No aspect of insurance defence counsel’s tripartite retainer with an insured and a liability carrier more frequently strains the divided loyalty more than the over-limits exposure. Whether it is an automobile policy responding to a catastrophic bodily injury claim, or a general liability policy building collapse or fire attributed to the carelessness of a tradesperson, the cost of indemnity has increased dramatically in relation to standard million-dollar policy limits. Those limits have not changed in Canada for over a decade.
It is a matter of economic conflict between two independent markets. In a competition for premiums, underwriters have failed to market increases in policy limits, while medical and rebuilding costs for commercial buildings have soared. This simple divergence of demand-and-supply curves has many ramifications for tort law in Canada. Here, I discuss one issue, the rise and apparent panic in the insurance industry over the importation of an American doctrine of “Bad Faith for Refusal to Settle.” It is mainly because of the widening gap between damages awards and insurance limits that the issue is more common than a decade ago.
In a nutshell, fears about U.S.-style bad faith litigation still appears unjustified. The reason for this has less to do with factual necessity than with the institutional conservatism of the Canadian judiciary. The following three highlights of the Canadian experience validate this hypothesis:
- Canadian Common Law jurisdictions do recognize actions against insurers for failing to protect the underinsured interests of policyholders. The cause of action arises from a refusal to negotiate settlements within policy limits.
- The failure to settle within limits does not, of itself, justify granting relief against the insurer. Rather, the action against the insurer arises from the primary insurer’s exclusive control over the defence and settlement process making the policyholder vulnerable to the insurer’s decisions.
- The principle’s reliance on policyholder vulnerability means the courts must determine whether the impugned insurer misconduct falls into established Canadian law regarding insurer bad faith in the execution of contractual obligations. The law of insurer bad faith remains conservative and applied only in exceptional cases.
The American Doctrine
The doctrine has emerged in the United States due to the ingenuity or necessity of personal injury lawyers in the face of low or non-existent mandatory automobile insurance, and to some extent in the insurance sold to small businesses. Canadian Snowbirds involved in accidents in Florida, for example, may be surprised that a negligent resident driver may be carrying only $50,000 in automobile liability insurance. Fortunately, if they are insured drivers in Canada, their own policies will usually respond to provide underinsured insurance coverage. For many American residents, however, their failure to carry higher limits on their own policies will result in having to accept the tortfeasor’s low limits. The absence of a Canadian-style loser-pays costs system also means plaintiffs can stand to recover only a portion of those limits.
Except in minor injury cases, it is impossible to settle an accident claim for under $50,000. In response to that reality, an insurer will very frequently offer up the limits at an early stage of the proceedings. Failure to do so can give rise to the allegation that the insurer wrongfully deprived its insured of the opportunity to obtain peace from litigation. While the rationale has been described in some quarters as “equitable subrogation,” analogous to an excess insurer’s claim against a primary insurer for improvident failure to settle, that principle historically emerged from cases involving underinsured defendants and not the other way around.
The legal footing of the doctrine is important for the Canadian context. Instead of reconciling various judicial attempts to rationalize the doctrine, it is helpful to summarize the end-product of the U.S. case law. One helpful articulation of the American doctrine can be seen in California Standard Civil Jury Instruction No. 2334, which can be paraphrased from the American legalese as follows, for ease of reading:
Insured claims that she was harmed by insurer’s breach of the obligation of good faith and fair dealing because the insurer failed to accept a reasonable settlement demand in a lawsuit against the insured. To establish this claim, the insured must prove all of the following:
1. a lawsuit was brought against the insured for a claim that was covered by insurance policy;
2. the insurer failed to accept a reasonable settlement demand for an amount within policy limits; and
3. a monetary judgment was entered against the insured for a sum greater than the policy limits.
“Policy limits” means the highest amount available under the policy for the claim against the insured.
A settlement demand is reasonable if the insurer knew or should have known at the time the settlement demand was rejected that the potential judgment was likely to exceed the amount of the settlement demand based on the claimant’s injuries or loss and the insured’s probable liability.
