Insurer Liable for Insured’s Entire Defence Costs Although Only One Small Part of Claim Covered

In ARG Construction Corp. v. Allstate, a decision released last week, Justice Lee Ferrier of the Ontario Superior Court of Justice ruled on the apportionment of defence costs in an insurance dispute arising out of a construction claim. He held that the insurer of a contractor was liable for the entire amount of the contractor’s defence costs in the underlying litigation, even though only a very small part of that claim was within the policy coverage.The name of the case may ring a bell with some readers. Last week’s ruling was the second set of reasons released by Ferrier J. in this case. Last November, he wrote a judgment dealing with the duty to defend owed to the plaintiff by its insurer. The recent decision is a sequel, dealing with one issue that was not determined last November.The case is instructive on several points. In order to understand the second decision though, it is necessary to review briefly Justice Ferrier’s decision of November, 2004.

Ruling of November, 2004

In the underlying litigation, ARG was sued by the Co-operators General Insurance Company, as a result of what was alleged to be the negligent construction of a commercial building.ARG sought liability insurance coverage for the claim from its insurer, Citadel Insurance. Citadel denied coverage and ARG commenced third party proceedings against it.Ultimately, ARG settled Co-operator’s claim for $125,000. It incurred legal fees of over $400,000 in the process. It sought reimbursement from Citadel.

The “Pleadings” Rule

In the November, 2004 decision, Ferrier J. began with a statement of the traditional “pleadings rule” governing the duty to defend: “Whether an insurer is bound to defend a particular claim has been conventionally addressed by relying on the allegations made in the pleadings filed against the insured, usually in the form of a statement of claim. If the pleadings allege facts which, if true, would require the insurer to indemnify the insured for the claim, then the insurer is obliged to provide a defence. This remains so even though the actual facts may differ from the allegations pleaded.” (Monenco Ltd. v. Commonwealth Insurance Co., [2001] 2 S.C.R. 699 (S.C.C.)).Justice Ferrier went further and made it clear that the duty to defend is determined on the basis of the statement of claim only. ARG had argued that its statement of defence in the main action should be taken into account for purposes of the “duty to defend” issue, but Justice Ferrier rejected that submission.There was an unusual wrinkle in this case. When Citadel denied coverage, ARG (the defendant in the underlying suit) arranged with Co-operators (the plaintiff in that action) for the statement of claim to be amended. The amendment resulted in Co-operators’ claim being worded in precisely the language of Citadel’s policy, in an obvious attempt to attract insurance coverage. For example, the amended pleading alleged: “As a result of the negligence and/or breach of contract … the property of the Plaintiffs has been injured or damaged as a result of incidents or accidents, which include continuous or repeated exposure to conditions resulting in property damage which was neither expected or intended.” This wording mirrored the language of the policy.Ferrier J. concluded that the statement of claim had been deliberately “manipulated”, in an effort to trigger insurance coverage. But while he was not sanguine about such an approach, in the end, he decided that the fact of the manipulation was irrelevant to the issue before him. He said, “the consequences are immaterial because the court is still required to examine the pleading to determine the true nature of the claim”.

The Coverage Decision

In the November, 2004 ruling, Justice Ferrier dealt with the familiar issues that regularly arise in construction insurance cases. He reviewed the caselaw and extracted two key principles:(i) a liability policy is not akin to a performance bond for and on behalf of the insured; 

(ii) policy interpretation which would allow an insured under a liability policy to be indemnified for the costs of remediation of its own flawed work or product or work performed on its behalf is contrary to public policy;In this case, Ferrier J. held that virtually none of the underlying claims against ARG fell within the coverage, because, for the most part, they related to the cost of remedying defective workmanship.The sole claim that was within the coverage, in Justice Ferrier’s view, was one for damage to vehicles belonging to occupants of the building in question.His conclusion, therefore, was that Citadel owed to ARG a duty to defend, but “but only in reference to the claim concerning damage to the occupants’ automobiles”.Justice Ferrier concluded by leaving it to the parties to sort out: 

  1. whether Citadel was obliged to pay to ARG none, part or all of the $125,000 settlement monies paid to Co-operators plus interest?
  2. whether Citadel was obliged to pay to ARG none, part or all of its legal fees and disbursements for the defence of claims made against ARG?

ARG and Citadel were unable to resolve these issues, so Justice Ferrier heard further argument in relation to them. His decision was released last week.

Ruling of July, 2005

The November, 2004 decision had gone almost entirely in favour of Citadel. Only one small part of the total claim was found to trigger the duty to defend.But the second decision, as far as it went, was a complete victory for ARG. 

In relation to question 1 above, Justice Ferrier held that Citadel was required to pay “the full value of the automobile claims”. It is not entirely clear (to us, at least) what this means. It appears, from Justice Ferrier’s reasons, that he was not prepared to require ARG to pro rate the overall settlement figure of $125,000, in order to “break out” the portion that was attributable to the automobile claim (even though it was conceded that “by far the greater portion of damages suffered by Co-operators related to remediating the structure and design defects in the building”). It appears that Ferrier J. required Citadel to pay the automobile claim, in the amount that Co-operators had originally claimed, even though ARG had negotiated a compromise of that figure as part of the overall settlement.The second question pertained to the apportionment of the legal fees and disbursements that ARG had incurred in its litigation with Co-operators. Ferrier J. held that Citadel was required to pay the entire amount of ARG’s defence costs. As noted above, the legal fees and disbursements paid by ARG in the course of this litigation exceeded $400,000.Justice Ferrier reasoned that even though the one part of the claim that was within coverage (the automobile claim) represented only a small fraction of the entire claim, it arose out of the same “factual matrix”. As His Honour said, “all the claims against ARG, including the relatively small one concerning the automobiles, are rooted in the same facts. Thus, defending the automobile claims meant defending all the liability issues of breach of legal duty and causation.”Justice Ferrier has not yet ruled on what portion of ARG’s $400,000 legal bill related to defence costs (as opposed to the cost of the proceedings against Citadel). He has requested further submissions on this and other issues.What does this decision mean? It is quite common for an insurer (especially in the context of construction litigation) to be faced with some liability claims falling within its coverage and others that do not. Justice Ferrier’s ruling makes it imperative that an insurer (and its counsel) analyze the factual basis underlying each of the claims. If the facts alleged in support of a non-covered claim is entirely independent of facts alleged in support of a covered claim, then the insurer will probably be entitled to pro rate the defence costs accordingly. But if the facts alleged in support of the two types of claims overlap, then the A.R.G. v. Allstate decision suggests that the insurer will be liable for the entire amount of the defence costs, no matter how small a portion of the overall claim the “covered” claim might be.

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