Canadian Business and the Law - Second Edition

have reorganized under the CCAA include Air Canada, AbitibiBowater, Canwest, Nortel, QuebecorWorld, and Stelco.

P. 672

When the court grants the initial CCAA order staying the creditors, it will also appoint a monitor, usually a major accounting
firm, that will oversee the operations of the company while it attempts to reorganize. The monitor reports to the court on any
major events that might impact the viability of the company, assists the company with the preparation of its reorganization
plan, and tabulates the votes at meetings of creditors.

There are no restrictions on what may be contained in a CCAA arrangement. Indeed, one of the most attractive features of
the CCAA for large companies is its flexibility. Arrangements will often involve companies paying a percentage of the debt
owed to creditors, either in a lump sum or over time, or exchanging specific debt for debt with higher interest and longer
repayment terms. Sometimes, shares will be offered to creditors in place of existing debt, or a combination of cash and
shares.

Eventually, the arrangement will be voted on by creditors, who are grouped together by class for voting purposes. If the
arrangement is approved by creditors of a class representing two-thirds of the total amount owed and a majority in number,
then the arrangement is binding on that class of creditors. Once all the classes of creditors have approved the arrangement,
court approval is required.

If a CCAA plan of arrangement is not approved by the creditors, then the company is not automatically bankrupt, as is the
case with a Division I proposal under the BIA, but the court ordered stay of creditors is lifted. At that point, creditors are
free to pursue their claims and it is likely that the company will be pushed into receivership or bankruptcy.

While a company is reorganizing under the BIA or the CCAA, it will need to fund its business operations. This may be
difficult, because the reorganization proceedings are obvious evidence of insolvency and creditors will be reluctant to lend
money in such circumstances. However, creditors may be willing to provide funding if the debtor has sufficient assets to
provide as collateral and the creditors are given priority over existing creditors. This type of financing is called debtor in
possession (DIP) or interim financing. DIP financing places existing secured creditors behind new lenders, which can be
controversial. Accordingly, when approving DIP financing and giving priority to new lenders over existing secured
creditors, courts are careful to balance the competing interests of existing secured creditors, the company in need of funds,
and other creditors as well as employees and other stakeholders. The BIA was recently amended to allow for DIP financing
in connection with a Division I proposal,7 however, DIP financing is very difficult for smaller companies to find when
making a BIA proposal.

The CCAA is often preferred over the proposal mechanism of the BIA because of its flexibility, the fact that it binds secured
creditors, and the availability of DIP financing. However, the minimum debt threshold of $5 000 000 and the very high costs
associated with a CCAA reorganization make it a viable option only for very large companies.

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Remedies for Creditors

A creditor whose payments are overdue has several options. The first step is to determine the reason for the debtor's failure
to pay. If the default is temporary, the creditor may decide to continue doing business with the debtor. However, if the debtor
is in serious financial difficulty, then the creditor will want to take action before it is too late. The creditor often has a
difficult choice to make between allowing the debtor additional time to pay or taking legal action for the recovery of the
debt.

A secured creditor can seize its collateral and sell it to pay down its debt, or appoint a receiver to take control of the debtor's
business, as discussed in Chapter 26. An unsecured creditor can sue the debtor and try to obtain judgment, which can then
be enforced against the debtor. A creditor with a guarantee can pursue the guarantor for payment upon default by the
primary debtor. A supplier can threaten to discontinue selling to the debtor, as Good Lumber did with Hometown. Any
creditor can threaten to commence legal action in the hope that the threat will persuade the debtor to bring the debt into
good standing.

If the business is in serious financial jeopardy and is unable to make a proposal or reach an arrangement with its creditors,
bankruptcy may be the only remaining option.

Business Application of the Law: Bankruptcy Protection and Corporate Reorganization

In 2010, Blockbuster Inc., the U.S. video rental company, filed for bankruptcy protection in the United States. The success
of video streaming and video-on-demand services such as Netflix proved to be insurmountable competition for
Blockbuster's traditional video rental business. Blockbuster announced that its goal was to reduce its $1 billion in debt to
approximately $100 million and that its senior secured debtholders would receive equity in exchange for their debt.
Blockbuster obtained $70 million in DIP financing from major Hollywood studios, including Warner Bros., Twentieth
Century Fox, and Sony Pictures. It was essential for Blockbuster to have the major studios on side during their
reorganization to ensure that Blockbuster could continue to provide customers with new releases on the first day of their
release. The collateral provided for the DIP financing was the assets of Blockbuster's profitable Canadian operation,
Blockbuster Canada.

In 2011, Blockbuster Inc. announced that it would not emerge from bankruptcy protection. The U.S. bankruptcy court
ordered the company to be liquidated and, in a court ordered auction, satellite television provider Dish Network Corp.
purchased the assets of the company for $320 million, with the result that the DIP loans went into default. Shortly after, on
application from the movie studio DIP lenders, an Ontario court appointed accounting firm Grant Thornton as the receiver
for Blockbuster Canada giving them the power to “take possession of and exercise control over” Blockbuster's

What happens when a business is no longer viable?

CHRIS COOPER-SMITH/GETSTOCK.COM

400 retail stores in Canada. By the end of 2011, all Blockbuster stores in Canada had been closed and all the employees
were terminated.

Critical Analysis

Were the interests of stakeholders, including the public, adequately protected by the process described above? Should the
bankruptcy process work differently when there is an economic downturn?

Sources: Steve Ladurantaye, “Receiver to close up to 140 Blockbuster Canada Outlets” The Globe and Mail (25 May 2011)
at B10; Jameson Berkow, “Blockbuster Canadian unit seeks bankruptcy protection” Financial Post (5 May 2011) online:
Financial Post<http://business.financialpost.com/2011/05/05blockbuster-canada-cohas-finally-gone-bust/ >; Marina Strauss
and Iain Marlow, “Blockbuster to pull plug in Canada” The Globe and Mail (31 August 2011) online: Globe and Mail
<http://www.theglobeandmail.com/report-on-business/blockbuster-to-pull-plug-in-canada/article592808 >.

P. 674

Bankruptcy

Bankruptcy is the legal process by which the assets of the bankrupt are automatically transferred to a trustee in bankruptcy
for liquidation and distribution to creditors. The bankruptcy process is governed by the BIA. The purposes of the BIA are

to preserve the assets of the bankrupt for the benefit of creditors
to ensure a fair and equitable distribution of the assets to creditors

in the case of personal bankruptcies, to allow the debtor a fresh financial start

There are three methods by which a person may become bankrupt. An assignment in bankruptcy occurs when a person
voluntarily assigns her assets to a trustee in bankruptcy. Creditors can also apply to the court for a bankruptcy order which,
if granted, results in a person being declared bankrupt. The bankruptcy order will normally be granted if the creditor is owed
at least $1000 and the debtor has committed an act of bankruptcy . Acts of bankruptcy include: defaulting on a proposal,
making a fraudulent transfer of property, preferring one creditor over another, trying to avoid or deceive creditors, admitting
insolvency or not meeting financial obligations as they come due.8 Lastly, bankruptcy occurs automatically if the creditors
reject a proposal, or if the creditors accept a proposal but the court rejects it. Regardless of the method by which a person
becomes bankrupt, the result is the same.

If Hometown makes an assignment in bankruptcy, Hometown will be bankrupt as of the date of the assignment to the trustee
in bankruptcy. If creditors of Hometown decide to apply to the court for a bankruptcy order against Hometown, they will
probably obtain the order, as Hometown has likely engaged in at least one act of bankruptcy and owes several creditors
more than $1 000.

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The Bankruptcy Process

Once a person is bankrupt, the assets of the person are transferred to the trustee in bankruptcy, who holds those assets in
trust for the benefit of creditors. The trustee has legal authority and responsibility to deal with the assets in a manner which
preserves their value. Ultimately, the trustee will dispose of the assets and distribute the proceeds to creditors of the
bankrupt in the manner required by the BIA. Creditors may appoint an inspector to act on their behalf and supervise the
actions of the trustee.9

Protection of Assets

Following an assignment in bankruptcy or bankruptcy order, the trustee gives public notice of the bankruptcy in order to
identify and protect the assets of the estate and to identify all liabilities. Typically, the trustee will

secure the business premises and storage facilities
conduct a detailed examination of assets
prepare the appropriate statements
ensure that assets are adequately protected, including insurance coverage
establish appropriate books and accounts
sell any perishable goods immediately

In exceptional circumstances, the trustee may continue running the business for a period of time in order to perform the
duties above.

The protection of assets requires a review not only of assets in possession of the debtor at the time of bankruptcy, but also of
assets that were transferred by the debtor prior to bankruptcy. If the debtor made payments to creditors in the ordinary
course of business, they will not be challenged. However, if payments were made to favour one creditor over another, assets
were transferred for less than their fair value, or transactions have taken place with related parties, then the trustee will
review those

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transactions to ensure that creditors are treated equitably and according to the priorities set out in the BIA. The 2009
amendments to the BIA revised the rules regarding preferences and removed the concepts of settlements and reviewable
transactions and replaced them with new transfers at undervalue rules.10 The simultaneous CCAA amendments
incorporated identical rules.11

Transfers at Undervalue

A transfer at undervalue occurs when assets are transferred, a payment is made, or services are provided for conspicuously

less than their fair market value. Where a transfer at undervalue is found, the court can declare the transfer to be void or can
order that the other party to the transaction pay the bankrupt estate the amount by which the consideration for the
transaction was less than fair market value.

In order for a transfer at undervalue to be found, specific conditions must be satisfied and the conditions differ depending on
whether or not the transaction was at arm's length. Parties are at arm's length when they are independent and not related
(there are extensive rules in the BIA to determine when parties are related12 ).

If the parties to the transaction are at arm's length, then a transaction is a transfer at undervalue if: (a) it took place within
one year prior to bankruptcy; (b) the debtor is insolvent (or was rendered insolvent by the transaction); and (c) the debtor
intended to defraud, defeat, or delay the interests of a creditor.

If the parties to the transaction are not at arm's length, then a transaction is a transfer at undervalue if it took place within
one year prior to bankruptcy. In that case, there are no solvency or intent criteria. If a non-arm's length transaction took
place within five years prior to bankruptcy, it is a transfer at undervalue if the solvency and intent criteria in (b) and (c)
above are satisfied.

For example, if Hometown transferred its inventory to Bill six months before bankruptcy, the transfer would be a transfer at
undervalue and would be void.

There are no cases yet that illustrate the approach the courts will take in determining whether a party intended to defraud,
defeat, or delay creditors pursuant to the new BIA rules. However, there are cases dealing with similar language in other
statutes which suggest that the courts will look primarily to the value of the consideration for which property was
transferred in determining intent. If a debtor transfers property to a third party and receives nothing or significantly less than
its fair market value in consideration, there will be a presumption of fraudulent intent on the part of the debtor. The
presumption will be stronger where the transfer was made in secret or in contemplation of impending bankruptcy or
litigation. There may even be fraudulent intent where property is transferred for fair value, if the court finds that the
intention of the debtor was fraudulent and the recipient of the property knew of the debtor's intention. The issue of
fraudulent intent is always highly specific to the facts of each case.13

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Preferences

A preference is a payment that benefits one creditor over another. With solvent companies, this is a common occurrence and
not a concern. However, when a company is insolvent, the preference may result in the other creditor not being paid at all.
One of the purposes of the BIA is to ensure that creditors are treated fairly and equitably. This means that ordinary
unsecured creditors should be treated equally. When one such creditor receives payment and another does not, this goal is
not achieved. If a payment is found to be a preference, the court can rule the payment void, meaning that the creditor in
receipt of the payment would have to repay that amount to the bankrupt estate.

As with transfers at undervalue, there is a distinction with respect to preferences depending on whether the parties are
dealing at arm's length.

If the parties are dealing at arm's length, a payment is a preference if it is made within three months prior to bankruptcy and
it is made with the intention of preferring one creditor over another.

If the parties are not dealing at arm's length, then a payment is a preference if it is made within one year prior to bankruptcy
and it has the effect of preferring one creditor over another. In this case, it need only be shown that the effect of the payment
was to prefer one creditor over another. The intention of the debtor is irrelevant.

It may be difficult to determine whether the debtor intended to prefer one creditor over another when making a payment.
However, the courts have held that there is a rebuttable presumption of that intent if the result of the payment is that one
creditor gets paid and another does not. This presumption can be rebutted if it can be shown, for example, that the payment
was made in the ordinary course of business, or was made to take advantage of favourable payment terms or to secure the
continued supply of goods or services needed for the debtor to remain in business.

Suppose Hometown has made an assignment in bankruptcy. If Hometown's payment to Good Lumber was made within
three months of bankruptcy, and the effect of the payment was that Good Lumber received payment while other creditors
did not, then the payment is likely a preference, and Good Lumber will have to return the payment to the trustee. Good

Lumber is only entitled to the same proportion of their debt as other unsecured creditors. Similarly, the payment to George
will be a preference if it was made within one year of bankruptcy, since George is not at arm's length to Hometown.
Provided the salaries paid to Bill and Martha were genuine payments for services given, and were paid in the ordinary
course of business, they will probably not be considered preferences. Regular payments made to trade creditors that were
made in the normal course of business would also not be considered preferences.

Hometown could argue that the payment to Good Lumber was made in good faith and was therefore not a preference. If the
payment was made for goods supplied to Hometown, and was made with the intention of obtaining a continued supply of
lumber so Hometown could remain in business, then the payment should be allowed to stand.

