On May 22, 2014, the Ontario Court of Appeal released its decision in Mandeville v The Manufacturers Life Insurance Company, a unanimous decision of Gillese, Blair and Strathy, JJA., written by Gillese JA. In the decision, the Court determined that the defendant/ respondent (“Manulife”) was not negligent in failing to protect the right to demutualization benefits of certain class action plaintiff participating policyholders of Manulife when their policies were transferred to another insurer prior to Manulife’s demutualization. Given the imminent release of Regulations permitting the demutualization of federally incorporated property and casualty insurance companies (“P&C Companies”), what this decision has to say about the nature of a mutual policyholder’s ownership interests, and the  duty of care of an insurer to protect such interests, becomes increasingly important.

Insurance companies come in two basic ownership forms, stock companies, organized much like a standard business corporation and owned by their shareholders, and mutual companies. In a mutual company, there are no shareholders and a certain class or classes of policyholders (in life insurance companies, generally referred to as “participating policyholders”, and in P&C Companies as “mutual policyholders”) are conferred governance rights through a combination of contract rights (in the policy of insurance), the by-laws of the insurer, and statute (which may be federal or provincial, depending on where the insurance company is incorporated). These governance rights include the right to vote at policyholder meetings, and are accompanied by the possibility of receiving policy dividends (in the case of a life insurance company) or premium refunds or rebates (in the case of a P&C Company). In the case of a “demutualization” of the mutual company, policyholders are generally assumed to have the right to receive “demutualization benefits”. Some mutual companies (both life insurers and P&C Companies) are “pure mutuals” meaning that all the policies that they issue are participating policies or mutual policies, having these governance and ownership rights. Other mutual companies also issue cash policies, possessing only a contract right to insurance, but no governance or ownership rights.

A “demutualization” is the process by which a  mutual insurance company coverts itself into a stock company. This is done by way of the cancellation of the governance (voting) and other ownership rights of the participating or mutual policyholders and the issuance of shares of the new stock company to the policyholders, or to a new financial holding company, which in exchange issues its voting shares to the policyholders. The assets of the insurance company, including accumulated surplus from years or decades of retained profits while in mutual form, are unaffected by this process, and remain in the insurance company. It is only the value of the ownership interest, and  rights to returns from that ownership interest, that may be transferred by the policyholders or terminated through the demutualization transaction. After the demutualization, the transformed company is a private or public share corporation and in the latter case its shares may be listed on a stock exchange. Generally, the policyholder owners of these shares can trade them and monetize their share demutualization benefits. In some circumstances, some or all of the shares of the insurer being demutualized are sold by way of a pre-arranged sponsor agreement to a single sponsor, who pays cash and/or its shares to acquire control of the demutualizing insurer. This cash and or shares are then transferred to the demutualizing insurer’s policyholders, forming their demutualization benefits. This structure is generally referred to as a “sponsored demutualization”.

In 1991, the federal Insurance Companies Act (the “ICA”) was passed and contemplated that a federal mutual insurance company could demutualize, subject to the rules and procedures set out in Regulations to be passed under the ICA. In March 1999, Regulations (the Mutual Company (Life Insurance) Conversion Regulations) were passed under the ICA, setting rules for the demutualization of federally incorporated life insurers, and providing that only voting policyholders of a demutualizing life insurer would be entitled to receive demutualization benefits. No demutualization Regulations have yet been passed setting the procedures for the demutualization of federal P&C Companies.

Manulife is a federal life insurer, and in January, 1998,  14 months before the enactment of the Regulations under the ICA for the demutualization of federal life insurers, it announced its intention to demutualize. Its demutualization became effective in September of 1999, and through that demutualization, approximately $9 billion of demutualization benefits were transferred to its voting policyholders in the form of common shares of Manulife, which were listed on the Toronto Stock Exchange.

The class action plaintiffs in the Mandeville action were some 8,000 residents of Barbados who had owned participating policies of Manulife, whose policies had been transferred to a Barbadian insurer by way of an assumption reassurance transaction in December of 1996. Through this transaction, the policy liability of these participating policies had been assumed by the Barbadian insurer and the policyholders had ceased to hold any insurance policy of Manulife. Accordingly, they were not entitled to receive any demutualization benefits when Manulife demutualized almost three years later.

The class action was commenced on behalf of these policyholders, alleging that Manulife had been in breach of its fiduciary duties in not having made provision for them when their policies were transferred (to ensure that they would receive demutualization benefits), or alternatively, that Manulife had been negligent in not doing so, resulting in the loss of approximately $82 million in demutualization benefits that would have been received by these policyholders. The negligence claim was alleged on the basis that Manulife knew it was likely going to demutualize when it transferred the Barbados policies, and that it should have structured the transfer in a way that permitted the class action policyholders to receive demutualization benefits.

