Kohanski v. St. Paul Guarantee Insurance Company/Compagnie D'Assurance St. Paul Garantie et al.

Kohanski v. St. Paul Guarantee Insurance Company/Compagnie D'Assurance St. Paul Garantie et al. [Indexed as: Kohanski v. St. Paul Guarantee Insurance Co.]

78 O.R. (3d) 684

[2006] O.J. No. 157

Docket: C43308

Court of Appeal for Ontario,

Laskin, Sharpe and MacFarland JJ.A.

January 19, 2006

Insurance -- Insurer's obligation to defend -- Exclusion clauses -- Company suing former director for damages for breach of fiduciary duties, conspiracy and breach of s. 134 of Ontario Business Corporations Act -- Directors' and Officers' Liability Policy issued to company containing "insured v. insured" exclusion which provided that insurer was not liable to make any payment in connection with claim brought against director by company -- Exclusion clause unambiguous and clearly excluding coverage for claim by company against director -- Insurer not having obligation to defend claim by company against director -- Business Corporations Act, R.S.O. 1990, c. B.16, s. 134.

Two former employees of Master Insulators' Association of Ontario Inc. ("MIA") brought an action against MIA for damages for breach of contract, wrongful dismissal, bad faith discharge and defamation. MIA issued a counterclaim against those employees and added K, a former director and president of the board of directors of MIA, as a defendant to the counterclaim. Against K, MIA sought damages for breach of fiduciary duties, conspiracy and breach of s. 134 of the Ontario Business Corporations Act. K informed the insurer under a directors' and officers' liability policy issued to MIA of the claim against him. The insurer took the position that coverage was excluded under s. IV(7) of the policy, which stated that the insurer was not liable to make any payment for loss in connection with any claim made against the directors and officers "which is brought by or at the behest of the Corporation". The insurer argued that it was plain and obvious that the exclusion applied and that accordingly it owed no duty to defend K. K brought an application for a declaration that the insurer was obligated to defend him. The application judge found that the insurer owed K a duty to defend the action. In doing so, she purported to follow a line of American authorities where a duty to defend was found in circumstances where the stated purpose of the exclusion clause would not be defeated. The purpose of this particular exclusion clause was said to be to prevent collusive lawsuits between corporations on the one hand and the officers and/or directors of those corporations on the other. The insurer appealed.

Held, the appeal should be allowed.

At the time this matter was argued before the application judge, only one Canadian case discussed the exclusion at issue in this case, the "insured v. insured" [page685] exclusion. Where there are few Canadian authorities, it is appropriate for Canadian courts to look to American authorities for assistance to ensure uniformity in construing contracts of insurance used in both countries. However, the American authorities relied on by the application judge were distinguishable as in each of those cases the court found that the exclusion clause was ambiguous with respect to whether the party bringing the underlying action was an "insured" within the meaning of the policy. Such ambiguity did not exist on the facts of this case. On its face, the exclusion was unambiguous: it operated to exclude coverage when one insured sued another. In such circumstances, the court's obligation is to give effect to the language of the contract unless to do so could defeat the main object of the contract or virtually nullify the coverage. The application judge made no finding to the effect that the insured v. insured exclusion clause at issue in this case had the effect of virtually nullifying the coverage provided for under the policy, and such a finding could not be made on the facts of this case. Because MIA's claim against K was clearly and unambiguously excluded from coverage by reason of the insured v. insured exclusion, the insurer could not have a duty to indemnify K under the policy and accordingly had no duty to defend K in the underlying action.

APPEAL from the order of Horkins J., [2005] O.J. No. 5882 (S.C.J.) declaring that the insurer had an obligation to defend the insured.

