Court of Appeal for Ontario clarifies key coverage concepts including allocation of defence costs, control of defence and split file protocols

The Court of Appeal for Ontario has released its decision in Loblaw Companies Ltd. v. Royal & Sun Alliance Insurance Co. of Canada,^[1] a case that drew much attention in 2022^[2] for, among other things, the application judge's direction as to costs allocation and information sharing where multiple insurers owe the same insured a duty to defend.

In its decision, the Court weighed in on four key issues, namely:

• Allocation of defence costs among multiple insurers.        
• Exhaustion of self-insured retentions ("SIR"s) and deductibles where multiple policies are triggered.
• Relief from forfeiture for pre-tender defence costs.
• Defence reporting agreements and related matters.

Facts and procedural history

The case originated as a duty to defend application. The underlying litigation consisted of several class actions arising from the manufacturing, marketing, distribution and sale of opioids. The material time frame of the underlying claims dated back to 1996; and as such, there were multiple insurers and multiple responsive policies.

The insureds sought a declaration that they were entitled to a defence, and, in recognition of potential conflicts of interest, sought the institution of a defence reporting agreement detailing reporting, information sharing, and ethical screening protocols.

In a detailed decision, the application judge concluded:

• Regarding allocation of defence costs: a "time-on-risk" allocation was not appropriate. Rather, each insured was entitled to select any single policy under which there is a duty to defend, and require the insurer to defend. The selected insurer would be entitled to seek an apportionment of the defence costs at the end of the proceedings. ^[3]
• Regarding exhaustion of SIRs and deductibles: for the purpose of triggering the duty to defend, defence costs incurred by the insureds contribute toward the exhaustion of SIRs, even if they are reimbursed by another insurer.^[4]
• Regarding pre-tender defence costs: the insured who sought coverage for those costs despite providing late notice of the claim was entitled to relief from forfeiture based on the test set forth in Monk v. Farmers' Mutual Insurance Company (Lindsay),[5] and was thus entitled to those costs.^[6]
• Regarding defence reporting agreements: it was appropriate for the defence reporting agreement to require "split-handing" between coverage and defence, with correspondingly different levels of disclosure. This was because, in part, the insurers' reservations of rights gave rise to a reasonable apprehension of conflict vis-a-vis insurers who do not control the defence. The insurers who did not agree to the defence reporting agreement were required to maintain ethical screens to ensure that privileged defence information could not be received by or made available to anyone other than the designated authorized representatives. Further, those designated authorized representatives were not to have any involvement with the defence of any other defendants in the underlying claims, or the assessment or determination of coverage issues.^[7]

The appeal

Several of the insurers appealed the application decision. The finding that a duty to defend was triggered was not appealed.^[8]

In the result, the Court largely allowed the appeals.^[9] To summarize the Court's findings:

• Regarding allocation of defence costs: a "time-on-risk" allocation was appropriate. Specifically, there is to be a pro rata allocation of defence costs among the primary insurers based on their time-on-risk, subject to the exhaustion of applicable SIRs/deductibles.
  • Among the Court's reasons was that the duty to defend was time-limited in that it was linked to the grant of coverage, which is in turn linked to the policy period.^10] As well, there was a potential conflict if an insurer with minimal exposure to indemnity was to control the defence and the defence costs: "[r]equiring the insurer to defend claims which cannot fall within the policy puts the insurer in the position of having to defend claims which it is in its interest should succeed."^[11]
• Regarding exhaustion of SIRs and deductibles: each primary insurer's SIR or deductible must be exhausted before a duty to defend arises. Until then, the insured must contribute that insurer's pro rata share of the defence costs.^[12] However, the SIRs do not have to be collectively exhausted before the obligation of a single insurer with an exhausted SIR is triggered.^[13]
  The issues of attribution of SIR obligations, and whether reimbursement from another insurer exhausts an SIR obligation, are negated by the use of the time-on-risk formula because the pro rata time-on-risk formula applies to the exhaustion of the SIRs.^[14]
• Regarding pre-tender defence costs: relief from forfeiture was not appropriate in the circumstances. Specifically, the insurers did not reject the contract of insurance, and thus, there was no forfeiture to relieve against.^[15] However, the pre-tender defence costs incurred by the insured did count toward the exhaustion of the SIR.^[16]
• Regarding defence reporting agreements: the split-file protocol endorsed by the application judge was appropriate; though in general, the measures taken to address an apprehension of conflict must be tailored to the circumstances of the case.^[17] Regarding the excess insurers who sought only to associate in (not control) the defence, in the circumstances, the reservation of rights gave rise to a reasonable apprehension of conflict and measures were required to protect privileged defence information.^[18] Regarding two insurers who did not seek to associate in the defence of the insureds, they were not required to sign the defence reporting agreement; however they were also not entitled to complete disclosure and use of privileged defence information. They may reasonably request some information over and above what the DRA provided all insurers would receive; but the particular scope of what they are entitled to is fact-specific.^[19]
  • On the issue of conflict of interest, the Court clarified that while a reservation of rights does not automatically put defence counsel in a position of conflict, if the reservation of rights arises because of coverage questions which depend on an aspect of the insured's own conduct that is in issue in the litigation, there may be a reasonable apprehension of conflict.^[20]

Key takeaways

Although the result was mixed, much of the Loblaw appeal decision will likely come as a relief to the insurance industry.

For example, the model for allocation of defence costs in the application decision could have potentially required an insurer with even a very short period of coverage to fund a costly defence – an exposure that would be greatly out of proportion to the coverage that the insurer bargained to provide and collected premiums for. The "time-on-risk" model provides some certainty, particularly with respect to occurrence-based policies, the nature of which raises the prospect of long-tail liabilities.

The Court's findings on the SIR/deductible and pre-tender defence costs issues also provide some comfort that these provisions will be predictably applied. Insurers will not indirectly take on unanticipated risk by funding the exhaustion of their insured's SIR; and will avoid the potential of being required to pay the costs of defending a claim before they become aware of it.

Although the appeal of the application judge's findings on the defence reporting agreement issue was largely not successful for the insurers, the Court's unambiguous statement that "[t]he mere fact that an insurer has reserved its rights on coverage does not cause the insurer to lose its right to control the defence and appoint counsel"^[21] may quell some concerns about how broadly the application judge's findings may have been interpreted.

Similarly, the Court's recognition that a split-file protocol may not always be appropriate will provide some satisfaction that split-file protocols need not necessarily become the new status quo in all manner of insurance litigation.