When an insured incurs defence costs prior to giving their insurer notice of the claim, who bears responsibility for those “pre-tender” defence costs? The insurer, which is otherwise responsible for the insured’s defence? Or the insured, which incurred costs without the insurer’s knowledge or control?

This was the issue before the British Columbia Court of Appeal in Lloyd’s Underwriters v. Blue Mountain Log Sales Ltd., 2016 BCCA 352. The Court, in a unanimous opinion, overturned the lower court’s decision requiring Lloyd’s to pay the pre-tender defence costs. In doing so, the Court affirmed that an insurer’s duty and right to defend cannot arise until the insured provides notice of the claim.

The case originated in a Washington State action commenced in 2012 against companies affiliated with Blue Mountain. When Blue Mountain was added as a defendant, its chief financial officer did not immediately realize that this triggered coverage under the company’s Lloyd’s general liability insurance policies. It was not until 2014 that Blue Mountain gave notice and tendered its defence to Lloyd’s. At that point, its defence costs amounted to approximately $588,000.

Lloyd’s brought a petition against Blue Mountain in the British Columbia Supreme Court seeking a declaration that it did not owe a duty to reimburse Blue Mountain for the pre-tender defence costs. Lloyd’s relied, in part, on a voluntary payment clause in the policy, which provided that any voluntary payment made by Blue Mountain would be at its own cost.  

The chambers judge dismissed Lloyd’s’ petition, holding that the duty to defend arises when a claim potentially falling within the policy is made, and, in the absence of identified prejudice to the insurer caused by the insured’s failure to give timely notice, the insurer is liable for pre-tender defence costs. The chambers judge based his decision, in part, on an insured’s right to relief against forfeiture.

On appeal, Lloyd’s argued that the chambers judge erred in: (1) holding that an insurer’s duty to defend arises when a claim falling within the policy is made, and (2) employing a relief against forfeiture analysis instead of giving effect to the unambiguous terms of the insurance contract.

The Court of Appeal found there was no consensus in the case law as to when the duty to defend arises. The Court found the view that the duty is immediately present upon payment of the premium to be unpersuasive, in part, due to the fact that it fails to recognize that the insured may elect to mount its own defence. Instead, the Court agreed that the duty cannot arise until the insured provides notice.

The Court stated:

[38] … the policies in this case gave the respondents a contractual right to demand that Lloyd’s provide a defence, and Lloyd’s was contractually bound to do so. The right and duty to defend could not arise, however, until the respondents made that demand by providing notice or tender of the claims, thereby enabling Lloyd’s to determine whether they potentially fell within the scope of the policy. The chambers judge erred in holding the duty to defend arises as soon as a claim is made and before notice.

The Court held that relief against forfeiture did not apply. Because Lloyd’s waived Blue Mountain’s breach of the policy’s notice clause and honoured the “essential bargain” of the policy by providing coverage upon receiving notice, Blue Mountain was not at risk of a forfeiture of its insurance.

The Court of Appeal’s decision is good news for underwriters, as it means that insureds will be held responsible for any defence costs incurred prior to providing notice. The decision highlights the importance of including voluntary payment/assumption of liability clauses in policies to protect against costs outside the underwriter’s control. If an insured wants to disregard its policy and run its own defence, it can still do so, it just can’t expect someone else to foot the bill.