The Insurer’s Duty to Defend Under a Breach of Contract Exclusion

by Samah Rahman

The Ontario Superior Court of Justice recently ruled on an insurer’s duty to defend under an errors and omissions policy, where coverage for an insured’s breach of contract was excluded.

In this case, Panasonic Eco Solutions Canada Inc., the insured sought a declaration that its insurer, XL Specialty Insurance Company, owed it a duty to defend an arbitration pursuant to an errors and omissions policy that Solar Flow-Through Fund (“Solar Flow”) commenced against it. The arbitration claim was based on two monetary demands: one for liquidated damages of $92,309.62 arising out the insured’s failure to substantially complete the project; and the second for damages estimated at $1,300,000 arising out of what the parties referred to as the Proceeds Agreement.

The subject policy, excluded coverage for claims arising out of Panasonic’s assumption of liability in a contract or for breach of contract, unless the liability was one that the insured would have in the absence of the contract. XL denied coverage and asserted that Solar Flow’s claims against Panasonic were a result of its breach of contract, and fell within the exclusion, absolving the insurer of its duty to defend the claim. Panasonic in turn, argued that the plaintiff in the underlying action had named various causes of action, including negligent misrepresentation and unjust enrichment; and those were not captured under the ambit of the breach of contract exclusion.

The Court granted the application in part, finding that the insurer had a duty to defend the claim for liquidated damages, while dismissing the duty with respect to the Proceeds Agreement.

In its decision, the Court reaffirmed the following principles applicable to the duty to defend:

(a) The duty to defend is distinct from, and broader than, the duty to indemnify. There may be a duty to defend even if the insurer may not ultimately be required to indemnify the insured.

(b) The Court assumes that the pleaded facts are true.

(c) The Court applies the pleaded facts to the policy wording.

(d) The duty to defend arises if the underlying complaint alleges any facts that might fall within coverage under the policy.

(e) Where pleadings are not precise enough to determine whether the claims are covered by a policy, the insurer’s obligation to defend will be triggered where, on a reasonable reading of the pleadings, a claim within coverage can be inferred.

Notably, the Court clarified that a duty to defend analysis should focus on facts alleged in the underlying pleading and not on the pleading’s legal characterization of the claim.

Applying these principles to the demand for liquidated damages, the Court held that the damages sought for failure to sufficiently complete the project, could may well be attributable to the insured’s negligence, and thus require coverage. On the other hand, damages with respect to the Proceeds Agreement would not be accrued in the absence of a contract, and thus arose out of a breach thereof. Although the claim was also characterized as negligent misrepresentation, the misrepresentation was pertaining to the intention to pay under the contract. Therefore, the claim pertained to the insured’s assumption of liability in the contract and fell squarely within the contractual exclusion under the policy. In deciding this, the Court relieved the insurer of its duty to defend on this issue.

This case serves as a potent reminder that courts will not necessarily stay bound to a plaintiff’s potentially arbitrary characterization of the claim in determining whether the insurer has a duty to defend, but instead look to the facts of the case to assess whether the duty is triggered.