Thought Leadership

By Tipper McEwan, Shelley Wood, K.C., and Jennifer Taylor

In an important case for property insurers and their counsel, the Supreme Court of Canada (“SCC”) recently reviewed the principles of insurance contract interpretation — and finally clarified the “nullification of coverage” doctrine.

The case, Emond v Trillium Mutual Insurance Co., required the Court to interpret a home insurance policy with an endorsement providing additional coverage for home rebuilding costs. The insured homeowners sought coverage under the endorsement after their home was flooded. For the most part, the homeowners’ coverage claim was denied.

Part 1 discusses the framework for policy interpretation, Part 2 summarizes the facts and outcome in Emond, and Part 3 reviews the “nullification of coverage” doctrine.

Part 1: The Interpretive Framework

Justice Rowe’s majority reasons in Emond reaffirmed the proper approach to insurance policy interpretation from Progressive Homes Ltd. v Lombard General Insurance Co. of Canada, Ledcor Construction Ltd. v Northbridge Indemnity Insurance Co., and Sabean v Portage La Prairie Mutual Insurance Co..

The coverage analysis should be done in the following order:

• First, the insured must show that the loss comes within the initial grant of coverage.
• Second, the burden shifts to the insurer to prove that an exclusion clause applies.
• Lastly, if an exclusion applies, then the burden shifts back to the insured to prove than an exception to the exclusion applies.

The SCC clarified that endorsements are not “self-contained and standalone contracts disconnected from the insurance policy of which they form a part” (para 36). Instead, the interpretation of endorsements must be woven into the general interpretive analysis: endorsement provisions affecting coverage are considered first, as part of the coverage analysis; exclusion clauses within endorsements are considered next, in the analysis of exclusions; and exceptions found in endorsements are considered last, along with relevant exception clauses in the base policy.

Stages of policy interpretation – Ledcor analysis

The SCC in Emond confirmed the three stages of policy interpretation (aka the “Ledcor analysis”).

Stage One focuses on the policy wording at issue, using the following key principles:

• When the language of an insurance contract is clear, effect should be given to that language.
• The contract should be read as a whole, and words should be given their ordinary and grammatical meaning (think: average person, not insurance expert).
• The so-called “factual matrix” is less relevant to the interpretation of standard form insurance contracts than it is to negotiated policies and other commercial contracts.
• In determining whether a provision is ambiguous, it must be interpreted in context (this is resembles the statutory interpretation process — see paras 42-44 of Emond). Ambiguity will only arise where there are multiple reasonable but different interpretations of the policy; not all interpretations that may be advanced are necessarily reasonable.

There are two types of ambiguity that may arise. First is the ambiguity that arises when a provision is unclear in isolation, and remains unclear — i.e. capable of more than one reasonable meaning — even when read as part of the entire contract. A second type of ambiguity arises when a provision appears clear in isolation but, when read in context, becomes capable of more than one reasonable meaning.

Importantly, Justice Rowe explained that overlapping provisions do not necessarily indicate ambiguity: the goal is to find “harmony”, not “discord”, among the provisions at issue (para 47).

If there is ambiguity, then the analysis moves to Stage Two, where the court applies other rules of contractual interpretation to try to resolve the apparent ambiguity. These rules are about looking for consistency: consistency with the parties’ reasonable expectations; with commercial reality; and with how similar insurance policies have been interpreted.

Only if ambiguity remains after these rules are applied does the analysis move to Stage Three, where the court applies the contra preferentem rule and resolves the ambiguity in favour of the insured (thus holding the insurer responsible for the ambiguous language in the policy).

Part 2: Application to the Facts of Emond

As noted, the Emonds’ house sustained severe flood damage in 2019.

The home was on the Ottawa River, in an area under the jurisdiction of the Mississippi Valley Conservation Authority (the “Conservation Authority”). To rebuild their home after the flood, the Emonds had to do additional work to comply with Conservation Authority requirements.

Their home insurance policy with Trillium included an optional “Guaranteed Rebuilding Cost Coverage” endorsement (“GRC Endorsement”). As its name suggests, the GRC endorsement provided increased coverage for the cost of repairs or replacement, even if that amount exceeded the coverage limit stated on the policy’s declaration page.