From an outsider’s perspective, the basis for this articulation of the right of action misses a fundamental aspect of the freedom of contract: in most instances, the policyholder chose the minimum statutory limits in order to pay the lowest amount of premium. If I choose to carry on an activity in which I risk others to incur millions in future care expenses, why should I not bear the personal responsibility of that choice, if I buy only $50,000 in insurance? The fact is that such limits are so low that most of the time insurers will readily tender their limits early in a suit because there is not much to lose.
The freedom of contract argument is, instead, strained at the higher end of the spectrum. A driver who carries a statutory minimum for being allowed to drive on a public highway is consciously self-insuring for liability above the limits. More limits are available to be purchased, at a cost. A driver who purchases more than minimum insurance but is constrained from purchasing more because of insurers’ refusal to sell enough to cover liability for catastrophic injury losses arguably commands more loyalty from the insurer after an accident occurs. Further, liability in tort is an element of state power over the individual. Arguably, if the judiciary is going to award millions in damages, the state-regulated insurance industry should be required to sell adequate insurance or insurance without single-occurrence limits. Such insurance can be purchased by commercial institutions with premium buying power, but not so individuals purchasing personal lines insurance. In short, one needs to examine the fairness of an entity of the state awarding very high damages verdicts while a state-regulated financial industry is not required to sell insurance that addresses the risk of such awards.
In between, the rationale becomes murkier. The driver who insures for a million dollars is by no means reckless. Nevertheless, the amount is clearly inadequate to the address the exposure to liability claims in the tens of millions. It is generally in this middle area that Canadian law must navigate this topic.
Direct judicial treatment of the issue in Canada is rather sparse. In Ontario, Hollinger International Inc. v. American Home Assurance Co., 2006 CanLII 814, Justice Campbell of the Superior Court held :
I am also satisfied that as a matter of Ontario law, without a justifiable basis, any refusal to participate in the negotiations and to respond to the proposed settlement would constitute a breach of the duties the Primary Insurers owed to the Outside Directors. The fact that there were other insureds under the policies and the fact that the potential existed for claims for indemnity to be made at some later point, did not provide a justifiable basis for the Primary Insurers to refuse to participate in the negotiations or to refuse to respond to the proposed settlement in a fair and prompt manner.
More recently, in Ernst & Young Inc. v. Chartis Insurance Co. of Canada, 2014 ONCA 78, at paras. 71-73, the Ontario Court of Appeal fell short of recognizing the assignability of an action for breach of an insurer’s duty of good faith. The courts have not really addressed the technical prerequisites for the transfer of causes of action – a technical subject beyond the scope of this article.
The case law frequently cites two British Columbia trial court decisions. In Fredrikson v. Insurance Corporation of British Columbia, 1990 CanLII 3814, the court held:
Mr. Cowper for I.C.B.C. also submits that the factual circumstances which gave rise to the American doctrine of “bad faith refusal to settle” have no counterpart in this jurisdiction. It is widely accepted that the cause of action was created as a response to a history of harsh treatment of insureds by insurers in a context of low limits of coverage and high awards, so that claims “over the limits” were the norm rather than the exception. The fact patterns in many of the earlier American cases demonstrate an unconscionable lack of concern by the insurer for the interests of the insured. In Canada, by contrast, minimum limits have long been maintained at a relatively high level and awards, by comparison with those prevailing in the United States, have been relatively modest. Whether for that or other reasons, it seems reasonable to infer that there has been no pattern of unconscionable behaviour.
A further B.C. decision is often cited as the departure from Fredrikson which introduced a version of the U.S. doctrine to Canadian law. In Shea v. Manitoba Public Insurance Corp., 1991 CanLII 616 the court distinguished Fredrikson and set out an exhaustive list of factors to be considered:
- The relationship between insurer and insured is a commercial one, in which the parties have their own rights and obligations.
- Within the commercial relationship, special duties may arise over and above the universal duty of honesty, which do not reach the fiduciary standard of selflessness and loyalty.
- The exclusive discretionary power to settle liability claims given by statute to the insurer in this case, places the insured at the mercy of the insurer.
