Two insurers, a mutual policyholder, and the duty to defend

Ontario Court of Appeal upholds Application Judge’s treatment of Property Report Evidence

In AIG Insurance Company of Canada (“AIG”) v Lloyd’s Underwriters (“Lloyd’s”) (2022 ONCA 699), the Ontario Court of Appeal was tasked with answering “whether two insurers have a duty to defend a mutual policy holder in a progressive property damage claim.”[1] The Court ultimately dismissed Lloyd’s appeal and left in place a previous order requiring Lloyd’s and AIG to equally share the costs to defend the policyholder (City of Timmins).    

Background Facts

Karine and Marcel Forget the (“Homeowners”) purchased a vacant lot in 2012 upon which they intended to build a home. The lot was situated near the Mattagami river flowing through the City of Timmins (the “City”). The Homeowners obtained a building permit from the City in 2013, and built a new home on the property that same year.

Starting around 2016, the slope of an adjoining property began to fail. This resulted in erosion to the Homeowner’s property, impacting the stability of the surrounding land. This continued until 2019, at which time the City issued an order requiring the Homeowners to demolish, remove or relocate their residence.

The Homeowner’s brought a claim against the City and others based on property damage that occurred between 2016 and 2019. The claim against the City was based on the City’s negligence relating to “ongoing drainage issues, slope instability, and erosion.”[2] During this period, the City had a policy with AIG for 2016 and 2017, then Lloyd’s for 2018 and 2019.

Each insurer took a different approach to the City seeking insurance coverage. AIG agreed to defend the claim, while Lloyd’s denied coverage and subsequently did not defend the claim. Despite each insurer providing different policies (general liability insurance vs. “Public Entity Casualty Insurance Package Policies”), the policies offered “functionally identical” coverage to the City.[3]

Lloyd’s Position

Lloyd’s acknowledged that property damage occurred during its policy period, but denied a  defence because the damage did not constitute an “occurrence” to engage its coverage. In the alternative, Lloyd’s argued that its Exclusion Clause defeated its duty to defend.[4]

Lloyd’s first contention was underpinned by a report prepared by the City in 2017 which acknowledged and offered recommendations to the homeowner’s property damage issues (the “report”). Within Lloyd’s pleadings, the report formed the basis of its argument that an “occurrence” did not occur under the policy because the City did not implement the report before its coverage period began in 2018.[5]

In furtherance of its alternative argument, Lloyd’s contended that upon receiving this report, its Exclusion Clause was triggered because additional property damage was no longer accidental.

Application Judge’s Decision

On the initial application, Justice Black found that Lloyd’s had a duty to defend and share defence costs with AIG. The court found that Lloyd’s pleadings placed too much emphasis on this report when ultimately, it was “not sufficiently robust in its analysis and conclusions.”[6] Justice Black found it would be potentially controversial to accept Lloyd’s position, which could create a “trial in a trial” because both parties would litigate the report’s conclusions.[7] As a result, the Court found that Lloyd’s duty to defend was triggered because the report was not an occurrence to avoid coverage, and did not trigger the Exclusion Clause.

Before the decision was rendered, AIG and Lloyd’s had agreed that if they both had a duty to defend, they would share defence costs on a 50:50 basis.[8]

Analysis

Lloyd’s appeal was centered on the issue of whether the application judge was mistaken in finding that it owed a duty to defend.[9] Lloyd’s advanced two main arguments on appeal. First, it asserted that the application judge was mistaken in applying the “traditional ‘pleadings rule’ in the duty to defend analysis”, arguing that the report’s use within the statement of claim should be treated as true.[10] Second, it alleged that the law surrounding the admissibility of extrinsic evidence and the Exclusion Clause’s applicability was misapplied by the application judge.

Justice (of Appeal) Gillese agreed with Justice Black’s conclusions and dismissed the appeal.[11] In contrast to Lloyd’s argument, the appellate court found that Justice Black had applied the traditional pleadings rule correctly, because he excluded the report as evidence during his considerations. The appellate court reasoned that it is possible to mention the report in the pleadings, but this “does not make it part of the pleadings.”[12] Instead, the report was to be treated as extrinsic evidence, which could be referred to in pleadings as stated in Monenco Ltd v Commonwealth Insurance Co (2001 SCC 49 at para 36).[13] The court concluded that the acceptance of the report’s findings would amount to “premature evidence” since it would affect the other litigation stages without challenge at the pleadings stage.[14]

Justice Gillese went on to reaffirm that the Exclusion Clause also did not apply.[15] Lloyd’s argument relied on the fact that the City should have “expected” the property damage, which violates the principle of fortuitous.[16] The court found that the Homeowner’s chief claim against the City was based in negligence, which was considered accidental or fortuitous (citing Progressive Homes Ltd v Lombard Insurance Company of Canada, 2010 SCC 33 at para 50).[17]

Takeaways

AIG v Lloyd’s provides some insights for insurers and industry professionals. When two insurance companies are considering their respective ‘duty to defend’ obligations for the same mutual policyholder, both should be wary of how much weight they place on professional reports to defeat this obligation, at least during the pleadings stage. The “mere possibility”[18] test for triggering an insurer’s duty to defend is unlikely to be affected by a professional report where its findings are contestable. Further, an insurer’s Exclusion Clause is likely inapplicable where it also relies on the same type of professional report to deny coverage.

Should you have any questions, please feel free to reach out to a member of the Insurance Defence team.

[1] 2022 ONCA 699 at para 1 [“AIG v Lloyd’s”].

[2] Ibid at para 9.

[3] Ibid at para 15.

[4] Ibid at para 18.

[5] Ibid at para 21.

[6] Ibid at para 25.

[7] Ibid at paras 24-25.

[8] Ibid at para 28.

[9] Ibid at para 29.

[10] Ibid at para 31.

[11] Ibid at para 43.

[12] Ibid at para 51.

[13] Ibid at para 52, citing 2001 SCC 49 at para 36.

[14] Ibid at para 54.

[15] Ibid at para 60.

[16] Ibid at para 56.

[17] Ibid at para 58, citing Progressive Homes Ltd v Lombard Insurance Company of Canada, 2010 SCC 33 at para 50 [“Progressive Homes”].

[18] Progressive Homes, supra note 25 at paras 19-20.