Financial Services Commission of Ontario

Commission des services financiers de l’Ontario

Neutral Citation: 2006 ONFSCDRS 166

FSCO A06-001263

BETWEEN:

GARY MCLELLAN

Applicant

and

AVIVA CANADA INC.

Insurer

Before:

Arbitrator Lawrence Blackman

Heard:

October 10, 11 and 12, 2006, in Kingston, Ontario

Appearances:

Mr. Paul A. Brioux for Mr. McLellan

Mr. James M. Brown for Aviva Canada Inc.

The parties agree that the Applicant, Mr. Gary McLellan, was injured in a motor vehicle accident on December 9, 2000. They further agree that as a result of this accident, Mr. McLellan sustained an impairment which rendered him substantially unable to perform the essential tasks of his pre-accident employment for the 104 weeks following the accident.

Pursuant to subsection 4(1) of their insured's automobile insurance policy (the Schedule¹), Aviva Canada Inc. ("Aviva") paid Mr. McLellan a base weekly income replacement benefit ("IRB") of $91.09 for the 103 weeks following the initial one-week mandatory waiting period. In addition, pursuant to subsection 6(5) of the Schedule, Aviva paid Mr. McLellan over $15,000 in additional IRBs for accident-related losses from self-employment for the period December 16, 2000 to December 31, 2001.

At 104 weeks of disability, the IRB disability test under the Schedule changes. The parties agree that from the two-year anniversary of the accident to present, as a result of the accident, Mr. McLellan, has suffered a complete inability to engage in any employment for which he is reasonably suited by education, training or experience. Since the second anniversary of the accident, Aviva has paid, and continues to pay Mr. McLellan the minimum weekly IRB of $185 mandated by paragraph 6(1) of the Schedule.

Mr. McLellan submits that he is entitled to a higher IRB. The parties were unable to resolve their disputes through mediation, and Mr. McLellan applied for arbitration at the Financial Services Commission of Ontario under the Insurance Act, R.S.O. 1990, c.I.8, as amended.

The issues in dispute in this hearing are:

What is the weekly income replacement benefit Mr. McLellan is entitled to receive ongoing from December 16, 2000, claimed pursuant to section 6 of the Schedule?
Is Mr. McLellan entitled to interest on overdue payments, claimed pursuant to subsection 46(2) of the Schedule?
Is Aviva liable to pay Mr. McLellan's legal expenses of this arbitration proceeding, claimed pursuant to subsection 282(11) of the Insurance Act?
Is Mr. McLellan liable to pay Aviva's legal expenses of this arbitration proceeding, claimed pursuant to subsection 282(11) of the Insurance Act?

Mr. McLellan is entitled to:

(a) a base income replacement benefit of $91.09 per week from December 16, 2000 to December 8, 2002 inclusive;

(b) accident-related losses from self-employment of:

(i) $599.78 for the period December 9 to 31, 2000;

(ii) $14,979.14 for the year 2001; and,

(iii) $7,489.56 for the period January 1 to June 30, 2002; and,

Mr. McLellan is entitled, pursuant to section 46 of the Schedule, to interest of two per cent per month, compounded monthly, on each consecutive bi-weekly payment of $576.12 payable under subsection 6(5) of the Schedule for the period January 1 to June 30, 2002, from the last date of each bi-weekly period.
The issue of the legal expenses claimed pursuant to subsection 282(11) of the Insurance Act may now be addressed in accordance with the provisions of the Dispute Resolution Practice Code (Fourth Edition, Updated —October 2003).

The Applicant's Evidence And Submissions

At the time of this motor vehicle accident, Mr. McLellan was engaged in two businesses.

The first business was Wave Management Systems (WMS). This company was registered with the Province of Ontario on January 16, 1996 as a sole proprietorship under the name of "Mr. Gary J. McLellan". The registration form describes the company's business activity as consulting and sales. In his oral testimony, Mr. McLellan indicated that under the name of this company he would do the initial design of a client's required hardware and software system, as well as provide training for the new system, once purchased.

Mr. McLellan's second company was Wave Computer Design (WCD). This company was registered with the Province of Ontario on October 22, 2006 as a partnership between the Applicant and his wife, Linda McLellan. The parties agree that WCD was, in reality, and should be treated as a sole proprietorship operated by the Applicant. The company's function, in accordance with the Applicant's oral evidence, was hardware sales, delivery and set up.

