Special thanks to SBA articling student Ethan Edwards for his invaluable research and assistance writing this blog.
The Ontario Court of Appeal recently considered the traditional pleadings rule and found that the duty to defend cannot be ousted by use of premature evidence, that being evidence that would require findings to be made before trial, referred to as a “trial within a trial.”
The underlying action involved the City of Timmins being sued by property owners in a progressive property damage claim. The property owners purchased vacant land and built a home after obtaining several permits, including one from the City. Since September 2016, ongoing erosion began to impact the stability of the property until, in December 2019, the City issued an order requiring either the removal, relocation, or demolishment of the home. The property owners sued the City for negligence, relying on a report prepared at the City’s request by a geotechnical firm in May 2017, which allegedly alerted the City to the ongoing property damage.
The City had general liability insurance policies with two different insurers. AIG Insurance Company of Canada provided coverage for 2016 and 2017, and Lloyd’s Underwriters provided coverage for 2018 and 2019. While AIG agreed to defend the City, Lloyd’s refused to defend on the basis that the City’s knowledge from the May 2017 report of the ongoing property damage ousted its duty to defend and the obligation to provide coverage under the policy. The statement of claim contained allegations referencing the May 2017 report.
AIG brought an application to determine whether Lloyd’s had a duty to defend and contribute to the costs of the underlying action. Lloyd’s acknowledged that the alleged negligence occurred during its coverage period. However, Lloyd’s took the position that the property damage was not caused by an “occurrence” as required to engage coverage under its policy. The May 2017 report had provided notice to the City of the ongoing property damage such that its failure to implement recommendations meant that the damage was no longer accidental, and the “occurrence” alleged in the statement of claim had terminated once the report was issued.
In the alternative, if found to be an “occurrence”, Lloyd’s argued that the Exclusion Clause in the policy applied to oust the duty to defend. The Exclusion Clause barred coverage where, from the standpoint of the insured, further property damage was expected. Therefore, the City had been alerted by the May 2017 report that further damage was expected and could not rely on the insurer to defend the action.
With both arguments, Lloyd’s asserted that the May 2017 report was part of the statement of claim. Therefore, Lloyd’s argued that according to the “traditional pleadings rule”, the contents of the May 2017 report were assumed to be true.
The application judge held in favour of AIG and ordered that Lloyd’s would contribute to 50% of the costs to defend the underlying action. The judge found that the May 2017 report was not sufficiently robust in its analysis and conclusions to be incontestable, in that it was made on a preliminary basis with qualifying language and was not fairly construed as a “crystalizing event” after which ongoing damage would no longer be seen as accidental.
Lloyd’s first argument was that the application judge erred in his treatment of the May 2017 report by failing to apply properly the traditional pleadings rule. The Supreme Court of Canada in Monenco Ltd v Commonwealth Insurance(2001) set out the legal principles to assess whether the duty to defend has been triggered. The starting premise is the traditional pleadings rule, which directs the court to look to the substance and true nature of the pleadings and assess whether the claim, assumed to be true, would attract coverage under the policy. The court may look to extrinsic evidence explicitly referred to in the pleadings, but it may not look to premature evidence or evidence that would require findings be made before trial that would affect the underlying litigation.
The Court found that the application judge applied the traditional pleadings rule correctly. The rule assumes the pleadings to be true, but this assumption does not extend to extrinsic evidence itself. The May 2017 report was not part of the pleadings. It was extrinsic evidence. There is a prohibition against reliance on contested evidence as it would risk the application judge having to conduct a “trial within a trial,” leading to premature findings on controversial facts best left to the judge hearing the underlying action. Here, the application judge found that the report was not as conclusive as Lloyd’s argued it to be and held that the duty to defend was clearly triggered based on the pleadings.
The second argument advanced by Lloyd’s was that the application judge erred in determining that the Exclusion Clause did not apply. The Court again disagreed. Neither the pleadings nor the May 2017 report assisted in the claim that the Exclusion Clause applied. The substance and true nature of the statement of claim was negligence, which falls squarely within the coverage offered by the policy. The Report was premature evidence and was not the “crystallizing event” that Lloyd’s claimed it was.
As an interesting sidenote, the parties agreed that the standard of review was correctness when interpreting the Exclusion Clause, but the issue on appeal was whether the application judge erred in deciding on the duty to defend the underlying action. The Court of Appeal held that the correctness standard did not apply in this case because the alleged errors related to the application judge’s treatment of the May 2021 report, which was part of the factual matrix specific to the parties in the proceeding. Therefore, a deferential standard of review, or reasonableness, would apply. But in any event, the Court of Appeal found that the application judge’s decision was correct.
The Court did not throw any major changes into the insurer’s duty to defend; however, it has reaffirmed and clarified legal principles that insurers should consider when assessing defence decisions. First, the traditional pleadings rule applies as a starting premise to look to the substance and true nature of the pleadings. In deciding whether the duty to defend is triggered, the insurer must assume the pleadings are true and then consider whether the claim would fall within an insured risk under the policy. Second, insurers may look to extrinsic evidence mentioned in the pleadings to determine the substance and true nature of the claim, but it cannot rely on premature evidence and assume it to be true. Evidence that would require the application judge to determine contested facts or hold a “trial within a trial” is premature and should not be determinative to oust the duty to defend.
See AIG Insurance Company of Canada v. Lloyd’s Underwriters, 2022 ONCA 699
Daniel loves coverage. Want to know if the “your work” exclusion applies? Ask Dan. Want to know if a “house” is a “home”? Ask Dan. Want to know the best toppings to cover a pizza? Don’t ask Dan: He can’t eat gluten. But he does digest various insurance policy definitions, wordings, and exclusions without any heartburn.