Fraudulent Conveyances

In addition to the BIA provisions dealing with preferences and transfers at undervalue, there are provincial laws dealing with
similar situations where creditors are unfairly prejudiced.

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In Ontario, the Fraudulent Conveyances Act14 provides that every transfer of property that is made with the intent to defeat,
hinder, delay, or defraud creditors is void. This provision may be used by creditors outside of a bankruptcy situation, or may
be used by a trustee in a bankruptcy situation. Whether the debtor intended to defeat, hinder, delay, or defraud creditors is
highly fact specific and will depend on the circumstances of each case.

Bankruptcy Offences

For the BIA to be respected, it must provide penalties for those who violate its provisions. These violations are known as
bankruptcy offences . They are criminal acts and can be committed by any of the key participants, including debtors,
creditors, and trustees.

The BIA contains an extensive list of bankruptcy offences.15 The most common bankruptcy offences include: fraudulently
transferring property before or after bankruptcy, refusing to answer questions truthfully, providing false information, hiding,
falsifying, or destroying records, hiding or concealing assets, and obtaining credit through false representations.

Penalties for bankruptcy offences range from conditional discharges to fines up to $10 000 and prison terms up to three
years.

Identification of Debts

Creditors find out about the bankruptcy through a notice sent by the trustee in bankruptcy. Details of the bankrupt estate are
provided at the first meeting of creditors.

Each creditor must file a proof of claim in respect to the amount that it is owed. The trustee examines each proof of claim
and either accepts or rejects the claim. The trustee rejects claims of unsecured creditors if there is inadequate evidence of the
debt. The trustee rejects claims of secured creditors if the security interest is not perfected. Creditors whose claims are
rejected have the option to challenge the rejection in court.

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Distribution to Creditors

Once the trustee has liquidated the assets and determined the debts of the bankrupt estate, the trustee will turn to the
distribution of the proceeds to creditors. The BIA contains a comprehensive set of priority rules that determine the order of
payment. The three broad categories of creditors are: secured, preferred, and unsecured. In addition, unpaid suppliers have a
right of repossession under the BIA and certain government debts are deemed to be statutory trusts and thus are paid before
any creditors.

Unpaid Suppliers

Unpaid suppliers are given special protection under the BIA. They are allowed to recover any goods shipped in the past 30
days which were not paid for, provided the debtor is bankrupt and the goods are in the same condition as when shipped.

Deemed Statutory Trusts

The federal government has passed legislation which deems property to be held in trust in regard to unremitted payroll
deductions16 and GST/HST which has been collected but not remitted.17 These amounts are considered not to be part of the
bankrupt estate and as such are payable ahead of all creditors.

Secured Creditors

Secured creditors with properly perfected security interests are entitled to take possession of their collateral and dispose of
it, regardless of bankruptcy. If there is a deficiency still owed to the secured creditor, after payment of the secured creditor's
expenses and application of the proceeds of sale to the debt, then the secured creditor becomes an ordinary unsecured
creditor for the deficiency. A secured creditor can waive its security and elect to proceed as an unsecured creditor for the
entire debt owed—this is sometimes done if the collateral is of little value or if it would require undue effort or expense to
seize and dispose of the collateral.

Preferred Creditors

Preferred creditors are paid after secured creditors and before other unsecured creditors, in strict order of priority as set out
in section 136 of the BIA. The list of preferred creditors

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reflects the legislative intent as to the creditors who should be paid first. Preferred creditors, in order of priority, include

funeral expenses
trustee fees and expenses, including legal fees
arrears in wages (up to $2000 per employee for the previous six months)18
municipal taxes
arrears of rent and accelerated rent, in each case up to three months

Preferred creditors are paid in full before anything is paid to other unsecured creditors.

Unsecured Creditors

The remaining funds in the bankrupt estate, if any, are paid to the ordinary unsecured creditors in proportion to the amounts
they are owed. Secured creditors with deficiencies are unsecured creditors to the extent of those deficiencies. Good Lumber
and George, to the extent that the payments to them by Hometown are found to be preferences and repaid to the trustee, are
unsecured creditors for those amounts (see Figure 27.2).

Employees

Employees who are owed wages are deemed to be secured creditors, with a first charge on the current assets of their
employer, for up to $2000 per employee. In addition, the Wage Earner Protection Program allows employees to recover
some unpaid wages when their employment is terminated as a result of bankruptcy or receivership. These provisions are
intended to protect employees, who are particularly vulnerable in the event of business failure due to bankruptcy or
insolvency.

FIGURE 27.2 Revised Statement of Assets and Liabilities for Hometown Hardware Ltd.

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FIGURE 27.3 Final Distribution of Assets of Hometown Hardware Ltd. by Class of Creditor

In the final distribution of assets (see Figure 27.3),

CRA is paid in full for the unremitted payroll deductions
the bank is paid in full under its mortgage as a secured creditor
the trustee's fees and municipal taxes are paid in full as preferred creditors
the remaining claims of unsecured creditors are paid at the rate of $0.18129 for each dollar owed

Since Bill and Martha personally guaranteed the line of credit to the bank, they are personally liable to pay $44 211—the
amount remaining on that debt—to the bank. If they cannot pay, they may have to explore their own options regarding
insolvency or bankruptcy.

A discharge from bankruptcy is not available to a bankrupt corporation unless it has paid its debts in full. Hometown no
longer exists as a corporation as of the date of its assignment in bankruptcy. It is the end of the road for Hometown.

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Business and Legislation: Origins and Purposes of Bankruptcy Legislation

The most famous observer of the miseries of insolvency was Charles Dickens. In the early 19th century, debtors' prisons
still existed in most countries. The dubious logic of imprisoning debtors for failing to pay their debts was not lost on
Dickens, whose own father was imprisoned in the Marshalsea Prison when Charles was 12.

Dickens' writings made a powerful impact on the reading public throughout the English-speaking world. Largely as a result
of Dickens' writings, bankruptcy legislation was introduced in England and elsewhere. Canadian bankruptcy legislation tries
to balance the interests of a diverse group of stakeholders when debtors are unable to pay their debts. On one hand, the
legislation enables honest but unfortunate debtors to free themselves of their crushing debts and obtain a fresh start. On the
other hand, the law establishes priorities between creditors so that assets are distributed fairly and equitably. In the case of
dishonest debtors, the law imposes punishment for those who commit bankruptcy offences. Finally, the legislation creates a
framework under which potentially viable, but insolvent, businesses may be reorganized so they can continue operating for
the benefit of creditors, suppliers, customers, employees, and the broader communities in which they carry on business.

There have been many attempts to revise and update bankruptcy legislation in Canada over the years. It has, however,
proven very difficult to achieve consensus on how best to accomplish that goal, in large part due to the diverse group of
stakeholders affected by the legislation. In 2009, the BIA and the CCAA were amended to facilitate DIP financing, deal

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with collective bargaining agreements, create a process for appointing a national receiver where appropriate, and give the
courts authority to remove obstructive corporate directors, among other things. In addition, the 2009 amendments revised
the rules regarding preferences and replaced the rules regarding settlements and reviewable transactions with
comprehensive new “transfers at undervalue” rules (discussed later in this chapter).

Marshalsea Prison, the debtors' prison where Charles
Dickens' father was incarcerated. © HISTORICAL PICTURE ARCHIVE/CORBIS

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International Perspective: International Insolvencies

Part XIII of the Bankruptcy and Insolvency Act (BIA) and Part IV of the Companies' Creditors Arrangement Act (CCAA)
deal with international insolvencies. Generally, these provisions address two questions: What happens when a Canadian
company in bankruptcy proceedings in Canada has assets in a foreign jurisdiction? And what happens when a foreign
creditor wishes to seize assets that are located in Canada pursuant to a foreign bankruptcy proceeding? There are a number
of important public interests at stake. Given the importance of international trade to the Canadian economy, it is critical that
participants in both Canada and abroad feel confident that the bankruptcy laws of all countries will be respected and, in the
event of a bankruptcy order by a court of competent jurisdiction, that assets will be accessible wherever they are located.
Furthermore, it would be offensive if a Canadian bankrupt could shield assets from Canadian creditors by locating those
assets outside of Canada. It is also important that only foreign orders that generally equate to similar provisions in Canadian
law be capable of enforcement in Canada.

In 2009, the BIA and CCAA were amended to address these issues by repealing the existing provisions dealing with
international insolvencies and adopting a modified version of the UNCITRAL Model Law on Cross-Border Insolvency. The
new provisions give Canadian courts the authority and broad discretion to make orders and grant relief as the courts
consider appropriate, and provide a more comprehensive framework for the coordination of cross-border insolvency
proceedings in Canada.

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Generally, a foreign creditor can gain access to a debtor's assets located in Canada pursuant to a legitimate foreign court
order. Furthermore, Canadian creditors can gain access to assets located outside of Canada. Note, however, that such actions
are subject to international treaties. Should a Canadian bankrupt have assets in a foreign country where reciprocity does not
exist, and should that same bankrupt choose to relocate to that country, Canadian creditors will likely have no chance of
recovery.

Insolvencies across the Canada–U.S. border have become both common and complicated, with the huge growth in trade and
the economic downturn affecting businesses in both countries. The recent amendments provide a code for the recognition f
foreign insolvency proceedings, in line with international standards.

Critical Analysis

In practice, to what extent might these provisions be avoided by debtors who are determined to keep their assets from
creditors?

Source: Office of the Superintendent of Bankruptcy Canada, “Summary of Legislative Changes” online:
<http://www.ic.gc.ca/eic/site/bsf-osb.nsf/eng/br01782.html >.

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Personal Bankruptcy

Personal bankruptcy is the last remaining option when an individual is unable to pay her debts and there are no alternatives
to bankruptcy. People become insolvent for a wide variety of reasons, including loss of employment, medical or other
expenses beyond their

P. 682

control, bad business investments, or poor financial planning. Personal bankruptcies differ from corporate bankruptcies in a
number of important respects.

People in financial difficulty may attempt informal measures to address their financial situation, including altering their
budget, consolidating their debts into a single loan with lower interest and easier payments, or negotiating directly with their
creditors for lower payments or more time to pay.

Division II (consumer) proposals are available to individuals with debts (other than those secured by a principal residence)
under $250 000, as discussed above. Some provinces19 have systems for the “orderly payment of debts,” which involve a
consolidation of debts under the supervision of the courts.

If no other options are available, individuals may be forced into personal bankruptcy. The process of bankruptcy is the same
as discussed above and involves the assets of the bankrupt being assigned to a trustee in bankruptcy who holds those assets,
and ultimately disposes of them, for the benefit of creditors. Personal bankruptcy can be voluntary, with the debtor making
an assignment in bankruptcy, or involuntary, as the result of an application to the court by a creditor for a bankruptcy order.

In a personal bankruptcy, a debtor is entitled to retain certain assets to support themselves and their families, along with any
registered retirement savings (except deposits within one year of bankruptcy). The BIA provides that the property of the
bankrupt transferred to the trustee excludes any property that would be exempt from seizure under provincial law.
Accordingly, the property that will be exempt will vary by province. In Ontario, the Execution Act provides exemptions for
items such as clothing up to $5650 in value, household furniture and utensils up to $11 300, tools of a trade up to $11 300,
and one motor vehicle up to $5650.20

During the bankruptcy process, the debtor will usually be required to make payments to the trustee for the benefit of
creditors. The amounts of the payments are determined by the trustee, taking into account the debtor's total income and
living expenses. The bankrupt will also be examined under oath in regard to her assets and liabilities, the causes of
bankruptcy, and the disposition of any property. The debtor must also attend two mandatory financial counselling sessions.

Provided the bankrupt has completed all of the steps described earlier, has not committed a bankruptcy offence, and is not
required to make additional payments, a first time bankrupt will receive an automatic discharge of bankruptcy nine months
following bankruptcy. For a second bankruptcy, automatic discharge takes place 24 months following bankruptcy. If an
automatic discharge is not available for any reason, the bankrupt must apply to the court for a discharge and the court will
conduct a hearing.

Once discharged, a bankrupt is released from most of her debts. Not all debts are released by the discharge. Fines, penalties,
alimony and support payments, debts arising from fraud, and to some extent student loans21 survive the discharge.
Corporations are not discharged from bankruptcy unless they have paid their debts in full.

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Following discharge from bankruptcy, a first bankruptcy remains on a person's credit record for six years. A second
bankruptcy remains on the record for 14 years and a consumer proposal remains on the record for three years.

The discharge may be opposed, by the Superintendent of Bankruptcy, the trustee, or a creditor, if a bankruptcy offence has
been committed or where there is evidence of extravagance prior to the bankruptcy.

Case: Southwick-Trask - Re, 2003 NSSC 160

The Business Context

Personal bankruptcy of those involved in a business can follow the insolvency of that business. The individuals are eligible
for discharge of the unpaid debts at the end of the process, but the discharge may be conditional. Those conditions can be a
matter of dispute between the individuals, creditors, and trustee.

Factual Background

Trask (T) was president, CEO, director, and shareholder of RDI Group, a company that operated call centres in Halifax for
15 years and employed up to 150 people. Southwick-Trask (ST) was married to T. She was a director of RDI and operated
her own business in strategic management consulting. In 2001, a large account receivable of RDI fell past due and had to be
written off. This resulted in the insolvency of RDI. At the time, RDI owed TD Bank $525 000 on a revolving line of credit
secured by accounts receivable and guaranteed by T and ST. They attempted to negotiate a settlement with the bank and
presented a proposal, but the attempts were unsuccessful. The bank petitioned both T and ST into bankruptcy. At the time,
their total debt was in excess of $2 million, of which $573 000 was owed to the bank. The trustee recommended they be
discharged, subject to payments of $18 000 by T and $36 000 by ST. T and ST disputed the amount of these payments.