I accept the Applicant's testimony that WCD was registered subsequent to WMS on the premise that the more computer hardware one sells, the more clients one has who are reliant on one's services. Mr. McLellan testified that relatively little money is to be made selling computers and that it is far more lucrative training people, keeping systems running and adapting the systems as required.

As a result of the accident, WMS ceased operations immediately. Mr. McLellan tried to continue WCD with the help of his wife and hired personnel. Those endeavours were ultimately not successful and the company was phased out during 2002, largely being kept alive to honour the two-year warranties on the computer products which had been sold.

Prior to 2000, Mr. McLellan had combined the income, costs of sales and expenses of WMS and WCD. A December 1999 Profit & Loss Statement, solely under the name of WCD, shows (rounded) total income of $53,298, cost of sales of $44,805, expenses of $12,448, and a net loss of $3,955. This is reflected in Mr. McLellan's 1999 personal tax return (filed prior to the accident, on March 8, 2000), which shows a one-line reported gross business income of $53,297 and a one-line net business loss of $3,955, without any distinction between WMS and WCD.

Mr. McLellan testified that in 2000 he considered it necessary to isolate the financial data relevant to both companies. Thus, the December 2000 Profit & Loss Statement for WCD shows a (rounded) lower income of $43,744, with cost of sales of $39,693, expenses of $22,381 and a net loss of $18,330.

A separate December 2000 Profit & Loss Statement for WMS shows a total income of $24,028 (including $300 in tips). The entire $24,028 is then shown as a payroll wage expense. No other expenses are noted for WMS. Mr. McLellan's 2000 income tax return (filed after the accident, on March 6, 2001) shows T4 earnings of $23,728, other employment income of $300 (in tips), as well as a gross business income of $43,743 and a net business loss of $18,329.

Mr. McLellan testified that WMS clients were charged an hourly rate, depending on their status (corporate clients being charged up to $60 an hour, private individuals usually about $25 an hour) and on their location. At the time of the accident, Mr. McLellan resided on Wolfe Island. Wolfe Island clients were charged a much lower hourly rate than those living in the City of Kingston, as travel time to the latter, which involved taking a ferry to the mainland and back, could take up to three hours, including waiting time. The hourly rate would also take into account, amongst other things, the consumption of gas, especially in the winter when Mr. McLellan's vehicle would have to be kept running even while stationary on the ferry.

Mr. McLellan agreed with Aviva that in determining the correct IRB quantum in cases of self-employment, the general approach, as set out in Iankilevitch and CGU Insurance Company of Canada (FSCO P03-00013, August 31, 2004), is that:

Commission adjudicators have consistently taken a functional approach that prefers substance over form . . . The objective is to ensure that the insured person receives an income replacement benefit that fairly and realistically reflects her actual income situation, avoiding both over-and under-compensation.

Mr. McLellan proposed four alternative approaches to determining a fair and accurate IRB quantum.

1. Treating WCD and WMS as distinct entities

Mr. McLellan retained Mr. B.G. Brooks, a chartered accountant with the firm of Collins Barrow, to determine his appropriate IRB. In his February 21, 2005 report, Mr. Brooks opined that WCD and WMS should be treated as two distinct sources of self-employment income.

Based solely on the $24,028 in income shown in the December 2000 Profit and Loss Statement for WMS, Mr. Brooks calculated the Applicant's weekly IRB as $312.74. Mr. Brooks did not consider WCD in his equation for two reasons. First, he was of the view that no income was being earned from that source. Second, he was of the view that the losses from this source were not increased as a result of this accident.

Mr. R.G. Deacon, the Insurer's accounting expert from the firm of Wilkinson & Company, while not agreeing with Mr. Brooks' assumptions, believed that Mr. Brooks' mathematics were correct.

I find that there are several problems with Mr. Brooks' approach.

First, there are significant questions whether these companies are indeed distinct. Mr. Brooks, himself, noted the close relationship of the two companies, stating that "the closure of WCD was the reduction of an ongoing business loss which could no longer be subsidized due to the loss of his first source of income."

