Canada: Motion To Appoint Independent Defence Counsel Creates Confusion Over Insured's Right To Full Indemnity Costs

In a potentially controversial ruling, an Ontario judge recently refused to grant two insured applicants full indemnity for costs on a motion related to the duty to defend. This decision is likely to create some confusion regarding an insured's entitlement to full indemnity costs in duty to defend proceedings. Appellate authority has long established that when an insured applies to the court to enforce an insurer's duty to defend, that insured is entitled to full indemnification for both the costs of the defence and the costs of the insured to litigate with the insurer over entitlement to the defence. However, in Lefeuvre v. Boekee,¹ the court may have deviated from this general principle.

In Lefeuvre, the underlying case was a pedestrian/motor vehicle collision. Two municipalities had been sued in the action along with two winter maintenance companies. The two municipalities sought a defence from their insurers — however, those insurers were also defending the winter maintenance companies, who were adverse in interest. Due to this apparent conflict, the two municipalities brought a motion requesting that they be entitled to appoint and manage their own counsel at the insurer's expense. The insurers admitted coverage for the defence but maintained that there was no conflict. In the result, the insureds were successful and independent counsel was ordered. The insureds sought their costs on a full indemnity basis.

In additional reasons, the court concluded that full indemnity costs on the motion were not appropriate. Instead, the court applied the general rules for costs on a motion and found that the insureds were instead entitled to "reasonable indemnification". In arriving at that conclusion, the court held that the costs of the motion were not legal fees owing under a contract but instead, simply costs under the Rules of Civil Procedure.

This ruling appears to be out of step with appellate authority which holds the costs borne by an insured to secure his or her right to a defence under an insurance policy should be paid on a full indemnity basis. The Ontario Court of Appeal has consistently held that the insured is "entitled to a defence ... at no cost to them".² In other words, an insured is "entitled to be made financially whole" for legal costs incurred in securing a defence under the policy.³ This broad principle has not only been used to indemnify insureds for their past defence costs, but also the future defence costs of counsel of their choice, the costs of the coverage application and the costs of any subsequent appeal.⁴ This principle of full indemnity is based, not in the law of costs, but in the law of contract. The "costs" of the insured on an application are in fact damages for a breach of the insurance contract. A successful insured is therefore entitled to be placed in the same position it would have been in had the contract been fulfilled. In duty to defend cases, that includes the legal expenses incurred by the insured to ensure their rights under contract are secured.⁵

Despite this accepted principle, the court in Lefeuvre — without relying on any prior authority —  held that the motion costs did not flow from any contractual right under the policy and were not "incurred in 'defending' the action". Instead, the court decided that the costs were incurred to "[interpret] the meaning and scope of the duty to defend".  The court further concluded that the insured's right to costs flowed from "success on the motion" rather than the policy.  In arriving at this conclusion, the court in Lefeuvre appears to have characterized the conflict of interest question as one defining the "extent" of the duty to defend and not necessarily a "breach" of that duty. This is problematic for two reasons.

First, there is little difference between defining the "extent" of the duty to defend and determining whether there has been a breach of duty. In the face of a conflict of interest, an insurer's refusal to rectify that conflict is better characterized as a breach of duty. To allow the defence to proceed with a conflict would have undoubtedly been a breach of the insurer's obligations to the insured. Indeed, a conflicted defence is really no defence at all. As a result, the application to remove that conflict is not a mere question of "extent" or "interpretation", but a matter of securing a definitive right to a defence under the policy. If the conflict of interest issue were characterized in this way, the insured's right to full indemnity costs ought to have flowed from the principle that an insured should not to be put to expense in securing a defence under the policy.

Second, in concluding that the question before it was one of "extent" and not a breach of duty, the court noted in obiter that the underlying action may deal with a "mixed" claim of covered and uncovered allegations. For that reason, the court decided that, even if it were wrong, a portion of the defence costs may relate to uncovered claims for which there would be no entitlement to indemnity. If the court relied on this reasoning, it would have been conflating the concept of indemnity on an application for coverage with the concept of an after-the-fact "allocation" of defence costs.

The basis for such an allocation of defence costs was laid down in the Court of Appeal's well-known decision in Hanis v. University of Western Ontario.⁶ Contrary to the court's suggestion in Lefeuvre, the Court of Appeal in Hanis held that even in cases of "mixed" claims, "the insurer is required to pay all reasonable costs associated with the defence of [the underlying claim] even if those costs further the defence of uncovered claims".⁷ It is only where the "costs [relate] solely to the defence of uncovered claims" that an insurer need not indemnify the insured.⁸ The decision that a portion of a claim is "solely" uncovered is a finding of fact that is generally dealt with after final resolution of the underlying matter. It is only in exceptional cases that an allocation can be reliably made at an early stage in the proceeding. In the absence of any findings of fact, the court in Lefeuvre could not have decided the allocation issue.

In any event, an allocation of defence costs under Hanis is entirely distinct from the costs of an application to secure a defence under the policy. In an allocation case, there is no breach of duty. On a duty to defend application, the insurer's breach is the central issue: the insured is forced to litigate in order to gain benefit of a conflict free defence under the policy.  As noted above, damages for that breach of duty are the full indemnity costs of the application. Accordingly, where there is a breach of duty, the insured's entitlement to full indemnity for the application costs would apply even if an allocation of subsequent defence costs were ordered.

In the absence of confirmation of Lefeuvre from the Court of Appeal, the general rule remains: full indemnity is applicable to all breaches of the duty to defend. In any event, policyholders seeking coverage for defence costs are still encouraged to follow the best practice of addressing any potential conflict of interest issues as early as possible and ideally during the initial application for coverage.

Footnotes

1 Lefeuvre v. Boekee, 2018 ONSC 1010 (Ont. Sup. Ct.).

2 Aitken v. Unifund Assurance Co., 2012 ONCA 641 at para. 43-45. See also, M.(E.) v. Reed, 2003 CarswellOnt 1723 at para. 22, 2003 CanLII 52150 (Ont. C.A.); Godonoaga (Litigation Guardian of) v. Khatambakhsh (Guardian of), [2000] O.J. No. 3807 at para. 4 (Ont. C.A.); Carwardine (Litigation Guardian of) v. Northumberland Clarington Board of Education, [2001] O.J. No. 63 at para. 5 (Ont. C.A.); Savage v. Belecque, 2011 ONSC 5771 at para. 4 (Ont. S.C.J.), aff'd, 2012 ONCA 426 (Ont. C.A.); Austco Marketing and Service (Canada) Ltd. v. Lloyd's Underwriters, 2013 ONSC 6486 at paras. 4-5 (Ont. S.C.J.).

3 See e.g. Austco Marketing and Service (Canada) Ltd. v. Lloyd's Underwriters, 2013 ONSC 6486 at para 5.

4 See e.g. Aitken v. Unifund Assurance Co., 2012 ONCA 641 and Markham (City) v. Intact Insurance Co., 2017 ONSC 3150.

5 Savage v. Belecque, 2011 ONSC 5771 at para. 3-4, aff'd 2012 ONCA 426.

6 Hanis v. University of Western Ontario, 2008 ONCA 678.

7 Hanis v. University of Western Ontario, 2008 ONCA 678 at para. 2.

8 Ibid.

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