Justice Denis Power of the Ontario Superior Court has released a significant ruling on the issue of allocation of defence costs. The case is Hanis v. The University of Western Ontario et al.; Guardian Insurance et al., third parties.
As counsel for the insurer in this case noted, “allocation is a topic ‘that is in its relative infancy in law’.” For this reason, Justice Power’s decision is an important contribution to the relatively sparse jurisprudence on the subject.
The issue of allocation (or “apportionment”) of defence costs arises when a claim against an insured is only partly covered by an insurance contract. The jurisprudence usually requires that an insurer defend the entire claim in such circumstances (and Justice Power himself addressed this issue in an earlier decision in the Hanis case). The question that often arises after the fact is: how much of the cost of the overall defence should be borne by the insurer and how much should be paid for by the insured?
A common example of a claim raising both covered and non-covered claims, is one in which the plaintiff seeks punitive damages. Most liability insurance policies do not cover claims for punitive damages. Insurers nevertheless defend such claims (assuming that other claims for damages are within coverage). If it were to turn out that counsel retained by the insurer had to expend a lot of time in defending the non-covered claim (punitive damages, in this example), then the insurer might seek judicial allocation of defence costs at the end of the case, when it would presumably be possible to ascertain what portion of the defence lawyer’s efforts had been directed towards the claim(s) for the policy afforded no coverage. The insured might then be required to shoulder the responsibility for those defence costs.
The Hanis case did not involve anything so simple as a claim for punitive damages. Rather, the litigation arose out of complicated facts which have been the subject of several earlier decisions. The first 38 pages of Justice Power’s 65-page reasons for judgment are a summary of the relevant facts.
However, we do not have to be so detailed in our summary of the facts. In a nutshell, this was a coverage dispute between the University of Western Ontario and its insurer, the Guardian Insurance Company of Canada. The insurer had denied coverage to U.W.O. for a claim by a (very) disgruntled former employee, now dead, named Dr. Hanis. He had sued the university for a host of alleged wrongs, including wrongful dismissal, malicious prosecution, defamation and numerous other causes of action. According to Justice Power’s reasons, the Hanis claim was for something in the neighbourhood of $34,000 million. (We’re not even sure we can pronounce that figure, let alone quantify it!)
U.W.O. tendered the defence of the Hanis claims to its insurers (who, at the time, included companies other than Guardian), but the insurers denied coverage. Accordingly, U.W.O. defended the claim itself and brought third party proceedings against the insurers.
The Hanis claim went to trial, where it was dismissed. A 1998 appeal was partially successful: Hanis was awarded damages of $158,034.54 against U.W.O., for wrongful dismissal.
In 2003, Justice Power ruled that Guardian had been under a duty to defend U.W.O. and had failed to do so. In doing so, he found that there was an issue of apportionment “concerning Guardian’s duty to defend the mixed claims of the Plaintiff. As aforesaid, this is an issue still to be determined.” He ordered that further submissions be made to him with respect to that issue. Those submissions led to an 11-day trial, in which Justice Power heard evidence from two counsel who had represented U.W.O. in the Hanis trial. They gave evidence about how they had conducted the defence and the various theories of the claim that they had had to meet.
U.W.O. conceded that there was no coverage, under the Guardian policy, for many of the claims made by Hanis. But it argued that the university was nevertheless entitled to be reimbured in full for over $2 million in defence costs, because Hanis’ various legal claims had a common factual base. Hence, argued U.W.O., the cost of defending the covered claims could not readily be segregated from the cost of defending the non-covered claims.
Guardian contended that it should only have to pay the defence costs attributable to the one claim that, in its view, was covered: malicious prosecution. To require it to pay for the cost of defending all of the other non-covered claims would amount, in Guardian’s submission, to a windfall to the insured. (We should note that whether malicious prosecution was or was not the only covered claim was in dispute between Guardian and U.W.O.)
Decision of Power J.
For the most part, Justice Power sided with U.W.O. He ordered Guardian to pay 95% of the defence costs incurred by the university. (The amount of the legal fees incurred by U.W.O. had been conceded.)
