By Bo Carter
According to the Ontario Court of Appeal in the recent decision of IT Haven Inc. v. Certain Underwriters at Lloyd’s, London, 2022 ONCA 71, even if an insurer believes that an insured made a material misrepresentation in its application for insurance and can void the policy, the insurer may still be required to defend the insured under a liability policy. Although the conclusion by the Court of Appeal was that a duty to defend was owed, the Court of Appeal found that a flexible approach was required and held that there was no hard and fast rule with respect to whether an insurer is or is not obliged to defend an insured once it alleges a breach of a condition of the policy. Further, the Court of Appeal drew a distinction between coverage cases where the classic duty to defend analysis and the “pleadings rule” is utilized, and cases of alleged policy breaches where the “pleadings rule” is not applicable.
In this case, the insureds, IT Haven Inc. (“IT Haven”) and Ryan Hunt (“Hunt”), and others were sued in California by Niantic Inc. (“Niantic”) on the basis that the defendants essentially infringed Niantic’s copyright in its mobile applications. It alleged that the defendants created, distributed and profited from “unauthorized derivative versions” of Niantic’s computer applications and, in so doing, incorporated “substantial portions of Niantic’s copyrighted computer code.” Consequently, the insurer, Certain Underwriters at Lloyd’s, London (“Underwriters”) submitted that the Insureds made material misrepresentations about the nature of IT Haven’s business when it stated that IT Haven (i) did not provide products or services to the electronic games industry; (ii) derived 100% of its gross revenues from Canada; and (iii) had not incorporated software or products designed by others into its work.
Coverage under the Policy at issue in this case was for errors and omissions on a “clams made” basis. The Policy incorporated the application of insurance by reference, which it referred to as the “Proposal”. The Policy also set out under a clause named “Material Information” that if there was inaccurate or misleading information given by the Insured in the Proposal, or as a result of the insured’s failure to inform the insurer of a material change, that the insurer could either (a) void the Policy; or (b) at their election, void only the coverage affected by the misleading information or non-disclosure, while maintaining the remaining of the balance of the policy in full force and effect.
The motions judge held, and the Court of Appeal agreed, that on the face of the pleadings, Niantic’s claim against the Insureds fell within coverage under the Policy as the allegations fell within coverage under the Insuring Clause and none of the exclusions applied. However, the Court of Appeal treated Underwriters’ allegations of misrepresentation by the Insureds differently. Underwriters had asked the Court of Appeal to treat the case as a typical duty to defend case because the Policy incorporated the representations made in the application for insurance, but the Court of Appeal disagreed with that characterization.
The allegations against the Insureds were that the Insured had engaged in activities that were activities that it had represented in the application of insurance that it was not engaged in. Essentially, Underwriters submitted that it did not have a duty to defend because, based on the pleadings, the Insured made a material misrepresentation in the application for insurance which was incorporated into the Policy as a condition which allowed Underwriters to void the Policy. In response, the Court of Appeal held, at paragraph 43 of the decision:
At this stage, however, Niantic’s claims are simply unproven allegations. The existence of misrepresentations or breaches of policy conditions are factual issues that cannot be determined simply by looking to Niantic’s pleadings…
In addition to Underwriters submissions based on the pleadings alone, Underwriters had also tendered evidence. However, the Court of Appeal held that the issue was not amenable to summary disposition and would likely require a trial. Therefore, the Court of Appeal was unable to determine whether the allegation that the Insured had made a material misrepresentation was made out by Underwriters.
While the Court of Appeal upheld the duty to defend in this case, the Court of Appeal also held that a flexible approach was required when determining if actions by an insured have invalidated coverage. That is, there is no hard and fast rule with respect to whether an insurer is or is not obliged to defend an insured once it alleges a breach of a condition of the policy. The court will have to consider various factors to determine whether it is appropriate to make a determination on a breach of a condition of the policy at the outset, or whether it is unclear. If it is unclear, then, until there is a final disposition of the invalidation of insurance issue, an insurer must defend an insured under the Policy. If at the end of the day the insurer is able to establish that coverage is invalidated, then the insurer may be able to recover the defence costs it paid from the insured.
In this case, the Ontario Court of Appeal established that the analysis for whether an insured has invalidated coverage, such as through misrepresentation and breach of condition of the policy, is separate from the classic duty to defend analysis based on the “pleadings rule”. When assessing whether an insured has invalidated coverage, a flexible approach is required in determining whether a decision on the issue can be made at the outset. If it is not clear, then an insurer will likely have to defend the Insured, and proceed to a trial where the insurer will have to tender evidence to prove that coverage has been invalidated. If the insurer is successful, then it may be able to recover defence costs from the insured. Of note, it is possible that this case is not applicable throughout Canada, as other provinces have taken different approaches such suspending the duty to defend until a determination of whether coverage has been invalidated has been made.