Introduction and Background
It is a trite law of human nature that honesty is the best policy. And it is trite law, as in the actual law, that this is especially true for parties entering insurance agreements.
In Davies v. AIG Insurance Company of Canada, 2024 ONCA 509,[1] the Ontario Court of Appeal (the “Court”) reversed a decision regarding an insurance coverage determination. The Court found that the insurer, AIG Insurance Company of Canada (“AIG”), did not have a duty to cover costs for the insured because of the insured’s nondisclosure that amounted to material misrepresentation.
The Parties, Policies, and the Facts
I. Parties and Policies
Mr. and Ms. Davies owned several real estate development companies. Mr. Davies was the principal for these companies (both referred to as the “Insured,” unless specified). The Insured sought for liability coverage under the Directors’ and Officers’ Liability Insurance Policies offered by AIG (the “Policies”).
Importantly, the Policies contained an exclusionary clause:[2]
“[If] any of the statements, warranties or representations is not accurately and completely disclosed in the application and materially affects either the acceptance of the risk or the hazard assumed by the Insurer, no coverage shall be afforded for any Claim [related to the inaccurate or incomplete disclosure]…”
Investors in the real estate development companies brought several actions against the Insured. The Insured accordingly sought coverage to defend against these actions and AIG paid over $1 million in legal costs. The investors alleged that the Insured led a Ponzi scheme fraud operation, and that the Insured misappropriated monies gathered through syndicated mortgages advanced by the investors (the “Underlying Actions”).
AIG resiled from its duty to cover costs on the basis that there was a material misrepresentation. Neither the Insured nor their insurance broker (the “Broker”) disclosed that these syndicated mortgages financed the companies in question (see footnote 4 for a quick summary of “syndicated mortgages”).[3] [4]
II. The Facts
On behalf of the prospective Insured, the Broker submitted the Insured’s companies’ financial statements (the “Financial Statements”) to AIG’s underwriting group.
The Financial Statements indicated the Insured’s companies possessed a significant amount of inter-company loans and long-term debt to external lenders. Yet, the external lenders’ sources or identities were undisclosed. AIG’s underwriters refrained from responding with a price quote due to the missing information.[5]
An important exchange of emails was sent where AIG’s underwriters requested this necessary information. The Broker’s email responded in point form, but failed to mention that the companies were financed by syndicated mortgages. AIG’s underwriters did not ask for clarification, and AIG continued the insurance application process without this knowledge.
Applications Judge’s Decision
The Applications Judge granted the Insured’s application and dismissed AIG’s application.
The Applications Judge noted that for AIG to successfully deny funding the Insured’s defence costs, the following five proofs must be met:[6]
- There was a misrepresentation;
- the misrepresentation was during the coverage application;
- the misrepresentation was material;
- the Underlying Actions allege, arose out of, were based upon, were attributable to, or were in consequence of the subject matter of the alleged misrepresentation; and
- the insured knew of the misrepresentation.
The first was unmet. No misrepresentation was proven because the correspondence had a “complete absence of any mention of syndicated mortgages.”[7] The Applications Judge held that while it may not be best practice to not disclose that a company is financed by syndicated mortgages, this is still “insufficient to conclude a misrepresentation had occurred.”[8]
The third was also unmet. The alleged misrepresentation was immaterial. The Applications Judge found the relevant emails warranted AIG to seek clarification, and that AIG could not rely on its misinterpretation following its failure to seek clarification.[9]
Basis of the Appeal
Prior to the Court considering the main issues at play, unusual circumstances formed a secondary issue regarding the standing of one of the Insured.
The day before the original hearing date of this appeal, the Insured’s counsel discovered that one of the two Insureds was an undischarged bankrupt. AIG argued that as an undischarged bankrupt, this Insured had no standing. The Insureds denied.
The Court found it of no practical benefit to decide on this issue.[10] An assessment of standing would be a significant issue by itself, thus the Court found it unsuitable to consider without a more thorough findings of fact.
Following, the two main issues on appeal raised by AIG were:[11]
- Did the Applications Judge err in failing to find there was a misrepresentation?
- Did the Applications Judge err in not finding that the misrepresentation was material?
Decision – Reversed
I. The Misrepresentation
The Court reversed the Applications Judge’s decisions, finding that the Insured made a misrepresentation by omission.[12] The Court intervened to resolve the Applications Judge’s legal error, reconsidering all relevant evidence.[13]
While AIG’s underwriters were in a position to seek clarification following the Broker’s email, it did not extinguish the Insured’s obligation for full and frank disclosure. The syndicated mortgages were relevant information for ascertaining the nature and risk AIG would undertake under the Policies.
II. The Misrepresentation was Material
The Court found the misrepresentation was clearly material,[14] meeting the test laid out in Sagl v. Chubb Insurance Company of Canada, 2009 ONCA 388.
The objective and subjective elements of the test were met.[15] The Applications Judge failed to apply this test, leading to a legal error; additionally, they incorrectly treated the Broker’s email and AIG’s response as dispositive when considering materiality.
To correct this legal error, the Court considered the entirety of AIG’s responses for the subjective analysis. The following demonstrated that the misrepresentation was material: AIG’s request for further information that established the Insured’s adequate financing; that this information was required to provide a quote for the Policies; and the AIG underwriters would have reevaluated the risk of accepting the Insured’s submission had they known of the syndicate mortgages.
Takeaways
Davies shows that even a seemingly inconsequential misrepresentation can nullify one’s liability coverage. The fact the AIG underwriters did not specifically ask for “syndicate mortgages” or general clarification did not negate the material misrepresentation that affected their risk assessment of the Financial Statements. The expectations of the insured and insurer was that this fact should have been disclosed, regardless of AIG not asking for clarification.
The Court stresses the obligations and expectations for insureds to fully and frankly disclose all relevant information to their potential insurers. In sum, that honesty is the best policy.
[2] Ibid at para 8 (emphasis added).
[4] A “syndicated mortgage” involves numerous investors collecting funds for one mortgage. These mortgages are generally seen as “high risk, high reward” mortgages, and may have unique complexities that cause individuals to sustain large financial losses. Note, the Court does not mention such complexities or risks in concluding that syndicated mortgages should have been disclosed.
[5] Davies, supra note 1 at paras 12.
[11] Ibid at paras 21–22.
[12] Ibid at paras 30–32.
[14] Ibid at paras 34–36.
[15] Ibid at paras 37–39.
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