Last month, a very interesting coverage/conflict-of-interest application was decided by Ontario’s Superior Court of Justice in HMQ v AIG, 2019 ONSC 2964. Had it been decided differently, the consequences for Canadian liability insurers would have been costly and far reaching.
To briefly summarize, the liability policy’s additional named insured argued it should be entitled to appoint and direct counsel of its choice (at the insurer’s expense), because of a potential “party-based” conflict with the named insured in the underlying proceedings. In a well-reasoned decision, Ferguson J. observed that the liability insurer had appointed separate counsel for the named and additional insureds and “split the file” at the claims handling level. In light of the insurer’s demonstrably stringent claims handling procedure, and given there was no evidence that defence counsel’s mandate was in conflict with the additional insured’s interests, the application was dismissed. The liability insurer was permitted to retain control of both insureds’ separate defences, notwithstanding the two might be pointing fingers at each other in the underlying proceedings.
HMQ v AIG is definitely worth a read. With respect to the facts, the decision is actually quite scant on details. Very briefly:
The two underlying actions concerned blasting and construction work alleged to have caused elevated levels in surrounding ground water.
The named insured was a construction contractor, who was insured against liability arising from its own operations.
Her Majesty the Queen in Right of Ontario was the additional insured, with limited coverage for “liability arising out of” the construction contractor’s operations.
The liability policy included a cross-liability clause (“…this insurance shall apply separately to each Insured in the same manner and to the same extent as though a separate policy had been issued to each Insured”).
The Additional Insured’s Argument
The insurer appointed separate defence counsel for the named and additional insureds. Notwithstanding, the additional insured took issue with the insurer’s insistence that its appointed counsel “report to and share privileged reports with [the insurer], despite the clear presence of an actual if not at least reasonable apprehension of conflict of interest between [the additional insured] and [the named insured].” The additional insured argued that the limited scope of coverage (i.e. only for liability arising from the named insured’s operations) created an incentive for the insurer to “… [foist] liability onto [the additional insured] on the basis that the plaintiffs’ damages were caused by some independent act of negligence on the part of [the additional insured] rather than as a result of [the named insured’s performance under the contract.”
“Splitting the File”
In response to the additional insured’s arguments, the liability insurer provided detailed evidence that it followed a stringent “split the file” protocol when potentially conflicting interests insured by the same policy were identified. A file subject to the protocol was “digitally marked as confidential and cannot be accessed by any other handler, including the handler responsible for the defence of another adverse insured party.” This ensured that defence counsel appointed for the named and additional insureds were separately instructed and free to act in the best interests of each insured.
The Determining Issue is Defence Counsel’s Mandate
Reasonably considering the additional insured’s arguments, the Court first observed that a liability insurer’s duty to defend is closely bound and related to its right to select and instruct defence counsel. That right is “… only surrendered … if the insurer puts its appointed defence counsel in a position of a conflicted retainer or mandate.” Ferguson J. explained that the “focus of inquiry is therefore confined to the quality of the insurer’s retainer of defence counsel,” then stating:
22. [Brockton (Municipality) v. Frank Cowan Co.] remains the leading authority in this specific context, the Court of Appeal explained courts must weigh and balance “between the insured's right to a full and fair defence of the civil action against it and the insurer's right to control that defence because of its potential ultimate obligation to indemnify”, stating:
The question is whether counsel's mandate from the insurer can reasonably be said to conflict with his mandate to defend the insured in the civil action. Until that point is reached, the insured's right to a defence and the insurer's right to control that defence can satisfactorily co-exist.
Ferguson J. observed that the additional insured offered “… no evidence to show that AIG is improperly attempting to instruct defence counsel in a way which favours AIG’s interest in the coverage.” In oral argument, the additional insured’s counsel apparently conceded that there was no evidence of actual or potential conflict of interest, stating: “that is a legal” question and “a legal argument we intend to rely on.” Quite reasonably, the additional insured’s application was dismissed.
Again, an interesting decision. Had it been decided otherwise, liability insurers whose policies provide similarly limited coverage to additional insureds might continually face the risk of having to pay for separately instructed defence counsel, which cannot have been within anyone’s reasonable expectations.