Failure to identify changes in insured risks can render policies voidable

An insured must inform its insurer of any facts that affect its insurability or that an insurer would consider relevant in assessing risk. This duty to disclose such facts exists even in the absence of a specific request for them. An insured may face coverage issues if it breaches this obligation and withholds facts that are relevant to an insurer’s determination of the nature and extent of the risk being insured. The Ontario Court of Appeal recently confirmed this well-established principle of insurance law and elaborated on how to determine whether the duty has been discharged in W.H. Stuart Mutuals v. London Guarantee.[1]

The facts of the case are relatively straightforward. W.H. Stuart Mutuals sued its insurer, London Guarantee, for refusing to honour a claim under its Financial Institution or "Fidelity" bond. The loss claimed was caused by a dishonest employee who produced computer-generated cheques and electronically deposited them into private, personal accounts. London Guarantee denied coverage because it didn’t know that this computerized chequing and electronic funds transfer facility existed, and alleged that there were related misrepresentations in the application for renewal of the bond. Simply put, the prior bond contemplated that the principals of the business would review and physically sign all outgoing cheques – the new chequing system allowed staff to print off electronically pre-signed cheques, as well as issue funds electronically. London Guarantee was not advised of this new system when the policy was renewed (and the insured misrepresented that in effect, the prior system was still in place).

The plaintiff’s action was successful at trial. The trial judge found that the insured’s failure to disclose the true nature of its cheque-issuing process was not a breach of its general disclosure obligations.

The Court of Appeal disagreed, holding that the insured materially misrepresented that it had controls in place that involved principals in the cheque-issuing process. These lack of controls, and the dishonest employee’s access to the cheque system, facilitated the fraud that caused the loss. The Court of Appeal rejected the trial judge’s finding that the plaintiff could be excused from disclosure obligations because it did not subjectively understand the risks associated with its new chequing system. Instead, the Court of Appeal declared that there must also be an objective element to the insurer’s awareness of the risk: whether it can be reasonably believed that the insurer had the necessary information to assess the risk insured. Here, the changes to the cheque issuing process created a "significantly enhanced risk of theft" compared to the earlier process. The insured "should have been made aware of that fact – the existence of the new system should have been disclosed."

The court declined to further define a test to determine what facts should be disclosed – likely because each case will be largely fact driven. However it did cite its own, similar decision in Gregory v. Jolley,[2] which also includes a broad review of the duty of disclosure, and contemplates that the facts of each case will determine whether a fact should have been disclosed, or would have affected the determination of the risk to be underwritten. In any event, it seems clear that the court is willing to impose on insureds a broad duty of disclosure during the application process.

Published November 14, 2005