A Recent Decision on the Duty to Defend and Additional Insureds

Insurance policy

In Oshawa v. MEARIE, 2021 ONSC 6334, the Ontario Superior Court of Justice addressed the following questions that are of interest to liability insurers:

  • How does ambiguity in a Certificate of Insurance affect the duty to defend?
  • What is an insurer’s obligation to pay defence costs where the allegations include a mix of covered and uncovered claims?
  • When does an insured have the right to their choice of counsel based on alleged conflicts of interest?

In Oshawa, the plaintiff alleged that on September 14, 2016, she tripped and fell on an uneven Oshawa city (the “City”) sidewalk. The City’s power corporation (“PUC”) had recently performed repair work on the sidewalk. Prior to the work commencing, the City issued a road occupancy permit for the repairs which required, among other things that:

  • PUC obtain commercial general liability insurance;
  • PUC would provide the City with a Certificate of Insurance identifying the City as an additional insured under PUC’s commercial general liability policy; and
  • PUC would fully indemnify the City against all claims brought against the City, “arising out of the issuance of this Permit or in any way related to the work performed by the Applicant“.

PUC obtained the stipulated coverage from its insurer (the “Insurer”) and a Certificate of Insurance was provided to the City.

The plaintiff sued the City and PUC. The City sought a declaration that the Insurer’s duty to defend it against the claim was triggered since the allegations in the action arose from PUC’s operations. The City also alleged there was a conflict of interest between the City and the Insurer such that the City should be entitled to appoint and instruct counsel of its choice without reporting obligations to the Insurer.

The Duty to Defend

The City owned, maintained, and was responsible for the sidewalk where the plaintiff fell. The plaintiff alleged that the City failed to take proper measures to ensure that the sidewalk was level and in a good and safe state of repair for pedestrians; failed to properly inspect the sidewalk; and failed to warn pedestrians of the sidewalk’s dangerous condition. Some of these claims were solely due to the City’s negligence, while others arose out of PUC’s conduct.

The Certificate of Insurance issued to the City stated that it was added as an additional insured “but only with respect to Additional Insured’s vicarious liability arising out of the operations covered of [PUC] solely as it relates to the project, event or contract listed below, but excluding any negligent acts committed by such Additional Insured.” However, the second page of the Certificate of Insurance listed the City as an additional named insured, “but only with respect to liability arising out of the Operations Covered of the Named Insured“.

The Insurer’s position was that the Certificate contained a clear and unambiguous exclusionary clause that limited the City’s coverage to vicarious liability for PUC’s operations and expressly carved out negligent acts of the City from coverage. The Insurer further alleged that even if the City’s negligent acts were not excluded from coverage, the true nature of the entire claim against the City did not arise from the PUC’s operations, since the claim alleged liability for the City’s own negligence and breach of duty under the Municipal Act, regardless of any alleged negligent work performed by PUC.

The Court found that the Certificate confirmed two slightly different coverages (the policy itself was not before the Court). Due to the ambiguity between the actual scope of coverage afforded the City under the Certificate, the City was entitled to rely on the wording that provided the more favourable scope of coverage, which stated the City was an additional insured for claims, “arising out of the operations covered of [PUC]” without further qualification. Therefore, the Court found the Insurer had an obligation to defend the City against at least those claims that arose out of PUC’s operations.

Who should pay for defence costs?

The City argued there was no practical means of distinguishing between defence costs attributable to the covered and non-covered claims, therefore the Insurer should provide the City with independent counsel at the Insurer’s expense to defend the action in its entirety.

In determining which claims the Insurer was required to defend, the Court applied the principle from Markham (City) v. AIG Insurance Co. of Canada, 2020 ONCA 239, where the Court of Appeal held that an insurer is obligated to pay the reasonable costs of an insured’s defence of covered claims, even if that defence furthered the defence of uncovered claims. However, an insurer is not obligated to pay costs related solely to the defence of uncovered claims.

The Court recognized the difficulty in distinguishing the costs of defending various allegations between covered and non-covered claims at an early stage in the litigation. Since the City did not have coverage for all of the claims, the Court held that the Insurer did not have an obligation to bear all costs of the defence. The City must bear its share of the defence costs solely attributable to defending uncovered claims, or those costs which exceeded the reasonable costs associated with defending covered claims.

Who controls the defence?

The Court re-affirmed the general principle that an insurer who has a duty to defend an action also has a prima facie right to control the defence itself. The mere fact of an insurer reserving its rights regarding coverage does not cause the insurer to lose its right to control the defence and appoint counsel. The Court in Oshawa was not satisfied that denying coverage for some claims, as opposed to reserving coverage, was sufficient by itself to cause the Insurer to lose its right to control the defence. It was a factor to be considered but was not determinative.

In order to control the defence and appoint its own counsel, the City had the onus to establish a reasonable apprehension of conflict of interest. The City took the position that the Insurer-appointed counsel may “soft-pedal” the City’s defence in a way that limited the Insurer’s exposure to paying out indemnity under the policy. The City argued, further, that the Insurer had no incentive to vigorously defend non-covered claims.

The Court was not convinced that the City’s conflicts of interest arguments rose to the level that required the Insurer to lose its right to control the defence and appoint counsel. Further, the Insurer was prepared to take certain measures to address the City’s concerns by:

  • appointing different counsel to defend the City and PUC;
  • ensuring that each defence counsel was required to report to a different adjuster; and
  • ensuring neither adjuster would have access to each other’s file.

The Court was satisfied that the proposed safeguards adequately addressed any perceived conflict or potential prejudice to the City’s defence.

This case provides useful insight on issues often encountered by insurers when handling liability claims. At the outset, care should be had in identifying who may be an insured or additional insured under a liability policy, keeping in mind that ambiguities are typically resolved in favour of the insured. In so far as defending claims is concerned, the case re-affirms the prevailing law regarding who bears the cost of defending covered and non-covered claims, while providing guidance on when a potential conflict of interest results in an insured being able to appoint and instruct their own counsel and some safeguards that can avoid such a situation.