Ontario – insurer’s duty to defend in arbitration includes right to select/add new counsel and control defence – #308

In Panasonic Eco Solutions Canada Inc. v. XL Specialty Insurance Company, 2020 ONSC 1502, Mr. Justice Markus Koehnen granted in part an arbitral defendant’s application to enforce its insurer’s duty to defend.  That duty also included the right under the policy to select and add new counsel in the arbitration to defend that portion of the claims made by the third party in the arbitration.  The insured and insurer were bound by the allegations of fact made in the arbitration and not the legal characterization made by the third party about those facts.

XL Specialty Insurance Company (“XL”) issued an errors and omissions policy (“Policy”) to Panasonic Eco Solutions Canada Inc. (“Panasonic”).  Under the Policy, XL undertook the obligation to:

(i) pay monetary judgments which Panasonic becomes legally obligated to pay because of a claim “resulting from an act, error or omission” in “Professional Services” as defined in the Policy; and,

(ii) defend Panasonic against any claim to which the Policy applied “even if any of the allegations are groundless, false or fraudulent”.

The Policy excluded coverage for claims arising out of Panasonic’s assumption of liability in a contract or for breach of contract unless the liability is one which Panasonic would have had in the absence of a contract.

A third party, Solar Flow-Through Fund (“Solar Flow”) commenced arbitration against Panasonic and made two (2) separate monetary demands:

(a) liquidated damages of $92,309.62 arising out of an Engineering, Procurement and Construction Agreement (the “Engineering Agreement”) – (“Liquidated Damages claim”); and,

(b) damages estimated at $1,300,000 arising out of what the parties have referred to as the Proceeds Agreement – (“Proceeds Agreement claim”).

Panasonic received invoices from defense counsel of $492,965.25 to defend in the arbitration.  The arbitration remains active and the costs are expected to increase.  XL refused to pay those costs, asserting that the liability alleged by  Solar Flow against Panasonic in the arbitration arose out of an allegation of breach of contract regarding which Panasonic would not have in the absence of a contract and therefore XL had no duty to defend.

Panasonic applied for a declaration that XL owes it a duty to defend in the arbitration.

Koehnen J. sets out the scope of each claim more fully at paras 6-11 of his reasons.  In his analysis, he addresses the liquidated damages claim at paras 19-27 and the proceeds agreement claim at paras 28-36. Koehnen J. held that, on the record before him, XL had a duty to defend on the liquidated damages claim seeking $92,309.62 but no duty to defend on the proceeds agreement claim seeking $1,300,000 in estimated damages.

The result rests on the facts alleged by Solar Flow and do not lend themselves to extensive application to other factual matrixes.  Koehnen J. did identify the principles applicable to determining whether a duty to defend arose or not.

First, the court should focus on the facts alleged and not on a party’s legal characterization. 

[26] While that may be the case, the Supreme Court of Canada has pointed out that,  in deciding whether there is a duty to defend, the court should focus on the facts alleged in the underlying pleading and not on the pleading’s legal characterization of the claim.  Simply because the underlying pleading alleges breach of contract does not mean that an insurer under an errors and omissions policy does not have a duty to defend. If the facts alleged are capable of supporting a tort, then the duty to defend is triggered, regardless of whether the claim pleads tort:  Non-Marine Underwriters, Lloyd’s London v. Scalera, 2000 SCC 24 [,[2000] 1 SCR 551] at para. 83.

[27] Presumably one issue in the arbitration may be whether the failure to achieve Substantial Completion was due solely to Panasonic’s acts or omissions or whether the delay was attributable to circumstances beyond Panasonic’s control.  If it is the former, it will be up to Panasonic and XL to determine whether the acts or omissions that led to the failure of Substantial Completion by the Guaranteed Date are acts of negligence which are insurable or whether the delay is attributable to deliberate choices by Panasonic such as diverting staff from work under the Engineering Agreement to other, perhaps more profitable, projects which would not fall within coverage under the Policy”.

Second, Solar Flow’s use of such terms as “negligent misrepresentation” or an alternative claim of unjust enrichment as an equitable remedy did not engage XL’s duty to defend.  Terms such as “negligent misrepresentation” are “simply labels” as stated in Rashid v. Intact Insurance Company, 2011 ONCA 806:

[7] In our view, the claims for negligence in this case are simply labels.  The substance of the allegations are breaches of contract.  The only duties underlying the negligence claims are the duties found in the contracts pleaded.  Thus, we agree with the application judge that the insurance policy does not cover the claims of negligence”.

An equitable remedy does not expand the duty to defend to include excluded liability.

[35] Unjust enrichment is an equitable remedy.  The Policy excludes liability for equitable relief.  This exclusion arises through the defined terms in the policy.  As noted earlier, the policy provides coverage for “Professional Loss which the insured becomes legally obligated to pay because of a claim resulting from an act error or omission in professional services.”  Professional loss is defined in the policy. The conclusion of the definition provides “Professional Loss does not include: (i) injunctive or equitable relief…”

[36] Moreover, the whole purpose of insurance is to provide protection against fortuitous risk. The nature of the unjust enrichment claim here is not one that arises because of fortuitous risk that Panasonic has incurred. Instead it arises out of conscious, intentional, deliberate conduct to deprive Solar Flow of a sum of money that Solar Flow alleges it is entitled to.  In this light, the claim for unjust enrichment is a substitute for a contract claim in the event that the elements of contract are not made out.  That does not, however, turn it into a claim on account of a fortuitous risk”. 

