I Can’t Get No Subrogation
In Douglas v. Stan Fergusson Fuels Ltd., 2018 ONCA 192, the Court found that an insurer could not pursue a subrogated claim in the name of its bankrupt insured unless it obtained a court order authorizing the action in its own name or used the provisions in the Bankruptcy and Insolvency Act to acquire the bankrupts rights of action A five-judge panel clarified the nature of subrogated claims, confirmed that a cause of action is property under the Bankruptcy and Insolvency Act (“BIA”), and cautioned insurers that assignment and subrogation are not to be conflated. The decision contains a technical analysis of the interaction between the law of bankruptcy and the law of subrogation.
Mr. and Mrs. Douglas had an external home fuel tank that was filled by the Appellant, Stan Fergusson Fuels Ltd., oil spilled and contaminated the property, requiring extensive remediation. Mrs. Douglas was a discharged bankrupt, and so at the time of the spill, only her trustee in bankruptcy and Mr. Douglas were listed on title to the property. State Farm Fire and Casualty Company (“State Farm”) indemnified the Douglas’s for the remediation costs and exercised its rights under the subrogation clause of the Homeowners Policy. Mr. Douglas subsequently filed an assignment in bankruptcy. His trustee notified State Farm and just prior to the assignment, his trustee disclaimed any interest in insurance claims for damaged household contents as well as any proceeds of personal property that would not vest in the trustee.
By the time State Farm initiated the subrogated action against the Appellants, it had spent over $800,000 to remediate the property. More than two years into the litigation, the Appellants moved for summary judgement on the basis that the Douglas’s lacked capacity to commence an action due to the operation of bankruptcy law. State Farm brought a cross-motion for directions regarding continuing the claim, and alternatively, for a declaration that State Farm was master of the suit – dominus litis – and in the further alternative, for an order allowing it to amend its pleadings such that the named plaintiffs would be the Douglases by their Subrogee. The motion judge made a declaration that State Farm would be dominus litis following full indemnification of the insured
The Divisional Court dismissed the Appellants appeal finding that, at least with respect to Mr. Douglas, State Farm’s contingent right to subrogation crystalized the moment it began indemnifying the Douglases, which was prior to Mr. Douglas’ assignment in bankruptcy, and therefore the cause of action did not vest in the trustee as it normally would under section71 of the Bankruptcy and Insolvency Act (“BIA”).
A full panel of the Court of Appeal rendered a 3-2 decision. In dismissing the action the majority noted that while State Farm was entitled to rely on its subrogation clause, control of the litigation arises only where the common law right to subrogation begins on full indemnification for insured and uninsured losses. The Court maintained that subrogation claims are derivative, with limits on an insured’s right of recovery necessarily applying to the subrogee.
The Court then turned to a review of sections 2, 71, 67, 38 and 40 of the BIA. The Court established that:
- Under section 2, causes of action are property
- Under section 38, creditors can seek assignment of a cause of action the trustee does not pursue
- Under section 40, trustees must return unrealizable property to the bankrupt following the trustees discharge, though vesting of this property is not automatic
- Under section 67, property the bankrupt holds in trust is not divisible amongst the creditors
- Under section 71, on assignment in bankruptcy all property vest in the trustee
The Court found that State Farm could not be in a better place than its insured, and that since the insured’s cause of action is considered to be property, it vested in the trustee upon assignment. Importantly for insurers, the Court rejected any possibility that the subrogation clause amounted to an assignment. As a sophisticated insurer State Farm should have included an assignment clause. The disclaimer by the trustee was of no relevance – it dealt with personal property and not causes of action, and it operated only against insurance claims made as against State Farm, and not for tort claims made by the insured.
The Court denied State Farm’s request to normalize the proceedings by ordering the return of the bankrupt’s unrealizable property – the cause of action – to the bankrupt insured, which would allow State Farm to pursue its subrogated claim. The Court emphasized that this order would have to be effective the day before the claim was commenced and found no compelling basis on which to do so, since State Farm had not pursued this remedy before the relevant limitation period had expired. With respect to section 38 of the BIA, the court found again that State Farm had not pursued this remedy before the relevant limitation period had expired. Such an order would have to be made in conjunction with an order allowing granting leave to amend the statement of claim and would be made in reliance on and section 21(2) of the Limitations Act, 2002 which permits amendment after the expiry of a limitation period to correct misnomer. The Court ruled that the test for misnomer is not sufficiently broad to be relied upon by State Farm in this case, stating at paragraph 125 that the “’irregularity’ that State Farm seeks to correct was intentional”.
The dissent took a softer approach with respect to remedy, citing the equities militating in favour of treating State Farm’s pleadings as a procedural irregularity, as well as the good faith displayed by State Farm and the lack of prejudice suffered by the Appellant. In finding that remittance was the appropriate remedy, the dissent also looked to subrogation first principles, suggesting that the Appellants might enjoy a windfall, contrary to the principle that the loss falls on the person who is legally responsible for causing it.
What the insurers need to know
- Subrogation clauses do not replace the need for assignment clauses
- Subrogation rights are always derivative
- Do not initiate claims without considering the implications of the BIA:
- A cause of action is property
- Request that a bankrupt insured’s trustee commences a claim against the responsible party
- Apply for an order authorizing the insurer to take a proceeding in its own name
- If the trustee has been discharged, apply for an order under section 40(2) of the BIA to dispose of any property that is incapable of realization where the trustee has been unable to dispose of such property
|Shawn O'Connor||Hamish Mills-McEwan, Articling Student|