The Legal Question

Are T and ST eligible for discharge from bankruptcy and, if so, on what terms?

Resolution

The judge found that the bankruptcies of T and ST resulted from misfortune in business. He reviewed general principles:

The act permits an honest debtor, who has been unfortunate in business, to secure a discharge so that he or
she can make a fresh start and resume his or her place in the business community. The conditional discharge,
that is most frequently a result of proving that the value of assets was less than half the liabilities, may also
address the purpose of fair distribution. Aside from cases where the conduct of the bankrupt has been
reprehensible, setting a condition for discharge requires a balance of rehabilitating the bankrupt and
providing the creditors with some dividend.

The judge went on to consider specific factors—RRSPs held by the couple, transfers of their residence and cottage to a
family trust, debts for income tax, T's earning capacity, ST's drawings from her business, and household expenses.

Based on the cause of the bankruptcies (misfortune in business), the significant value of assets in the estate, and the absence
of any misconduct, the judge ordered that T be discharged without condition and that ST be discharged subject to the
payment of $750 per month for 24 months or an equivalent lump-sum payment.

Critical Analysis

Does this case preserve the integrity of the bankruptcy regime? Did the court adequately balance the interests of the debtor,
creditors, and the public?

Business Law in Practice Revisited

1. What options does Hometown have in dealing with this financial crisis?

Hometown can seek a voluntary negotiated settlement with creditors in order to continue the business or bring it to an end.
Hometown can make a Division I proposal to creditors under the BIA that would allow the business to continue. As a last
resort, Hometown can make an assignment in bankruptcy.

2. What rights do Hometown's creditors have?

Creditors can exert pressure on Hometown or threaten legal action in an attempt to persuade Hometown to pay. Secured
creditors can seize and dispose of their collateral.

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Unsecured creditors can sue Hometown and try to obtain judgment. Finally, creditors can apply to a court for a bankruptcy
order against Hometown.

3. What will happen to Hometown, its owners, its creditors, Bill, and Martha if Hometown goes bankrupt?

Bankruptcy will result in the transfer of all of Hometown's assets to the trustee, including payments made which constitute
preferences. The trustee will dispose of the assets and distribute the proceeds to creditors. Secured creditors will likely
realize on their security, leaving only the unsecured assets to be dealt with by the trustee. Preferred creditors will be paid in
full before other unsecured creditors receive any payment. Any unpaid debts that Bill and Martha have guaranteed will
become their personal responsibility and may result in their personal bankruptcies. Hometown will cease to exist, but Bill
and Martha may be discharged from bankruptcy if they satisfy the statutory requirements.

Bankruptcy and Insolvency: Chapter Summary

The BIA and CCAA govern situations where debtors become insolvent. The purposes of the legislation are to ensure that all
stakeholders are treated fairly, including debtors, creditors, employees, government, and the broader community. It is,
however, a very difficult task to try and reconcile all of these different interests.

Prior to bankruptcy, debtors may be able to take informal steps to address their financial situation. Creditors will usually be
willing to negotiate if they believe that they will fare better through an informal process than through a formal process such
as a proposal or bankruptcy.

If informal steps are not an option, an insolvent debtor can make a proposal to creditors under the BIA. Individuals with less
than $250 000 in debt can make consumer proposals. Large companies with more than $5 000 000 in debt can reorganize
under the CCAA. In order to be successful, the debtor will have to submit a plan of reorganization that creditors will
approve.

Secured creditors are in a much better position than unsecured creditors in the event of insolvency or bankruptcy, because
they can generally enforce their security regardless of bankruptcy proceedings. Secured creditors become unsecured
creditors for any deficiency owed.

Bankruptcy is usually a last resort. Bankruptcy is the formal legal process by which the assets of the debtor are transferred
to a trustee in bankruptcy for the benefit of creditors. Bankruptcy can be either voluntary, by the debtor, or involuntary, on
an application by creditors. The BIA contains rules to ensure that creditors are treated fairly and that debtors conduct
themselves appropriately both before and during the bankruptcy process. In a bankruptcy situation, secured creditors will
usually realize on their security first, leaving only unsecured assets for the trustee to deal with. The trustee will dispose of
the remaining assets and distribute the proceeds to creditors in the specific manner and order of priority set out in the BIA.
Personal bankruptcy differs from business bankruptcy in a number of important respects, including the ability of the
bankrupt to be discharged from most debts after a period of time.

P. 685

Bankruptcy and Insolvency: Chapter Study: Key Terms and Concepts

act of bankruptcy (p. 675)
arm's length (p. 677)
assignment in bankruptcy (p. 675)
bankrupt (p. 675)
bankruptcy offences (p. 679)
bankruptcy order (p. 675)
debtor in possession (DIP) financing (p. 673)
discharge of bankruptcy (p. 683)
estate (p. 669)
insolvent (p. 670)
inspector (p. 676)
preferred creditors (p. 680)
proof of claim (p. 679)
transfers at undervalue (p. 677)
trustee in bankruptcy (p. 669)

Bankruptcy and Insolvency: Chapter Study: Questions for Review

1. How can negotiated settlements be used when a business is in financial difficulty?
2. What is the difference between insolvency and bankruptcy?
3. What are the purposes of bankruptcy legislation?
4. What is the difference between an assignment in bankruptcy and a bankruptcy order?
5. What are two examples of an act of bankruptcy?
6. What is a preference?
7. Who investigates preferences and transfers at undervalue?
8. Who are preferred creditors?
9. How are preferred creditors treated differently from secured and unsecured creditors?
10. How are employees protected in the bankruptcy of their employer?
11. Under what circumstances will a bankrupt likely not be discharged automatically from bankruptcy?
12. What are the duties of the trustee in bankruptcy?
13. What debts are not released in a discharge?
14. What is the purpose of a proposal?
15. What is the difference between a Division I proposal and a consumer proposal?
16. Why might a large company prefer reorganizing under the CCAA rather than making a proposal under the BIA?
17. What happens if unsecured creditors do not vote to approve a proposal?
18. What are the differences between an individual being bankrupt and a corporation being bankrupt?

Bankruptcy and Insolvency: Chapter Study: Questions for Critical Thinking

1. Business decisions made prior to bankruptcy can be challenged by the trustee if they are found to be preferences or
transfers at undervalue. What is the rationale for giving the trustee this authority? How does it relate to the purposes
of bankruptcy legislation?

2. Current bankruptcy law bars graduates from being discharged from their outstanding student loans for seven years
after the completion of their studies or five years in cases of hardship. Why does the law deal with student loans in
this way? Is it fair to treat student loans differently from other debts?

3. In late 2008, the North American auto industry was in serious financial difficulty. General Motors and Chrysler
sought large bailout packages from both the American and Canadian governments. It was speculated that the ripple
effects on the economy would be far reaching if these companies failed. Other commentators suggested that
bankruptcy protection would be a positive step for the companies. They would be able to sharply reduce their
excessive costs by negotiating deals with creditors, dealers, and the unions, and emerge in a stronger position to
compete with automakers from other countries. In 2009, both companies went through an expedited process
supported by government. Is bankruptcy protection an appropriate process in a potential industry failure of this
magnitude?

4. Proposals are an important part of the bankruptcy and insolvency legislation. However, despite the controls that
exist, they can have the effect of delaying legal actions by creditors to protect their interests. Does the

P. 686

potential benefit of proposals in salvaging troubled businesses outweigh the potential losses to creditors?
5. The category of preferred creditor is not found in the bankruptcy legislation of many countries. What is the rationale

for the protection afforded preferred creditors in Canadian law? Is this special treatment appropriate considering the
interests of all creditors?
6. Why does the bankruptcy legislation treat individuals differently from corporations regarding a discharge from
bankruptcy? Is this treatment appropriate?

Bankruptcy and Insolvency: Chapter Study: Situations for Discussion

1. Before creditors can petition a debtor into bankruptcy, they must be able to show that at least one act of bankruptcy has
been committed by the debtor. Review the events in the Hometown situation and identify any possible acts of bankruptcy.
Do the various acts of bankruptcy have a common theme? Should it be obvious to a debtor such as Hometown that such
conduct is inadvisable? When the debtor has committed an act of bankruptcy, at what point should the creditors act upon it?

2. Ontario Realty (OR) is a major property developer based in Toronto. It is in the business of building office towers and
other commercial premises. In the past year, the Ontario economy has been weak and commercial properties are difficult to
sell. OR now finds itself with several significant properties for which there is little chance of development until the economy
recovers. OR's debts are $150 million and its assets at today's values are worth $80 million. Two banks hold security for 90
percent of the debt. The balance of the debt is unsecured. The company is unable to make regular payments on its loans.

John, the CEO of the company, has weathered this kind of crisis before. He believes an economic recovery will begin within
a year. His discussions with the two major creditors suggest that only one would be prepared to negotiate a more favourable
payment scheme until the market recovers. John seeks advice from an insolvency practitioner about the pros and cons of
making a proposal.

What advice is John likely to receive? What factors will the creditors consider in responding to OR's situation? What are
John's options?

3. Designer Shirts is a supplier to Classic Stores (Classic), a major national retail outlet. There are rumours that Classic is in
trouble, but the company has been in trouble before and has managed to recover. Industry analysts say that there is too much
at stake to allow the company to fail.

Classic has recently announced an infusion of cash from a major investor. On the strength of this news, Designer Shirts
agrees to make deliveries, although it insists on a shorter payment period than normal. Designer makes the first delivery of
summer stock at the end of March. It receives its payment within the specified 20 days. It then makes a second delivery, but
this time payment is not forthcoming in 20 days. Based on further promises that the payment will be made within two days,
Designer makes a third shipment. Within 10 days there is an announcement that Classic has made an assignment in
bankruptcy. Designer has received payment for neither the second nor the third shipment and is owed $1.5 million.

What are Designer's options? Could Designer have better managed its risk in this situation?

4. Falcon Gypsum Ltd. is in the business of manufacturing wallboard, largely for the U.S. housing market, which has been
growing for many years. In recent months, several developments have caused Falcon management to become concerned.
The U.S. housing industry has slowed considerably. This has caused wallboard prices to fall sharply. In addition, the
Canadian dollar has risen in relation to the U.S. dollar, making Canadian manufacturers such as Falcon less competitive in
export sales. Falcon currently employs 40 workers. The company owes $32 million to 90 different creditors. The major
creditors are the bank and the provincial government, who hold secured loans. Management's strategy is to attempt to wait
out the current adverse conditions and hopefully return to prosperity. In order to do that, Falcon needs some breathing room
from creditors and some additional bridge financing.22 What are Falcon's options? What should Falcon do? If Falcon makes
a proposal, are creditors likely to approve the proposal?

5. Kim owns a family business that is experiencing serious difficulties because of changing economic circumstances. It
operates as a sole proprietorship and

P. 687

has borrowed from a number of sources (originally commercial, but lately from friends and family) over the last three years
to keep the business afloat. There are three employees, without whose services Kim could no longer run the business. He is
beginning to feel overwhelmed and needs some basic advice as to what he can and cannot do. For example, should he create
a corporation and sell the business assets to that corporation? Should he consolidate his loans and pay off as many as he can
now by extending his borrowing with the bank? If he repays his friends and family, is there any risk in doing so? What
should Kim do?

6. The Great Big Bank has recently conducted a review of its small-business loan failure rates and is concerned about the
results. There is strong evidence that failures are increasing disproportionately to loans made and that amounts recovered
are decreasing. Interviews of local loans managers suggest a good deal of confusion about how to assess risk, when the bank
should call a loan, and what mechanism best meets the bank's needs after the loan has been called. In addition, the credit
market is tight and the bank's senior management has ordered that lending requirements be strengthened. Based on all of
this information, the bank is redesigning its basic training manual. The primary focus now is on the section entitled “The
loan has gone bad. Now what do you do?” Develop guidelines that would offer practical advice and basic information for
loans officers. Identify the options and the circumstances under which each might be appropriate.

7. Gaklis was the sole director, officer and shareholder of Christy Crops Ltd. He controlled the company and made all major
decisions. The company had financial difficulty and was placed in receivership. Gaklis had guaranteed substantial debts of
the company and was unable to respond to demands for payment. He was forced into bankruptcy and eventually applied for
discharge. The trustee and the creditors opposed his application for a discharge based on his conduct: Gaklis had disposed of
land belonging to the company. He had given a security interest for $60 000 on an airplane and transferred ownership to his
father. He had failed to cooperate with the trustee by refusing to disclose particulars of bank accounts and insurance
policies.23

Should Gaklis be discharged from bankruptcy and released from his unpaid debts? If so, on what terms?

8. Gregor Grant was the president and sole shareholder of Grant's Contracting Ltd. On application by a major creditor, an
order of bankruptcy was issued against the company. In the course of investigating the company's affairs prior to
bankruptcy, the trustee discovered that a cheque received in payment from a supplier had not been deposited in the
company's account but had been diverted to another company owned by Gregor's brother, Harper. Harper had kept some of
the money for himself and returned the remainder in smaller amounts to Gregor.24 What, if anything, can the trustee do
about this situation? What could the impact be on the two companies, the two brothers, and the customer who sent the
cheque?