Further, Mr. McLellan confirmed on cross-examination that both companies had always operated from the same office, even when the office moved. Both companies had the same telephone number. Both companies had the same GST registration number. Both companies operated through Mr. McLellan's personal bank account. 90 per cent of customers paid their bills by cheque made out personally to Mr. McLellan. Only in 2000, the year of the accident, did Mr. McLellan differentiate between the financial affairs of the two companies, a change which he never adequately explained other than to say it was a more accurate reflection of his income.

Secondly, even if one accepts that these are two distinct companies, as supported by their separate registrations in January and October 1996 and that WCD continued in operation after WMS, there is a question regarding the allocation of expenses.

Mr. McLellan testified that the hourly rate charged for the services of WMS included a consideration of travel expenses, specifically gas. Nonetheless, the year of the accident, for the first time, all auto and gas, van lease and auto insurance expenses are attributed solely to WCD. In addition, both companies shared the same telephone, yet all telephone expenses are allotted solely to WCD. Both companies shared the same office, yet all rent expenses are allotted to WCD.

Arbitrator Palmer, in Peter Bonitatibus and Wellington Insurance Company (OIC File No. A-000082, April 8, 1993), stated that:

I accept that the Applicant clearly has the right to structure his financial affairs, within the law, in whatever manner he chooses. However, I find I cannot accept inconsistent evidence which restates the Applicant's income from employment or self-employment so as to maximize his benefit under the No-Fault Benefits Schedule.

I find the proffered accounting approach serves to artificially inflate the Applicant's IRB entitlement by not merely minimizing, but eliminating all expenses which rightly belong to WMS. I find that this approach neither fairly nor realistically reflects Mr. McLellan's actual income situation and would result in overcompensation.

Thirdly, the Applicant confirmed that under Mr. Brooks' approach, there would be no claim pursuant to subsection 6(5) of the Schedule, on the premise that losses existed both before and after the accident and that there were no losses as a result of the accident.

However, over $15,000 was, in fact, paid to Mr. McLellan by Aviva for post-accident losses from self-employment pursuant to subsection 6(5) of the Schedule. These losses were solely those of WCD. The Applicant does not submit that this was an error, or that these monies should be repaid. I find that it is inconsistent and that an unfair result would follow if WCD were ignored in setting a base IRB of $312.74, while at the same time, benefits paid pursuant to subsection 6(5) of the Schedule solely with respect to the same WCD are retained.

In any event, I find that Mr. McLellan did sustain losses from self-employment as a result of this accident, and that he was entitled to the additional subsection 6(5) IRB payments. This finding undermines both Mr. Brooks' basic assumption and his accounting theory.

A subtle alternative argument advanced by the Applicant is that Mr. McLellan was an employee of WMS and that only his T4 earnings of $23,728 and the $300 in tips shown as other employment income in his 2000 Income Tax return should be included in the IRB calculations, implicitly ignoring the losses sustained by WCD.

Mr. Deacon testified that one cannot report income from self-employment in a T4. Mr. McLellan, however, cited Piper and Zurich Insurance Company (FSCO A-002585, December 6, 1993) as support for the proposition that where a company is run by a single individual, that individual can draw a T4 salary from the company. However, Piper involved a corporation, not a sole proprietorship. Piper also involved a long-standing salary arrangement, whereas, in this case, a T4 was issued for the first time the year of the accident.

However, more fundamentally, the employee theory endeavours to base the IRB quantum on revenue rather than on net income. As such, it does not answer the fairness and overcompensation concerns regarding what I consider the inappropriate allocation of all expenses to WCD. Further, it is inconsistent to treat WCD as irrelevant regarding the base IRB, while at the same time, claim, and accept, significant subsection 6(5) benefits based solely on the post-accident operations of WCD.

2. Compensating for Future Loss of Revenue

As an alternative approach, Mr. McLellan critiques the March 7, 2002 Wilkinson & Company enumeration of post-accident losses payable under subsection 6(5) of the Schedule as $879.68 for the period December 9 to 31, 2000 (the first week of which, no IRB would be payable) and $14,979.38 for 2001. The Applicant submits that this approach only addresses losses from WCD but omits the $24,028 he made from WMS in 2000 and the even higher profits he would have made in the future. Simply put, Mr. McLellan argues that if the Insurer pays 80 per cent of his post-accident losses, it must also pay 80 per cent of his lost business revenue.

