A dispute clause allowing an insurer to defer its indemnity obligations in cases where a dispute exists between an insured and a third party, may be enforceable, even where the insurer is subrogated to the disputed rights and has effective control over the resolution of that dispute.
 O.J. No. 804
2017 ONSC 618
Ontario Superior Court of Justice
January 27, 2017
This action arises out of a coverage dispute. The defendant insurer provided the plaintiff insured coverage under an accounts receivable policy. This included coverage for unpaid amounts owing under contracts between the insured and third parties, but only when the non-payment was a result of an insured occurrence.
The dispute arose after a customer of the plaintiff, Zheijang, failed to pay for several shipments of whey powder. Three categories of shipments were identified: (1) unpaid shipments; (2) partially-paid shipments; and (3) unreleased shipments. The latter category was shipped, but never released, due to Zheijang’s failure to pay for its previous shipments. The insured incurred demurrage fees as a result.
The insured sought coverage for its unpaid invoices and for demurrage fees. The insurer indemnified the insured for the unpaid shipments (category 1), but refused to cover the insured’s other losses. It relied on a dispute clause and an exclusion clause in support of its position. It denied demurrage fees were covered under the policy.
The dispute clause at issue deferred the insurer’s obligation to indemnify where there was a dispute between the insured and a third party about the amount of debt owed. The insurer argued the clause was applicable as Zheijang denied it owed the insured any money. It claimed it had received a 30% discount for quality control issues, and that it had paid the remainder of the invoice. The insured denied it offered any such discount. Further, the insured led evidence that Zheinjang had defaulted due to decreased demand for whey products in China.
The Court considered the policy and the parties arguments. It found that the dispute clause operated as a condition precedent to coverage, and that the purpose of the dispute clause was to ensure that the insurer was only subrogated to clear and non-litigious rights. The intent of the clause was to ensure that the insurer was not placed in the position where its enforcement rights depended on information from the insured. The Court noted that this provision was complicated by a clause providing full subrogation rights to the insurer, even where only partial indemnity was provided to the insured (as had occurred in this case). This meant that the insurer was assigned the rights to recover losses for the partially and unreleased shipments, although both remained in dispute. Theoretically, the insured argued, the insurer could avoid resolving the disputes and rely on the deferment clause indefinitely.
The Court found that it was only required to determine whether there was a tenable and a non-frivolous dispute between the insured and Zeihjang, as delineated by the deferment clause of the policy. The Court further elaborated on the insurer’s obligation in this regard, stating:
 It follows that the insurer’s obligation, when assessing its coverage position, is to determine only whether a tenable dispute exists. The insurer need not, and most likely cannot, adjudicate the underlying dispute. However, when the insurer is considering whether a tenable dispute exists, it must make that determination in a manner consistent with its obligation to act in good faith. This requires the insurer to act promptly and fairly when investigating, assessing and attempting to resolve claims made by its insured. The duty to act fairly applies to the manner in which the insurer investigates and assesses the alleged dispute and to its decision about whether its obligations are deferred by reason of the dispute clause: see 702535 Ontario Inc. v. Non-Marine Underwriters Members of Lloyd’s London, 2000 CanLII 5684 (ON CA) at paras. 27 and 29.
The Court found that the insurer had satisfied its obligations in this case, and that a tenable dispute existed between the insured and Zeihjang. It further found that the exclusion clause applied to the unreleased shipments, as there was some dispute whether the transaction completed prior to the shipping of the goods. In both instances, the Court noted that it could not rule on the underlying dispute, but simply determine whether or not such a dispute existed. As it found such a dispute existed, the Court ruled that the insurer was entitled to rely on the deferment clause, even though it had subrogated the insured’s losses. The Court noted that this mischief was alleviated by the insurer's duty of good faith.
The insurer raised two other defences. First, it sought to rely on an exclusion clause precluding coverage where an insured changes the payment terms with a purchaser without notice to the insurer. The Court made a finding of fact that no modified terms were ever offered or agreed to (hence the tenable dispute). It concluded that this exclusion clause did not apply. Secondly, the insurer took the position that demurrage fees were not covered under the policy. The Court accepted that this was the case.