A clause obliging the insurer to defend an insured, or pay for the insured’s defence, is a well know feature of liability insurance policies. Recently, some Canadian courts have held that the duty of one party to defend or pay for defence of another party to the contract may arise in contracts outside the field of insurance, for instance in building contracts. This obligation has been found to arise from an indemnity clause or insurance clause in the contract. Such a duty has been held to exist in a service or building contract even though that contract contained no express duty to defend or pay for a defence.
However, a duty to defend or pay for a defence before a finding of liability seems to be an obligation of a different kind than a duty to indemnify or to obtain insurance. Recently, the Ontario Court of Appeal has clarified this issue in Papapetrou v. 1054422 Ontario Limited. The court held that an insurance clause may create an obligation to pay damages equal to defence costs, but it does not create a duty to defend.
Ms Papapetrou brought a slip and fall claim after she fell on ice on the stairs of The Galleria. That building was owned by the numbered company and managed by the Cora Group. The Cora Group hired Collingwood to provide winter maintenance and snow removal.
The service contract between Collingwood and the Cora Group contained the following indemnity clause:
The Contractor assumes sole responsibility for all persons engaged or employed in respect of the Work and shall take all reasonable and necessary precautions to protect persons and property from injury or damage. The Owner shall not be responsible in any way … resulting from any act or omission of the Contractor…The Contractor shall indemnify and save harmless the Owner …against all claims, losses, liabilities, demands, suits and expenses from whatever source, nature and kind in any manner based upon, incidental to or arising out of the performance or non-performance of the contract by the Contractor….[Emphasis added.]
The contract also contained an insurance clause. Collingwood agreed to obtain CGL insurance covering the liability of Collingwood and its employees and agents for bodily injury up to a minimum of $2,000,000 and to include the Owners as additional insureds on the policy. Instead, Collingwood obtained an insurance policy covering a maximum of $1,000,000 and the policy did not name The Cora Group as an additional insured.
The Cora Group brought a motion to compel Collingwood to indemnify, and assume the defence of the action on behalf of, The Cora Group. The motion judge granted the motion, finding that “the true nature of [Ms. Papapetrou’s] claim is that [Collingwood and The Cora Group] were negligent in failing to maintain an ice free pedestrian stairway” and that based on the service contract, a duty to defend and indemnify therefore arose. The motion judge stated that Collingwood “should not escape responsibility to defend/indemnify merely because [it] failed to meet [its] contractual responsibility” to name The Cora Group as an additional insured in its CGL policy. She ordered that Collingwood indemnify The Cora Group and undertake the defence of the action against The Cora Group.
The Court of Appeal’s decision
In the Court of Appeal, The Cora Group acknowledged that an order that Collingwood indemnify it was premature. No evidence about liability or damages had been led on the motion. The service contract did not require that Collingwood assume sole responsibility for damage to persons and property. Rather, it required Collingwood to assume “sole responsibility for all persons engaged or employed in respect of the Work” and “take all reasonable and necessary precautions to protect persons and property from injury and damage.” Moreover, Collingwood’s contractual obligation to indemnify The Cora Group was limited to claims “based upon, incidental to or arising out of [Collingwood’s] performance or non-performance of the [service] contract”.
In these circumstances and at this juncture, the Court of Appeal held that there could be no finding that Collingwood’s duty to indemnify had been triggered. Accordingly, the motion judge’s order to indemnify was set aside.
The Court of Appeal also held that the order requiring Collingwood to assume the defence of The Cora Group must be set aside, for two reasons:
First, the service contract contained no duty to defend.
Second, any duty to defend could be no wider than claims arising from Collingwood’s performance or non-performance of its contract.
The Cora Group argued that Collingwood’s obligation to defend arose, not out of the indemnity clause, but rather out of the insurance clause. It argued that Collingwood’s failure to name The Cora Group as an additional insured in its CGL policy was a breach of contract and that the appropriate remedy was an order requiring Collingwood to defend it. However, the court held that “Collingwood’s breach of this contractual obligation does not create a duty to defend; rather, it gives rise to a remedy in damages.” The court also held that the failure of The Cora Group to object to the form of the insurance was irrelevant.