Cigna Insurance Co. v. Gulf United States Corp., 1997 W.L. 1878757 (D. Idaho 1997); Conklin Co., Inc. v. National Union Fire Insurance Co., 1987 W.L. 108957 (D. Minn. 1987); Rieser v. Baudendistel (In re Buckeye Countrymark, Inc.), 251 B.R. 835, 44 Collier Bankr. Cas. 2d (MB) 1107 (Bkrtcy. S.D. Ohio 2000); Township of Center v. First Mercury Syndicate, 117 F.3d 115 (3rd Cir. 1997), distd Other cases referred to Nichols v. American Home Assurance Co., 1990 144 (SCC), [1990] 1 S.C.R. 801, [1990] S.C.J. No. 33, 72 O.R. (2d) 799n, 39 O.A.C. 63, 68 D.L.R. (4th) 321, 107 N.R. 321, [1990] I.L.R. para. 1-2583; People's Department Stores Ltd. (1992) Inc. (Re) (1998), 1998 9390 (QC CS), 23 C.B.R. (4th) 200, 1998 CarswellQue 3442 (S.C.); Stuart v. Hutchins (1998), 1998 7163 (ON CA), 40 O.R. (3d) 321, [1998] O.J. No. 3672, 164 D.L.R. (4th) 67, [1999] I.L.R. para. I-3619, 27 C.P.C. (4th) 1 (C.A.); Videotron Group Ltd. v. London Guarantee Insurance Co., [2005] J.Q. no 10049 (S.C.); Weston Ornamental Iron Works Ltd. v. Continental Insurance Co., [1981] O.J. No. 78, [1981] I.L.R. para. 1-1430, 9 A.C.W.S. (2d) 410 (C.A.); Zurich Insurance Co. v. 686234 Ontario Ltd. (2002), 2002 33365 (ON CA), 62 O.R. (3d) 447, [2002] O.J. No. 4496, 222 D.L.R. (4th) 655, [2003] I.L.R. para.I-4137 (C.A.)

Robert J. Howe, Ava Kanner and Amber Stewart, for appellants. M. Boussidan and James F. Diamond, for respondent.

The judgment of the court was delivered by

[1] MACFARLAND J.A.:-- This is an appeal from the order of the Honourable Madam Justice Horkins dated the 4th day of March, 2005, wherein she ordered that the appellants had a duty to defend the respondent in an action commenced against him in the Ontario Superior Court of Justice bearing file number [page686] 03-CV-242318 CM1 pursuant to Directors' and Officers' Liability Policy Number 10016654 issued by the appellants to Master Insulators' Association of Ontario Inc.

[2] The facts which give rise to this appeal are not in dispute. In January, 2003, Peter and Anna Woloszankyj, both former employees of Master Insulators' Association of Ontario Inc. ("MIA"), issued a statement of claim against MIA seeking damages for breach of contract, wrongful dismissal, bad faith discharge and defamation. In February 2003, MIA issued a counterclaim against the Woloszanskyjs and added Kohanski, a former Director and president of the Board of Directors of MIA as a defendant to the counterclaim. As against Kohanski MIA counterclaimed for:

(c) general damages against Kohanski in the amount of $203,000.00, or alternatively the entire amount, if any, as may be found by the Court to be owing to either/both Plaintiffs by the Defendant MIA in the main action for:

(i) breach of fiduciary duties;

(ii) the tort of conspiracy; and,

(iii) breach of section 134, of the Ontario Business Corporations Act;

(f) Punitive, aggravated and exemplary damages against all the defendants to the counterclaim in the amount of $100,000.00.

[3] In May 2003, Kohanski wrote to the appellants stating that he had been sued in his capacity as a director of MIA and sought coverage for the claim under the subject policy.

[4] In early April 2002, London Guarantee Insurance Company issued Directors' and Officers' Liability policy number 10016654 to MIA effective April 19, 2002 to April 19, 2004. Responsibility for the policy was subsequently assumed by St. Paul Guarantee Insurance Company.

[5] By letter dated June 24, 2003, the insurer wrote to Kohanski in the following terms:

Section IV(7) of the Policy provides:

The Insurer shall not be liable to make any payment for loss in connection with any claim made against the Directors and Officers:

(7) which is brought by or at the behest of the Corporation, or any affiliate of the Corporation, or by any security holder of the Corporation whether directly or derivatively except where such security holder bringing such claim is acting totally independently of, and totally without the solicitation of, or assistance of, or participation of, or intervention of, any Director or Officer, or the Corporation or any affiliate of the Corporation. [page687]

MIA has commenced the action against you by way of counterclaim in its statement of defence and counterclaim to the action brought against it by Peter and Anna Woloszanskyj. It is therefore clear that the action against you is a claim which is brought by MIA (i.e., the Corporation). Coverage for this matter is therefore unavailable pursuant to Section IV(7) of the Policy, and the Policy will not be responding.

[6] The issue raised on this appeal is whether the appellant insurer owes the respondent insured Kohanski a duty to defend the suit brought against him by MIA under the terms of the subject policy.

[7] The insuring agreement in respect of the directors and officers insurance coverage provides:

The Insurer agrees with the Directors and Officers of the Corporation that if, during the Policy Period, any claim is first made against them for a wrongful Act, the insurer will pay on behalf of the Directors and Officers, all loss which the Directors and Officers shall become legally obligated to pay, except for such loss for which the Corporation is required or permitted by law to indemnify the Directors and Officers unless and to the extent that the Corporation is unable to make actual indemnification solely by reason of its financial impairment.