For more study tools, visit http://www.NELSONbrain.com .

Footnotes

1. RSC 1985, c B-3.
2. RSC 1985, c C-36.
3. Supra note 1, s 2.
4. Supra note 1, s 50.
5. Supra note 1, s 66.11.
6. Supra note 1, s 57.
7. Supra note 1, s 50.6.
8. Supra note 1, s 42.
9. Supra note 1, s 116.
10. Supra note 1, s 96.
11. Supra note 2, s 36.1.
12. Supra note 1, s 4.
13. For example, see Abakhan & Associates Inc v Braydon, (2009) BCCA 521, leave to appeal to SCC refused [2010]
SCCA No 26 (June 24, 2010).
14. RSO 1990, c F-29.
15. Supra note 1, Part VIII.
16. Income Tax Act, RSC 1985, c 1, s 227(4).
17. Excise Tax Act, RSC 1985, c E-15, s 222(3).
18. This amount is secured by a first charge on the employer's current assets pursuant to s 81.3 of the BIA.

19. For example, Alberta, Saskatchewan, and Nova Scotia.
20. Execution Act RSO 1998, c E-24.
21. If it is less than seven years after ceasing to be a student. However, application may be made for release on the basis of
hardship after five years.
22. Based on Bruce Erskine, “Plant shuts down for a bit”, The Chronicle Herald (13 June 2008) at C1.
23. Based on Re Gaklis (1984), 62 NSR (2d) 52 (SCTD).
24. Based on Grant Bros Contracting Ltd v Grant, 2005 NSSC 358.

P. 688

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Chapter 28 : Insurance
(pp. 690-712)

Insurance: Chapter Objectives
Objectives

After studying this chapter, you should have an understanding of
the role of insurance in risk management
the nature of an insurance contract, including the rights and obligations of the insurer and the insured
the various kinds of insurance

Insurance: Chapter Overview

QMI AGENCY

Business Law in Practice

Wire Experts and Company Ltd. (WEC) is a small business owned and operated by three shareholders. It produces wires used in the manufacture of tires. It buys metal,
formulates the alloys, extrudes the necessary wires, and then sells them to tire manufacturers both in Canada and abroad. The manufacture of the wire creates some
contaminated waste products that require special storage and disposal. WEC's business office is on the first floor of its manufacturing plant. Suppliers, sales personnel, and
representatives of various purchasers are frequent visitors. WEC also owns several trucks, which its delivery personnel use to deliver wires to customers.
As there are considerable risks associated with its business, WEC has purchased a full range of insurance products, including comprehensive general liability, automobile,
property, occupier's liability, errors and omissions, directors and officers, and business interruption insurance.
In 2005, WEC moved its operations to Alberta to be closer to its customer base. WEC closed its manufacturing plant in New Brunswick and opened a new facility in Red
Deer. Three months later, the vacant plant was destroyed by fire. WEC brought a claim under its fire insurance policy. The insurance company denied the claim on the basis
that WEC failed to inform it that the plant was vacant. Furthermore, the insurance company alleged that the fire was suspicious and that perhaps WEC was involved in the
plant's destruction.

1. Was WEC under a duty to disclose the plant's vacancy to the insurance company? If so, what is the effect of a failure to disclose?
2. What risk does the insurance company run by making allegations of arson?

P. 690

Introduction

A cornerstone of an effective risk management program is insurance coverage. As discussed in Chapter 3, insurance is the primary means of transferring the risk of various
kinds of losses. It permits a business to shift the risk, because through an insurance policy , the insurer promises to compensate the person or business (known as the

insured ) should the contemplated loss actually occur. The insurer provides this protection in exchange for payment, known as an insurance premium , from the insured (see
Figure 28.1 below).

Insurance is not, however, a panacea for all risks, as insurance can be costly and is not always available (or is available only at an exorbitant cost). For example, in the wake
of high-profile liability cases involving the directors of Enron and WorldCom, directors' and officers' liability insurance premiums have skyrocketed1 ; for many public
companies, the premiums have tripled. For some companies, this has meant that the insurance is so expensive that it is essentially unobtainable. It is also important to
remember that insurance does not prevent a loss from occurring, nor does it prevent the potential adverse publicity associated with a loss.

FIGURE 28.1: The Insurance Relationship

An insurance policy is a contract. By the terms of the contract, the parties agree to what kind of loss is covered, in what amount, under what circumstances, and at what cost.
Insurance policies are also regulated by legislation in each of the provinces.

Insurance legislation serves a number of significant purposes, including the following:

mandating the terms that must be found in insurance contracts
regulating the insurance industry generally by setting out licensing requirements for insurance companies, insurance brokers, and insurance adjusters
putting in place a system for monitoring insurance companies, particularly with respect to their financial operation

The main goal of insurance legislation is to protect the public from unscrupulous, financially unstable, and otherwise problematic insurance companies. It also provides
working rules that create stability within the industry at large.

P. 691

The three basic kinds of insurance are as follows:

Life and disability insurance: provides payments on the death or disability of the insured.
Property insurance (also known as fire insurance): provides payment when property of the insured is damaged or destroyed through accidents. It also can cover the
costs of machine breakdown.
Liability insurance (also known as casualty insurance): provides payment in circumstances where the insured is held legally responsible for causing loss or damage to
another, known as the third party.2

With the exception of life insurance contracts, insurance policies can be written so that the insured pays a deductible . This means that the insured is responsible for the first
part of the loss, and the insurer has liability for the balance. Agreeing to a deductible generally reduces the premiums that the insured must pay for the coverage. For example,
WEC agreed to a $100 deductible for windshield replacement on its delivery trucks. If a WEC vehicle windshield requires replacement and the cost is $600, WEC's insurers
will pay $500. The $100 deductible is WEC's responsibility, and to that extent, WEC is self-insured.

The Insurance Contract

Duty to Disclose

Insurance contracts are of a special nature. They are known as contracts of utmost good faith. A key consequence is that the insured has a duty to disclose to the insurer all
information relevant to the risk; if the insured fails in that duty, the insurer may choose not to honour the policy. For example, assume that WEC wants to change insurers in
an effort to save on premiums. Max, one of WEC's employees, fills in an application for fire insurance. In response to the question, “Have you ever experienced a fire?” Max
writes, “Yes—in 2001.” Max does not mention that WEC also had a fire in 2000, because he is convinced that WEC will end up paying an outrageously high premium. Max
has failed to disclose a fact that is germane to the insurer's decision to insure and relevant to what the premiums should be in light of the risk. For this reason, if WEC tries to
claim for fire loss should another fire occur at the plant, the insurer could refuse to honour the policy based on Max's non-disclosure.

An insurance company can deny coverage for non-disclosure even if the loss has nothing to do with the matter that was left undisclosed. For example, since WEC has failed
to disclose a previous fire loss, the insurer can deny a vandalism claim that WEC might make some time in the future.

The law places a duty of disclosure on the insured for a straightforward reason: the insurer has to be in a position to fully assess the risk against which the insured wants
protection. The only way the insurer can properly assess risk is if the insured is candid and forthcoming. In short, the insured is usually in the best position to provide the
insurer with the information needed.

P. 692

However, The duty to disclose is not all encompassing. The law expects the insurer to be “worldly wise” and to show “personal judgment.”3 For this reason, there is no onus
on the insured to inform the insurer of matters “not personal to the applicant.” For example, assume that in the application for fire insurance Max notes that some welding
occurs on the premises, but he does not go on to observe that welding causes sparks, which, in turn, can cause a fire. This is not a failure to disclose—after all, the insurer is
expected to be worldly wise. That said, the insured is much better to err on the side of disclosure, since a miscalculation on the insured's part can lead to the policy being void.

A duty to disclose exists not just at the time of applying for the insurance—it is an ongoing duty. The insurer must be notified about any change material to the risk. For
example, if WEC decides to stop producing wire and turn its attention instead to manufacturing plastic cable, the insurer should be advised, in writing, of this change. In the
same vein, when WEC leaves a building vacant, the insurer should be contacted so that necessary adjustments to the policy can be made.

Patrick Bennett/CORBIS When does an insured have a duty to disclose? ©

P. 693

Insurable Interest

The special nature of the insurance contract also means that its validity is contingent on the insured having an insurable interest in the thing insured.5 The test for whether
the insured has an insurable interest is whether he benefits from its existence and would be prejudiced from its destruction.6 The rationale behind this rule is that allowing
people to insure property they have no real interest in may, for example, lead them to intentionally destroy the property in order to make an insurance claim. If WEC's bank
holds a mortgage on the WEC production plant, it can purchase insurance on the plant because the bank has an insurable interest in property that is being used as security for
a loan. The bank benefits from the continued existence of the plant and would be prejudiced by its destruction. Once the mortgage is paid off, the insurable interest of the
bank no longer exists, and the bank cannot file a claim.

Indemnity

With the exception of life insurance contracts, insurance contracts are contracts of indemnity . This means that the insured is not supposed to profit from the happening of the
insured-against event, but at most will come out even. For example, if WEC insured its

P. 694

manufacturing plant against the risk of fire with two different insurance companies, WEC, in the event of a loss, is entitled to collect only the amount of the loss. WEC cannot
collect the loss from both insurance companies. However, WEC would be entitled to select the policy under which it will claim indemnity (subject to any conditions to the
contrary). The insurer, in turn, would be entitled to contribution from the other insurer on a prorated basis.

Some policies, such as fire insurance policies, require the insured to have coverage for a specified minimum portion of the value of the property in order to fully recover from
the insurer in the event of a fire. This requirement takes the form of a coinsurance clause, which is intended to discourage the insured from insuring the property for less than
its value on the gamble that any loss is likely to be less than total. If such a clause is in place, and the insured carries less insurance then the amount specified in the clause, the
insurer will pay only a specified portion of the loss, and the insured must absorb the remainder. In essence, the insured becomes a coinsurer for the amount of the deficiency
(see Figure 28.2).

FIGURE 28.2 Example of the Application of a Coinsurance Clause $500 000
Building value $300 000
Actual insurance coverage $100 000
Amount of loss 80%
Coinsurance clause

* Subject to policy limits

FIGURE 28.2 Example of the Application of a Coinsurance Clause

Subrogation

The insurer also has what is called a right of subrogation . This right means that when an insurer compensates the insured, it has the right to sue a third party—the wrongdoer
—who caused the loss and to recover from that party what it has already paid out to its insured. In this sense, the right of subrogation permits the insurer to “step into the
shoes” of the insured and sue the wrongdoer. Because of the insurer's right of subrogation, WEC must act carefully in the face of a loss. For example, it should not admit
liability for any accident that has occurred, since doing so might jeopardize any future action the insurer might commence against the wrongdoer. Instead, WEC should
immediately contact its insurer, as well as its legal counsel, for advice on how to proceed.

In addition to the right of subrogation, the insurance company will also have the right to rebuild, repair, or replace what is damaged so as to minimize its costs. It will also
have the right of salvage. If, for example, stolen goods are recovered, the insurer can sell the goods to recover its costs.
An insured is also not permitted to profit from his willful misconduct. If he deliberately causes a loss, the forfeiture rule will prevent him from collecting on his insurance.
For example, if an insured deliberately sets fire to his business, he cannot collect on his fire insurance.

P. 695

Case: Marche v Halifax Insurance Co, 2005 SCC 6, [2005] 1 SCR 47
The Business Context

The duty of an insured to report material changes to the risk in a fire insurance policy is currently prescribed by statutory conditions in all Canadian common law provinces.
This case concerns the ability of an insurance company to deny coverage on the basis of the insured's alleged breach of the statutory condition requiring an insured to report a
material change.4

Factual Background

Theresa March and Gary Fitzgerald (the insureds) purchased a house, converted it into apartments, and insured it under a fire insurance policy issued by the Halifax Insurance
Co. In September 1998, the insureds left Cape Breton Island to find work in British Columbia. The house remained vacant from September to early December, when Danny, a
brother of one of the insured's, moved in. Danny fell behind in the rent

P. 693

but refused to vacate the premises. In an effort to induce Danny to move out, the insureds had the water and electrical power disconnected. On 7 February 1999, the house
was destroyed by fire. At this time, Danny's possessions were still in the house.
Halifax denied liability on the grounds that the insureds had failed to notify Halifax of the vacancy between September and December 1998. The insurer alleged that this was
a breach of Statutory Condition 4 of Part VII of Nova Scotia's Insurance Act that provides, in part, “Any change material to the risk and within the control and knowledge of
the insured shall avoid the contract as to the part affected thereby, unless the change is promptly notified in writing to the insurer.”
The insured argued that, if their failure to report the vacancy constituted a breach, they should be relieved from the consequences of the breach by s 171(b) of the Insurance
Act that provides in part, “Where a contract … contains any stipulation, condition or warranty that is or may be material to the risk … the exclusion, stipulation, condition or
warranty shall not be binding on the insured if it is held to be unjust or unreasonable.”

The Legal Question

Does s 171 (b) of the Nova Scotia Insurance Act apply to statutory conditions? Was there a breach of Statutory Condition 4?

