According to the next to last words of the renowned criminal genius Vizzini, the greatest mistake is to get involved in a land war in Asia. “But”, he famously continued, “only slightly less well known is this: never attempt to prove disputed facts which might jeopardize your insured’s underlying legal position, in order to establish that you have no duty to defend”.

A recent decision involving this principle is called Borgatti Estate, which also is notable for its application of the doctrine of estoppel in the context of an insurer’s unsuccessful effort to escape a duty to defend several claims against its insured arising from a boating accident, including due to late provision of Reservation of Rights letters.

As the background facts, Mr. Borgatti was the owner a boat insured under a watercraft insurance policy which contained, among other things, a Safety Equipment Warranty.

Tragically, the Borgatti boat collided with another watercraft resulting in injuries and fatalities to multiple persons (including Mr. Borgatti). Several personal injury actions were commenced against his Estate and in addition, the Estate claimed under the Policy for damage to the boat.

The investigation into what occurred ultimately led Mr. Borgatti’s insurer to conclude that certain equipment was not functional at the time of the accident in breach of the Safety Equipment Warranty. According to the decision, some evidence arguably tending to that conclusion was available shortly after the accident, while additional evidence was received and developed by the insurer later including through a commissioned expert report referred to as the “Schouffoer Report”.

In the meantime and among other things, the insurer had confirmed that it would appoint defence counsel to respond to the actions against the Estate, but had not alerted the Estate of a potential concern with the Safety Equipment Warranty or issued a Reservation of Rights letter. Further, the Borgatti boat was disposed of by the insurer (who had completed its examination).

The insurer thereafter did issue several reservation of rights letters and ultimately, with the Schouffoer Report in hand, denied coverage and brought summary judgment proceedings in the Federal Court against the Estate seeking amongst other things, declarations that the claims asserted against the Estate were not covered such that it had no duty to defend or indemnify on the basis of the alleged breach of the Safety Equipment Warranty.

Ultimately, the insurer was estopped from denying coverage on the basis of the Safety Equipment Warranty, with the court pointing to its conduct in having, among other things, advised the Estate that defence counsel would be appointed, disposed of the boat before notifying the Estate of the Safety Equipment Warranty issue (so that the Estate could not complete its own examination of the physical evidence), and having failed to timely provide a reservation of rights letter. From that point of view, key take aways include the necessity of timely issuance of a reservation of rights letters and preservation of key evidence.

However, the case is interesting as well from the perspective of the near to last words of Vizzini faithfully recited at the outset. In seeking summary judgment disposing of its indemnity and defence obligations to the Estate, the insurer filed and sought to rely on the Schouffoer Report to establish that the Safety Equipment Warranty had been breached by Mr. Borgatti.

The Estate argued successfully that the Court should disregard the Report entirely and took issue with the propriety of it being filed given that it expressed opinions “arguably supportive of liability on the part of Mr. Borgatti for the Collision…” in the underlying tort claims against the Estate. Any findings by the Court as to the non-operation of safety equipment prior to the accident could prejudice the Estate’s defence to the underlying claims.

The question of whether an insurer has a duty to defend its insured against liability claims is usually determined based on an examination of the pleadings and the policy wording alone, with cases such as Monenco v. Commonwealth holding that “The mere possibility that a claim falling within the policy may succeed will suffice” to trigger a duty to defend.

The question of whether extrinsic evidence can be relied on in a duty to defend dispute (meaning, evidence apart from the policy wording and pleadings) was discussed in Monenco where the court, without deciding the extent to which extrinsic evidence can be considered, confirmed at the least that “extrinsic evidence … explicitly referred to within the pleadings may be considered to determine the substance and true nature of the allegations, and thus, to appreciate the nature and scope of an insurer’s duty to defend”, but the court hearing such an application may not look to “premature evidence” being evidence “which, if considered, would require findings to be made before trial that would affect the underlying [tort] litigation” against the insured. A duty to defend application, which typically arises as a preliminary matter (shortly after underlying claims are asserted), should not become a “trial within a trial”.

In addition to Monenco, the Borgatti court cited a 2008 Ontario decision called Unique Labelling, where the court cautioned, “whether coverage is conceded or denied in respect of a particular claim, the insurer must endeavour not to compromise the position of the insured in the underlying action…”, and a 1994 case called Slough Estates, which applied analogous American authority in context of competing motions for summary judgment by insured and insurer.

The underlying action in Slough Estates involved allegations by the plaintiff that the insured owned adjacent lands and stored thereon certain pollutants which spilled or escaped (negligently or otherwise) starting at a time unknown to the plaintiff (but allegedly known to the defendant/insured), and which migrated into and contaminated the plaintiff’s lands. The defence denied the allegations.

In the coverage dispute, the insured sought summary judgment requiring the insurer to defend the underlying action relying on the allegations and coverage terms, while the insurer denied it had a duty to defend and itself sought summary judgment dismissing, alleging among other things that the liability policy was void ab initio due to material non-disclosure by the insured of historic pollutant spills at the site in question. The insurer tendered affidavit evidence which it viewed as evidencing the insured’s prior knowledge, and therefore the existence of a material non-disclosure at policy inception. For its part, the insured tendered affidavits denying knowledge of historic spills or that any material spills had occurred.

Considering the competing motions, the court first assessed the insured’s motion for judgment for a duty to defend, finding in its favour based on the allegations in the underlying action and policy language. Turning to the insurer’s motion for summary judgment (reliant on affidavit evidence), the court followed a California decision called Montrose Chemical respecting the availability of extrinsic evidence, quoting with approval the following passages from that case:

…we see the critical distinction as not whether extrinsic evidence may be considered, but whether such evidence presents undisputed facts which conclusively eliminate a potential for liability.

…

…an insurer will be required to defend a suit where the evidence suggests, but does not conclusively establish, that the loss is not covered. …A carrier remains free to seek declaratory relief if undisputed facts conclusively show, as a matter of law, that there is no potential for liability.

…

There are at least two exceptions to the general rule barring declaratory relief on the insurer’s duty to defend. First, declaratory relief is available if the insurer can establish lack of coverage by means of facts that the insured does not dispute. Second, declaratory relief is available if the insurer’s defense to coverage hinges on factual issues that are unrelated to the issues in the third party liability action. … In each of these situations, the duty to defend can be determined without forcing the insured to litigate issues that may arise in the third party action

…

An insurer moving for summary judgment must demonstrate an absence of coverage without engaging in litigation that could prejudice the insured’s interests in the third party action. It can do so either by relying on undisputed facts or by adducing evidence of facts unrelated to the issues in the liability action. If the trial court determined that the facts on which the insurer relies are disputed and may be litigated in the liability action, the court should deny summary judgment and stay or dismiss the declaratory relief action.

In the result, the court in Slough Estates followed Montrose, saying “the attempt by the insurer to prove facts that are in dispute between the insured and the plaintiff jeopardize the defence of their insured and should be left to the trial judge”.

Returning to Borgatti, the court likewise concluded,

I am satisfied that it would not be in the interest of justice for the Court to make findings in this Motion that, if such findings should favour [the insurer], could operate to the Defendants’ detriment in the underlying tort litigation.

The foregoing review highlights the constraints under which an insurer must operate when called upon to defend a claim which may attract coverage based on the allegations and policy terms, but where it believes – and even has evidence – that there will be no coverage at the end of the day. While there is precedent for the limited use of extrinsic evidence to evaluate a duty to defend at the outset, such use is subject to serious limits.  Certainly, extrinsic evidence should not be tendered to prove disputed facts which might jeopardize the insured’s underlying legal position vis-à-vis the third party plaintiff.