clause. He found that the language of the clause in fact outlines two preconditions to the insurer’s right of subrogation: The first is that the insurer pays the mortgagee some portion of the loss award under the policy, and the second is that the insurer must establish that it is not liable to the mortgagor.

On the second precondition, Juriansz observed that if read literally, it could mean the insurer’s right of subrogation would be triggered by the mere assertion that it has no liability to the mortgagor. He held that such a meaning would be incompatible with the clause’s language and inconsistent with the insurance policy as a whole. It contradicts the longstanding principle outlined in Consolidated Bathurst Ltd. v. Mutual Boiler & Machinery Insurance Co., that the literal meaning of insurance contracts should never be read in a way as to bring about an unrealistic result, or one which would not be within the reasonable contemplation of the parties at the time the contract was formed. Despite the fact that the standard mortgage clause is

for the benefit of the mortgagee in the event of loss, it is also for the benefit of the insured — as long as the policy remains in force, the insurer’s payment to the mortgagee would be a fulfillment of its obligations to the insured just as much as to the mortgagee. Accordingly, the second precondition in the clause should be interpreted to require that the insurer establish that the insured mortgagor has voided the policy in some way.

Juriansz noted the importance of ensuring that there remains a consistency in terms of insurance schemes throughout North America, and described it as “essential” to examine American jurisprudence regarding this issue. A series of American cases consistently maintain that a right to subrogation in these circumstances does not arise as the result of a “naked claim” asserting that there is no liability to the mortgagor — there must be some basis or merit relating to the claim that the policy is void.

Here, the court found the second precondition was a genuine issue for trial. Farmers’ claim that there was a material change in risk resulting in the policy being vitiated had not been established prior to initiating the subrogation action.

Given the court’s decision, the approach often taken by insurers of paying the insured mortgagee’s claim and then pursuing the insured mortgagor without the mortgagor’s entitlement being determined is no longer viable. An interesting question, however, is whether an insurer can fully pay off the mortgagee, take an assignment from the mortgagee, and then pursue the mortg
agor under the mortgage. Based on American authority cited by the court, even this approach is not acceptable unless the insurer establishes it has no liability to the mortgagor as its insured. We query whether the mortgage clause can be read to permit this, as, from a contractual perspective, there should be no reason why such an assignment is not permissible. Ultimately, however, it appears the court is saying it would be inappropriate and beyond the parties’ contemplation that an insurer can use this tactic against its insured without it being found that one or more grounds exist for the negation of an insured mortgagor’s rights under its policy.

Michael S. Teitelbaumisapartner with Hughes Amys LLP. Juliana Stone, student-at-law, assisted in preparing the article. Hughes Amys is a member firm of The ARC Group Canada.