Resolution

The Supreme Court of Canada held that s 171(b) applies to both contractual and statutory conditions. In coming to this conclusion, the majority rejected the notion that
statutory conditions by definition cannot be unnecessary or unjust. The court noted that as the purpose of s 171(b) is to provide relief from unjust or unreasonable insurance
policy conditions, it should be given a broad interpretation. The word “condition” in s 171 (b) is not qualified by a restrictive adjective and further, a reading of the entire Act
does not support the contention that “condition” in s.171 (b) refers only to contractual conditions. The court stated that s 171 (b) authorizes the court to not only relieve
against conditions that are prima facie unjust but also to relieve against conditions that in their application lead to unjust or unreasonable results.
The court noted that while the insured had failed to report the vacancy, it is unclear whether the failure constituted a breach of Statutory Condition 4 as the vacancy had been
rectified prior to the loss occurring. In any event, if the insureds were in breach, s 171(b) should be applied to relieve the insureds from the consequences of this breach. It
would be unjust to void the insurance policy when the vacancy had been rectified prior to the loss occurring and was not causally related to the loss.

Critical Analysis

The court rejected the insurance company's attempt to deny coverage based on an alleged breach of Statutory Condition 4. What is the uncertainty created by the decision for
insurers?

P. 694

The Policy

Insurance contracts are particularly technical documents. Their content is settled to some extent by legislation, which requires standard form policies for some types of
insurance. Changes in standard policy terms take the form of riders and endorsements. A rider adds to or alters the standard coverage and is part of the policy from the outset.
An endorsement is an alteration to the coverage at some point during the time in which the policy is in force. Policies generally contain a number of exclusion clauses that
exclude coverage for certain situations, occurrences, or persons for which there would otherwise be protection. For example, the standard fire policy excludes coverage when
the insured building has been left unoccupied for more than 30 consecutive days. If a loss occurs after this point, the policy does not cover it. Other common exclusions in
property insurance include damage caused by wear and tear or mould, and vandalism or malicious acts caused by the insured.

DILBERT © SCOTT ADAMS. USED BY PERMISSION

OF UNIVER SALUCLICK. ALL RIGHTS RESERVED.

Case: Canadian National Railway v Royal and Sun Alliance Insurance Co of Canada, 2008 SCC 66, [2008] 3 SCR 453

The Business Context

Exclusions are common in insurance policies. For example, in standard property insurance policies, common exclusions include damage that arises from external sources
such as pollution, arson, mould, vandalism, temperature changes, settlement, and earth movement. Property insurance policies also contain exclusions that preclude coverage
from internal defects such as faulty materials, workmanship, or design. The following decision addresses the “faulty or improper design” exclusion in “all-risks” property
policies. Prior to this decision, there were two competing standards for interpreting “faulty or improper design.” One standard held that a design was faulty if it simply failed
to work for its intended purpose. The second standard held that a design was faulty if it failed to provide for, and withstand, all foreseeable risks.

Factual Background

In the early 1990s, Canadian National Railway (CNR) undertook to build a rail tunnel under the St. Clair River from Sarnia, Ontario to Port Huron, Michigan. To do so, it
commissioned the design of the world's largest tunnel boring machine (TBM). Prior to undertaking the project and in recognition of the risks inherent in developing such a
machine, CNR purchased an all-risks insurance policy from Royal and Sun Alliance Insurance Co. of Canada (Royal). The policy insured all risks of direct physical loss or
damage to all real and personal property including the TBM. There was also an exclusionary provision that stated “this Policy does not insure the cost of making good faulty
or improper design.”

The TBM, constructed in 1993 was 10 metres in diameter, 85 metres long and designed to withstand 6000 metric tonnes of pressure from soil and water. A system of 26
independent lubricated seals prevented excavated material from getting into the main bearing. However, after two months of excavating with only 14 percent of the tunnel
complete, dirt penetrated through to the bearing. During design, the engineers realized that dirt could penetrate and bypass the seals if the differential between key
components was more or less than 3 mm, but were satisfied that the differential could be kept within the range. In operation, however, this was not possible and the sealing
system failed. The project had to be stopped and after a delay of 229 days and a cost of more than $20 million, the boring was restarted and completed. CNR attempted to
collect on its insurance policy with Royal but it denied coverage based on the clause in the policy that excluded damages caused by “faulty or improper design.”

P. 696

The Legal Question

Did the design of the TBM fall within the “faulty or improper design” exclusion in the all-risks insurance policy?

Resolution

In a 4 to 3 decision, the Supreme Court of Canada adopted a narrow interpretation of the “faulty or improper design” exclusion and found in favour of CNR. Binnie J. writing
for the majority stated that, “the policy did not exclude all loss attributable to ‘the design’ but only loss attributable to a ‘faulty or improper design.’” Simply because a design
fails to achieve its intended purpose is not sufficient evidence that it is a “faulty or improper design.” The term “faulty or improper design” implied a comparative standard
and that the appropriate standard was the state of the art. If a design met the highest standards of the day and failure occurred simply because engineering knowledge was
inadequate to the task, the design is not faulty or improper. As the TBM had been designed to state of the art specifications at the time, Royal was not entitled to the benefit of
the exclusion simply because the state of the art fell short of perfection and omniscience. The damages caused by the design failure were, therefore, properly covered by the
insurance policy.

Critical Analysis

How does this decision affect policy-holders who suffer a loss that the insurer attributes to a failed design?

Insurance Products

Insurance is broadly divisible into three categories—life, property, and liability. However, there are many specialized insurance policies or products available to meet the risk
management needs of business. In order to secure optimal coverage, a businessperson should assess the business operation and identify the kinds of legal risks it may
encounter. For example, in its business, WEC faces a number of possible kinds of liabilities and losses, including the following:

Injury and property damage related to the operation of WEC's delivery trucks. If WEC's delivery personnel drive negligently, they may be involved in traffic accidents
that cause injury to other people, as well as property damage to other vehicles. Additionally, such negligence may cause injury to the WEC drivers themselves and
damage to WEC vehicles.
Personal injury to suppliers, sales personnel, and purchasers who visit the manufacturing plant floor. Since WEC's business office is located in its manufacturing
plant, many people who are not directly involved in production may visit the plant on business. Injuries—from tripping on a carpet to being burned by the extrusion
process—can result. As well, WEC employees who work in the manufacturing process and elsewhere face the risk of being hurt on the job.
Financial loss and injury to others caused by defective wire that WEC produced. If WEC delivers defective wires that are later incorporated into tires produced by
WEC customers, those tires may fail while being used or repaired, potentially causing both physical injury and financial loss to those involved.
Financial loss and injury caused by employees giving negligent advice to WEC customers concerning their wire needs. If an employee provides bad advice to WEC
customers, they may end up with wire that is not appropriate for its intended use. This problem, in turn, may lead to physical injury and financial loss to WEC
customers and to the ultimate consumers of the tires produced by WEC customers.

P. 697

Injury and property damage caused by a fire or other disaster in the manufacturing plant. If WEC experiences a fire in its plant, there can be a significant financial
loss, since the building, as well as the equipment and machinery, will have to be repaired or replaced before company operations can resume.
Loss of profit owing to business interruption as a result of a fire or other causes of a plant shutdown. In the event of a fire or other disaster, WEC may have to suspend
business operations while it rebuilds. This loss of profit could cripple the company financially and even cause its demise.
Environmental damage caused by improper storage or disposal of waste products. Environmental protection legislation in all jurisdictions prohibits businesses from
discharging or spilling contaminants into the environment. Legislation may also permit the government to order the party responsible to clean up or otherwise repair
the environmental damage that the contaminant caused.
This cleanup can be costly for the company involved. As well, WEC can face civil actions by those who are injured or who suffer loss because WEC has improperly
stored or disposed of its waste products. Since WEC produces fabricated metal products—a process that is likely to have significant environmental implications—it
needs to pay particular attention to this kind of potentially catastrophic liability.
Death of one of the shareholders in WEC. Should one of the WEC shareholders die, the others will likely want to buy out that person's shares. Financing the buyout
will be a challenge for WEC.

In order to address these risks, WEC has in place the following policies.

Auto Insurance

An automobile owner is required by law to have insurance for liability arising from its ownership, use, and operation. While each jurisdiction has its own scheme in place, a
common aim of these schemes is to ensure that owners are financially responsible for the liabilities that arise through use of their vehicles. Most people do not have the assets
on hand to pay off a large judgment against them; insurance provides the funds to fulfill that financial responsibility, should it arise.

There are several types of auto insurance coverage. In Alberta, for example, the Standard Automobile Policy provides the insured with coverage against liability for the injury
or death of someone else (third-party liability) caused by the operation of the insured vehicle. It also provides benefits to the insured for injury or death caused by an accident
arising from the use or operation of the insured automobile, as well as compensation for loss or damage to the insured automobile itself. The latter is known as collision
coverage.

Some people decide not to get collision coverage because the car itself is not worth very much. Third-party liability insurance, however, is not an option, and its purchase is
required by law. Since a car accident causing paraplegia, for example, can result in millions of dollars of damages, owners should not be content with purchasing the
minimum amount

P. 698

required by law. The minimum amount is simply not enough to cover a catastrophic accident. If there is a deficiency between the amount of insurance coverage and the actual
damages sustained by the plaintiff, the insured will be personally responsible for the difference.

Each province specifies through legislation the minimum amount of coverage an owner must obtain for third-party liability. In Ontario, for example, the statutory minimum is
$200 000.7 Since this amount is insufficient to pay damages to another who has been seriously injured, the owner should purchase additional coverage.

automobile insurance systems? GEOSTOCK/PHOTODISC What are the advantages and disadvantages of no-fault

P. 699

Employees injured in car accidents on the job may have coverage through workers' compensation legislation. Under such legislation, which is in place in every Canadian
province, participating employers pay premiums into a fund administered by a tribunal. Employees who are injured in the workplace or who, for example, suffer from a
disease as a result of exposure to a pollutant in the workplace, can then make a claim for benefits from this fund. When an employer participates in a workers' compensation
board (WCB) plan, payment from the fund is usually the only compensation the employee is entitled to receive. The legislation makes participation mandatory for most
industries and business activities13 and prevents employees from suing the employer for losses that occur in the course of employment.

Occupiers' Liability Insurance

WEC, as a building owner and occupier, is liable for injuries suffered to people on its premises if the injuries are due to WEC's failure to ensure that the premises are safe.
WEC's occupiers' liability insurance will compensate the injured person on behalf of WEC if unsafe conditions, such as improperly installed carpet, uneven walkways, wet
floors, or the like, caused the injury. Although WEC has a program in place to prevent such accidents, the insurance will fill the gap when and if the system fails.

Comprehensive General Liability Insurance

The purpose of comprehensive general liability insurance (also known as CGL insurance) is to compensate enterprises like WEC, in a comprehensive way, for any liabilities
they incur

P. 700

during the course of their business. For example, an important general risk faced by WEC is that its wires may fail in use and lead to some kind of loss. WEC's CGL
insurance will respond by compensating WEC for property damages, personal injury, loss of profit, and related losses suffered by a third party when WEC is legally
responsible for such losses.14

The CGL does not respond, however, to losses directly suffered by WEC itself. For this latter type of loss, WEC would need warranty insurance. The following examples
reveal the important difference between these two kinds of insurance:

Example 1

WEC produces wire that is seriously defective. When the customer incorporates that wire into its tire-manufacturing process, the tires fail and must be discarded. The

customer loses about $50 000 in materials, time, and profit—all of which is attributable to WEC's defective product. WEC's CGL insurance policy will cover this loss.

Example 2

WEC produces wire that the customer notices is defective as soon as WEC attempts to deliver the shipment. Accordingly, the customer refuses to accept delivery, and WEC
loses $50 000 in revenue. CGL insurance does not cover this loss because it is not a loss sustained by a WEC customer or other third party—it is a loss suffered directly by
WEC itself. For coverage in this situation, WEC would need a warranty policy. Since its cost is so high, WEC has not purchased warranty insurance. From a business
perspective, WEC has determined that it is better off establishing an effective quality assurance and testing program, thereby dealing with such risks in-house rather than
looking to an insurance company for coverage.

Errors and Omissions Insurance

When WEC's engineers provide professional engineering advice to WEC customers, they are promising that they meet the standard of the reasonably competent person
engaged in such activity. Although this implied promise does not amount to a guarantee of perfection, they will be responsible for losses resulting from negligent advice.
Through errors and omissions insurance (also known as E&O insurance),15 the insurer promises to pay on the engineers' behalf all the sums they are legally obligated to pay
as damages resulting from the performance of their professional services. Investigation costs and legal expenses will also usually be covered by the policy. However, there
may be limits. For example, the policy may only cover defence costs for actions brought in Canada.16 Like all insurance policies, the engineers' coverage is subject to a
number of conditions, such as the requirement that they give immediate notice to the insurer of a claim or potential claim. This notice allows the insurance company to carry
out an investigation and otherwise gather facts associated with the alleged negligence. Failure to give prompt notice or to comply with any other condition can result in the
insurance company successfully denying coverage.

Corporate directors and officers also face liability for their errors and omissions related to operating their company. This risk can be insured against through directors and
officers (D&O) liability insurance described below.

P. 701

Property Insurance

WEC has insured its manufacturing plant and equipment in order to fund any rebuilding or replacement that a fire or other disaster might occasion. One of the key choices
WEC made was whether to insure for the replacement value of its property or for the property's actual cash value.

If WEC had chosen the second option, it would receive from the insurance company only the value of the property at the time it was destroyed; that is, not enough to purchase
a replacement. WEC chose the first option; therefore, it will receive a higher level of compensation from the insurer—and also pay a higher premium—but the insurer has the
right to require WEC to actually rebuild or otherwise replace its property before it will pay out on the claim. WEC also chose coverage for a number of losses, including loss
caused by fire, falling aircraft, earthquake, hail, water damage, malicious damage, smoke damage, and impact by vehicles. Not surprisingly, the more perils WEC insures
against, the higher the premiums it must pay.

