How courts should apportion costs when some claims are covered by insurance and others are not is an issue that has vexed courts throughout North America.
"Probably the most prevalent test, including the one used in Ontario, was that the insurer had to pay every expense unless it could show that an expense was solely and undeniably related to the defence of an uncovered claim," says Geoff Adair of Toronto's Adair Morse LLP.
Indeed, that was the test used by Ontario Superior Court Justice Denis Power in his December 2005 judgment in Hanis v. Teevan. It would not, however, survive the appeal. In October 2008, a unanimous Court of Appeal enunciated a new standard.
"I would hold that the question of apportionment of costs should be determined by the operative language in the policy," wrote Justice David Doherty for a court composed also of justices Robert Sharpe and Eileen Gillese.
"Where there is an unqualified obligation for the defence of claims covered by the policy, as in this case, the insurer is required to pay all reasonable costs associated with the defence of those claims even if those costs further the defence of uncovered claims. The insurer is not obligated to pay costs related solely to the
defence of uncovered claims."
Adair, who represented Guardian Insurance Co. of Canada in Hanis, says the new test is more favourable to insurers than the old one.
"The insurer formerly had the burden of pointing to a specific expense and proving that the expense was totally related to the uncovered claim," he says. "Now the insurer only has to pay the expenses reasonably associated with the defence of the covered claim."
Adair's client, who maintained throughout that costs be allocated between covered and uncovered claims, has sought leave to appeal to the Supreme Court of Canada.
"The problem I see with the Court of Appeal's test is that it's somewhat difficult to ascertain what 'reasonably associated' means," Adair says.
He says the new test is also unfair. "For example, if an insurer interviews 10 witnesses, it will have to pay the entire cost even if each of the witnesses speak and testify to both covered and uncovered claims," he says. "Our leave application is aimed at a test that distributes that burden more fairly."
The case arose when the University of Western Ontario fired Dr. Edward Hanis in 1986 from his position as director of the university's Social Science Computing Laboratory. At UWO's instigation, police also charged Hanis with a criminal offence arising out of alleged misuse of the SSCL.
Hanis sued Western, and following his acquittal on the criminal charges in October 1988, added a claim of malicious prosecution to his suit. Western had comprehensive general liability insurance policies with Guardian Insurance.
Under the policies, Guardian agreed to defend actions brought against Western if the claims were covered by the policy. At trial, the parties agreed the policies covered the malicious prosecution claim, but not the wrongful dismissal allegations.
When originally put on notice of the claims, however, Guardian denied its duty to defend. Western commenced third party proceedings seeking a declaration that Guardian was required to provide a defence. The parties agreed to hold off the third party proceedings while the main action continued.
UWO retained its own counsel, and after a 64-day trial, obtained a dismissal of the entire action in 1995. Hanis appealed, and in 1998 the Ontario Court of Appeal ruled that UWO had denied Hanis procedural fairness and awarded him damages for wrongful dismissal.
In 2002, UWO moved for summary judgment against Guardian. Power granted the motion in October 2004. He found that Guardian had a duty to defend at least some of the claims in one of the two policies, but ruled that the insurer should have defended UWO with respect to all claims, covered or not, subject to a reservation of its right, if any, of apportionment.
Power held that Guardian was obliged to pay all defence costs related to the defence of claims covered by the policy even if those same costs furthered the defence of uncovered claims.
He also ruled the insurer was not required to pay defence costs solely related to the defence of uncovered claims. On this analysis, Guardian was liable for 95 per cent of the costs, quantified as slightly over $2 million. Guardian appealed, arguing it should be responsible for only 20 per cent.
According to Doherty, the issue was ultimately one of contractual interpretation. Guardian had contracted to "defend in the name and on behalf of the insured and at the cost of the insurer any civil action which may at any time be brought against the Insured on account [of claims covered by the policy.]"
There was nothing in this language to qualify the insurer's obligation or to suggest it did not apply to "mixed claims," such as those that engaged both the malicious prosecution and wrongful dismissal allegations.
"For example, costs incurred by Western to meet and refute Dr. Hanis' allegation that he was wrongfully dismissed in October 1986 might also be said to have been directed at negating the malice component of the malicious prosecution claim," Doherty wrote.
"If the costs were reasonably associated with the defence of the malicious prosecution claim, nothing in the policy exempts Guardian from paying those costs simply because they also assisted Western in the defence of uncovered claims."
Guardian could have written qualifying words into the policy providing for an allocation of mixed costs or requiring that the costs relate principally to a covered claim, but chose not to do so.
As Guardian had not challenged the trial judge's findings of fact, but based its appeal on the submission that an allocation was appropriate, the trial judge's finding - that 95 per cent of defence costs related to the defence of a covered claim and were therefore payable by Guardian - was unimpeachable.
But Doherty did not stop there: "My characterization of the allocation issue as one of contractual interpretation leads to three additional observations concerning the principles drawn from the cases put forward by both counsel."
First, a contractual interpretation approach dictated the rejection of the position that where the insurer fails to defend a covered claim it must assume the defence costs of all claims both covered and uncovered.
"I can see no justification for imposing upon the insurer, as a consequence of its breach of contract, an obligation to pay defence costs that are clearly not covered by the contract," Doherty wrote.
The second observation related to language in some of the jurisprudence as reflected in the trial judge's reasons, which suggested the insurer must pay the costs where there is no practical means of distinguishing between costs referable to the covered and uncovered claims.
"This language is potentially misleading," Doherty wrote. "I think the cases are, in the main, referring to situations where the costs are incurred for both covered and uncovered claims.
It is preferable to express the finding in that way, as it makes more obvious the insurer's obligation to pay those defence costs, assuming the policy requires payment of all costs related to the defence of covered claims."
The third observation sprang from the onus of proof which the trial judge appeared to place on Guardian to demonstrate clearly what portion of the defence costs related exclusively to uncovered claims.
"I question whether there is any compelling reason to depart from the general rule that the party claiming damages bears the ultimate or legal burden of proof on that issue, including proving the quantum of damages suffered," Doherty wrote.