Don’t lose sight of the forest for the trees when considering a duty to defend

Insurance company was required to defend the insured in an underlying action. This was in spite of the insured potentially having made material misrepresentations that will void the coverage if required to pay a judgment.

Insurance law – Errors and omissions policies – Misrepresentation in obtaining insurance – Exclusions – Copyright breach – Duty to defend – Practice – Pleadings – Underlying action – Evidence – Extrinsic evidence

IT Haven v. Certain Underwriters at Lloyd’s, London, [2020] O.J. No. 5504, 2020 ONSC 7835, Ontario Superior Court of Justice, December 15, 2020, M.L. Edwards J.

The insureds brought an application seeking a declaration that the insurer had a duty to defend an information technology specialist (the “personal applicant”) and an IT company (collectively, the “applicants”), under an errors and omissions policy (the “Policy”) in a California lawsuit (the “U.S. Proceedings”). In the U.S. Proceedings, a video game company (the “Company”) sued the insureds for breach of copyright and the insurer refused to defend and indemnify them.

The history of the parties involves the personal applicant incorporating the IT company, while acting as its sole director. The personal applicant obtained the Policy on behalf of the IT company. The applicants were later sued in the U.S. Proceedings, for various relief, and included allegations that the IT company was a front for the personal applicant’s business, and that he was also the leader of a group of hackers which worked to allow people to cheat at the Company’s games, including Pokemon Go, Ingress and Harry Potter Wizards Unite.

The insureds argued that the facts alleged and the damages sought in the U.S. Proceedings brought the claim within the scope of coverage on the basis of a reasonable possibility, and that the onus then shifted to the insurer to show the claim fell outside of coverage. The insurer argued that the insureds made material misrepresentations in their insurance application, did not comply with a “material information” provision that excludes certain claims, and that various other exclusions applied. Much of what the insurer argued was grounded in extrinsic evidence, including an affidavit of the cover holder for underwriting the Policy, expert opinion evidence, post-claim statements made by the personal applicant, and a transcript of a cross examination of the personal applicant.

The court applied the principles from Progressive Homes Ltd. v. Lombard General Insurance Co. of Canada, 2010 SCC 33. The pleadings determine whether the insurer has a duty to defend: if, on reading the allegations in the pleadings to determine the substance and true nature of the claims, there is any possibility that the claims fall within coverage, the duty to defend is triggered.  Extrinsic evidence may be considered if it was explicitly referred to in the pleadings or is necessary to determine the nature of the claim against the insureds.

The court excluded the extrinsic evidence relied on by the insurer, which was not referred to in the pleadings in the U.S. Proceeding. The court noted that in the U.S. Proceeding it may well turn out that the claims are not covered by the Policy and there is no duty to indemnify the insureds, but emphasized that issue of materiality should be proven at trial, not in pleadings-based applications. As there was no admissible evidence to trigger any of the Policy’s exclusions, the insurer was obligated to defend the insureds.

This case was digested by Mark A. McPhee, and first published in the LexisNexis® Harper Grey Insurance Law Netletter and the Harper Grey Insurance Law Newsletter. If you would like to discuss this case further, please contact Mark A. McPhee at mmcphee@harpergrey.com.

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