Business Interruption Loss Insurance

This kind of coverage—often contained in what is called an “all-risk” policy—provides WEC with financial compensation should it have to temporarily shutdown because of
a fire or other insured peril. There are two basic forms of business interruption insurance: earnings and profits. The earnings form provides compensation to a business for loss
of earnings from the time of a loss until it reopens for business to the extent of the limits

P. 703

of the policy. The profits model provides compensation from the date of the loss to the time the business returns to normal profitability, or until the indemnity period (usually
12 months) expires.

Environmental Impairment Insurance

Not only may WEC face substantial fines for failing to comply with environmental protection legislation and for any cleanup costs associated with a spill or other accident, it
can also be sued by its neighbours for polluting the soil or ground water. Furthermore, if a subsequent owner of WEC's plant can trace pollutants back to WEC, it has civil
liability for the cleanup and other associated costs, even though it no longer owns the land.

The extensive nature of this type of liability explains why comprehensive general liability insurance policies usually contain pollution exclusion clauses18 and why
environmental impairment liability policies are very expensive. A more viable—though not foolproof—alternative is for WEC to ensure that it has an operational
management policy in place to prevent environmental accidents from happening in the first place.19

P. 704

Key-Person Life Insurance

The partners in a firm or the shareholders of a small corporation likely wish their business to continue to be operated by the surviving owners if one of them dies. Their
partnership agreement or shareholders' agreement will specify that the surviving owners have the right to buy the shares of the deceased owner. The effective exercise of that
right requires a means of valuing the business and the shares of the deceased, as well as a means of financing the purchase of the shares by the survivors. Insurance on the
lives of the owners is a means of financing the buyout. The owners need to agree on a method of evaluating the business when the insurance is purchased and at the time of
death. They must then agree on how much insurance to purchase on the life of each key person. Key factors in this decision are the age of the key people, the extent of their
ownership, and the payment method each prefers for their survivors.

The amount of life insurance purchased by the business for each key person will depend on the affordability of the premium, which will be higher for older owners. Because
of their age or medical condition, key people may find that insurance is unobtainable. The owners must also decide whether to purchase enough coverage to provide a lump
sum large enough to buy the shares of the deceased outright, or whether the insurance should provide a portion of the buyout price, with the remainder paid to the heirs by the
business over a period of time.

Since WEC is owned by three shareholders, it would be prudent for there to be life insurance policies on each one of them. However, as this proved to be uneconomic for
some of the shareholders, an agreement between them addresses how the deceased's shares will be purchased.

It may also be prudent for the main stakeholders in WEC to secure disability insurance, so that if one of them is unable to work—owing to serious illness, for example—
insurance will fund at least part of that person's salary or other remuneration. 706

P. 705

Business Application of the Law: No-Fault Insurance Systems

Automobile insurance systems vary significantly from province to province. A major distinguishing feature is the extent to which they rely on either a tort-based liability
system or a “no-fault” system for compensating claims for bodily injury or death. A no-fault system involves the diminution of the ability to sue a tort-feasor for
compensation. In this system, the emphasis is on providing accident benefits without regard to the victim's fault. This is a marked departure from the traditional tort system
with its emphasis on fault-based liability.

Quebec was the first Canadian jurisdiction to adopt a no-fault system. Automobile accident victims have lost the right to sue in return for a form of income replacement
benefit, medical and funeral expenses, and a modest award for pain and suffering depending on the extent of the injury. Manitoba has adopted no-fault legislation similar to
Quebec's. Manitoba has eliminated all tort actions for bodily injury or death resulting from automobile accidents. Victims are restricted to recovery of no-fault benefits
provided by a universal bodily injury compensation scheme. Saskatchewan consumers can choose between no-fault (or tort-restricted) auto insurance and a tort option. The
tort option provides reduced accident benefits, but claimants can sue to recover general damages for their non-economic losses. The no-fault option eliminates the right to sue
to recover damages for pain and suffering.

Ontario has adopted a threshold no-fault scheme. Under this scheme, a person who is injured in an automobile accident is entitled to statutory accident benefits (e.g., income
replacement, medical benefits, rehabilitation benefits, attendant care benefits, death and funeral benefits), regardless of

P. 699

fault. In order to make a claim for general damages caused by another, however, the injured person must have sustained injuries in excess of the threshold, which is defined as
death, permanent serious disfigurement, permanent serious physical impairment, or impairment of important psychological and mental functions. If an accident victim is
entitled to receive general damages, then a $30 000 deductible will be applied unless the general damages awarded are $100 000 or more. Also, an injured person may sue for
economic losses, such as lost wages and medical expenses, and no threshold is applied to such a claim.

In the other provinces and territories, the automobile insurance systems are based on the tort-liability model. In Newfoundland, because accident benefits under automobile
policies are optional, some accident victims have no choice but to rely on tort law for recovery of their bodily injury or death claims. New Brunswick and British Columbia
have undergone significant reforms to their tort-based models that have enhanced the level of accident benefits that claimants are entitled to receive. Also, in New Brunswick,
Nova Scotia, Prince Edward Island, and Alberta, legislation has been passed to cap awards for pain and suffering related to minor injuries (usually defined as a strain, sprain,
or whiplash injury that leaves no long term impairment or pain). The cap in Nova Scotia is $7500,8 and it is $2500 in New Brunswick and Prince Edward Island, and
approximately $4500 in Alberta.9 The caps have been unsuccessfully challenged on constitutional grounds in both Nova Scotia10 and Alberta11 and the Supreme Court of
Canada has refused to hear an appeal in both the cases.12

Critical Analysis

What is the purpose of “pain and suffering” caps for minor injuries? Do you see any problems with imposing caps? What is the likely effect on the insurance industry if the
caps are removed?

Sources: C Brown et al, Insurance Law in Canada, vol 2 loose-leaf, (Scarborough, ON: Carswell, 2005), at 17 1(i)–17 2(a); Donna Ford, “Commentary: Has Ontario's no-
fault system lost its way?”, The Lawyers Weekly (12 January 2007) 7; and Dean Jobb, “Nova Scotia triples auto insurance cap”, The Lawyers Weekly (25 June 2010) 9.

P. 700

Business Application of the Law: Directors and Officers - D and O Liability Insurance: The Basics

The U.S. Securities and Exchange Commission, the Ontario Securities Commission, and Nortel Networks are suing Frank Dunn, the former chief executive officer of Nortel,
and Douglas Beatty, Nortel's former chief financial officer. It is alleged that Dunn and Beatty, along with other former executives, engaged in accounting fraud from 2000 to
2004 at Toronto-based Nortel, which at the time was North America's biggest maker of telephone equipment. In 2004, Nortel was required to restate its earnings going back
to 1999 after investigations by regulators indicated that executives had incorrectly booked revenue, thereby inflating sales figures by 3.4 billion. Nortel fired Dunn, Beatty,
and other executives.

Chubb Insurance Company, Nortel's provider of directors and officers (D&O) liability insurance, refused to pay the full defence costs of Dunn and Beatty, claiming some of
their alleged wrongful conduct occurred after the policy had lapsed. Dunn and Beatty sued Chubb. The Ontario Court of Appeal,17 applying a special endorsement in one of
the insurance policies, ordered Chubb to pay 90 percent of the defence costs up to the policy limits. Although Dunn and Beatty have been successful in having most of their
legal costs covered by D&O liability insurance, this situation raises questions about the protection offered by this insurance and the basis upon which an insurer can deny
coverage.

Purpose

D&O liability insurance provides protection over and above indemnification by the corporation. Indemnification by the corporation does not provide complete protection, as
the corporation may become insolvent or have insufficient funds to pay losses and expenses; or the board, in cases where indemnification is discretionary, may refuse to
indemnify the officers and directors; or the claim, as a matter of law, may not be indemnifiable. For example, indemnification for a derivative action must be approved by the
court, and, when approval is obtained, typically only defence costs are indemnified.

For these reasons, D&O liability insurance is needed to fill the gap between liabilities imposed on directors and officers and indemnification by the corporation.

Basic Features

Generally, there are three types of D&O coverage available:

Side A coverage, which provides coverage for individual directors and officers against specified losses and where indemnification is not provided
Side B coverage, which reimburses the corporation for amounts paid to indemnify directors and officers

Frank Dunn INGRID BULMER/HALIFAX CHRONICLE-HERALD/THE CANADIAN PRESS

Side C coverage, which extends coverage to include the corporation's liability with respect to securities claims

These three types of coverage are usually obtained from the same insurer under the same policy.

The insurance policy is generally sold for one-year period on a “claims made,” rather than a “claims incurred” basis. This means that only those claims that are made during
the term of the policy are insured, regardless of when the events giving rise to the claims occurred. Thus, if a policy is in force in year one and a claim is made in year two
with regard to the directors' and officers' activities in year one, the year one insurance policy would not be responsible.

Potential Problems

Despite the presence of D&O liability insurance, directors and officers may end up having to make payments out of their own pockets. Such an occurrence may be due to
coverage limits being exhausted or coverage being excluded for a number of reasons:

Rescission. A policy may be rescinded by the insurer on the basis of a misrepresentation in the policy application. Where the same policy of insurance is provided to
both the directors and officers and the corporation, the directors and officers run the risk that the policy will be rescinded against all insureds, even those that did not
participate in the mis-statement. This problem can be addressed by a well-drafted severability clause.

P. 702

Cancellation. Insurers and insureds generally have the right to cancel the policy of insurance during the term of the policy by giving notice. This possibility makes
directors and officers vulnerable, and it is particularly problematic for directors and officers who have left the board or the corporation. D&O liability insurance is on a
“claims made” basis, which means that after the currency of this year's policy, claims made in the future are only insured if insurance is in place. If the corporation
does not maintain insurance, retired directors and officers may be without protection. The problem of insurers cancelling a policy can be solved by negotiating a non-
cancellation clause. The retired-directors-and-officers problem can be addressed by directors and officers negotiating with the corporation to maintain coverage for a
particular period of time.
Exclusions. The insurance policy may exclude coverage either because the matter is insured elsewhere, because the matter is uninsurable by law, or because the matter
is outside the intent of the policy. The most common example of this last category is the “insured versus insured” exclusion. This exclusion excludes coverage when
one insured makes a claim against another insured—for example, when the corporation makes a claim against the directors.
Exhausting coverage. The policy limits in the coverage provided to both the corporation and the directors and officers may be exhausted by the corporation before the
directors' and officers' claims are covered. This problem may be addressed by directors and officers obtaining separate coverage or obtaining a further layer of
insurance coverage that is not shared with the corporation.

D&O liability insurance is an important aspect of a corporation's risk management plan. It can respond where an indemnity cannot, and it can provide benefits where the
corporation is obligated to indemnify the directors and officers. D&O policies are complex documents and, without proper care, directors and officers may end up with
inadequate protection.

Critical Analysis

How much D&O liability insurance is appropriate? What internal and external factors should be considered in making this decision?

Sources: Jacquie McNish & Catherine McLean, “Executives left to foot their own legal bills”, The Globe and Mail (28 November 2007) B16; Joe Schneider, “Ex-Nortel
CEO Dunn seeks payments for legal expenses from Chubb”, Bloomberg (21 January 2008) online: Bloomberg <http://www.bloomberg.com/apps/news?
pid=newsarchive&sid=aTfNpxBawUWM>; Barry Reiter & Aaron Ames, “Protecting Yourself Using Directors' and Officers' Insurance: Part 1”, Lexpert (May 2006) 98;
Barry Reiter & Aaron Ames, “Protecting Yourself Using Directors' and Officers' Insurance: Part 2”, Lexpert (June 2006) 104; “D&O: An Overview for Public Companies”,
Marsh Canada FINPRO (18 March 2008) 1; and Christina Medland, Tara Sastri & Stacey Parker-Yull, “Executive Compensation”, Lexpert/CCCA Corporate Counsel
Directory and Yearbook, 7th ed (Thomson: 2008/2009), online: Mondaq <http://www.mondaq.com/canada/article.asp?articleid=66234 >.

P. 703

Environmental Perspective: The Pollution Exclusion in Commercial General Liability Policies

The cost of environmental cleanup can be enormous. Beginning in the 1970s, in an attempt to limit its exposure, the insurance industry started including a pollution exclusion
clause in commercial general liability (CGL) policies. The wording of these clauses has changed considerably in response to court decisions that tended to limit their effect.
By the mid-1980s, the “absolute pollution exclusion” became the standard used in most CLG policies. The clause is very broad and attempts to exclude from coverage all

losses arising out of the discharge or escape of pollutants into the environment.

Interpreting the Pollution Exclusion

The effect and scope of absolute pollution exclusion clauses has also been the subject of much litigation. In Zurich Insurance Co v 686234 Ontario Ltd,20 the Ontario Court
of Appeal concluded that the exclusion clause did not apply to the escape of carbon monoxide from a negligently installed furnace in a high-rise apartment building. In
reaching its decision, the court emphasized that insurance coverage should be interpreted broadly in favour of the insured and exclusion clauses strictly and narrowly
construed against the insurer.

