Executive Summary: Key legal and evidentiary issues

• Determination of whether an insurer had a duty to defend under a liability insurance policy

• Interpretation and application of an exclusion clause related to product defects

• Evaluation of the nature of the underlying legal claim to assess potential coverage

• Consideration of the appropriate scope of a Wellington motion at the preliminary stage

• Analysis of whether the facts alleged in the originating claim could trigger coverage

• Clarification of how broadly courts should construe allegations in favour of the insured

Facts of the case

Intact Insurance Company appealed a Superior Court ruling that had ordered it to assume the defence of its insured, Hydromec Inc., in a civil liability action initiated by AIG Insurance Company of Canada. The underlying lawsuit stemmed from a fire involving a piece of equipment—a transporter—sold by Hydromec to 9351-9817 Québec Inc. The transporter stopped functioning and caught fire while in use. AIG, as the subrogated insurer of 9351-9817 Québec Inc., sued Hydromec under the legal warranty of quality provided in the Civil Code of Québec.

Following the initiation of that lawsuit, Hydromec brought a Wellington motion seeking a court order requiring Intact to defend it, arguing that the liability policy issued by Intact potentially covered the damages claimed. The Superior Court judge agreed, reasoning that the possibility of coverage could not be ruled out without further expert evidence as to the cause of the fire. However, the judge also ruled that Hydromec could not choose its own defence counsel, as that right belonged to the insurer.

Arguments before the Court of Appeal

On appeal, Intact argued that the Superior Court had applied the Wellington framework incorrectly. It contended that the nature of the lawsuit was solely based on the legal warranty of quality—specifically, an alleged defect in the transporter existing at the time of sale. According to Intact, this type of claim fell squarely within an exclusion in Hydromec’s insurance policy for damage caused by product defects existing at the time of sale. Hydromec countered that the policy should be interpreted broadly and that, given its line of business, the coverage was meant to include its principal activities.

Outcome of the appeal

The Court of Appeal allowed the appeal and overturned the lower court ruling. The appellate court concluded that the allegations in the lawsuit, when accepted as true and viewed broadly, pointed only to liability under the legal warranty of quality, which was clearly excluded under clause 2.9 of the policy. There were no alternative allegations that could trigger potential coverage.

The court emphasized that while the obligation to defend requires courts to interpret allegations in the insured’s favour, this principle does not extend to creating imaginary causes of action. In this case, the legal foundation of the claim was entirely excluded under the policy. Consequently, Intact had no duty to defend Hydromec in the underlying lawsuit.

The Court of Appeal set aside the order requiring Intact to defend Hydromec and dismissed the Wellington motion, awarding costs against Hydromec.