The court held that the amount of damages suffered by The Cora Group was the amount the CGL insurer would have paid on behalf of The Cora Group. That amount had to be determined from the service contract, not the CGL insurance policy that Collingwood obtained, since that policy did not contain the additional insured coverage for The Cora Group that it was supposed to contain. The scope of Collingwood’s contractual obligation to indemnify was limited to “claims … based upon, incidental to or arising out of the performance or non-performance of the contract by the Contractor”. Accordingly, the amount of damages was “the amount The Cora Group must pay to defend claims for bodily injury arising out of the manner in which Collingwood performed or failed to perform the service contract.”
The court held that “these costs will include all costs of The Cora Group’s defence of the Papapetrou action, save for any costs incurred exclusively to defend claims that do not arise from Collingwood’s performance or non-performance of the service contract.” The court arrived at this conclusion by analogy to the payment of defence costs under an insurance policy.
First, it applied the principle that an insurer’s obligation to defend is limited to claims that, if proven, would fall within the policy.
Second, it applied the apportionment principle applicable to defence costs under an insurance policy that “where an action includes both covered and uncovered claims, an insurer may nonetheless be obliged by the terms of the policy to pay all costs of defending the action save for those costs incurred exclusively to defend uncovered claims.”
In view of the allegations of Ms. Papapetrou, there was a conflict of interest between Collingwood and The Cora Group, and The Cora Group was entitled to retain separate counsel.
The Court of Appeal set aside the motion judge’s order and substituted an order requiring that Collingwood pay for The Cora Group’s defence of the action, save for any costs incurred exclusively to defend claims that did not arise from Collingwood’s performance or non-performance of the service contract.
There are a number of interesting aspects of this decision from the aspect of construction law and insurance law.
First, this decision has to some extent clarified the law with respect to whether a duty to defend can arise from an indemnity or insurance clause in a non-insurance contract, such as a building contract. The Court of Appeal has certainly held that such a duty does not arise from the breach of an insurance clause, and that the proper remedy is damages. If this is so, it seems hard to imagine that another court could conclude that an indemnity clause gives rise to a duty to defend and not damages. As well, it appears that a number of recent lower court decisions, holding that a duty to defend may arise from an indemnity clause in a non-insurance contract, are no longer good law.
Second, if a future action arises from the breach of an indemnity clause, we cannot be certain what principles the court will apply to the calculation of damages. In the present case, since the breach was of the insurance clause, the court had a convenient proxy or reference point in the cases dealing with the determination and apportionment of defence costs under a liability insurance policy. No policy reasons come to mind for applying different principles to breach of an indemnity clause, but we will have to await such a case for a clear answer.
Third, it may be a little surprising that, on an interlocutory motion, the court made what appears to be a final order determining the principles upon which damages were to be paid. There may be an argument on a duty to defend motion under an insurance policy as to whether, and to what degree, the court should finally determine the principles upon which the defence costs are to be paid, and the degree to which the trial judge should be left with some discretion on that matter. In the present case, the Court of Appeal appears to have finally decided the matter.
Fourth, the court appears to have finessed the issue of whether the claim by Ms. Papapetrou was entirely covered under Collingwood’s CGL policy. There is no mention in the decision of any coverage dispute under that policy, so perhaps coverage was not an issue. In addition, the Court of Appeal may be saying that, because Collingwood did not obtain the coverage for The Cora Group, it could not argue anything about the scope of coverage under the policy. But in another case, if coverage is an issue under the “policy that wasn’t obtained” then this may be raised as an issue by the defaulting party. That party may argue that there should be an additional exception to its liability, namely, “to the extent that coverage was not available under the policy not obtained.”
Fifth, this decision shows how a breach of an insurance clause can be expensive. By failing to obtain the right insurance, Collingwood turned what would have been a claim for payment of costs against the insurer under the CGL policy into a claim for costs against it personally.
Finally, the insurance law junkies will take note that the Court of Appeal has once again applied the apportionment principle that requires the insurer (and by analogy in this case, the party in breach of contract) to pay defence costs except to the extent that those costs are due exclusively to uncovered claims. This rule is favourable to the insured and is generally applied by Anglo-Canadian courts to apportionment disputes, but other rules less favourable to the insured may be applied in other jurisdictions and are advocated for by many insurers.
See Heintzman and Goldsmith on Canadian Building Contracts, 4th ed. Chapter 5, part 3
Papapetrou v. 1054422 Ontario Limited, 2012 ONCA 506