Are Split Coverage/Defense Files A Conflict of Interest if Both Handlers Report to the Same Manager?

I wanted to share a really interesting decision that was released this week in Ontario – the citation is https://canlii.ca/t/jlw3q.

This case relates to ongoing opioid-related litigation against Loblaws and their affiliates. There are currently a total of five class actions against Loblaws related to their distribution of opioids, with billions in damages sought. As you might have guessed, the loss is complex from the perspective of an insurer – the allegations against Loblaws span a significant number of years and have triggered a number of different policies. In addition, many of those allegations may give rise to coverage issues such as allegations of fraud, negligent marketing, and intentional act. There are a total of 16 different primary and excess insurers who are involved in the defense of these class action lawsuits and are acting independently of each other.

The decision is as a result of several applications brought by Loblaws and various insurers relating to a number of different topics, including allocation of defense costs amongst insurers and whether SIRs have been exhausted. While the decisions for these applications are interesting, it was the final application that I think warrants some further discussion – whether the involved insurers should be required to sign a defense reporting agreement (DRA) in order to receive privileged materials from defense counsel.

In mid-2020 counsel for Loblaws raised concerns that the insurers may be operating in a potential conflict of interest due to the fact that they had all reserved their rights to deny coverage (while still participating in the defense) and because they were involved in the defense of other defendants whose positions may be adversarial to Loblaws. Loblaws noted that, while all insurers had taken steps to ensure that the defense and coverage files of Loblaws had been split between different handlers and that different adjusters were handling the claims of other defendants, all adjusters were still reporting to the same claims manager for authority and direction. Loblaws took the position that this would place its defense counsel in the position of a conflict of interest given that information would potentially flow from the defense file of Loblaws to the coverage file and eventually to the defense files of the other defendants. In order to safeguard against this, Loblaws proposed that all insurers participating in its defense sign a DRA and commit to designating a specific person to handling the defense file who is able to make file decisions without reporting to the same decision maker that the coverage handler reports to. If an insurer is not willing to sign the DRA, it will not be entitled to receive reports from defense counsel but would still be required to fund the defense of Loblaws in accordance with the coverage available under the policy.

This prompted a mixed reaction from the insurers. A number of the insurers agreed to sign the DRA and abide by the requirements specified by Loblaws. A number of others opposed the requirement of the DRA (AIG, Chubb, Markel, QBE, and RSA). The dissenting insurers offered three reasons for their refusal. Firstly, they argued that all insurers have protocols in place to split their files to ensure that there is no conflict of interest when the interests of insurer and insured deviate from each other which ought to be sufficient for this scenario. Secondly, they argued that an insured is required to make a full disclosure of all material facts to its insurer in order for the insurer to be able to take a reasonable position on coverage. Refusing to release defense reports might constitute a breach of the policy. Finally, they argued that their claims managers have a legitimate need to know about all claims files to ensure the insurer is meeting their policy obligations and is able to set accurate reserves.

The court found that the concerns raised by Loblaws relative to the existence of a conflict of interest were reasonable and that it was realistic to assume that an insurer would use privileged defense information to inform its coverage position. The court found that while Loblaws does have a duty to disclose material facts to all of its insurers, it has no good faith duty to produce communications relating to those facts. Finally, the court found that the existing protocol for splitting files was inadequate for this case and required that insurers adopt the provisions of the DRA in order to receive communications about the defense of the file.

This is a significant decision borne out of a unique situation that may eventually change the way that an insurer approaches split file handling. It is common practice in the industry to split defense and coverage files once a file moves into litigation and a defense is acknowledged. It is also a common occurrence to discover that an insurer represents more than one party in litigation. However, all reporting eventually leads to the same claims manager. This decision appears to suggest that this may be a conflict of interest if the interests of the insurer and insured or two different insureds do not align. A potential way around this might be to reach liability sharing agreements between same insurer-insured parties early in the litigation process, but we can expect split coverage/defense files to be under increased scrutiny.

It will be very interesting to see how more sophisticated insureds use this decision in the coming months and years.