More recently, in ING Insurance Company of Canada v Miracle (Mohawk Imperial Sales and Mohawk Liquidate),21 the Ontario Court of Appeal appears to have taken a
more

Cleanup of Sydney tar sands is estimated to be $400 million. RAY FAHEY/CAPE BRETON

POST/THE CANADIAN PRESS

expansive approach to pollution exclusion clauses. The court held that a pollution exclusion clause applied to a liability claim for the escape of gasoline from a service station.

Reconciling the Decisions

In Zurich, the Court found that although carbon monoxide was a pollutant within the meaning of the exclusion, the history of exclusion clauses shows that their purpose was
to bar coverage for damages arising from environmental pollution, not damages where faulty equipment caused pollution. The pollution exclusion clause was meant to apply
only to an insured whose regular business activities placed it in the category of an active industrial polluter of the

P. 704

natural environment. It was not intended to apply to a case where faulty equipment caused the pollution. Therefore, an improperly operating furnace that produced carbon
monoxide in a residential building fell outside of the exclusion.

In Miracle, the court noted that the insured was engaged in an activity that carries an obvious and well-known risk of pollution and environmental damage. The business of
the insured, the running of a gas station, and the storing of gasoline in the ground for resale at the gas bar, was precisely the kind of activity that the exclusion was intended to
address. The court stated that the phrase “active industrial polluter of the natural environment” should not be read to restrict the pollution exclusion clauses to situations where
the insured is engaged in an activity that necessarily results in pollution. The exclusion was found to apply to activities that carry a known risk of pollution and environmental
harm such as storing gasoline in the ground for resale.

The Ontario Court of Appeal's decision in Miracle appears to have clarified the scope of its decision in Zurich. An exclusion clause's actual wording and its historical roots
are important factors determining its effect and scope. However, an exclusion clause's application is also dependent on the nature of the business and the actual business
activities of the insured.

Critical Analysis

Does giving effect to the pollution exclusion clause virtually nullify the insured's coverage? What are public policy considerations in upholding absolute pollution clauses?

Sources: Douglas McInnis & Aleksandra Zivanovic, “Clarifying pollution exclusions in commercial insurance policies”, The Lawyer's Weekly (19 August 2011), online:
McCague Borlack LLP <http://www.mccagueborlack.com/emails/articles/pollution_exclusions.html >; Daniel Kirby, John MacDonald & Dave Mollica, “Ontario Court of
Appeal clarifies application of pollution exclusion clauses in commercial general liability policies”, (5 July 2011) online: Mondaq
<http://www.mondaq.com/canada/x/137682/Insurance/Ontario+Court+Of+Appeal+Clarifies+Application+Of+Pollution+Exclusion+Clauses+In+Commercial+General+Liability+Policies
>.

P. 705

Remedies of the Insured

Against the Broker

It was crucial for WEC to establish a solid working relationship with an insurance broker22 in order to secure proper advice as to what kind of insurance it required. The term
“insurance broker” refers to the middle person between the insurance companies and the insured. As the party who sought insurance, WEC needed the assistance of the
broker in reviewing its business operations, assessing the risks it faces, and understanding the coverages available and the policy costs. If WEC did not spend sufficient time
with the broker or if it chose a broker who was simply not up to the job, WEC may have ended up with the wrong coverage—or not enough coverage—and face a loss against
which it has not been properly insured.

Should WEC face such a situation, it may have an action against its broker for negligence. If WEC is successful in its action, the broker will be required to reimburse WEC
for any of its underinsured or uninsured losses or liabilities.

The term “insurance agent” usually refers to someone who acts on behalf of an insurer to sell insurance. An agent acting in that capacity is primarily obligated to the insurer
as principal, and not to the third-party insured.

P. 706

Against the Insurance Company

When an insured makes a claim under its policy, an insurance adjuster will likely investigate the events and evaluate the loss. On the adjuster's advice, the insurer will offer
to settle the claim. There may be disagreements between the insured and the insurer as to the nature or amount of coverage. Should they be unable to resolve these
differences, the insured may have to sue the insurer for breach of contract. The claim will be that the insurer has failed to honour its obligations under the policy.
In addition to the obligations specified in the insurance policy, an insurer owes the insured a duty of good faith, including a duty to deal with an insured's claim in good faith.
Factors considered in determining whether an insurer has fulfilled its obligation to act in good faith include whether the insurer carried out an adequate investigation of a
claim, whether the insurer properly evaluated the claim, whether the insurer fairly interpreted the policy, and whether the insurer handled and paid the claim in a timely
manner.23 When the duty of good faith has been breached, the court may award punitive damages, as was done in Whiten v Pilot Insurance Co discussed below.

P. 707

Since Whiten, it is invariably the case that litigation against an insurer will include allegations of bad faith and a claim for punitive damages. Appellate courts, however,
following the Supreme Court of Canada decision in Fidler v Sun Life Assurance Company of Canada,24 have exercised restraint and have only awarded punitive damages in
exceptional cases. In Fidler, the court stated that the duty of good faith requires an insurer to deal with the insured's claim fairly in both the manner of investigating and the
decision whether to pay. An insurer must not deny coverage or delay payment in order to take advantage of an insured's economic vulnerability or to gain bargaining leverage
in negotiating a settlement. However, a finding of lack of good faith does not lead inexorably to an award of punitive damages. While a lack of good faith is a precondition, a
court will only award punitive damages if there has been malicious, oppressive, or high-handed misconduct that offends the court's sense of decency.

P. 708

Technology and the Law: Social Networking Sites and Insurance

Nathalie Blanchard, a 29-year-old from Granby, Quebec, believes she lost her disability benefits because of pictures on her Facebook page. In 2008, Blanchard took a medical
leave for depression from her job as an IBM technician. Shortly thereafter, she began receiving monthly disability benefits from her insurer, Manulife Financial Corp. A year
later, and without warning, the payments ceased. When Blanchard called Manulife to find out why her benefits were discontinued, she says she was told that her Facebook
photos showed she was able to work. Investigators had discovered several pictures Blanchard posted on Facebook, including ones showing her drinking at a Chippendales bar
show, at her birthday party, and frolicking on the beach during a sun holiday. Blanchard is suing to have her benefits reinstated. Manulife would not comment on Blanchard's
case but confirmed that it uses the popular social networking site to investigate clients. It also stated to CBC news: “We would not deny or terminate a valid claim solely
based on information published on websites such as Facebook.”

Critical Analysis

Do insurers' use of social networks to check on people impinge on privacy rights? Should insurance companies be able to use information culled from sites such as Facebook
to deny or terminate an insurance claim or to investigate fraud?

How may social networking activities affect a person's insurance? BLANCHE/SHUTTERSTOCK
Sources: “Depressed woman loses benefits over Facebook photos”, CBC News (21 November 2009) online: CBC News
<http://www.cbc.ca/news/canada/montreal/story/2009/11/19/quebec-facebook-sick-leave-benefits.html >; Jeff Gray, “Facebook pokes the limits of personal-injury law”, The
Globe and Mail (3 March 2010) B9.

P. 706

Case: Whiten V Pilot Insurance Co, 2002 SCC 18, [2002] 1 SCR 595
The Business Context

An insurer's bad-faith conduct—alleging fraud when none exists or refusing to pay out unde Technology and the Law: Social Networking Sites and Insurance insured. This
kind of reprehensible conduct by the insurer can be addressed by an award of punitive damages. Prior to this decision, the highest punitive damage award handed down by a
Canadian court against an insurance company had been $15 000.

Factual Background

In January 1994, the Whitens' family home burned down in the middle of the night, destroying all their possessions and three family cats. Knowing that the family was in
poor financial shape, the insurer, Pilot Insurance, made a single $5000 payment for living expenses and covered the rent on a cottage for a couple of months. Pilot then cut off
the rent without telling the family, and thereafter it pursued a confrontational policy that ultimately led to a protracted trial. Pilot maintained that the Whitens had burned
down the house, even though it had opinions from its adjuster, its expert engineer, an investigative agency retained by it, and the fire chief that the fire was accidental. After
receiving a strong recommendation from its adjuster that the claim be paid, Pilot replaced the adjuster. Counsel for Pilot pressured its experts to provide opinions supporting
an arson defence, deliberately withheld relevant information from the experts, and provided them with misleading information to obtain opinions favourable to an arson
theory. Pilot's position was wholly discredited at trial. The jury awarded compensatory damages and $1 million in punitive damages. The majority of the Court of Appeal
allowed the appeal in part and reduced the punitive damages award to $100 000.

The Legal Question

Should the jury's punitive damages award be restored?

Resolution

The court held that, although the jury's award of punitive damages was high, it was reasonable. Pilot's conduct had been exceptionally reprehensible. Its actions, which
continued for over two years, were designed to force the Whitens to make an unfair settlement for less than what they were entitled to receive. The jury believed that Pilot
knew its allegations of arson were not sustainable and yet it persisted. Insurance contracts are purchased for peace of mind. The more devastating the loss, the more the
insured is at the financial mercy of the insurer, and the more difficult it may be to challenge a wrongful refusal to pay.

The jury decided that a strong message of denunciation, retribution, and deterrence needed to be sent to Pilot. The obligation of good-faith dealing requires that the insurer
must respect the insured's vulnerability and reliance on the insurer. It was this relationship that was outrageously exploited by Pilot.

An award of punitive damages in a contract case is permissible if there is a separate actionable wrong. In addition to the contractual requirement to pay the claim, Pilot was
under an

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obligation to deal with the insured in good faith. The breach of this separate obligation supports a claim for the punitive damages. The award of $1 million in punitive
damages was more than the court would have awarded but was still within the high end of the range where juries are free to make their assessment.

Critical Analysis

The Insurance Council of Canada was an intervenor at the Supreme Court. It submitted that there should be a judicially imposed cap of $25 000 on punitive damages awards.
What are the arguments for such a cap? What are the arguments against such a cap?

Business Law in Practice Revisited

1. Was WEC under a duty to disclose the plant's vacancy to the insurance company? If so, what is the effect of a failure to disclose?

A contract of insurance is a contract of good faith. This means that the insured has a duty to disclose all material facts to the insurer concerning the subject matter to be
insured. Good faith on the part of the applicant is necessary for insurance firms to effectively assess risks and set premiums. The duty to disclose not only arises at the time of
applying for insurance but also is a continuing obligation of disclosure. Leaving a building vacant for a period of time, particularly in excess of 30 days, would constitute a
breach of the obligation to disclose. The effect of the breach would make the insurance contract null and void with respect to the loss suffered by WEC. In addition, it is
probable that WEC's insurance policy contains a clause excluding coverage when the insured building has been left vacant for more than 30 consecutive days.

2. What risk does the insurance company run by making allegations of arson?

The insurer has a duty to deal with an insured's claim in good faith. An insurer's duty to act in good faith developed as a counterweight to the immense power that an insurer
has over the insured during the claims process. An insurer may be in breach of its duty of good faith if, for example, it does not properly investigate a claim, does not properly
evaluate the claim, and does not handle the claim in a timely manner. Making unfounded allegations of fraud and arson is a breach of the duty of good faith and could result
in an award of punitive damages if the dispute between WEC and the insurer ends up in litigation.

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Insurance: Chapter Summary

Insurance is one of the simplest and most cost-effective ways of managing risk in a business environment. It permits the business to shift such risks as fire, automobile
accidents, and liability for defective products onto an insurance company in exchange for the payment of premiums by the business.

An insurance contract is a contract of utmost good faith. This means that the insured must make full disclosure at the time of applying for insurance, as well as during the life
of the policy. Failure to do so may permit the insurer to deny coverage when a loss has occurred.

The insured must have an insurable interest in the item insured to prevent moral hazards. The test for insurable interest is whether the insured benefits from the existence of
the thing insured and would be prejudiced from its destruction.

Insurance contracts are not intended to improve the position of the insured should the loss occur. Rather, they are contracts of indemnity and are intended to compensate the
insured only up to the amount of the loss suffered.

When the insurer pays out under an insurance policy, it has the right of subrogation. This right permits the insurer to sue the wrongdoer as if it were the party that had been
directly injured or otherwise sustained the loss.

A business needs to communicate effectively with its insurance broker, as well as its insurance company, in order to assess the kinds of risks its operation faces and the types
of insurance coverage that can be purchased to address those risks. Though insurance policies can take a variety of forms, there are three basic kinds: life and disability
insurance, property insurance, and liability insurance. More specific insurance policies are simply a variation on one of these types.

Insurance policies are technically worded and often contain exclusion clauses. These clauses identify circumstances or events for which coverage is denied. They may also

identify people for whom coverage is denied.

If the insured ends up with insurance of the wrong type or in an inadequate amount, it may have an action against its broker for breach of contract and/or negligence. If the
insurance company wrongly refuses to honour the policy, the insured may have to sue the insurer to obtain compensation for its losses.

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Insurance: Chapter Study: Key Terms and Concepts

deductible (p. 692)
duty to disclose (p. 692)
endorsement (p. 696)
forfeiture rule(p. 695)
indemnity (p. 694)
insurable interest (p. 694)
insurance adjuster (p. 707)
insurance policy (p. 691)
insured (p. 691)
insurer (p. 691)
premium (p. 691)
rider (p. 696)
subrogation (p. 695)

Insurance: Chapter Study: Questions for Review

1. What is the purpose of an insurance contract?
2. What is a premium?
3. Every province has enacted insurance legislation. What are the purposes of insurance legislation?
4. What are the three main types of insurance?
5. What is a deductible? What effect does it have on insurance premiums?
6. What does it mean to say that an insured has a duty to disclose? What happens if the insured fails in this duty?
7. What is an insurable interest? Why is it important?
8. Why are contracts of insurance known as contracts of indemnity?
9. What is a coinsurance clause? What is its purpose?
10. What is the right of subrogation? When does the right of subrogation arise?
11. What is the difference between a rider and an endorsement in an insurance policy?
12. How do “no-fault” liability systems differ from tort-based liability systems?
13. Describe comprehensive general liability insurance. How does it differ from warranty insurance?
14. What is the purpose of errors and omissions insurance?
15. When should a business consider buying key-person life insurance?
16. What does an insurance broker do?
17. What is the purpose of an insurance adjuster?
18. Does the insurer have a duty of good faith? Explain.

