The Quebec Court of Appeal rules on the possibility for the insurer to be reimbursed for defense costs paid for its insured

The Quebec Court of Appeal recently rendered a decision regarding the application by a liability insurer (the Insurer) for leave to appeal a judgment of the Superior Court of Quebec, which granted a Wellington motion filed by its insured, the civil engineering company Gervais Dubé Inc.¹ The insured was sued before the Superior Court of Quebec by the Attorney General as a prime contractor involved in the damage caused by the partial collapse of a retaining wall built in 2003.  The Insurer denied coverage and refused to defend its insured on the grounds that the damages to the wall were observed prior to the beginning of the policy's insurance period and that the claim was excluded from coverage.  After a summary review of the file, the trial judge² determined that the mere possibility that the claim fell within the scope of the policy issued by the Insurer required the Insurer to fulfill its obligations during the proceedings.

The Court of Appeal was therefore faced with a question that had not been clearly addressed by Quebec case law: Can a judgment granting a Wellington motion, which requires the insurer to take up the insured's defense, be the subject of a leave to appeal? In answering this question on civil procedure, the Court of Appeal also elaborated on a subject which, until now, had not been dealt with in great detail by the Quebec Court of Appeal, namely, the possibility for the insurer to obtain reimbursement from the insured of defense costs incurred if, at the end of the trial, the insurer was found to be justified in denying coverage.

The decision

Before diving into the question, it is important to reiterate the principles governing a Wellington motion, as did the Court of Appeal in its judgment.  This type of motion is typically filed in the context of a third party claim by an insured against its liability insurer.  It allows the insured to compel its liability insurer to fulfill its obligation to defend as long as the insured establishes that there is a "mere possibility" that the insurance coverage will apply.³  Moreover, since this motion is filed after legal proceedings have begun, it is considered an application "in the course of a proceeding" and an appeal of the decision that rules on the application will only be possible with permission.⁴

In order for the Insurer to obtain leave from the court to appeal the decision granting the Wellington motion, the Insurer had to prove, as per the legal requirements of the Code of Civil Procedure, that the judgment in question determines part of the dispute or causes irremediable injury to a party.⁵ The Insurer argued the following: (1) that the judgment granting the Wellington motion determined part of the dispute since it gave a definitive ruling on an insurer's duty to defend and was therefore res judicata; and (2) that the judgment caused irremediable injury since the Insurer had to assume the defense of the insured at its own expense until the final trial judgment without, however, this final judgment releasing the Insurer from this obligation retroactively.  

First, with respect to res judicata, Baudouin J., speaking for the court, explains that when a judgment is rendered on a Wellington motion, there is a "crystallization of the duty to defend on the basis of the allegations as contained in the proceedings at a given time"⁶  [our translation].  Therefore, the Wellington motion decides part of the dispute with respect to the Insurer's duty to defend since it requires that the Insurer's duty to defend be fulfilled and, unless there are new facts brought to light, the decision cannot be reviewed thereafter.

As for the possibility of invoking irremediable injury, the Court of Appeal explained that it is only possible to review a judgment that grants a Wellington motion by way of an appeal.  In fact, according to Baudouin J., the insurer will certainly suffer irreparable harm during the entire proceeding, as it has no way of freeing itself from its obligation to defend the lawsuit.  The court then discusses, in obiter, the possibility for the insurer who has assumed the defense of its insured to recover the legal fees and disbursements incurred in the event that a judgment on the merits concludes that the claim was in fact not covered by the policy.  According to the court, the answer to this question will depend on the grounds for denial of coverage invoked by the insurer and retained by the judge after considering all of the evidence presented at trial.

Where the evidence reveals that there are reasons for the annulment or voiding of the insurance policy, the situation is such that the policy should never have existed due to the conduct or failure by the insured.  In such a case, the insurer is released from its obligation to indemnify the insured (in the event of an unfavourable judgment), but the Insurer also has recourse against the insured for reimbursement of the defense costs it has incurred given that, in principle, the insurance policy should never have been triggered.

In the event that the evidence retained by the trial judge confirms the insurer's decision to deny coverage based on the application of a specific exclusion or the fact that it falls outside the scope of the policy's coverage, the insurer will be relieved of its obligation to indemnify the insured.  However, the insurer cannot then be retroactively relieved of its duty to defend, meaning that the insurer will not be entitled to reimbursement of defense costs.  Indeed, according to the Court of Appeal, any subsequent discoveries confirming the application of an exclusion or establishing the fact that the claim did not fall within the scope of the policy's coverage does not, in any way, alter the insurer's legal and contractual obligation as it existed before all of the evidence was administered at trial.

The Court of Appeal ultimately denied the Insurer's motion for leave to appeal.  Although the Insurer was able to show that the judgment granting the Wellington motion was partly decisive of the dispute and that, if upheld, it could cause irremediable injury, the Insurer was unable to convince the court that the judgment of the Quebec Superior Court was tainted by an apparent weakness, which is an additional criterion for obtaining permission to appeal a judgment rendered in the course of proceedings.⁷

Main takeaways 

This decision illustrates the importance for the liability insurer to clearly identify the grounds for denial of coverage applicable to the claim submitted and to gather all the evidence needed for said denial, even if the insurer agrees to defend the insured under a reservation of rights or further to a judgment on a Wellington motion.  Indeed, if the insurer has strong arguments that could potentially lead the trial judge to conclude, in the context of his decision on the third party claim, that the policy is null and void due to the insured's behaviour, the insurer can expect to be reimbursed for the legal fees and disbursements paid to defend the insured since the filing of the action.