Court Finds Duty to Defend but Refuses Insured’s Request to Appoint Own Counsel

In PCL Constructors Canada v. Lumbermens Casualty Company Kemper Canada, Madam Justice Julie A. Thorburn dealt with the recurring problem of whether an insurer owes a duty to defend and if so, whether the insured is entitled to have its own counsel conduct the defence, at the insurer’s expense. Justice Thorburn did find that a duty to defend had been triggered here but despite the insurer’s denial of coverage, was not satisfied that the insured was entitled to select counsel to defend.

In the underlying action, a hospital was suing the insured, PCL Constructors Canada for damages resulting from water leaks through a PVC roof. After analyzing the insuring agreement, exclusions and exceptions, Justice Thorburn concluded that there might be coverage for the claim, depending on whether the damage to the roof had arisen before or after PCL’s work had been completed. Because there was a possibility that the claim would turn out to be covered, the duty to defend was triggered.

Her Honour then considered PCL’s request, that it be permitted to appoint counsel to defend the claim, at the expene of the insurer (Lumbermens). PCL argued that given the position of the insurer, there was a risk that defence counsel appointed by Lumbermens would have an incentive to demonstrate that the allegations against PCL fall within the policy exclusions as this would be consistent with their stated “no indemnity” position.

Justice Thorburn began by acknowledging that, under the terms of the policy, the insurer has the right and duty to defend the claim and may investigate and settle the claim at its discretion. The mere fact that there is a “potentital tension” in the relationship between insurer and insured is not a basis for forcing the insurer to relinquish control of the defence. For that to occur, said Her Honour, “there must be a reasonable apprehension that if counsel were to act for both the insurer and the insured in defending the action, counsel would be in a conflict of interest”. Several pages later in her reasons though, she went further and said that there must not only be a conflict of interest but also, “a reasonable apprehension that the insurer may abuse its right to defend and settle to the prejudice of the insured”.

Her Honour went on to observe that, in this case, both insurer and insured had an interest in defending the claim because some portions might be covered and others not, and that “both will seek to prove that the insured is not liable for the damage or that the damages claimed are excessive. As such there is no conflict of interest in this regard”.

In what we think is probably the key to Justice Thorburn’s decision not to allow the insured to appoint defence counsel, she said that “[t]his is not the sort of  situation where a party acting improperly could mischaracterize the insured’s conduct so as to take a claim into or out of coverage.”

However, she did provide some direction to Lumbermens as to who it could retain as defence counsel. She said:

Unless the parties agree otherwise, legal counsel selected:

a) must be different from counsel who argued coverage;

b) must be counsel who has not acted for either party in the past five years, such that there is no appearance of conflict of interest;

c) must have no discussions about the case with coverage counsel; and

d) will provide identical concurrent reporting to both the insurer and the insured.

Moreover, the claim is to be assigned to claims staff within the insurer who have had nothing to do with this claim up until this point, and who will have no communication with any person who has had dealings with this claim. New claims staff is to have access to the claims file only once it has been purged of any consideration of coverage.

The conditions imposed by Her Honour are practical and will be a useful template for future coverage disputes.

It seems to us though, that the first part of her decision on the issue of controlling the defence, is a bit harder to understand. It is difficult to tell what led her to conclude that this was not a case in which the insured should be permitted to select and instruct defence counsel. As noted above, in one part of her reasons (para. 75), Her Honour said that before the insurer can be forced to surrender the defence of the underlying claim, there must be a reasonable apprehension that counsel acting for both insurer and insured would be in a conflict of interest. Later (para. 80), she said that there must be both a conflict of interest and “a reasonable apprehension that the insurer may abuse its right to defend and settle to the prejudice of the insured”.

Realistically, a conflict of interest is always present in these sorts of cases, where the insurer is taking an off-coverage position that is disputed by the insured. So long as the coverage issue continues, so will the conflict. But despite her comments at para. 75 of her reasons, Justice Thorburn seems to have recognized that the existence of such a conflict, without more, is not a basis for taking the defence away from the insured. Justice Thorburn seems to have concluded that for that to occur, the insured would have to show that “a party acting improperly could mischaracterize the insured’s conduct so as to take a claim into or out of coverage”.

We think that statement probably goes further than the authorities warrant. In Brockton (Municipality) v. Frank Cowan Co. Ltd., the Court of Appeal endorsed the approach taken by the California Court of Appeal in Foremost Insurance Co. v. Wilks, 253 Cal. Rptr. 596, (1988), where that court said: “If the reservation of rights arises because of coverage questions which depend upon an aspect of the insured’s own conduct that is in issue in the underlying litigation, a conflict exists. On the other hand, where the reservation of rights is based on coverage disputes which have nothing to do with the issues being litigated in the underlying action, there is no conflict of interest requiring independent counsel paid for by the insurer.”

Thus, requiring that the case be one in which one party, acting improperly, is in a position to “mischaracterize” the insured’s conduct so as to affect the outcome of the coverage issue, sets the bar too high for permitting the insured to control the defence. Rather, as the Court of Appeal said in Brockton, the focus should be on whether the coverage dispute will be decided by the disposition of the factual issues in the underlying action. That places counsel in a conflict of interest, without the need of speculating about whether “improper” conduct and “mischaracterization” would actually occur.

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