On November 29, 2017, Justice De Sa granted an Application brought by an insured seeking autonomy in defending an action against it despite the insurers paying for its lawyers.  The Applicants argued that their cross claim against the co-defendants, also defended by the same insurers, put the insurers in a position of conflict of interest.  The insurers argued their ability to appoint and instruct counsel is a natural corollary of the duty to defend.

While walking on King Avenue East, Mr. Lefeuvre was hit by a car driven by Boekee.  Lefeuvre sued five parties; Boekee, the Regional Municipality of Durham (“Durham”), its road maintenance contractor, Miller, the Corporation of the Municipality of Clarington (“Clarington”) and its street lighting contractor, Langley.  Like most standard indemnity clauses between contractors, Miller’s contract with Durham required them it to fully indemnify Durham for any claims against Durham arising from Miller’s responsibilities, which included maintenance of King Avenue East.  Durham third partied Miller’s insurer, Zurich for coverage.  Similarly, the street lighting maintenance contract between Clarington and Langley obliged Langley to indemnify Clarington for Langley’s responsibilities.  Langley held a CGL policy through the Dominion and Clarington was a named additional insured (for actions arising from Langley’s contractual obligations).  Clarington third partied Dominion for coverage arising from Langley’s negligence.

Zurich and Dominion (the Respondents) agreed to defend Durham and Clarington (the Applicants) in respect of any of the claims advanced by Lefeuvre, regardless of the nature of the allegations being covered and uncovered as part of their duty to defend. However, the issue dealt with on the Application was whether or not the Respondent Insurers, Zurich and Dominion, were entitled to appoint counsel and control the defence for the Applicants, Durham and Clarington.

The Applicants argued that because Zurich and Dominion were only liable to indemnify them to the extent of Miller’s and Langley’s liability, the defence furnished by the insurers will favour the position of the Contractors (Miller and Langly) creating a conflict of interest.  The Respondents relied on their contractual right, under the policies to manage the defence as part of their duty to defend. Their position was essentially, if they are paying for the defence they are entitled to oversee it.  Further, they argued, there is always an “inherent tension” when dealing with covered and uncovered claims but absent “wrongful conduct” on the part of the insurer, the inherent tension is insufficient to shut out the insurers’ carriage of the defence.

Test and Decision
Justice DeSa followed the test of “a reasonable apprehension of conflict of interest” as set out by the Court of Appeal in Brockton v Frank, 2002 CanLII 7392 (ON CA) at para 43:

I agree with the approach taken in Zurich and Foremost. The issue is the degree of divergence of interest that must exist before the insurer can be required to surrender control of the defence and pay for counsel retained by the insured. The balance is between the insured’s right to a full and fair defence of the civil action against it and the insurer’s right to control that defence because of its potential ultimate obligation to indemnify. In my view, that balance is appropriately struck by requiring that there be, in the circumstances of the particular case, a reasonable apprehension of conflict of interest on the part of counsel appointed by the insurer before the insured is entitled to independent counsel at the insurer’s expense. The question is whether counsel’s mandate from the insurer can reasonably be said to conflict with his mandate to defend the insured in the civil action. Until that point is reached, the insured’s right to a defence and the insurer’s right to control that defence can satisfactorily co-exist. [Emphasis added].

Justice DeSa concluded that the inherent conflict of interest in this case was evident because;

1. The bulk of Durham’s and Clarington’s defence were that the Contractors (Miller and Langley) failed to carry out their responsibilities.
2. The Insurers were only liable to indemnify Durham and Clarington to the extent of the Contractors’ liability.
3. Information obtained from Durham and Clarington may be used against them in the litigation to protect Zurich’s and Dominion’s pecuniary interest.

The essence of a conflict of interest as cited by Justice De Sa was explained by the Supreme Court in  Canadian National Railway Co. v. McKercher LLP, [2013] 2 SCR 649, 2013 SCC 39 (CanLII), the Supreme Court at para 23:

The law of conflicts is mainly concerned with two types of prejudice: prejudice as a result of the lawyer’s misuse of confidential information obtained from a client; and prejudice arising where the lawyer “soft peddles” his representation of a client in order to serve his own interests, those of another client, or those of a third person. As regards these concerns, the law distinguishes between former clients and current clients. The lawyer’s main duty to a former client is to refrain from misusing confidential information. With respect to a current client, for whom representation is ongoing, the lawyer must neither misuse confidential information, nor place himself in a situation that jeopardizes effective representation.

The Respondents’ suggestion that “ethical walls” sufficiently address these concerns was rejected. The court ordered the Respondents to compensate the Applicants for past reasonable costs incurred, to pay for but not chose or instruct defence counsel for  the Applicants against all allegations in the Main Action and the Third Party Actions and to determine disputes arising over costs attributable to “covered” claims to be addressed at settlement or the end of trial.  The court further ordered that the Applicants were not required to report to the Respondent Insurers (aside from settlement discussions).

This decision is a good reminder for insurers to be prepared to reserve double defence costs when the duty to defend has been acknowledged in cases where co-defendants protected by the same policy have serious allegations against each other and/or information supporting those allegations that will affect liability and ultimately, the insurer’s duty to indemnify.  From a practical viewpoint, insurers may consider acknowledging complete indemnity in circumstances of clear liability evidence and crystalized damages.  

The ruling indirectly speaks to a trending issue that arises in cases where some or all parties are insured by the same company.  While practical underwriting solutions may protect litigating insureds from adverse claim ratings allowing defence costs to be shared among insureds, insurers should remain cognizant that their duty to defend does not necessarily buy control over the defence of an action.

At the outset of litigation, appointing separate counsel in either situation can seem unnecessary and wasteful when interests of all defending parties are 99% aligned.  However, pitfalls can arise in the course of litigation when information comes to light that clearly diverges the position of litigants. Ultimately, it is up to the insurers and their coverage counsel to determine at what point a potential conflict of interest becomes a reasonable apprehension.

Shanti Barclay is a member of the General Liability group. If you have a question about this decision or a similar file, please contact Shanti.