Regarding anticipated future higher profits, the Applicant did not provide any basis or precedent for compensation for such losses under the Schedule. In any event, the Applicant failed to provide any proof of anticipated higher future profits.

Regarding past revenue, I find that the Wilkinson report did include the $24,028 the Applicant allotted in revenue to WMS in determining a base weekly IRB of $91.09. Otherwise, that IRB would be zero (taking into account the losses of WCD). To include the $24,028 in calculating both the base IRB and the post-accident losses would be double counting, would lead to an inaccurate and unfair result, and would over-compensate the Applicant.

3. Ongoing Business Losses

Mr. McLellan notes that the November 20, 2002 report of Wilkinson & Company provides a weekly base IRB of $91.09 and a weekly subsection 6(5) IRB of $288.06. Mr. McLellan submits, as an alternative argument, that he is entitled an ongoing total weekly IRB of $379.15.

I do not agree with the Applicant's submission, for which he provided no case law in support, that once a subsection 6(5) post-accident loss is established, it continues indefinitely, regardless of whether losses continue, or indeed, whether the business continues.

4. Post-Accident Losses for 2002

Mr. McLellan's final submission is that he is entitled to 80 per cent of the $14,726.86 that WCD lost in 2002. This equals $11,781.49. The Applicant submits that as his post accident losses through to the end of 2001 were not challenged by Aviva, it is inconsistent to question his 2002 losses.

The Insurer's Evidence and Submissions

Aviva queries whether WCD was still operating through to December 2002, noting Mr. Deacon's comments in his report of June 7, 2004 that:

the business registration for WCD expired October 21, 2001 and there was no evidence it had been renewed;
WCD reported only $250 in income after March 2002 ($1,542 in income being earned that year up to that date);
the GST registration was cancelled effective July 1, 2002;
the cost of providing warranty services for hardware or software previously sold was questionably a loss as a result of the accident, as such costs would have been incurred in any event; and,
unsworn hearsay evidence of the belief of a third party on May 13, 2002, that Mr. McLellan had ceased his business (which I give no weight).

Aviva puts forward Welsh and Economical Mutual Insurance Company (FSCO P02-00024, October 7, 2003) as support for the proposition that subsection 6(4) provides limits on business losses and "gives insurers some control over an insured person who continues to operate a business in a manner that has little chance of generating revenues." Likewise, paragraph 6(6)(a) of the Schedule prohibits the deduction of expenses that were not reasonable or necessary to prevent a loss of revenue.

The Insurer argues that by 2002, Mr. McLellan had essentially abandoned all hope of generating income from WCD and the $14,726 in losses for that year was not reasonable in relation to $1,792 in revenue. Hence, Aviva submits that the 2002 losses are not reasonable or necessary and should not be compensated.

The Insurer cross-examined Mr. McLellan on certain specific increased post-accident expenses. The Applicant testified that the increased office supplies reflected, in part, the purchase of cell phones so that he could be reached while at physiotherapy. The increase in bank charges reflected interest on a higher line of credit as well as penalties, both of which Mr. McLellan attributed to the accident's adverse effect on business profit. The Insurer did not argue that these explanations were unreasonable. I find both the explanations and the increased expenses reasonable.

Decision re IRB Quantum

Paragraph 6(1)(a) of the Schedule provides that during the first 104 weeks of disability, the amount of the weekly IRB shall be 80 per cent of the insured person's net weekly income from employment determined in accordance with section 61. Section 61 calculates the IRB on the basis of an insured person's net weekly income from employment, less the applicable Employment Insurance premium, Canada Pension Plan contribution and income tax.

I am not persuaded, for these first two years of disability, that Mr. McLellan is entitled to a higher base IRB than the $91.09 calculated by Aviva, for the following reasons:

it is inappropriate to treat WCD and WMS as separate entities in 2000 such that all expenses are attributed to WCD, especially given their close interrelationship, the considerable overlap of expenses, the incurring of expenses solely for WMS which were reflected in the hourly billing rate but which nonetheless are attributed solely to WCD, and the different accounting method chosen previously;
it is inconsistent to disregard WCD when determining the base IRB, yet consider it when calculating post-accident losses. I find that it was proper and appropriate for Aviva to have paid and for Mr. McLellan to have received the more than $15,000 paid for subsection 6(5) post-accident losses up to December 31, 2001;
Aviva's accounting methodology best achieves the object of fairly and realistically reflecting Mr. McLellan's pre-accident actual income situation; and,
I find that the Applicant's suggested higher base IRB payments result in over-compensation.

