The issue of « estoppel » resulting from the contents of a reservation of rights letter addressed by the insurer to the insured has been the object of a fair number of judgements in recent years. Another judgement has been rendered recently that will be helpful in determining the extent of the insurer’s duty in that respect. That judgement was rendered on October 22nd, 2010 by the Honorable Manon Savard, SJC, in Nicholas Smith, ès qualité c. Solution Air Pro Inc. et al

The judgment sends a very clear message to insurers: be vigilant in the drafting of your reservation letters.

Nicholas Smith ès qualité (Lloyd’s) was the property insurer of Hauber Fashions Inc. that imported clothing from other countries. Hauber had retained the services of Solution Air Pro Inc. to store the clothing temporarily in its warehouse situated at the Dorval Airport. Solution Air Pro was to clear the goods through customs and have them shipped to Hauber’s clients via land transportation. As the goods had to be delivered very early the following morning, Air Pro’s employees loaded the trailer left on site by the transportation company. Once the goods were loaded, the trailer doors were closed and locked. When the driver of the transportation company arrived the following morning, he discovered that the trailer and its contents had disappeared.

Lloyds indemnified its insured and sued Solution Air Pro Inc. Air Pro was insured by Compagnie Canadienne d’Assurance générale Lombard (Lombard) in virtue of a commercial insurance policy that provided coverage for goods in transit with a limit of $50,000, goods stored in a warehouse, and for general liability. The latter coverage was subject to an exclusion for goods under the care or direction of the insured.

Shortly after the subrogation action was initiated, Lombard sent a reservation of rights letter to its insured in which it confirmed that it would assume the insured’s defense. Lombard drew the insured’s attention to the fact that coverage for goods in transit was limited to $50,000. The letter said nothing insofar as the other coverages were concerned.

In its defense to the liability action, Air Pro raised that its liability was limited to several thousand dollars in virtue of the limitation of liability clause printed on the bill of landing issued by the carrier. The clause limited liability to the standard $4.41/kg.

The Superior Court dismissed Air Pro’s argument after finding that the goods were not “in transit” when the theft occurred. Therefore, the limitation of liability clause did not apply. The tribunal also concluded that Air Pro was liable to reimburse Lloyd’s for the full amount of its loss.

Upon reception of the judgment in 2009, Lombard sent a letter to Air Pro informing the latter that the $50,000 limit of coverage did not apply because the goods had been determined by the Superior Court not be “in transit” and therefore that the coverage for goods in transit did not apply. Lombard added in its letter that the civil liability coverage did not apply either because, on the one hand, the goods were not “stored” at the time they were stolen and, on the other hand, the exclusion pertaining to goods under the care or direction of an insured applied. The end result was that Lombard would not pay any indemnity.

Being unpaid, Lloyd’s executed its judgement by way of a seizure by garnishment in the hands of Lombard. Lombard filed a negative declaration in the court record that Lloyd’s contested. Lloyd’s argued that Lombard’s policy covered the loss in the circumstances revealed by the Superior Court judgment. Subsidiarily, Lloyd’s raised that Lombard was estopped from raising arguments of coverage that were not already in its reservation of rights letter sent to its insured in 2001.

The Superior Court dismissed Lloyds’ arguments relating to coverage. On that issue, the Court decided that the trial judge had determined that the goods were not “in transit”. The principle of “res judicata” applied and the coverage for goods in the course of transportation therefore did not apply. The Court also ruled that the rider applying to goods being stored did not apply since coverage was limited to goods situated inside the warehouse. As the goods had been placed in the trailer at the time of the theft, they were no longer covered in virtue of the warehouseman rider. Finally, the Court accepted Lombard’s position that the policy did not cover civil liability for goods under the care of the insured. More specifically, the Court dismissed Lloyds’ argument to the effect that by loading the goods in the carrier’s trailer that was subsequently closed and locked, the insured had no longer the control or care of the goods.

The Court, however, upheld Lloyds’ seizure by garnishment against Lombard for the reason that its reservation of rights letter of 2001 made no mention of the exclusion Lombard was now raising to deny coverage. The Court noted that Lloyds’ action against Air Pro was obviously based on the civil liability of the insured (as opposed to Air Pro’s liability as warehouseman or carrier). The allegations of the action were such that the coverage for civil liability would have been triggered had it not been of the exclusion. As Lombard had not raised that exclusion in its reservation of rights letter it was estopped from doing so after judgement was rendered. On this issue, the Court concluded :

“It (Lombard) had to raise all the exclusions applicable to the allegations of the action, even more so if the insured’s protection was different whether the goods were considered in transit or in storage by the Court” [Our translation]

A little further, the Court added :

“The fact that Air Pro knew Lombard would not have assumed the payment of 100% of the damages claimed (when it indicated in its reservation of rights letter that coverage for goods in transit was limited to $50,000) is not sufficient to fulfill its obligation to raise all the grounds of denial.”

The importance of the contents of a reservation of rights letter is critical. The message is clear. Insurers must raise in their reservation letters all limitations and exclusions that may reasonably apply given the allegations of the action. If the insurer does not do so immediately or shortly after the allegations of liability are known, it may be prevented from raising policy exclusions later.

Lombard presented a Motion for leave to appeal the judgment before the Court of Appeal, but the Motion was dismissed on December 6th, 2010.