Carriage and Control of Litigation in Subrogated Actions

The following paper was presented at the Canadian Bar Association's annual conference in Vancouver BC on August 15, 2012. Hillel David was co-counsel for the insurers in Zurich Insurance Company Ltd. et al. v. Ison T.H. Auto Sales Inc.

The Ontario Court of Appeal's recent decision in Zurich Insurance Company Ltd. et al. v. Ison T.H. Auto Sales Inc. sets out important principles on the issue of who has the right of carriage and control of litigation in circumstances where there is a combined subrogated and uninsured claim.

The decision turned on the issue of whether the contractual subrogation clause in the Zurich insurance policy altered the insured's common law right to carriage and control of the litigation. The Court confirmed that unless the subrogation clause expressly grants the insurer the right to control of the action, the insured retains control until they are fully indemnified.

Facts
In July of 2008, an explosion occurred at an apartment building in Toronto resulting in a fire. The insured, Ison T.H. Auto Sales o/a Toronto Honda, stored new cars in the underground parking lot of the building. As a result of the explosion and fire, the cars were damaged and could no longer be sold as new. The insurers paid out approximately $1.9 million to cover Toronto Honda's losses, but recovered salvage, leaving a net subrogated claim of approximately $1 million.

Toronto Honda claimed that it suffered a loss of profits as a result of the damage to the cars, and that it lost the ability to service the damaged vehicles, the opportunity to resell trade-ins on the same vehicles, as well as a loss of general goodwill. Toronto Honda calculated its uninsured loss to be $700,000.

History of the Action
A class action was commenced in October 2008 on behalf of the residents and owners of properties and businesses who suffered damages as a result of the explosion. Toronto Honda opted out of the class action and retained class action counsel to separately represent it in a lawsuit which was commenced in April 2009 (the "Ison action"). Shortly thereafter, an order was made by the class action judge that both the Ison action and the class action were to be tried together, with common discoveries and production.

In November 2009, the insurers retained McCague Borlack LLP to protect the subrogated claim. Prior to this time, the insurers had taken no active steps in the ongoing litigation. McCague Borlack LLP made requests of Toronto Honda's lawyers to permit them to participate in discoveries on behalf of the insurers. These requests were denied. Toronto Honda's lawyers took the position that they would keep the insurers advised of developments and would consult with them, but that Toronto Honda would control the litigation.

The Application
On August 4, 2010, the insurers launched an Application against Toronto Honda (the "Application") seeking an order that they are entitled to have carriage and control of the Ison action and full control by them of the subrogated claim. Alternatively, the insurers asked for an order that their counsel have "full and meaningful participation" in the conduct of the Ison action and full control of the subrogated claim.

The Application was heard by the class action judge. The court found that the subrogation clause in the applicable insurance policy did not expressly grant the insurers the right to carriage and control of the litigation. The court relied on the existing common law, holding that the insured retained carriage and control of the litigation until it was fully indemnified. The decision was affirmed by the Ontario Court of Appeal.¹

The Principle of Subrogation
Subrogation is one of four major principles of insurance law, along with insurable interest, good faith and indemnity. Once the insurer has indemnified the insured, the insurer is subrogated to all its rights of recovery and is entitled to exercise those rights in the name of the insured. In other words, the insurer steps into the "shoes" of the insured and can bring a claim in their name, with a view to recovering the amounts it paid out as a result of the actions or omissions of third parties.

The principle of subrogation is a creature of equity, arising out of the relationship between the insurer and insured. The insurer may subrogate when a third party is liable for the loss sustained by the insured and indemnified by the insurer. Under equity, there are three main principles of subrogation:

1. (a) the insured shall not be more or less than fully indemnified, and
   
   (b) the loss falls on the legally responsible party;

2. the insurer's right to subrogate comes after the full indemnity of the insured; and

3. the insured is obliged to pursue any claims it has against any third parties, and as such, has control of the litigation, in good faith.²

Thus the insured remains dominus litis until full indemnity has been made and the insurer may not control the litigation until the insured has been fully indemnified.

