When erring on the side of caution backfires: Quebec ruling stands as a warning to insurers when paying out claims

In cases where an insured’s claim contains one or more complex or difficult-to-prove grounds for denying coverage, insurers might be tempted to simply indemnify the insured and focus on the possible subrogation recourse that follows payment of the indemnity if a third party is at fault.  However, insurers who choose this path must be mindful of all of the ramifications of this decision, as can be seen from a recent judgment handed down by Justice Lukasz Granosik of the Superior Court of Québec¹ dealing with the conditions that must be present for subrogation in favour of the insurer to exist.

The facts

The insureds in this matter owned an apartment building built by a general contractor. The contractor had hired a plumber to install plumbing fixtures and pipe fittings that were all from the same distributor.

After having purchased the building in 2007, the insureds chose to rent out the three apartments. In 2011, they decided to convert the building into condominiums, and the last tenants left their apartment on August 1, 2011.  Between August 1, 2011, and August 1, 2012, the building was vacant. One of the insureds regularly visited the building and took care of exterior maintenance, among other things. On August 1, 2012, the building sustained water damage, with the suspected cause of this loss being a broken toilet connector on the third floor.

The insureds filed a claim with their insurer, but the latter refused to indemnify them on the grounds that the building was vacant at the time of the loss. In June 2013, the insureds sued the insurer, but the parties reached an agreement: the insureds received a $140,000 indemnification from the insurer in consideration for the execution of a release and discharge.

Afterwards, claiming to be subrogated in the rights of the insureds, the insurer filed an action against the general contractor for $140,000. The contractor called the plumber as a third-party defendant, and, in turn, the plumber did the same with the distributor. The defendants’ defence included the argument that the insurer could not file suit in this case because there simply had been no subrogation.

The decision

Legal subrogation

The insurer argued that, having indemnified its insureds, it automatically benefitted from the legal subrogation provided for in article 2474 of the Civil Code of Québec (CCQ). The insurer invoked the Quebec Court of Appeal decision rendered in the case of Kingsway General Insurance Co. v. Duvernay Plomberie et chauffage Inc.,² in support of its argument, a ruling it believed introduces the notion of “prospective subrogation” in Quebec civil law and allowing it to file a subrogation action despite the absence of an obligation to pay. The defendants, for their part, argued that legal subrogation cannot exist where the insurer is under no obligation to indemnify the insureds and that no such obligation existed in this case, the building being vacant at the time of the loss.

The judge did not agree with the insurer’s position, being of the view rather that the Court of Appeal’s decision in Kingsway mainly dealt with a procedural issue that did not apply in this matter. Moreover, the judge opined that such an interpretation would obviate article 1657 CCQ, which authorizes debtors to invoke the failure to comply with the conditions for subrogation to exist. The judge relied on the Supreme Court of Canada decision in ABB Inc. v. Domtar Inc.³  and concluded that there can only be legal subrogation pursuant to article 2474 if: both the insurer indemnifies the insured and an obligation to indemnify exists.⁴ Any payment made by the insurer when not required to do so therefore does not trigger this mechanism, according to the court.⁵

The judge therefore had no choice but to determine whether the insurer actually had an obligation to indemnify the insureds.  To do this, he had to assess whether the building was in fact “vacant” within the meaning of the insurance policy seeing as, if it was, the insurer was under no obligation to indemnify the insureds.  Relying on a similar case rendered by the Superior Court of Quebec,⁶ which associated the word “vacant” with the “idea of abandonment,” the court reached a conclusion that was diametrically opposed to what the insurer was proposing.

The court therefore concluded that the policy’s exception applied in light of the fact that the triplex was “vacant” and found that the insurer was under no obligation to indemnify the insureds.  As a result, there could be no legal subrogation in favour of the insurer.

Conventional subrogation

The insurer also maintained that the release and discharge executed by the insureds in consideration for the indemnity paid to them allowed the insurer to be conventionally subrogated to the rights of the defendants. Although the release and discharge in question did not explicitly provide for this type of subrogation, the insurer believed that it could be inferred from the document’s context. 

The judge set this argument aside on the grounds that article 1653 CCQ provides that conventional subrogation must not only be made in writing, but also provided for expressly. Here, the court did not find any intent to subrogate in the release and discharge, which only stipulated a framework for payment of the indemnity to the insureds. The judge therefore ruled that there was no conventional subrogation.

Given the absence of legal or conventional subrogation, the judge dismissed the insurer’s action against the defendants, as there was no right of action.

Takeaway

This decision is a good example of why an insurer who decides to pay a claim when there are credible grounds for denying coverage must also consider the impact this decision may have on a possible future subrogation recourse. The parties potentially responsible for the loss may raise arguments in that action that would have been available to the insureds but for the settlement of the claim.

One possible solution for insurers in this type of situation would be to provide for a conventional subrogation or an assignment of rights with the insured.  However, these agreements must be drafted in a manner that meets specific conditions.

The author wishes to thank law student Mathieu Canuel for his help in preparing this legal update.