Subsection 6(5) of the Schedule provides that if an insured person was self-employed at the time of the accident, the insurer shall add to the IRB payable, 80 per cent of the losses from self-employment incurred as a result of the accident. Subsection 6(6) provides that such losses shall be determined in the same manner as under the Income Tax Act (Canada) without making any deduction for expenses that were not reasonable or necessary to prevent a loss of revenue, salary expenses that were not reasonable in replacing the person's active participation, or non-salary expenses that were different in nature or greater than pre-accident non-salary expenses unless they were necessary to prevent or reduce post-accident losses.

The Insurer's experts determined, in their report dated March 7, 2002, that 80 per cent of Mr. McLellan post-accident losses for the period December 9 to 31, 2000 were $879.68 and for 2001, $14,979.38. I find these amounts to be correct, except that as subsection 5(1) provides that the insurer is not required to pay an IRB for the first week of disability, the December 2000 losses payable are $599.78.

I am persuaded that Mr. McLellan's business in WCD continued into calendar 2002. Income was still being received. Expenses were still being incurred. The company still had a GST number.

In 2001, an effort was made to keep WCD alive. At a certain point it was decided that was not tenable. That was a reasonable decision. It was further decided to gradually phase WCD out, keeping in mind the company's continuing obligations regarding warranties. I find that, too, to be a reasonable and necessary decision.

The question is, what period of time was reasonable to phase WCD down and what period was actually used. I received no evidence of any income received by WCD in the second half of 2002. I received no evidence that there were any service calls continuing in the second half of 2002. I received no evidence of warranties actually continuing into the latter half of 2002. I received no evidence that there were variable expenses (as opposed to claimed continuing expenses such as the Applicant's home office and telephone) specific to that period. By the second half of 2002, both the business registration and the GST registration for the company had expired. I am persuaded that an additional six months, rather than the twelve months claimed, was reasonable and necessary to wind WCD down, and was, in fact, used to wind WCD down.

I find that the expenses claimed by WCD in 2002 were similar to those claimed the prior year. I find that the expenses incurred for the first half of that year were either reasonable in replacing Mr. McLellan's active participation, or if they were different in nature or greater than pre-accident non-salary expenses, they were necessary to prevent or reduce larger post-accident losses. As Aviva accepted the expenses claimed in 2001 as reasonable and necessary, I am persuaded that the expenses incurred in the first half of 2002 were likewise reasonable and necessary.

I was not provided with a breakdown of the precise expenses for the first and second halves of 2002. One way to approximate the amount payable is to simply continue the payments from 2001. As noted above, 80 per cent of the total losses payable for that year were $14,979.38, or $288.07 a week. Hence, the amount payable for the first 26 weeks of 2002 would be $7,489.69.

A method of confirming whether this result is reasonable is to take 80 per cent of the claimed losses for 2002, being $11,781.49, and divide it in half, which equals $5,890.75, which is fairly close to the $7,489.69 figure. Given my finding that it was the first six months of 2002 that saw the reasonable and necessary winding down of WCD, it makes sense that the amount is somewhat more than half of the total loss incurred in 2002.

I am persuaded that $7,489.69 fairly represents Mr. McLellan's losses from self-employment as a result of this accident during a reasonable phasing down period covering the first half of 2002. I am persuaded that this sum fairly and realistically reflects Mr. McLellan's actual accident-related losses. I am persuaded that WCD was still in actual operation during this period, certainly based on a measure of continued revenue. I am persuaded that during this period it was reasonable and necessary for WCD to remain in business to honour its contracts, deal with actual or the reasonable likelihood of necessary follow-up, and to prevent reasonably possible losses of revenue from lawsuits which might follow any failure to honour the warranties provided.

At 104 weeks of disability (which the parties agree exists in this case), namely December 8, 2002, the minimum IRB payable changes to the lesser of the amount payable under paragraph 6(1)(a) (which was $91.09) and $185. I find that the applicable IRB to which the Applicant is entitled after December 8, 2002 is $185.

