Did you ever wonder why reservation of rights letters and non-waiver agreements are essential steps whenever an insurer observes any possibility that coverage might ultimately be denied? The Commonwell Mutual Assurance Group v. Campbell, 2018 ONSC 5899, aff’d 2019 ONCA 668, provides an object lesson.
Notwithstanding there was good reason to deny coverage on the plain wording of the liability policy, the Ontario Court of Appeal agreed the insurer was obliged to defend and (ultimately) indemnify.
In Commonwell , the underlying action involved a collision between two off-road vehicles while they drove along a roadway. The injured operator of one vehicle sued the operator of the other, who was insured under separate motor vehicle and homeowners liability policies. The insured tendered the suit to both insurers for a defence.
The motor vehicle liability insurer immediately issued a reservation of rights letter and a non-waiver agreement was executed. Thereafter, the motor vehicle liability insurer denied coverage. In the coverage proceedings that followed, the Court observed: “In this case [the motor vehicle insurer] made it clear to [the insured] that any steps it took to investigate or adjust the claim were subject to a reservation of rights. It ultimately denied coverage and refused to defend him. …, I find no obligation on [the motor vehicle insurer] to provide or to take over the defence.”
By contrast, the insurer of the homeowners liability policy took none of those steps. There was no initial coverage analysis; no reservation of rights letter; and, no non-waiver agreement. This insurer appointed counsel, who filed a defence and conducted the proceedings for about 10 months. When examinations for discovery were being considered, the plaintiff’s counsel asked if there were coverage issues. This triggered the appointment of coverage counsel, who identified operative exclusions. Thereafter, the homeowners insurer took the position there was no liability coverage and it had been an error to defend. It brought an application to withdraw from defending the proceedings.
MacLeod J.’s dismissal of the application did not turn upon his consideration of the policy issues raised by the homeowners insurer. Indeed, MacLeod J. observed that he might have agreed with the insurer’s substantive point had the insurer reserved its rights before defending the proceedings. He explained:
… If there is some doubt about coverage and the insurer requires time to investigate, the general practice is to obtain a non-waiver agreement or to reserve rights. This is precisely what [the motor vehicle insurer] did before ultimately denying coverage. An insurer that proceeds to defend an action, or even an insurer which unequivocally states that it will defend an action, may be taken to have waived reliance on the exclusion or it may be estopped from later denying coverage.
… In cases where there is doubt about a duty to defend or where there may be a duty to defend but there may not be a duty to indemnify, the insurer must take steps to bring the possibility the claim will be denied to the attention of the insured. Non-waiver agreements or reservation of rights letters are important tools to ensure an insured clearly understands she or he may be without coverage.
In MacLeod J.’s view, the insured must not be prejudiced by a false sense of security. Insurers who defend proceedings without reserving any rights will likely be estopped from taking an off-coverage position later in the litigation. Declaring the homeowner’s insurer had a duty to defend and an obligation to indemnify, MacLeod J. observed:
... if the litigation is at an advanced stage, prejudice to the insured is inferred, estoppel applies and in that case there is no need to decide if the actions of the insurer also constitute a waiver. … it is too late for [the homeowner’s insurer] to now deny coverage. Either waiver or estoppel would apply. There was no hint of a reservation of rights.
The homeowner’s insurer appealed, arguing that the litigation was not well enough advanced to trigger presumed prejudice. The Court of Appeal was unimpressed, explaining that MacLeod J. was not purporting to draw a line as to when litigation is "well advanced" ("He was simply explaining why prejudice could be inferred in the case before him.”). With respect to the issue of prejudice, the Court of Appeal observed:
... Ultimately, [defence counsel] acted for him for 10 months before [the insurer] gave [the insured] any reason to believe his liability was not covered and he would not be defended. In these circumstances, the application judge was entitled to conclude that the litigation was well-advanced, and to infer that allowing [the insurer] to now assert that there is no coverage and therefore no duty to defend [the insured] would be detrimental to him.
The Court of Appeal also noted “supplementary direct evidence of prejudice”. Assuming his interests were being protected, the insured did not secure personal counsel to protect his interests. He also had no reason to challenge the motor vehicle insurer’s denial of coverage, which he might have done had he not otherwise been lulled into a false sense of security.
The Court of Appeal also rejected the argument that it was premature to decide the insurer’s obligation to indemnify, explaining:
... Even leaving aside that [the insurer] put both matters in issue in its application, we disagree. The application judge's finding that [the insurer] is estopped from relying upon the unowned registrable vehicles exemption and the consent exemption undercuts [the insurer]'s ability to invoke these exemptions, whether to dispute its duty to defend or to dispute indemnification.
The insurer was ordered to pay costs of $52,000 (unsuccessful application) and $25,000 (unsuccessful appeal), which was “Consistent with the general practice of awarding substantial indemnity costs where an insurance company has unsuccessfully sought to avoid its duty to defend.”
The lesson here is pretty obvious. Cross your T’s and dot your I’s.