Insurance Coverage: The Duty To Defend

• Published date: 08 April 2021
• Subject Matter: Insurance, Litigation, Mediation & Arbitration, Insurance Laws and Products, Trials & Appeals & Compensation
• Law Firm: McCague Borlack LLP
• Author: Mr Hillel David

Must an Insurer wait until Trial to Contest the Validity of the Policy?

Case Study: IT Haven v Certain Underwriters at Lloyd's

A recent decision¹ indirectly raises the interesting question: Can an insurer under a liability policy make an application, at an early stage of its conflict with the insured, for a declaration that the policy is void ab initio for material non-disclosure or misrepresentation? More particularly, can the insurer, facing a duty to defend application made by the insured, and especially when the insurer has no defence available under the policy per se, make that application in response to the insured's application? Or must the insurer find itself subject to an order that it has a duty to defend until a trial is held?

One would think that the insurer ought generally to be entitled to raise as a response to the duty to defend application a counter-application seeking a declaration that the insurer has no duty to defend because the policy is void ab initio. Not only does fairness call for the insurer to have that right, but it would serve the policy goal of resolving the issues raised both by the insured and the insurer expeditiously and economically. The importance of those considerations is made clear in the following remarks:

Generally speaking, in this province the process adopted to decide a duty to defend issue is an application under rule 14.05(3)(d) or (h). This is a summary procedure well suited to determining a duty to defend issue which necessarily arises, as Iacobucci J. noted in Monenco, as a preliminary matter...That is not to say that evidence is never permissible on a duty to defend application. Indeed, as in this case, it is not uncommon that expert evidence is helpful to the court in the interpretation of the insurance coverage and, on occasion, in interpreting technical language in the underlying claim.²

When an insured person is sued for a claim that may fall within a risk that is insured, it is essential that he or she know at a very early stage whether or not the claim falls within the coverage, thereby creating a duty to defend, as it is necessary that prompt steps be taken to defend the lawsuit and to forestall default judgment. No doubt this underlies the principle that the duty to defend issue is to be decided expeditiously as a preliminary matter on the basis of the allegations in the underlying litigation read with the insurance coverage. The insurer's procedure in this case did not result in either an early, or an economical resolution of the issue. Indeed, it has now been more than four years since [the insurer] commenced its action claiming a declaration that it was not under a duty to defend.³

The question whether an insurance policy is void ab initio for non-disclosure or misrepresentation of material information is equally a preliminary matter (in fact, a matter that is even more foundational than the duty to defend issue) that ought, for the reasons expressed above, to be determined expeditiously and economically at an early stage of the dispute between the insured and the insurer. Just as it is "essential that the insured know at a very early stage whether or not the claim falls within the coverage", it is essential that the insured (as well as other parties in the underlying litigation) know whether there is a valid and enforceable insurance policy in place. Apart from all else, knowledge regarding the status of the policy will reduce the uncertainty regarding the presence or absence of insurance coverage for the claim, and therefore will have an impact on the likelihood, and terms, of settlement of the underlying action.

The decision in IT Haven, however, appears to call into question the ability of an insurer in cases where there is a dispute as to facts - i.e. in most cases - to bring before the court, at any early stage, its position that the policy is void.

The factual background in IT Haven

The case arose from an application by two insureds for a declaration that the insurer had a duty to defend them under an errors and omissions policy in an action commenced in the U.S. The application judge summarized the insurer's position as follows:

1. The insureds had made material misrepresentations in the application for insurance;
2. The insureds had not complied with the "material information" provision in the policy which excluded coverage for claims arising from undisclosed material changes to the conditions described in the application for insurance; and
3. Various exclusion clauses in the policy applied.⁴

Two different issues: Duty to defend and Validity of the insurance policy

It appears that the main thrust of the insurer's position in IT Haven was directed to the issue of whether the policy was void ab initio because of misrepresentation or non-disclosure of material information by the insured. As indicated above, the first two of the three defences raised by the insurer went to that issue. The reasons for judgment, however, are strewn with references to the fact that the issue for determination in the application was whether the insurer had a duty to defend the insured in the underlying litigation.⁵ The proceeding was described as "what is in essence a pleadings motion",⁶ again highlighting the issue of whether the statement of claim in the underlying action raised a duty to defend on the part of the insurer. Almost the whole of the reasons for judgment was focused on the admissibility of the insurer's extrinsic evidence insofar as it related to the issue of whether or not there was a duty to defend, rather than insofar as it related to the validity issue. The application judge held that the extrinsic evidence proffered by the insurer was inadmissible for that purpose. The correctness of that finding is not an issue in this paper (although there seems to be little doubt as to that correctness).

Reasons of the application judge regarding the validity of the insurance policy issue

Only one paragraph of the reasons in IT Haven was devoted to this issue, despite the fact that it appears have constituted the, or least a, major defence to the duty to defend application. That paragraph reads as follows:

Dealing with the allegations made by [the insurer] that [a particular insured] breached his duty to disclose relevant information engages the fundamental question of not only whether [that insured] did breach such obligation but just as important it engages the question of whether the information he failed to provide was material. [The insurer] relies in part on expert opinion evidence to establish such materiality which at least in part demonstrates why the alleged breach of the material information clause in the Policy cannot possibly be relied upon at this stage of the proceedings. A further reason to preclude reliance on this clause can be found in Section 124(5) and (6) of the Insurance Act which strongly suggests that issues of materiality should be proven at trial.⁷

The application judge went on to say that "If the evidence that [the insurer] seeks to rely upon is not contained in the pleadings then [the insurer] may only rely on extrinsic evidence if the purpose of the evidence is needed by the court to determine the nature of the claim against the [insureds]."⁸

Why was there no counter-application made by the insurer?

When considered in the context of the proceeding - which, as repeatedly emphasized by the application judge, was a duty to defend application made by the insured - the insurer's procedural approach was questionable. To the extent that its response to the duty to defend application was that the insurance policy was void ab initio, with the result that the issue of whether there was a duty to defend would be moot, that response required, from a procedural standpoint, a request to the court for that relief. The general rule prohibiting the introduction of extrinsic evidence was applicable within the context of the insured's duty to defend application. Whether that general rule would apply had the insurer expanded the scope of the proceeding to include its own request for relief is the subject-matter of this paper, but the point being made here is that the insurer's failure to request that relief was effectively an invitation to have the general rule applicable to all issues raised within the duty to defend application.⁹ The brief comments made by the application judge that are reproduced above, however, appear to go well beyond that explanation.

Nevertheless, the question that arises is: Why didn't the insurer respond to the insured's duty to...