[8] As the application judge noted there is no dispute that a claim was made against Kohanski for a wrongful act within the policy period. At the relevant time he was a director and officer within the meaning of the policy. The sole issue is the applicability of the exclusion in s. IV(7).

[9] In her reasons the application judge succinctly stated the positions of the parties:

The insurer argues that it is plain and obvious that the exclusion applies and so it owes no duty to defend Kohanski in the action. Simply put, the counterclaim is a claim made against a director (Kohanski) brought by the Corporation (MIA). As a result they say there is no need to look beyond the words of the exclusion in order to determine if there is a duty to defend.

Kohanski relies on a body of case law in the United States that discusses the policy reasons behind the exclusion. The exclusion was intended to prevent collusive actions between insureds. Since this counterclaim is adversarial he argues that a duty to defend is owed. A "mere possibility" that a claim might fall within the policy is enough to trigger the duty to defend. The insurer takes the position that given the plain and obvious wording, I should not look behind the exclusion to consider its purpose.

[10] The application judge concluded that the appellants owed the respondent a duty to defend the action brought against him pursuant to the terms of the policy. In so doing she purported to follow a line of American authorities where a duty to defend was found in circumstances where the stated purpose of this exclusionary clause would not be defeated. The purpose of this particular exclusionary clause was said to be to prevent collusive [page688] lawsuits between corporations on the one hand and the officers and/or directors of those corporations on the other.

[11] For the reasons that follow, I am of the view that the application judge erred in concluding that a duty to defend is owed in the circumstances of this case.

[12] It is well established that the duty to defend arises only where the pleadings raise claims that would be covered by the insuring agreement contained in the policy. Equally, if the claims fall outside the coverage by reason of an exclusion clause the duty to defend does not arise. As McLachlin J. (as she then was) noted in Nichols v. American Home Assurance Co., 1990 144 (SCC), [1990] 1 S.C.R. 801, [1990] S.C.J. No. 33, at para. 16:

However, general principles relating to the construction of insurance contracts support the conclusion that the duty to defend arises only where the pleadings raise claims which would be payable under the agreement to indemnify in the insurance contract. Courts have frequently stated that "the pleadings govern the duty to defend": Bacon v. McBride (1984) 1984 692 (BC SC), 6 D.L.R. (4th) 96 (B.C.S.C.), at p. 99. Where it is clear from the pleadings that the suit falls outside of the coverage of the policy by reason of an exclusion clause, the duty to defend has been held not to arise: Opron Maritimes Construction Ltd. v. Canadian Indemnity Co. (1986), 1986 89 (NB CA), 19 C.C.L.I. 168 (N.B.C.A.), leave to appeal refused by this court, [1987] 1 S.C.R. xi.

[13] Exclusion IV(7) is known in insurance parlance as the insured v. insured exclusion. At the time this matter was argued before the application judge only one Canadian case discussed this exclusion. That case was People's Department Stores Ltd. (1992) Inc. (Re) (1998), 1998 9390 (QC CS), 23 C.B.R. (4th) 200, 1998 CarswellQue 3442 (S.C.) a decision of the Quebec Superior Court where the court held that in an action where the trustee in bankruptcy asserts claims against former directors of the bankrupt corporation the insured v. insured exclusion does not apply -- a case very similar on its facts to the four American authorities relied upon by the application judge.

[14] Since the case was argued below there has been another decision of the Quebec Superior Court Videotron Group Ltd. v. London Guarantee Insurance Co., [2005] J.Q. no. 10049 (S.C.) (translated by All Languages Ltd.) where the court held, at para. 12, that the language of the insured v. insured exclusion was "... in no way ambiguous".

[15] In such circumstances, where there are few Canadian authorities, it is appropriate for Canadian courts to look to American authorities for assistance to ensure uniformity in construing contracts of insurance used in both countries. See Zurich Insurance Co. v. 686234 Ontario Ltd. (2002), 2002 33365 (ON CA), 62 O.R. (3d) 447, [2002] O.J. No. 4496 (C.A.), at p. 461 O.R. [page689]

[16] Each of the four American authorities considered and relied upon by the application judge differed significantly in their facts from the case before her. In each of those four cases the courts found that the exclusion clause was ambiguous with respect to whether the party bringing the underlying action was an "insured" within the meaning of the policy.