Interest

Subsection 46(1) of the Schedule states that an amount payable in respect of a benefit is overdue if the insurer fails to pay the benefit within the time required under Part X of the Schedule. Subsection 46(2) provides that if payment of a benefit is overdue, interest is payable on the overdue amount for each day the amount is overdue from the date the amount became overdue at the rate of two per cent month, compounded monthly.

Subsection 35(1), which falls within Part X of the Schedule, provides that if the insurer determines that a benefit is payable, the benefit shall be paid within fourteen days after the insurer receives the application. Subsection 35(4) requires the IRB to be paid at least once every second week.

The Applicant did not make any submissions regarding interest on the base weekly IRB of $91.09 paid to the second anniversary of disability, nor on the weekly $185 which continues to be paid. Neither did he make any submissions regarding the ultimately paid subsection 6(5) IRBs covering the period to the end of 2001.

I have found that an additional weekly subsection 6(5) IRB of $288.07 was payable for the first twenty-six weeks of 2002.

Regarding the question of interest, Aviva firstly submitted that section 33 of the Schedule provides that where an applicant fails to provide an insurer within fourteen days of a request with any information reasonably required to assist the insurer in determining the person's entitlement to a benefit, the benefit is not payable until the insured person complies. Aviva pointed to the June 7, 2004 letter of its expert, Mr. Deacon, setting out seven areas of additional material he required in order to calculate a subsection 6(5) IRB for 2002. This included such items as copies of the warranties related to the services rendered in 2002 and a mileage log for the same year. Aviva submitted, relying on the appeal decisions in Iankilevitch and CGU Insurance Company of Canada (FSCO P03-00013, August 31, 2004) and State Farm Mutual Automobile Insurance Company and Sivananthan (FSCO P05-00001, October 14, 2005), that no interest would accrue until that information was provided.

Even if one can ignore that this defence was not raised until final submissions and no prior notice of the Insurer's reliance on section 33 was given to the Applicant, the fundamental difficulty with this argument is that Mr. Deacon's letter was addressed to Aviva, not to Mr. McLellan. Aviva conceded that there was no evidence before me when or if the request of information was, in fact, made of Mr. McLellan. Accordingly, I find that there is no basis for the section 33 defence.

In the alternative, Aviva submits that interest should run only from the end of the 2002 calendar year, when it was clear what Mr. McLellan's losses might be.

I find that it is the intent of the Schedule that benefits be paid in a timely manner. But one example of this intent is the significant rate of interest payable under section 46 of the Schedule. If an insurer makes an error in calculation, it is protected by the repayment provisions of section 47 (which also allows for interest), including the option of allowing an insurer to deduct up to 20 per cent of further IRBs until it is repaid. An insurer is also protected by section 33 of the Schedule (which has "teeth" in the form of the insurer's ability to suspend payments for non-compliance) in its ability to obtain, in a timely manner, continuing relevant information. As noted, I have no evidence that a section 33 request was made of Mr. McLellan for information regarding the year 2002.

When a business is struggling to survive with losses, it does little good that IRBs are paid months, if not longer, after the company's expenses are due, only when there is a requisite measure of certainty as to the precise, to the penny, past loss of the business entity, even when the analysis may have become a post-mortem. To use the vernacular, this can be a situation of the operation being a success, but the patient is dead.

I find it consistent with the intent of the Schedule, especially considering the protections available to insurers, that where losses are established, the insurer should continue to pay at least realistic rough approximations, subject to their rights under the Schedule. If an insurer fails to do so, the remedies available to an insured person includes a significantly high rate of interest.

Accordingly, I find that Aviva Canada Inc. shall pay Mr. McLellan interest of two per cent per month, compounded monthly, on each bi-weekly payment of $576.14 payable under subsection 6(5) of the Schedule for the period January 1 to June 30, 2002, from the last date of each bi-weekly period.

EXPENSES:

The parties agreed that it was appropriate to bifurcate, from the main decision, the issues of entitlement to and the quantum of legal expenses of this arbitration hearing.

Having determined all of the issues in dispute except that of legal expenses, if the parties cannot agree on the entitlement to or the quantum of legal expenses, either party may request, in writing, an appointment before me to determine same, in accordance with Rule 79 of the Dispute Resolution Practice Code (Fourth Edition Updated —October 2003).

October 31, 2006

Lawrence Blackman

Arbitrator

Date