- The insureds’ position of vulnerability imposes on the insurer duties of good faith and fair dealing, equitable consideration of insurer and insured interests, and disclosure of material information and settlement negotiations.
- The fact that the insured is at the mercy of the insurer for the purposes of settlement negotiations gives rise to a justified expectation in the insured that the insurer will not act contrary to the interests of the insured, or will at least, fully advise the insured of its intention to do so.
- While the commercial nature of the relationship permits an insurer to assert or defend interests which are opposed to, or are inconsistent with, the interests of its insured, the duty to deal fairly and in good faith requires the insurer to advise the insured that conflicting interests exist, and of the nature and extent of the conflict.
- The insurer’s statutory obligation to defend its insured imposes on the insurer, where conflicting interests arise, a duty to instruct counsel to treat the interests of the insured equally with its own; and where one counsel cannot adequately represent both conflicting interests, an obligation to instruct separate counsel to act solely for the insureds, at the insurer’s own cost.
- The insurer’s duty to defend includes the obligation to defend on the issue of damages, and to attempt to minimize by all lawful means the amount of any judgment awarded against the insured. In this case that would include arguing that court order interest and no fault benefits are payable in addition to the policy limits, where such an argument is available in law.
- Defence preparations and settlement negotiations must take place in a timely way, and, where last minute negotiations are required, advance planning must be made to ensure that the insureds’ interests are given equal protection with those of the insurer.
As a generality, the most obvious difference between this formulation of the duty of the insurer is that there is a nuanced approach to the role of counsel. Under Canadian law, defence counsel appointed by an insurer is considered to have a “tripartite” retainer, between the insurer and the insured. In contrast, most U.S. courts have held that insurer-retained defence counsel only owe a duty of care to the insured. Under U.S. insurance law, settlement authority and strategy are much more concentrated in the insurer, and the insurer’s role in instructing defence counsel is subject to closer scrutiny to ensure compliance with the duty to avoid conflict of interest. In other words, American case law attaches primacy to the insurer’s duty to settle within policy limits. Any instruction of defence counsel attempting to balance the insurer’s interests against the defended policyholder’s interests is seen as an encroachment of the policyholder’s rights – a reflection of the boundary-based American approach to contract law.
Canadian law navigates this conflict of interest through mechanisms such as even-handedness in sharing of information, and independent legal advice. Although the Canadian articulation of the legal principles seem to resemble the American precursor, the language of the Canadian judicial treatments clearly indicates that the insurer’s duty to settle within limits is much less strict.
The Legacy of Pilot v. Whiten
Because of the label of “bad faith” employed in the American case law, Canadian counsel are prone to employ those two words in situations where they are unwarranted. In Canada, the well-known case of Whiten v. Pilot Insurance Co.,  1 SCR 595introduced bad faith in execution of insurer duties as an independent cause of action in support of a punitive damages claim. However, most articulations of the Whiten rationale have limited its application to clearly harsh or egregious conduct by an insurer. The assertion of an arguable coverage position, asserted in good faith, falls short of bad faith.
What emerges from the Canadian articulation of the duty to settle within insurance limits is that the courts will not push insurers into improvident settlements, where there is a reasonable defence or a legitimate ground for disputing the quantum of damages. As with many aspects of Canadian law, the courts treat disputes between insurer and insured as a balancing of interests within a commercial reality. Disagreeing with a policyholder is not bad faith. By the same token, a policyholder is also afforded latitude to press an insurer to settle, without jeopardizing her position on coverage on the grounds of non-cooperation in the defence.
Strategies for Compliance
The strategies for a Canadian insurer or insured in navigating this most protean of insurance law issues are fact-dependent. Ultimately, the aim of counsel advising either insurers or policyholders must be to prevent coverage or bad faith litigation from happening. Short of that, if litigation appears unavoidable due to the circumstances, the advice must position the insurer or insured client in the best position possible. The Canadian law does allow these parties to make meaningful decisions when faced with a substantial over-limits claim. In making these decisions, however, it is always important to have the benefit of legal advice applicable to the particular facts of the case.