[17] In Rieser v. Baunodendistel (In re Buckeye Countrymark, Inc.), 251 B.R. 835, 44 Collier Bank. Cas. 2d (MB) 1107 (Bkrtcy. S.D. Ohio 2000), at 7-8, the court concluded:

In summary, the Trustee does not represent the Debtor nor is the Trustee acting on the Debtor's behalf in this litigation. Instead, the Trustee brings his claims as a separate legal entity acting on behalf of the bankruptcy estate and the estate's creditors. Mindful of the rule of construction requiring the court to construe ambiguous language in an exclusionary provision liberally in favour of coverage, the court concludes that the insurance contract provision excluding coverage for claims brought "by" or "on behalf of" the Debtor does not apply to exclude coverage for claims brought by the Chapter 7 Trustee.

[18] In that case after the debtor, Buckeye Countrymark, Inc. filed its Chapter 7 Bankruptcy petition, the Chapter 7 Trustee filed a complaint against nine of the debtor's former directors, former manager and others alleging that these individuals had breached their fiduciary duties causing the debtor's demise. The directors sought entitlement to insurance coverage for the claims brought against them. The insurers claimed that the insured v. insured exclusion contained in the policy precluded coverage for the claims brought against the directors by the Chapter 7 Trustee.

[19] In the case of Cigna Insurance Co. v. Gulf United States Corp., 1997 W.L. 1878757 (D. Idaho 1997), at 4, the stated issued was whether insured v. insured endorsements applied to exclude insurance coverage for claims asserted against Gulf's former directors and officers. The claim asserted by Gulf followed its filing of a petition for relief under Chapter 11 (bankruptcy legislation) and in its capacity as debtor-in- possession, was against certain officers and directors alleging breach of fiduciary duty, corporate waste and mismanagement, civil conspiracy, misrepresentation, breach of contract and fraudulent conveyance claims. In its claim, Gulf asserted that the action was "brought aeat the demand of and on behalf of the estate ... all creditors' equity holders and all other parties who have an interest in the estate'."

[20] The insurers denied coverage to the former directors and officers based on the insured v. insured exclusion contained in their policies. Gulf then moved for declaratory judgment that the [page690] insurers were obligated to provide coverage for losses arising from the claims asserted against the officers and directors.

[21] Thereafter Gulf transferred their claims to a litigation trust -- a trust formed for the purpose of prosecuting the claims against the former officers and directors and for the sole benefit of creditors designated in the plan of reorganization. By its terms the trust agreement specifically excluded Gulf as a beneficiary of the trust.

[22] At first instance the bankruptcy court held that the insured v. insured exclusion did not bar coverage where the litigation trustees are not acting for the benefit of the corporation, but for the benefit of the corporation's creditors, including shareholders.

[23] For the purpose of its analysis the District Court ignored the after-the-fact transfer to the litigation trust. Instead the court based its analysis on the identity of the plaintiff at the time the claims were made: Gulf as a debtor- in-possession.

[24] The court noted that the insured v. insured provisions excluded insurance coverage for claims made by the company or corporation -- the language of the exclusion does not address claims made by a debtor-in-possession. The insurers argued that Gulf as debtor-in-possession is the same legal entity as Gulf pre-petition (in bankruptcy).

[25] The court proceeded to consider the relevant authorities with a view to determining the identity of the party asserting the claims against the former officers and direction and concluded:

The court finds the same considerations present here. Under the Bankruptcy Code and the confirmed Chapter II plan, Gulf as debtor-in-possession is asserting claims on behalf of and for the benefit of Gulf's shareholders and creditors. In this respect the claims are not made by, or on behalf, or by successors to Gulf. Instead the asserted claims are of the same type that could have been made pre-petition by the corporation's shareholders. The "insured v. insured" exclusions at issue in this appeal explicitly provide for insurance coverage for such claims. Accordingly, the court concludes that the "insured v. insured" exclusions do not apply to the D & O claims.

[26] I note parenthetically that the exclusion clause here similarly provides for the type of coverage noted by the court in Cigna.

[27] The court in effect concluded that Gulf as debtor-in- possession was a separate and distinct legal entity from Gulf-pre-petition. The policy exclusion contemplated the company pre-petition and hence the exclusion did not apply.

[28] The court after completing its legal analysis went on to add that its decision was "bolstered" by the policy considerations underpinning the insured v. insured exclusion -- the prevention of collusive suits. [page691]

[29] In my view, the Cigna decision is readily distinguishable on its facts. The company asserting the claim here is MIA the same legal entity contemplated by the language of the exclusion. There has been no change in the legal status of MIA.