At first instance, Justice Newbould of the Ontario Superior Court of Justice found that a prima facie duty of care existed in favour of the plaintiffs based on the foreseeability of loss and proximity, because  he accepted that there was at least a reasonable likelihood in late 1996 (when the Barbados transaction took place) that demutualization would occur in Manulife. However, he found no fiduciary duty was owed to policyholders to protect their right to participate in a future demutualization, and he refused for policy reasons to recognize that Manulife owed  the class plaintiffs a duty of care to protect against their pure economic loss. The action was accordingly dismissed (Mandeville v The Manufacturers Life Insurance Company, 2012 ONSC 4316; 6 B.L.R. (5th) 175).

The plaintiffs appealed, on the basis only of the allegation of negligence of Manulife by failing to protect their rights to demutualization benefits at the time of the transfer transaction.

The Court of Appeal concluded that the sole question raised on the appeal was whether Manulife owed the class members a duty of care under the circumstances.In answering this question, the Court first looked to determine the nature of the right affected by the alleged negligence (whether it constituted a proprietary right to receive demutualization benefits), or whether the claim was in respect of pure economic loss. In analyzing this issue, Justice Gillese stated:

“I accept that in normal parlance, immediately prior to the transfer to LOB, it could be said that the class members, in conjunction with Manulife’s other participating policyholders, were the owners of Manulife … It was the participating policyholders who had the right to vote and to receive the company’s surplus, by means of annual dividends. Those are the rights of ownership.” “The Question is not whether the participating policyholders can or should be described as the owners of a mutual insurance company. Rather, the question is whether at the time of transfer to LOB, the class members had a legally recognized right or interest in respect of a possible demutualization of Manulife. In my view, they did not.”

“Because Manulife had no right to demutualize in 1996 (because Regulations to permit such demutualization had not yet been passed), the appellants could have no right to share in the benefits of demutualization. In short, as no right to share in demutualization benefits had been conferred by contract, legislation or regulations, the class members could not have had a right to, or interest in, something that did not exist and was not legally possible. At its highest, what the class members had immediately before their policies were transferred to LOB was the hope or mere expectancy that if and when Manulife were allowed to demutualize and did demutualize, their then-existing rights as participating policyholders would entitle them to receive the benefits of that demutualization. A hope or mere expectation is not a legally enforceable right or interest, however”.

“When the 1999 Regulations came into effect, Manulife’s participating policyholders gained a contingent interest in the value of Manulife on demutualization. This interest was contingent on a number of events, including Manulife’s board approving the plan of demutualization, the policyholders approving the plan of demutualization, and the Minister approving the plan. Nonetheless, as a contingent interest, it is recognized by law.”

The Court thus concluded that the alleged negligence was not in relation to damage to a recognized proprietary interest, and constituted a claim for pure economic loss. As such, and applying existing Canadian jurisprudence on the special examination of proximity needed for the recognition of a duty of care in relation to pure economic loss (Martel Building Ltd. v Canada [2000] 2 S.C.R. 860; Canadian National Railway Co. v Norsk Pacific Steamship Co. [1992] 1 S.C.R. 1021), the Court concluded that “the relationship between the class members and Manulife was not sufficiently proximate that a prima facie duty of care arose.” The Court also indicated that even if it had concluded that a prima facie duty of care existed (the first part of the test for a claim for pure economic loss), there might be policy considerations weighing against the imposition of a duty of care and thus liability (the second part of this test).  These include “the spectre of indeterminate liability”and encouraging a “multiplicity of inappropriate lawsuits.” The Court stated that these “inappropriate lawsuits” might include claims for economic loss by policyholders of mutual insurance companies that decided not to demutualize, or more generally, a failure to meet a mere expectancy of any other corporate benefit.

As mentioned above, this decision may have special implications for policyholders of federally incorporated P&C Companies, where there are currently no Regulations permitting demutualization, but an expectation that such Regulations are going to be released later in 2014.

This case states that property rights of policyholders (presumably mutual or cash) in demutualization benefits in fact only comes into being when Regulations are passed that permit a demutualization to occur. Presumably, this also means that such right to benefits only comes into being in the manner set out in the Regulations. It has been suggested that the Department of Finance believes that the benefits of a demutualization of a federal P&C Company should be shared more broadly among cash policyholders (where the P&C Company is not a pure mutual and has both mutual and cash policyholders), although it has yet to be seen how this sharing will be brought into effect. It thus appears that legal entitlement to demutualization benefits is to be judged on the basis of the content of these Regulations, and neither mutual nor cash policyholders have any legal rights to demutualization benefit entitlement before the Regulations are passed or in greater amounts than is contemplated by the Regulations.

It also appears from this case that there would be no basis for a tort claim in negligence against a mutual insurer or its directors if the mutual insurer elects  not to demutualize. Such a claim would be for pure economic loss, and would thus not fit within the proximity analysis set out in this case, or would raise the policy considerations against “indeterminate liability” or a “multiplicity of inappropriate lawsuits”, that would not allow such litigation to proceed successfully.