Insurance: Chapter Study: Questions for Critical Thinking

1. A manufacturing business is in the process of applying for property insurance. What kind of information must the business disclose to the insurance company? Why
can insurance companies deny coverage on the basis of non-disclosure or misrepresentation of information?

2. What does it take to establish an insurable interest? For example, does an employer have an insurable interest in an employee's life? A retired executive's life? Does a
creditor have an insurable interest in a debtor's life? The owner of property has an insurable interest in the property. Do mortgagees and lien holders have an insurable
interest in property? Does a tenant have an insurable interest in the landlord's property? Does a thief have an insurable interest in stolen property?

3. In many regions of the world, kidnapping for ransom has become a thriving business. The victims of this crime have included not only journalists, diplomats, and aid
workers, but also business executives. What role, if any, should insurance play in addressing the risk of being kidnapped in a foreign country? Do you think that the
presence of insurance might exacerbate the risk? Aside from having money to pay a ransom demand, what are the other advantages of having kidnapping insurance?

4. Fraudulent insurance claims are a problem faced by the insurance industry. Common examples involve inflated property values, exaggerated personal injuries, arson
and other deliberate acts of sabotage, and “insider theft.” Insurance companies are entitled to question the authenticity of all claims. How far should the insurance
company be able to go in obtaining

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evidence of fraud? On what basis should the insurance company be entitled to deny a claim? For example, should an unusual pattern of claims be a basis for denial?
5. In Whiten v Pilot, the court upheld an award of punitive damages against an insurer for breach of the insurer's duty of good faith. Should the courts award punitive

damages against claimants who make fraudulent insurance claims? For example, there have been instances where a group of individuals have conspired to stage motor
vehicle accidents and then submitted false property damage and personal injury claims.25 What factors should the courts consider in awarding damages for insurance
fraud?
6. Between April 17 and April 19, 2011, hackers accessed Sony's online gaming service, PlayStation Network (see Technology and the Law: Business' Liability in
Contract and Tort for the Consequences of Online Hacking, Chapter 11, page 246, for a detailed account). The names, birth dates, addresses, email addresses, phone
numbers and passwords of millions of people who entered contests promoted by Sony were stolen. Credit card information may also have been compromised.26 What
are the potential costs to Sony as a result of this hacking incident? What are the insurance issues?

Insurance: Chapter Study: Situations for Discussion

1. Athena Aristotel operates a retail clothing store in West Vancouver. The store is located on the bottom floor of a building owned by Athena. One of Athena's friends rents
the top floor for a residence. Recently, Athena suffered major property damage when a three-alarm fire destroyed her building. The cause of the fire is not known, although
faulty wiring is suspected. As a result of the fire, Athena was required to temporarily move her retail operations to a nearby location. Her friend had to find a new place to
live.27 What type of insurance coverage will respond to Athena's loss? Assume that Athena discovers that she is not covered for the full extent of her losses. Must Athena
absorb the uninsured portion of the loss, or does Athena have any other options? Explain. What steps should Athena take to ensure that she has optimal insurance coverage?

2. In an increasing number of residential communities, dwellings are being used for marijuana grow operations. In many instances, a rented house is converted to a hot house
to cultivate the plants. The conversion causes extensive structural damage, a compromised electrical system, excessive condensation and mould and it is unlikely that the
damage is covered under the homeowner's insurance policy. This is because it is common practice in the insurance industry to include a clause that excludes damage that

results from illegal activity, whether the homeowner is aware of the illegal activity or not, and a clause that specifically excludes damage that arises from marijuana growing
operations. How can a business that rents out real estate manage the risk posed by marijuana grow operations? What steps should the business take prior to renting out its
property? What steps should the business take after the property has been rented out?

3. Dorothy is a sole proprietor who recently incorporated her business in order to take the benefits of limited liability. As part of this change, she transferred all her business
assets over to her corporation, Dorothy Ltd. Unfortunately, she forgot to change her insurance policies to name the company as the new insured. The property remains insured
in Dorothy's name. Soon after the transfer, there was a break-in at Dorothy Ltd.'s corporate offices, and much of the company's expensive computer equipment was stolen.
Dorothy made a claim on her policy, but the insurance company took the position that she did not have an insurable interest in the corporate property.28

Explain why the insurance company refused Dorothy's claim. What can she do now? What arguments can she make in support of her claim? What practical advice would
Dorothy now give to other small-business owners?

4. Twelve-year-old Aaliyah Braybrook was babysitting two boys, aged three and five, when a fire broke out in their home. Braybrook was able to get the boys and the family
pet out but the fire destroyed the home and damaged two neighbouring homes. It is alleged

P. 711

the fire was started by the five-year-old playing with a lighter in the bathroom. TD Insurance, the insurance company for the owners of one of the damaged neighbouring
homes, filed on their behalf a $350 000 lawsuit against Braybrook and the father of the boys, who was the owner of the destroyed home. After a public outcry, including a
speech by the local Member of Parliament in the House of Commons, TD Insurance dropped the suit against Braybrook.29 What was the likely basis of the lawsuit by the
neighbours against Braybrook? On what basis could TD Insurance sue Braybrook on behalf of the neighbours? What do you think was the reason for TD Insurance naming
Braybrook in the lawsuit? What was the risk to TD Insurance in naming Braybrook in the lawsuit?

5. Precision Machine Ltd. manufactures pistons and rings for draglines and excavators that are used in oil sands exploration. Demand for these components is unpredictable
but critical, as machines cannot operate without them. In an effort to ensure that customers are satisfied, Precision keeps about $100 000 worth of components in inventory at
all times. The value of the inventory is covered by property insurance from SPADE Insurance Ltd. The policy contains a coinsurance clause that requires Precision to hold 80
percent coverage. Precision, however, only carries $60 000 worth of coverage. An electrical fire destroys some of Precision's inventory and precision makes a claim of $30
000 on its policy. How much of the claim is Precision entitled to receive from SPADE? Why would Precision underinsure its inventory? How much is Precision entitled to
receive from SPADE if its loss is $40 000?

6. On 12 April 2001, portions of the retractable roof of the Toronto SkyDome collided when it was being opened. Pieces of the roof fell onto the playing field, making the
SkyDome unsafe for use. The regularly scheduled Major League Baseball game between the Toronto Blue Jays and the Kansas City Royals was postponed. The Blue Jays
sued Sportsco, the owner/operator of the SkyDome, for damages in the amount of $1 million, alleging a loss of revenues from the loss of use of the building on 12 April
2001. Sportsco made a claim under its comprehensive general liability policy with ING Insurance for a defence to the Blue Jays' claim. ING denied coverage and brought an
application seeking a declaration that it did not owe Sportsco a defence (an insurer has a duty to defend the insured only when allegations fall within the coverage of the
policy).30 Who has the onus of proving whether a claim falls within an insurance policy? On what basis may an insurance company like ING Insurance deny coverage to an
insured?

7. Greenhouse Inc. owns and operates a greenhouse in rural Nova Scotia. On a busy Saturday in early spring, customer Xavier Donnelly trips over some bags of potting soil
and falls onto a table used for repotting large plants and shrubs. Xavier suffers a severe gash to his right arm and a large bruise on his forehead. The way in which accidents
and other incidents are handled can have a significant impact on the ultimate cost of a claim. How should the employees of Greenhouse handle Xavier's accident? Outline the
steps that they should take in this situation.

8. In 1999, John Jacks signed a long-term car lease agreement, which was assigned by the dealership to GMAC Leaseco. On the same day, Jacks contacted a representative of
the Wawanesa Mutual Insurance Company to insure the vehicle. The representative asked Jacks a few questions related to driving. In particular, the representative asked Jacks
how many accidents he had had in the previous six years, whether he had ever been convicted of impaired driving, and whether his driver's licence had ever been revoked or
suspended.

In 2002, Jacks had an accident and his car was destroyed. In response to his claim for compensation, Wawanesa conducted an investigation and discovered that the insured
had been convicted of several crimes between 1980 and 1991, including break and enter, theft, possession of property obtained by crime, abetting in fraud, identity theft,
fraud, and possession of drugs. Wawanesa refused to pay compensation on the basis that Jacks had failed in his duty to inform.31 What is the purpose of the insured's duty to
disclose? What is the content of the duty to disclose? Who has the onus of proving whether the duty to disclose has been fulfilled? Did Jacks fulfill the duty to disclose?
Discuss.

For more study tools, visit http://www.NELSONbrain.com .

Footnotes

1. In 2004, directors of both WorldCom and Enron made large payments out of their own pockets to settle with shareholders. See: Janet McFarland, “The soaring cost of a
boardroom safety net”, The Globe and Mail (23 February 2006) B12.
2. The person who is injured or otherwise suffers loss is the third party in relation to the contract of insurance. In the contract of insurance, the insurer and insured are the first
and second parties.
3. C Brown & J Menezes, Insurance Law in Canada, loose-leaf, (Scarborough: Carswell, 2008), at 5-6.1 [Brown & Menezes].
5. Supra note 3 at 4.1. Note that the ordinary insurable interest test is typically altered by statute for life insurance. In life insurance, the statutes generally provide that certain
dependants have an insurable interest in the life insured, as does anyone else who gets the written consent of the person whose life is being insured.
6. Lucena v Craufurd (1806), 2 Bos & Pul (NR) 269 at 301, 127 ER 630 (HL). Discussed in Brown & Menezes, supra note 3 at 66–67.
4. See also Royal Bank of Canada v State Farm Fire and Casualty Co, 2005 SCC 34, [2005] 1 SCR 779. This case deals with the statutory condition requiring reporting of a
material change in relation to an insurance policy's standard mortgage clause.
7. Insurance Act, RSO 1990, c I-8, s 251(1) provides: “Every contract evidenced by a motor vehicle liability policy insures, in respect of any one accident, to the limit of at
least $200,000 exclusive of interest and costs, against liability resulting from bodily injury to or the death of one or more persons and loss of or damage to property.”
13. Participation is non-mandatory for some businesses. For example, in Ontario participation is optional for law offices, insurance companies, and call offices.
14. Note that coverage generally extends only to unintentional torts, rather than intentional acts.
15. See Scott J Hammel, “Insurance Pitfalls: Your errors and omission coverage may surprise you”, Canadian Consulting Engineer (December 2004) online: Canadian
Consulting Engineer <http://www.canadianconsultingengineer.com/news/insurance-pitfalls/1000191738/>.
16. Ibid.
18. Jonathan LS Hodes, “Pollution Exclusion Clauses in the CGL Policy”, Clark Wilson LLP (February, 2009), online: Clark Wilson LLP
<http://www.cwilson.com/publications/insurance/pollution-exclusion-clauses.pdf>.
19. See Chapter 3.
8. The cap was raised to $7500 from $2500 in 2009.
9. The caps in both Alberta and Nova Scotia are indexed to inflation and in New Brunswick, the provincial government has recommended an increase to $7500.

10. Hartling v Nova Scotia (Attorney General), 2009 NSCA 130, 286 NSR (2d) 219, leave to appeal ref'd 2010 CanLII 28780 (SCC)
11. Morrow v Zhang, 2009 ABCA 215, 454 AR 221, leave to appeal ref'd 2009 CanLII 71477 (SCC)
12. 2010 CanLII 28780 (SCC); 2009 CanLII 71477 (SCC).
17. Dunn v Chubb Insurance, 2011 ONCA 36, 105 OR (3d) 63.
20. (2002), 62 OR (3d) 447, 222 DLR (4th) 655 (Ont CA).
21. 2011 ONCA 321, 105 OR (3d) 241.
22. See Chapter 13 for further discussion of insurance brokers and insurance agents.
23. Adams v Confederation Life Insurance, 152 AR 121, [1994] 6 WWR 662 (Alta QB).
24. 2006 SCC 30, [2006] 2 SCR 3.
25. Tara Perkins & Grant Robertson, “Staged car accidents on rise, insurers say”, The Globe and Mail (27 November 2010) A17.
26. Gordon Hilliker, “Cyber risks & liability insurance”, The Lawyers Weekly (19 August 2011) 9.
27. Based, in part, on Denise Deveau, “Lost: A workplace, and a living”, The Edmonton Journal (6 October 2008) A14.
28. Based on Kosmopoulos v Constitution Insurance Co of Canada, [1987] 1 SCR 2, 34 DLR (4th) 208.
29. Florence Loyie, “‘Hero’ babysitter sued over fire”, Edmonton Journal (6 May 2010) A12; Karen Kleiss, “Insurer drops lawsuit against hero babysitter”, Edmonton Journal
(8 May 2010) A3.
30. Based on ING Insurance Co of Canada v Sportsco International LP, [2004] OJ No 2254, 12 CCLI (4th) 86 (Ont Sup Ct).
31. Based on Compagnie mutuelle d'assurances Wawanesa v GMAC location ltée, [2005] RRA 25 (Que CA).

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