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Ontario Court of Appeal rules that an insurer is unable to rely on contested allegations of misrepresentation by the insured to escape its duty to defend

Ontario

,

Canada

Duty to Defend When the Insurer Alleges Misrepresentation by the Insured In IT Haven Inc. v. Certain Underwriters at Lloyd’s, London, 2022 ONCA 71, the insured, IT Haven Inc. (“IT Haven”) was incorporated in 2016 and was engaged in the information technology business. Immediately following incorporation, the insured obtained a liability insurance policy from the appellants which provided coverage for “Wrongful Acts”. The definition of “Wrongful Act” included numerous types of intellectual property violations. In 2019, IT Haven was sued by a video game producer, Niantic, who alleged that IT Haven infringed its intellectual property by distributing unauthorized derivative versions of its computer applications and in so doing, incorporated substantial portions of Niantic’s copyrighted code.The appellant refused to defend IT Haven against Niantic’s claim on the basis that they had made misrepresentations when they applied for the policy, failed to inform them of material changes in IT Haven’s business, and breached the conditions of the policy. IT Haven brought an application for a declaration that the appellant was required to provide a defence. Application Judge’s Decision Edwards J. ruled that the appellant was required to defend IT Haven from the Niantic claim since insurers owe a duty to defend where there is a mere possibility that a claim falls within the insurance policy. The Niantic claim fell squarely within the coverage afforded by the policy, occurred during the time covered, and was not subject to any exclusion. Edwards J. declined to rely on extrinsic evidence presented by the insurer, since it was premature (i.e., it would have required findings to be made before trial that could affect the underlying litigation). Appeal Strathy C.J.O. agreed with the application judge and dismissed the appeal, but for “slightly different reasons” (para 30). Strathy C.J.O. distinguished this case from “classic” duty to defend cases where courts apply the pleadings rule. Under the pleadings rule, an insurer is required to provide a defence when the pleadings allege facts that, if true, would require the insurer to indemnify the insured in respect of the claim. The mere possibility of coverage triggers the duty to defend, and the insured has the onus of establishing that the claim falls with the policy (para 32).Strathy C.J.O. explained that judges have been reluctant to consider extrinsic evidence in duty to defend applications for two reasons: (1) the use of extrinsic evidence to determine whether the insurer owes the insured a duty to defend could require findings of fact or the resolution of live issues in the underlying litigation, which could lead to prejudice, and (2) the use of extrinsic evidence could prevent the issue being resolved expeditiously, which could leave the insurer stranded in his or her litigation (para 38-39).It was inappropriate, in the opinion of Strathy C.J.O., to characterize this case as an ordinary duty to defend case, since the appellant did not argue that the claim fell outside of the policy or was subject to an exclusion. Rather, the appellant had contended that since the insured had made misrepresentations in the insurance application and breached policy conditions, it had no duty to defend. These unproven allegations were contested and would require determinations of some of the issue in the Niantic action (para 40-45).Strathy C.J.O. relied on the Court of Appeal’s decision of Longo v. Maciorowski, 2000 CanLII 16897 (ON CA) and the New Brunswick Court of Appeal’s decision in Drane v. Optimum Frontier Insurance Co., 2004 NBCA 52 which had applied it, for the proposition that a flexible approach had to be taken to determine whether an insurer has a duty to defend where there are allegations by the insurer that the insured breached the terms of the policy (para 46). A flexible approach was necessary since a hard and fast rule could potentially cause prejudice to either the insured or the insurer. A rule that allowed an insurer to avoid the duty to defend by making allegations of a breach would be unfair to the insured. On the other hand, requiring the insurer to defend automatically despite the possible breach of conditions could prejudice the insurer who might be unable to later recover costs from an impecunious insured that it was forced to defend (para 48).Strathy C.J.O. stated that the dispute was fundamentally a misrepresentation case and not a breach of condition case, but that this flexible approach was appropriate since in either situation the issue was whether the actions of the insured had invalidated coverage that would otherwise have been available (para 55). Strathy C.J.O. considered several factors including that (1) the allegations of misrepresentation were “hotly contested”, (2) there was a manifest risk of inconsistent findings, (3) factual matters and expert evidence would be required to resolve the misrepresentation issue, (4) there was no information before the Court concerning the state of the Niantic litigation, (5) there was no evidence of IT Haven’s financial ability to defend the Niantic action, and (6) there was no evidence that IT Haven would be unable to reimburse the appellant’s defence costs, should it be required to do so (para 56).Considering the above factors, Strathy C.J.O. ruled that the appellant had the duty to defend IT Haven against the Niantic claim and dismissed the appeal. He commented that it might very well be that the appellant would be able to establish its claims of misrepresentation. In that case, it would be entitled to recover the defence costs from IT Haven (para 57-58).

April 14, 2022
IT Haven Inc. v. Certain Underwriters at Lloyd’s, London, 2022 ONCA 71