In light of his determinations, Koehnen J. invited Panasonic and XL to reach agreement on allocation of past defence costs in the arbitration given that the Liquidated Damages claim and Proceeds Agreement claim are “quite discrete”.  Failing agreement, he confirmed his availability to “fashion a process whereby that issue can be determined efficiently although I will not necessarily be the one making that determination”.

Role of insurer in arbitration – At paras 37-43, Koehnen J. considered the impact of the duty to defend and how to exercise it following the denial of both coverage and duty to defend.  XL sought the right to control the defence for which it had a duty to defend.  Koehnen J. agreed with XL and ordered that it could control the defence for the Liquidated Damages claim but not the Proceeds Agreement claim. The Policy included Panasonic’s agreement that XL’s duty to defend included “the right to select counsel”.

[40] To avoid any possible allegation of conflict of interest between the insurer or the insured given that XL has denied both coverage and a duty to defend,  XL has offered that the adjuster with carriage of the defence will be different from the adjuster who had carriage of the coverage issue, and that new defence counsel will not have any discussions with the coverage counsel, the coverage adjuster or other XL personnel involved in the coverage issues to date.  The terms of that offer should be incorporated into the provisions of the formal order arising out of these reasons”.

Judicial costs of Panasonic’s application – Regarding costs of the application, Panasonic submitted precedents granting costs on a full indemnity scale to an insured which succeeded in a duty to defend application. See E.M. v. Reed, 2003 CanLII 52150 (ON CA) and Godonoaga v. Khatambakhsh, 2000 CanLII 16891 (ON CA). Koehnen J. dismissed the request, holding that it was inappropriate in the circumstances.

[45] I do not believe that would be appropriate here.  As noted above, the real economic battle was not about the duty to defend a liquidated damages claim.  That claim should be capable of relatively easy resolution.  The real issue concerns the duty to defend against the allegations under the Proceeds Agreement; an issue on which Panasonic failed”.

urbitral note – First, the insurer was ordered to defend only part of the claims but it did obtain confirmation that it could select different counsel to appear in the arbitration. The addition of new counsel enforces the bargain made between the insured and the insurer and preserves the bargain until the completion of the arbitration of the claim subject to the duty to defend or its resolution by settlement. 

The addition of new counsel was authorized because it was part of the duty to defend and not because of any hint of issues with current counsel. Exercising the right to appoint counsel stemmed from the Policy and arises independent of the quality of the services provided and cannot be easily anticipated.

In the present case, new counsel would be appointed but not to replace current counsel, only to add to the representation and be limited to the claim covered by the duty to defend. In another case, where the duty to defend might have comprised the entirety of the claim, the right to select counsel might have more impact on the arbitration. Even in such cases, new counsel cannot revisit prior agreements made in the arbitration or assert the right to do so exclusively in light of new counsel’s different opinion as to what procedures are appropriate or sufficient.

The addition of new counsel in an ongoing arbitration requires care not to unduly affect or revisit the dynamic and arrangements established to date in the arbitration, including disclosures by the tribunal, procedural steps/decisions taken to date and the manner in which the parties agreed to prepare for the hearing on the merits.  Such issues need to be addressed so as not to affect the bargain made by the parties to the arbitration.  The insurer’s rights vis-à-vis its insurer do not prevail over (i) the other arbitral party’s rights in the arbitration to respect of the bargain it made to arbitrate and (ii) arrangements made up to that date, subject to the ability to renegotiate them or modify them upon application to the arbitral tribunal.

Second, the principles established by Koehnen J. urge parties to focus more on the facts alleged than the legal characterization assigned to them.  In this case, neither of the parties had drafted the allegations and were not held to the characterization. The allegations made by a third party in the arbitration served as the frame for Panasonic and XL to dispute the duty to defend.  Unlike applications to stay litigation or refer the parties to arbitration, neither Panasonic nor XL had control over the claims made which prompted their dispute over the duty to defend.

Third, regarding recovery of the costs of the application, the Ontario Court of Appeal provided the following statements in the cases submitted by Panasonic.  Despite those broad statements, Koehnen J.’s decision on costs of the judicial application serves as a caution. His costs decision appears to urge litigants against making such applications and, instead, apply the principles he identified especially when the claims are “quite discrete”.

From Godonoaga v. Khatambakhsh, 2000 CanLII 16891 (ON CA):

[4] The appellants were entitled to a defence by their insurer without expense to them. Accordingly, that matter now having been determined in their favour, they should have their costs on a solicitor and his own client scale for the defence of the main action and cross-claims until such time as the respondent insurer serves and files a notice of change of solicitors and takes over the insurers’ defence. Such costs would include the conduct of the third party proceedings and the motion before Pitt J. and this appeal. It would, of course, obviate the necessity of determining their party and party costs of this appeal as ordered by the court”.

From E.M. v. Reed, 2003 CanLII 52150 (ON CA):

[22] Entitlement to solicitor-and-client costs in the third party proceeding flows directly from the unique nature of the insurance contract which entails a duty to defend at no expense to the insured.  The obligation to save harmless the insured from the costs of defending the action is sufficiently broad to encompass the third party proceedings.  It is the contractual basis for the claim to solicitor-and-client costs that justifies the award and therefore constitutes an exception to the usual rule that solicitor-and-client costs will not be awarded except in unusual circumstances”.