Justice Power found that, on the facts of this case, the claim for malicious prosecution could not be isolated from the other claims. He also found that, contrary to Guardian’s submission, there were other claims that were within the coverage.
At paragraph 193 of the decision, Justice Power said: “The following is a summary of what I understand to be, or should be, the existing law with respect to apportionment, or allocation, in cases where some of the claims are covered by a duty to defend and some are not.” He then laid down ten principles that, in his estimation, apply to allocation cases. They will be required reading for future lawsuits that involve this issue. We will not reproduce all ten paragraphs here, but the following points are key:
- Once an insurer breaches the contract by wrongfully refusing to defend, it has the burden of clearly demonstrating what defence costs are not related to the covered claims.
- Where it is not practicable or it is impossible to separate the costs of defending covered from non-covered claims, the insured should absorb all of those costs.
- Any ambiguities must be resolved in favour of the insured.
- The insured and its counsel should maintain records of the time spent defending the claim.
- Insurers who deny coverage are well advised to seek directions from the court at an early stage with respect to allocation.
Justice Power was satisfied that not all of the defence costs related to either covered or “mixed” (i.e., overlapping covered and non-covered) claims. The problem was, how to apportion the overall defence costs? Justice Power accepted U.W.O.’s evidence, that “with ‘some possible minor exceptions’ it was not possible to attribute the recorded work to any particular factual issues in dispute because the factual issues were related. The University’s position, therefore, is that, as aforesaid, this case cannot be resolved simply by an analysis of the dockets.” As a result, His Honour elected to apportion those costs by what he referred to as an “unscientific” method: “Five per cent is my attempt at a reasonable assessment of the portion of all the time and expense expended in defence of Dr. Hanis’ claims that relates exclusively to non-covered claims.”
This decision illustrates the problem in attributing particular expenditures to time to one claim or another, even after the case has been tried. Understandably, the task would be even more challenging at the beginning of the case.
Justice Power imposed what he acknowledged was a “heavy” burden on the insurer. He ruled that it would be responsible for all but those defence costs that “clearly” do not relate to covered claims. He rejected U.W.O.’s argument, that the insurer must pay for all costs not “undeniably” unrelated to covered claims. That, he felt, would have imposed too onerous a burden.
Justice Power’s suggestion, that insurers seek direction of the court with respect to allocation, is likely to be taken up in the future. Where the insurer is defending the non-covered claims through its own counsel (under a non-waiver agreement or a reservation of rights letter, for example), it will want to instruct counsel to segregate its time records between covered and non-covered claims. In that instance, court direction will not be necessary. But when the underlying claim is being defended by the insured’s lawyer (as in the U.W.O. case) and an allocation issue looms on the horizon, the insurer would be prudent to ask the court, at an early stage, to give directions as to the segregation of time records between covered and non-covered claims. This would provide the court with much better tools to perform the allocation once the facts have been found at trial.
In order to make the segregated time dockets meaningful though, the insurer and its counsel will have to do a careful analysis of each “claim” advanced by the plaintiff in the underlying action, the legal theory underlying it and the facts that would have to be established in order to support it. It would be a good idea for the insurer to address these issues when it seeks the direction of the court, early in the litigation.
Justice Power’s decision can be compared with that of Justice Ferrier in ARG Construction v. Allstate, which was the subject of another recent Update. That was another allocation case. There, Justice Ferrier ordered the insurer to pay the entire cost of the defence, even though only a very small part of the overall claim was within the coverage. His rationale for doing so was that the covered and non-covered claims had a common “factual matrix”. Justice Ferrier did not review the jurisprudence in the same detail as did Justice Power, but his notion of “factual matrix” seems equivalent to that of “mixed claims” (see paragraph 193 (a) of the reasons).
We can anticipate more “allocation” litigation in the future, but those lawsuits will probably now be handled somewhat differently (in particular, with respect to seeking court direction) as a result of Justice Power’s ruling in the U.W.O. case.