Apportionment of defence costs between the insurer and insured in cases where there are claims which are covered and claims which are not covered
How, if at all, should the costs of defending a lawsuit be apportioned between the insurer and insured when only some of the claims made in the lawsuit are covered by the applicable insurance policy? This question was answered by the Court of Appeal for Ontario in Hanis v. Teevan.1
It is well established that there is a general duty to defend where a claim alleges a state of facts that if proven would require the insurer to indemnify the insured under the policy. What is less well understood is what happens when there are multiple claims contained in the pleadings, only some of which would trigger the duty to defend. As such, apportionment of defence costs is an important issue for everyone involved in the insurance industry, insurers and insureds alike.
The decision rendered by the Court of Appeal on October 8, 20082 in Hanis v. Teevan clarifies what was until recently a murky area in insurance law. While it clarifies the principles that now apply in Ontario and confirms that the policy or policies in question are the key to deciding the issue of defence costs allocation, it does not provide complete certainty for parties dealing with allocation issues. The decision, however, suggests that in most cases it will be difficult for an insurer, in the absence of specific policy language, to allocate any defence costs to the insured in situations where there are claims that are covered and claims that are not covered.
THE HANIS DECISION
The plaintiff, Mr. Hanis, had been employed by the University of Western Ontario as director of its computing laboratory. After he was fired and charged with a criminal offence arising from his alleged misuse of the computing system, he commenced an action against the University of Western Ontario alleging wrongful dismissal and malicious prosecution among other things. The University of Western Ontario sought defence costs from its insurer, Guardian Insurance Company of Canada, under a comprehensive general liability insurance policy. Guardian denied that it had a duty to defend.
The University of Western Ontario brought a third party claim against Guardian. The trial judge found that Guardian had a duty to defend under one policy with respect to the claims of malicious prosecution and concluded that Guardian should have defended with respect to all claims, covered or not, subject to a reservation of its rights. He found Guardian liable to pay all costs associated with defending the covered claims, whether or not they also furthered the defence of the claims that were not covered. He determined that only 5% of the defence costs related exclusively to the defence of claims that were not covered, and thus held Guardian liable for 95 % of the costs. In coming to this conclusion, the judge reviewed and set out the principles that he thought applied in cases where allocation of defence costs was in issue.3
Guardian appealed, arguing that it should only be responsible for 20% of the costs. The appeal was dismissed.
In dismissing the appeal, the Court analyzed the factual circumstances against the wording of the insurance contract itself. The decision of the Court of Appeal and the current law on apportionment of defence costs in Ontario is summarized at the beginning of the decision. The Court states:
I would hold that the question of apportionment of costs should be determined by the operative language in the policy. Where there is an unqualified obligation to pay for the defence of claims covered by the policy, as in this case, the insurer is required to pay all reasonable costs associated with the defence of those claims even if those costs further the defence of uncovered claims. The insurer is not obliged to pay costs related solely to the defence of uncovered claims.
The Court, in providing some guidance to determine when allocation of defence costs would be warranted, states:
[I]n the context of defending covered and uncovered claims in the same suit, a distinction must be drawn between cases where defence costs are related exclusively to the defence of either covered or uncovered claims, and cases where the same costs are incurred in the defence of both covered and uncovered claims. In the former circumstance, an allocation of costs would be required, barring a policy which provided for payment of defence costs relating to uncovered claims. In the latter case, allocation would not be necessary unless the policy provided for allocation where the costs related to both covered and uncovered claims.
The Court of Appeal explicitly rejected the idea that fairness should be a consideration when dealing with the possibility of apportionment of defence costs. In looking at other cases on apportionment, it had this to say about the idea of fairness:
The cases do not look to the language of the policy as the primary consideration when assessing an allocation claim. Instead, these cases assume that allocation is necessary where there are both covered and uncovered claims and impose what the court regards as a "fair" allocation.
For the reasons set out above, I do not think that the nature and extent of the insurer’s obligation to pay defence costs is a question of fairness or unfairness. Rather, it is a question of what the insurer has agreed to do in the policy. The answer to that question lies in the language of the policy, not in judicial notions of fairness.
There are two very helpful principles that come out of this recent Court of Appeal decision. Firstly, the Court is very clear that apportionment of costs should be determined by the operative language in the policy. In other words, where there is an unqualified obligation to pay for the defence of claims covered by the policy, as there was in this case, the insurer is required to pay all reasonable costs associated with the defence of those claims even if those costs further the defence of uncovered claims.
Secondly, the Court rejects the idea that an insurer should be responsible for paying all defence costs, both for covered claims and claims that are not covered where it wrongfully refused to defend at the outset. In reliance on the contract interpretation approach, the Court stated that “I can see no justification for imposing upon the insurer, as a consequence of its breach of contract, an obligation to pay defence costs that are clearly not covered by the contract.”
SUMMARY OF LEGAL PRINCIPLES
The most important principles to keep in mind when faced with a situation that involves claims that are covered and claims that are not covered are as follows:
- Generally an insurer will have the duty to defend all claims in an action where it has the duty to defend any claim.
- Except in rare circumstances, if an insurer has a duty to defend, the insurer must pay all defence costs until such time as they can be allocated, either by a court or by agreement of the parties.
- The insured will be held liable to the insurer for any defence costs which can be identified by reliable evidence as relating solely to claims that are not covered.
- If there are no practical means, or it is impossible, to distinguish between the defence costs of covered and uncovered claims, then the insurer will likely be responsible for all defence costs.
- The most important factor in determining allocation issues will be the relevant insurance policy or policies.
It is clear based on the recent decision of the Court of Appeal that there is no hard and fast approach to determining responsibility for defence costs in all cases. The key is to examine the facts underlying each particular case, including the wording of the relevant insurance policy or policies.
It is of vital importance that the issue of allocation be identified early in the proceedings so that both the insurer and the insured can make the best strategic decision in the circumstances. Regardless of whether or not the insurer or the insured appoints defence counsel, it is recommended that the parties have discussions about possible apportionment issues at the outset of the claim. If an agreement can be reached whereby the insurer and the insured will each pay a certain percentage of the defence costs, it may save much time and money down the road. While it may not be possible in all cases to accurately predict the percentage which will be incurred on covered and uncovered claims, an agreement will provide certainty for both parties. While it may not be possible to make an exact determination, there will be sufficient information available to allow the parties to reach a reasonable agreement.
If it is not practical to enter into an agreement at the outset, or if either party is not receptive to such an agreement, it may be possible for a party to apply to a court for directions on apportionment issues. Everyone should be aware, however, that a court may refuse to deal with the apportionment issue prior to the resolution of the litigation. It is only in clear cases that such a step is likely to be viable.
If an agreement is not reached and both parties decide it is not worth applying to a court at the outset, the parties should take steps to ensure that enough information is available after the resolution of the litigation, either at trial or through settlement, to allow them or a court to properly allocate the defence costs. Defence counsel, whether appointed by the insurer or the insured, should be informed that apportionment of defence costs is an issue and that detailed dockets must be kept.