Failure to disclose knowledge of a potential claim at the time of application may not exclude entitlement to insurance proceeds
The defendant insureds sought and were granted a declaration that their professional liability insurer was required to provide a defence in an action on the basis the insurer was not able to conclusively show that coverage would be excluded on the basis of the insureds' knowledge of a potential claim at the time they applied for the insurance.
Sydie v. Murad,  O.J. No. 5381, November 28, 2011, Ontario Superior Court of Justice, P. Lauwers J.
This was an application by the defendants in an action seeking a declaration their insurer under a professional liability insurance policy was required to defend them and that they were entitled to select counsel of their own choice for which the insurer was obligated to pay. In the main action, the plaintiffs sued the defendants alleging breach of contract and negligence in respect of a home inspection done by the defendants in May 2007 on a home subsequently purchased by the plaintiffs. The plaintiffs became aware of a rodent infestation after they moved into the home and contacted the defendants regarding the situation in July 2007. In September 2007 the defendants obtained the professional liability insurance policy. In November 2007 the plaintiffs began the main action and the defendants sought coverage under the policy. The insurer denied coverage, claiming the defendants made a material misrepresentation at the time of application for the insurance. In the alternative, the insurer denied coverage of the basis of an exclusion in the policy which excluded coverage for any claim arising out of any act, error, or omission prior to the inception date of the policy and which the insureds knew or could reasonably have foreseen might be expected to be the basis of a claim.
The court reviewed the jurisprudence on the issue of the duty to defend, which establishes that there will be a duty to defend when there is a mere possibility that a claim within the policy may succeed. Because the threshold for the duty to defend is just the possibility of coverage, the burden is on the insurer to show that an exclusion clearly and unambiguously excludes coverage. The test for whether an insured has knowledge of an event or circumstance that could result in a claim is objective.
The insurer argued that the defendant insureds were aware of a potential claim as soon as they were contacted by the plaintiffs advising of the rodent infestation and asserting the defendants had misled them on the home inspection report. The defendants argued that the content of the inspection report and limitation clauses incorporated in the report were exculpatory and on that basis the defendants did not believe they faced a professional negligence claim from the plaintiffs. The evidence on what was communicated between the plaintiffs and the defendants was conflicting and were issues of fact that should be determined at trial. In the circumstances, the motions judge was unable to determine conclusively that the insurer did not owe the defendants a duty to defend. In the result, the insurer was ordered to proceed with the defence, without prejudice to its right to re-argue the issue later.
With respect to the defendants' application that they be entitled to choose their own defence counsel, to be paid for by the insurer, the court noted that in cases where there is an active and ongoing coverage dispute, the insured might reasonably perceive that defence counsel’s loyalty lies with the insurer and this might undermine the confidential relationship that should exist between counsel and client. The motions judge held that the prudent approach in this case was to avoid both the perception and the actuality of a conflict of interest by permitting the defendants to retain their own counsel, with the insurer being obligated to pay reasonable fees, disbursements, and taxes.