[30] In Conklin Co. Inc. v. National Union Fire Insurance Co., 1987 W.L. 108957 (D. Minn 1987), at 2, the plaintiffs sought a determination that the directors and officers liability insurance policy (D. & O. policy) issued by the defendant to the plaintiffs, covered claims arising from a wrongful discharge suite brought by a former officer one Thomas Misurer of the plaintiff companies against the plaintiffs. The plaintiffs were Conklin Company Inc., Personal Dynamics Inc. a subsidiary of Conklin Co. and Robert Conklin, chairman of the boards of directors of both companies.

[31] The insurer relied on the insured v. insured endorsement contained in its policy which read:

In consideration of the premium charged, it is hereby agreed that the insurer shall not be liable to make any payment for loss ... under this policy in connection with any claim or claims made against the insureds by an insured as defined in this policy, including the Company named in Item 1 of the Declarations, except for stockholders' derivative actions brought by a shareholder of the Company other than an Insured.

[32] After noting that the purpose of the endorsement is not to exclude coverage for claims arising from wrongful discharge suits but rather to prevent collusive or friendly lawsuits, the court concluded that if Misurek (the former employee) were merely asserting claims in his own right he could not be considered an "insured" within the meaning of the subject insured v. insured endorsement. The court found the exclusion to be ambiguous in this respect and because of that ambiguity construed the exclusion against the insurer.

[33] In its reasons the court acknowledged that while Misurek may technically be a potential "insured" under one of the insuring clauses, his wrongful discharge suit against the plaintiffs is an adverse action, not a friendly or collusive lawsuit. Also Misurek neither sought nor was subject to coverage under the policy for his wrongful discharge claims. He was not suing in his capacity as an officer, and therefore as an insured, but was suing in his capacity as an employee.

[34] Again on its facts Conklin is readily distinguishable. It may have had some relevance had the Woloszanskyjs sued Mr. Kohanski directly but they did not.

[35] The fourth American authority relied on by the application judge, Township of Center v. First Mercury Syndicate Inc., 117 F. 3d 115 (3rd Cir. 1997) at 5, is similar on its facts to Conklin. The court concluded that on the facts of that case the ex-employee [page692] plaintiffs were not insureds within the meaning of the exclusion contained in the policy before the court in that case.

[36] In each of the American authorities the court concluded that the exclusion clause was ambiguous with respect to whether the party bringing the underlying action was an "insured" within the meaning of the policy.

[37] Such ambiguity does not exist on the facts of this case. I agree with the application judge's observation at para. 31 of her reasons: on its face this exclusion is unambiguous. It operates to exclude coverage when one insured sues another.

[38] In such circumstances, the court's obligation is to give effect to the language of the contract unless to do so would "defeat the main object of the contract or virtually nullify the coverage". See Weston Ornamental Iron Works Ltd. v. Continental Insurance Co., [1981] O.J. No. 78, [1981] I.L.R. 1-1430 (C.A.), at para. 477 I.L.R.

[39] The application judge made no finding to the effect that the insured v. insured exclusion clause as contained in the subject policy had the effect of virtually nullifying the coverage provided for under the policy. In my view such a finding could not be made on the facts of this case. It would appear that had the Woloszanskyjs sued Mr. Kohanski directly the policy would respond.

[40] The exclusion is narrow and only excludes claims brought against directors and officers by MIA. A claim brought by any party other than MIA is not excluded by the insured v. insured exclusion.

[41] As this court noted in Stuart v. Hutchins (1998), 1998 7163 (ON CA), 40 O.R. (3d) 321, [1998] O.J. No. 3672, 1998 CarswellOnt. 3540 (C.A.), at paras. 29-30:

To the extent that the wording in a contract of insurance is found to be ambiguous, it is accepted that the ambiguity will generally be resolved in favour of the insured. This rule, however, has no application where the wording of the policy is plain on its face and capable of only one meaning.

Trite though it maybe, an insurer has the right to limit coverage in a policy issued by it and when it does so, the plain language of the limitation must be respected.

[42] Because the claim of MIA (against Kohanski) is clearly and unambiguously excluded from coverage by reason of the insured v. insured exclusion, the appellants cannot have a duty to indemnify Kohanski under the policy and accordingly the appellants have no duty to defend Kohanski in the underlying action. Whatever the policy behind the exclusion may be, where the language of the contract is clear and unambiguous, the court must give effect to that language. [page693]

[43] I would allow the appeal, set aside the order of Horkins J. and in its place an order will issue dismissing the application.

[44] By agreement of the parties, there is no order as to costs.

Appeal allowed.