Readers of this newsletter may be aware that liability insurance policies commonly impose, by written condition, obligations on the insured to given timely notice of a claim, to cooperate with the insurer’s defence of a claim and, by way of ‘voluntary payment clause’, provide that any expense the insured may incur without the consent of the insurer in respect of a claim is at the insured’s own cost. A typical form of the latter clause is as follows:
Except at its own cost, the Insured shall not voluntarily make any payment, assume any liability or obligation or incur any expense, unless with the written consent of the Insurer.
Despite this clear language, for a variety of reasons insureds occasionally incur expenses in the defence of a claim before the claim has been tendered to the insurer or notice has been given (called here, “Pre-Tender Expenses”), leading to disputes over whether such expenses are recoverable or not.
This article examines three recent decisions in this area.
We begin with Lloyd’s Underwriters v Blue Mountain Log Sales Ltd.[i] (“Blue Mountain”), a 2016 decision of the B.C. Court of Appeal. A U.S based affiliate of the insured (which carried on as a manufacturer of cedar shakes and shingles), was sued in Washington State. The U.S. affiliate tendered the claim to their U.S. based insurer (i.e., not Lloyd’s). Several months later, the plaintiff added the insured to the litigation. The insured did not immediately recognize that this triggered coverage under the Lloyd’s policy, and therefore did not tender their defence to Lloyd’s until months later.
Upon receiving notice of the claim, Lloyd’s acknowledged coverage for some of the causes of action and agreed to defend commencing on the date notice was given but refused to reimburse the insured for Pre-Tender Expenses (legal costs) in excess of $500,000. Lloyd’s then brought a petition in the B.C. Supreme Court for a declaration that it was not responsible for the Pre-Tender Expenses. Initially, Lloyd’s lost, and was held responsible for those costs on the basis of relief from forfeiture: late notice was a matter of inadvertence, and Lloyd’s had suffered no prejudice.
The Court of Appeal overturned and held that the unambiguous voluntary payment clause clearly placed responsibility for Pre-Tender Expenses on the insured. In so holding, the Court of Appeal noted a lack of relevant Canadian caselaw and diverging views in American jurisprudence before citing authors Lichty and Snowden, who wrote that “equity ought not to interfere in a contractual provision which serves to protect one of the parties from the other’s improvident or careless acts.”
Next is Aberdeen Specialty Concrete Services v. Temple Insurance Co.[ii] (“Aberdeen”), a 2021 decision of the Saskatchewan Court of Appeal which involved Pre-Tender Expenses claimed under a Wrap-Up liability policy issued by Temple for a seniors retirement living facility being built in Saskatoon. The Wrap-Up was subject to notice and voluntary payment clauses and provided coverage for the Owner, the general contractor, and all subcontractors for liability for property damage in connection with the project.
When problems arose with the project, the owner sued the general contractor, who sued the subcontractors for damage caused by their work. The subcontractors notified their individual liability insurers and retained their own counsel not realizing that they had primary coverage under the Wrap-Up until being so notified at a later date by Temple itself. At that time, Temple acknowledged a duty to defend the claims, but refused to reimburse the subcontractors for Pre-Tender Expenses they had incurred, leading to proceedings to determine the issue.
In the lower court, the Judge found Temple liable for the Pre-Tender Expenses, reasoning that Temple had effective notice of underlying events by reason of the Owner having made an early but ill-founded first-party claim under the Wrap-Up for remedial work required for the project. Such claim had been made before the owner commenced legal proceedings against the general contractor.
The Court of Appeal reversed and followed Blue Mountain.
As to early “effective” notice, the ill-founded first party claim might have given Temple notice that in due course the Owner might sue a party who might potentially then seek coverage under the Wrap-Up, but such knowledge could not be construed as notice of claims on the part of the subcontractors, which had not yet even arisen. As the Court of Appeal put it, “the effect of [the lower court’s] finding is that Temple is deemed to have notice of a claim that had not yet been made … on the basis of knowledge that Temple had gleaned by investigating a claim that did not fall within the terms of the Wrap-Up Policy.” Such a finding was inconsistent with the terms of the Notice clause.
Turning to the voluntary payments clause, the Court of Appeal found that it applied to preclude reimbursement of Pre-Tender Expenses even if Temple had earlier “effective” notice. Reading the voluntary payments clause, the Court found “no words that limit its application to whether the insurer has received effective notice.” Further, the fact the subcontractors were initially unaware that they were insured under the Wrap-Up was not relevant. Following Blue Mountain, what is relevant is that the insureds voluntarily paid legal fees without the insurer’s involvement, and “equity ought not to interfere in a contractual provision which serves to protect one of the parties from the other’s improvident or careless acts”.
Lastly, and because no article is complete without a case going the other way, we find Distillery S.E. Development Corp. v. Temple Insurance Co.[iii] (“Distillery”), a 2022 decision of the Ontario Court of Appeal.
The underlying litigation involved construction defect claims by the current owner of a condominium tower against the original project proponents, who in turn issued third party claims against the general contractor and a host of subtrades. Again, there was a Wrap-Up liability policy insuring the original proponents, the general contractor and subtrades. The Wrap-Up was subject to exclusions for repair or replacement of defective work and a $10,000 deductible for Property Damage.
The exclusions and deductible were significant in that the insurers argued that the vast majority of the claims were excluded, and there was only the possibility of coverage for an amount less than the deductible – and they should not be required to defend at all in those circumstances. The main issue in the application was therefore whether the insurers had a duty to defend at all, on which the Court of Appeal ruled against the insurers.
For our purposes, the case also addressed reimbursement of defence costs incurred by the project proponents including a relatively modest amount of “pre-notification” costs. Without citing authority, the Court of Appeal refused to allow the insurers to avoid paying the “pre-notification” costs despite the existence of a voluntary payments clause[iv], giving three reasons: it would be “unfair” to allow the insurers to rely on the clause where they had denied a duty to defend; the insurers did not allege they would have retained less expensive counsel or followed a different litigation strategy if notified earlier; and the “pre-notification” costs were modest – only 11% of the costs at issue.
Conclusion
What might we conclude from the foregoing?
- Lower courts seem eager to find ways to avoid the effect of a voluntary payment clause;
- Aberdeen and Blue Mountain strongly support the position that a voluntary payment clause precludes reimbursement of Pre-Tender Expenses at least in the circumstance where the insurer assumes the defence after formal notice of the claim has been given; and
- Distillery suggests that Pre-Tender Expenses might be payable in similar circumstances as pertained in the case, but it is not clear whether all three circumstances must exist or not. Relatedly, it remains to be seen how strong an authority Distillery will prove to be when it comes to the issue of Pre-Tender Expenses, given that the issue was addressed in only two paragraphs and no reference was made to relevant caselaw or even to the precise terms of the policy Condition.
[i] Lloyd’s Underwriters v Blue Mountain Log Sales Ltd. 2016 BCCA 352.
[ii] Aberdeen Specialty Concrete Services v. Temple Insurance Co. 2021 SKCA 94
[iii] Distillery S.E. Development Corp. v. Temple Insurance Co. 2022 ONCA 390
[iv] The actual clause is not reproduced either by the Court of Appeal or in the lower court decisions, but the Court of Appeal refers to the existence of a Condition whereby the insureds were not to incur any expenses before notification.