A few weeks ago, Ontario’s Court of Appeal endorsed a liability insurer’s proposed use of a “split file” protocol to address inherent conflicts of interest in the conduct of an additional insured’s defence. Markham (City) v. AIG, 2020 ONCA 239, illustrates that early initiation of a “split file” protocol can allow an insurer to retain control of an insured’s defence (named or additional) when the underlying allegations create conflicts of interest between insurer and insured, or as between conflicting co-defendants insured under the same liability policy (i.e. with cross-claims against each other the underlying proceedings). Usefully for practitioners, the Court of Appeal outlined the “split file” protocol as an 11-point “to do” list that can be incorporated into coverage counsel’s conflict of interest management strategy.
In the underlying proceedings, Hockey Canada, Markham Waxers Minor Hockey Association (“Waxers MHA”), and the City of Markham (“the City”) were all sued by the litigation guardian of a child, who was injured by a stray puck while watching a game at the City’s community center. The plaintiff alleged a variety of failures with respect to patron warnings and adequate safety systems for spectators around the rink. The City third-partied Waxers MHA, alleging a failure to supervise and otherwise prevent the child’s injury.
With respect to liability coverage:
Hockey Canada and Waxers MHA were the named insureds under a CGL policy issued by AIG (“the AIG CGL Policy”). The City was an additional insured, but “only with respect to the operations of the named insured [Hockey Canada and Waxers].” The AIG CGL Policy’s Other Insurance clause specified it was “primary insurance” with no excess provision.
The City was the named insured under its own CGL policy issued by Lloyd’s (“the Lloyds CGL Policy”), which specified it would “apply only as excess and in no event as contributing” if any other insurance “would have attached if this insurance had not been effected.”
AIG acknowledged a duty to defend the City, but argued that Lloyd’s duty was concurrent, seeking equitable contribution to the City’s defence costs. The Court of Appeal reconciled the policies’ respective Other Insurances conditions and concluded that Lloyd’s had a primary duty to defend allegations pertaining to physical safety features at the rink and community center, which did not arise vicariously from Hockey Canada’s or Waxers MHA’s operations and were not covered by the AIG CGL Policy. Speaking for the Court, Thorburn J.A. explained:
Each of AIG and Lloyd’s has a duty to defend at least some of the claims in the action so each is responsible to contribute to the defence costs of the City … the respective risk of the two insurers is real but the level of risk cannot yet be ascertained given the early stage of the proceedings … In these circumstances where there are two primary insurers, … and there is a concurrent duty to defend, the fairest and most equitable allocation of defence costs would seem to be to require each of AIG and Lloyd’s to pay an equal share of the defence costs pending final disposition of the action and the final determination of the allocation of defence costs …
The final issue was AIG’s right to participate in the City’s defence, which the application judge had refused to permit as a consequence of “potential or actual conflicts of interest between the City and AIG.” To better illustrate the issue, Thorburn J.A. explained how the insurers’ respective coverage obligations created conflicting interests in the conduct of the underlying proceedings. He explained:
AIG’s interests prefer a finding that insufficient safety features at the rink caused the child’s injury. In such a case, only the City will be liable, meaning only the Lloyds CGL Policy will respond to indemnify. AIG will not owe indemnity obligations because AIG’s policy only covers the incidents that arise out of the operations of Hockey Canada or [Waxers MHA].”
By contrast, Lloyd's interests favor a finding that the child’s injury arose from Hockey Canada’s or Waxers MHA’s operations, which will “minimize [Lloyds] exposure to the losses” (i.e. AIG will be obliged to contribute to indemnification).
Finally, the City prefers a finding that Hockey Canada or Waxers MHA was responsible “so that the City’s premiums do not rise and so that they do not have to assume the full $100,000 deductible in the Lloyd’s policy.”
As a statement of principle, the Court of Appeal observed that counsel defending any action must have the confidence of the insurer who is obliged to pay the legal fees and may have to pay a substantial judgment on behalf of the insured. Counsel must also meet their legal and ethical obligations to protect the interests of the insured. Thorburn J.A. also observed “There is no reason to believe that appropriate counsel who has an ethical obligation to defend the insured properly, will not conduct the defence in the best interest of the insured. There is also no evidence that any of the handlers have misused any confidential information or, with appropriate disciplinary measures put in place, will misuse confidential information.”
In recognition of the conflicting interests, AIG prudently proposed a 7-point “split file” protocol that “attempted to minimize the risk of harm by creating a system to protect confidential information and separate files, enable all three parties to participate in retaining, instructing and receiving instructions from counsel and provide recourse against those who do not adhere to the system.” Reversing the application judge’s decision, the Court of Appeal imposed 4 additional requirements to be observed if “AIG is to retain its right to participate in the defence.” The Court permitted AIG to participate in the City’s defence, subject to an 11-point “split file” protocol as follows:
The City's defence as an additional insured will be handled and screened internally so that the named insureds’ information is held separately and kept confidential from information in respect of the City’s claim.
Physical files will be scanned and converted into digital format upon receipt.
A file subject to the “split file” protocol will be digitally marked confidential and will not be accessed by any other handler, including the handler responsible for the defence of another adverse insured party. (“This is to protect confidential information and avoid any perceived or actual "party-based" conflict of interest between the insured interests”).
The handlers for the City’s defence will be different from those handling Hockey Canada’s defence. Similarly, the handlers for coverage issues will be different from the handlers for liability issues.
A claims handler in breach of the "split file" protocol will be subject to disciplinary action and may be dismissed if confidential information is disclosed.
AIG agrees to cooperate with Lloyd's. The two insurers will agree upon, appoint, instruct, and pay for independent defence counsel, who will be different from AIG's coverage counsel.
AIG committed to sharing funding costs incurred in the City's defence.
The terms of the split file protocol will be provided in writing to claims handlers and counsel involved in managing the defence.
Defence counsel will be instructed to fully and promptly inform the City and Lloyd's of all steps taken in defending the underlying action such that each would be in a position to monitor the defence effectively and address any concerns.
Defence counsel will be directed not to have any discussion about the case with any insurers’ coverage counsel.
Defence counsel must provide identical and concurrent reports to the insured and both insurers regarding the defence of the main action.
Practically speaking, Markham is an incredibly useful case for coverage counsel, who should already be advising insurers to implement similar “split file” protocols when managing actual or potential conflicts of interest between insurer and insured (e.g. over limits claims, potential exclusion based denials of indemnity coverage) or as between conflicting co-defendants insured under the same liability policy. Early initiation of a “split file” conflict management strategy can avoid costly litigation over who controls an insured’s defence (or at the very least reduce uncertainty in the outcome when conflict is unavoidable).