COURT OF APPEAL FOR ONTARIO
McMURTRY C.J.O., GOUDGE and BLAIR JJ.A.
B E T W E E N :
W.H. STUART MUTUALS LTD.
Robert J. Howe and David S. Cherepacha, for the appellants
Plaintiff/Respondent
- and -
LONDON GUARANTEE INSURANCE CO.
Eric Fournie and Caroline Jimdar for the respondent
Defendant/Appellant
Heard: December 10, 2004
On appeal from the judgment of Justice Herman Wilton-Siegel of the Superior Court of Justice dated October 31, 2003.
BY THE COURT:
1London Guarantee Insurance Company appeals from the judgment of Wilton-Siegel J. dated October 31, 2003 declaring that the plaintiff is entitled to indemnification in the amount of $265,863.13 pursuant to a financial institution bond issued by it.
2The appellant provided the respondent with a fidelity insurance bond that covered losses including theft by employees carried out by means of the electronic transfer of funds and computer accounting schemes. A long-time employee of the respondent misappropriated $265,863.13. She did so by abusing her position and responsibility in the company and by producing computer generated cheques and effecting the electronic transfer of funds to separate accounts set up for her own benefit.
3The appellant denied coverage on the basis that the respondent had made material misrepresentations in its application for renewal and that it had failed to disclose the true nature of its cheque issuing process. Specifically, it alleged that the following material misrepresentations had been made:
a) that the cheques were signed by the principals of the company only;
b) that cheque signing machines were not used; and
c) that the bank accounts were reconciled by someone not authorized to deposit or withdraw therefrom.
4The trial judge ruled that the plaintiff had not made any misrepresentations. He also concluded that the plaintiff had not failed to comply with its general obligations of disclosure because it subjectively did not understand the risks associated with the computerized chequing system it had implemented.
5In our view the trial judge erred in these respects.
6The representations referred to in paragraph 3 above were first made in the respondent’s initial application for coverage in 1997, which was completed by Mrs. Stuart (one of the two principals of the Company). They were repeated in, or in connection with, a renewal application that was submitted to the appellant in 2000. The specific questions asked, and the responses provided, are as follows (We use the question numbers from the 2000 renewal application):
Question 7(a): Is there countersignature of cheques? If “No”, please explain.
Response: No. All outbound cheques are signed by principals.
Question 7(d): If cheque-signing machines are used, describe control over signature plates:
Response: N/A
Question 7(f): Are bank reconciliations completed by person(s) not authorized to deposit or withdraw therefrom?
Response: Yes
7It is clear from the evidence that at the time she filled in the 1997 application form Mrs Stuart realized the matter of internal controls was important to the insurer. At that time, she answered “no” to the question “Is there countersignature of cheques?”, but then added “all cheques are signed by one of the principals”. She then testified that she meant – and represented to the insurer – that the cheques were signed manually by either her or her husband (the only principals of the Company). In 1998 and 1999 the policy was renewed on the basis of short form applications in which the respondent confirmed that there had been no change in internal controls. In 2000 the renewal form with the questions numbered 7(a), (d) and (f) outlined above was submitted to the insurer.
8When the 2000 form was submitted, the response to question 7(a) was left blank. The appellant pursued the lack of response, asking through the respondent’s broker for confirmation that all outbound cheques were signed by principals. After several requests, the respondent wrote to its broker on June 26, 2000 confirming that “all outbound cheques are signed by the principals”. The letter also advised that the external auditor’s letter on internal controls “along with Management’s response” had been sent directly to the appellant. In fact, the respondent had not forwarded management’s response to the appellant. Mrs. Stuart approved this letter before it was sent.
9While the representation that all cheques were signed by the principals was true when it was made at the time of the original application for insurance, it was not true at the time the response was given in relation to the application to renew. In about 1998, the respondent had changed its cheque issuing procedure, and had adopted a computerized cheque generating system. In this system, cheques were automatically generated and bore a computerized facsimile of the principal’s signature. No principal actually signed or participated in the signing of the cheques. However in 2000, by writing the letter it did confirming that all cheques were “signed” by principals, the respondent represented to the insurer that it had controls in place which at least involved the participation of principals in the cheque issuing process, and that nothing had changed since 1997 when the respondent first volunteered the information.
10This was not true. Furthermore, the misrepresentation was material. It was the lack of such controls, together with the dishonest employee’s authorized access to the computerized cheque generating system that facilitated the fraud in question, with respect to which the loss is claimed.
11Given this conclusion, it is not necessary to deal with the other two misrepresentations that were alleged. In our view, however, the trial judge erred in failing to hold that the respondent was in breach of its general obligation to disclose all material facts within its knowledge relevant to determining the nature and extent of the risk, even in the absence of specific questions from the insurer: see Gregory v. Jolley (2001, 54 O.R. (3d) 482 (C.A.). While we do not disagree with the trial judge’s view that this duty to disclose must relate to facts or risks of which the plaintiff is aware, the trial judge turned this test into a completely subjective one, which cannot be the case. There must be an objective element to the insurer’s awareness of the risk.
12On the facts of this case it is not necessary to determine the parameters of the objective/subjective mixture to be considered in assessing the insured’s awareness of the risk for purposes of the general obligation to disclose. Suffice it to say that on any analysis of the situation, in our view, the introduction of the new computerized chequing and electronic transfer system, together with the “back office” duties entrusted to the employee, created a significantly enhanced risk of theft. An insured in the position of the plaintiff respondent should have been aware of that fact.
13The existence of the new system should have been disclosed to the appellant.
14The appeal is therefore allowed, with costs to the appellant fixed in the amount of $14,000, all inclusive.
“R.R. McMurtry C.J.O.”
“S.T. Goudge J.A.”
“R.A. Blair J.A.”