In the Ison action, the insurers indemnified Toronto Honda for its insured losses; however, Toronto Honda maintained that it had suffered a significant uninsured loss and thus had not been fully indemnified. The insurers did not dispute that the insureds have a common law right to control the lawsuit until fully indemnified. The distinction in this case, argued the insurers, was that the subrogation clause in the insurance policy, properly interpreted, changed the common law rule thereby granting the insurers the right to carriage and control of the Ison action.

When a Subrogation Clause Grants the Right of Control
The strict common law rule that grants the right of control of litigation to an insured can be modified by both statute and contract. Although the language of the subrogation clause in the Zurich policy mirrored the language of section 152 of the Ontario Insurance Act, the issue in the Application was whether the language was sufficient to overcome the common law rule and grant control to the insurers.

The insurers made two arguments on the issue of control:

1. that the common law rule does not survive, and therefore cannot be relied upon, when its foundation and rationale (described in one decision as its "entire underpinning") have been contractually removed; and

2. that the subrogation clause affirmatively conferred on the insurer the right to control the underlying litigation.

The applicable language of the subrogation clause in the Zurich policy stated:

Release from Liability and Subrogation Clause

The Insurer, upon making any payment or assuming liability therefor under this Policy, shall be subrogated to all rights of recovery of the Insured against any person, and may bring action in the name of the Insured to enforce such rights.
…
Where the net amount recovered after deducting the costs of recovery is not sufficient to provide a complete indemnity for the loss or damage suffered, that amount shall be divided between the Insurer and the Insured in the proportion in which the loss or damage has been borne by them respectively. Any release from liability entered into by the Insured prior to loss hereunder shall not affect this Policy or the right of the Insured to recover hereunder.

The insurers argued that the subrogation clause modified the common law in three ways. First, it permitted the insurers to commence an action against the third party even before the loss was fully paid, as long as they have either paid part of the loss or assumed an obligation to do so. Second, it provided that the insurers are entitled to recovery even before the insured was fully indemnified. Third, the insurers were permitted to share in the recovered amount with the insured on a pro rata basis where there has been less than full recovery.

The issue before the court was whether the insurers' entitlement to be "subrogated to all rights of recovery of the Insured" and to "bring action in the name of the Insured" to enforce such rights, carried the right to control of the litigation. The court followed the British Columbia Supreme Court's decision in Farrell Estates,³ holding that control of the litigation would only be awarded if it was expressly granted in the insurance contract. The court did not interpret the subrogation clause in the Zurich policy in such a way as to grant control to the insurers. As a result, the court concluded that the insured was to remain dominus litis until fully indemnified for its insured and uninsured losses.

The Application judge noted that there may be cases in which a court should exercise a residual discretion to give the insurer control of the litigation, in the appropriate case, even where there is no express contractual or statutory provision—for example, where the insurer's interest is vastly disproportionate to the insured's interest.

Key Principles and Practical Implications
The circumstances in Zurich were unique. In most cases, the subrogated claim far exceeds the uninsured loss and the insured is happy to have its insurer pursue recovery of both the uninsured and insured claims.

What have we learned from the Zurich decision?

1. The insured remains dominus litis and is to be in control of the litigation until fully indemnified for all insured and uninsured losses.

2. The insurance policy must expressly grant the insurer the right to control the litigation.

3. The insurer and insured can contract for carriage and control of the litigation, regardless of indemnity.

4. Business efficacy does not in itself permit the insurer the right to carriage and control of the litigation.

5. The insured has a duty of good faith to the insurer with respect to the handling and settlement of the subrogated claim and is required to consider the insurer's interests and keep them apprised of the status of the litigation.

6. The court has a residual discretion to grant carriage and control to an insurer, in the appropriate circumstances, even if there is no express contractual or statutory provision.

7. The prudent insurer will immediately seek the advice of subrogation counsel where there are insured and uninsured losses. Even in circumstances where the insured insists on maintaining control of the litigation, there may be an opportunity for the insurer's counsel to negotiate an arrangement whereby the insurer's counsel could represent the insurer's interests in the litigation.

¹ Zurich Insurance Co. v. Ison T.H. Auto Sales Inc., 2011 ONCA 663.
² Somersall v. Friedman, 2002 SCC 59.
³ Farrell Estates Ltd. v Canadian Indemnity Co., (1989) 59 DLR (4th) 67 (BCSC), aff'd [1990] BCJ No 720 (CA).

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