However, the base policy excluded coverage for loss or damage arising from the “increased costs of repair or replacement due to” compliance with construction and zoning laws (the “Compliance Cost Exclusion”). The Compliance Cost Exclusion was itself subject to a conditional exception for “Building By-law & Code Compliance Coverage”, which provided up to $10,000 in coverage for compliance costs (the “BBCC Exception”).

The Emonds and Trillium disputed the amount of coverage available and, in particular, whether the costs of compliance with the Conservation Authority’s requirements were covered. The Emonds successfully applied to the Superior Court of Justice for a declaration of coverage, where the Court accepted their argument that the GRC Endorsement overrode the Compliance Cost Exclusion in the base policy. However, that decision was overturned on Trillium’s appeal to the Court of Appeal for Ontario.

The Emonds were also unsuccessful before the SCC, where the majority decided that the GRC Endorsement did not override the Compliance Cost Exclusion in the base policy, and that this did not result in a “nullification of coverage.”

The text of the GRC Endorsement clearly said that it only amended the formula for the “basis of claim payment” in the base policy for the rebuilding of the house. The GRC Endorsement provided that the insurer had to pay the cost of repairs or replacement even if it was beyond the limits of the policy. However, the GRC Endorsement said that the policy provisions and limits were otherwise unchanged.

The SCC further rejected the Emonds’ argument that the word “guaranteed” in the heading of the Endorsement guaranteed payment to the full replacement cost of the home, including compliance costs. The word “guaranteed” could not be read in isolation. When read in context, it was unambiguous that the Compliance Cost Exclusion excluded coverage for the cost of implementing the Conservation Authority’s requirements (other than the $10,000 in coverage available through the BBCC Exception), notwithstanding the GRC Endorsement.

The Court also held that if there was an ambiguity in the words “increased costs” in the Compliance Cost Exclusion, that ambiguity would be resolved against the insureds. As Justice Rowe explained (at para 98):

Parties reading the broad language of this exclusion would not reasonably expect an insurer to have implicitly accepted liability for all pre-existing non-compliance with applicable law. That would require insurers to ascertain the state of compliance of the insured’s property in each case or else bear indeterminate liability, and potentially to do so again annually, each time the contract is renewed.

This is helpful reassurance for insurers with compliance-related exclusions in their policies.

Summary

The Emonds argued that their policy, including the GRC Endorsement, covered the increased cost of rebuilding their flood-damaged home to meet the Conservation Authority’s requirements. Trillium maintained that the Compliance Cost Exclusion prevented this additional coverage. The SCC, applying the Ledcor analysis, mostly agreed with Trillium, although the BBCC Exception still entitled the Emonds to up to $10,000 in coverage for compliance-related costs.

Part 3: Nullification of Coverage

Emond represents the SCC’s first meaningful engagement with the “nullification of coverage” doctrine. Justice Rowe, for the majority, noted that Ontario Courts “have long refused to apply exclusion clauses in insurance contracts where the effect of the clause would be to virtually nullify the coverage provided by the policy” (para 51). According to Justice Rowe, this is “settled law in Ontario” (para 66), although the BC courts have questioned the Ontario approach (para 57).

The SCC has now confirmed that the doctrine operates outside of the Ledcor interpretive framework reviewed earlier. In other words, even if the policy wording is clear and unambiguous, courts may refuse to apply an exclusion clause if it would virtually nullify the coverage purchased by the insured. However, the SCC noted that the practical result of applying the Ledcor framework versus the nullification of coverage doctrine may be the same, as it seemed to be in Royal & Sun Alliance Insurance Co. of Canada v Snow (a Nova Scotia case discussed in Emond at para 62).

On the facts of Emond, the majority concluded that the nullification of coverage doctrine did not apply, affirming the “high bar” for applying this doctrine. Although coverage under the GRC Endorsement was limited by the Compliance Cost Exclusion, a limit is not a nullification. There was still a benefit to the GRC Endorsement in that it allowed additional recovery beyond the insurance limits in the policy, for costs unrelated to compliance. It was therefore not nullified by the Compliance Cost Exclusion.

It remains to be seen whether Emond will be relied upon to expand the “nullification of coverage” doctrine outside of Ontario.