Weighing in at the intersection of bankruptcy law and the doctrine of subrogation, the Ontario Court of Appeal has ruled that insurers are not entitled to commence subrogated claims in the name of bankrupt insureds.
In Douglas v. Stan Fergusson Fuels Ltd., the insureds had arranged for the appellants to deliver fuel oil to their home's external oil tank. The fuel oil escaped and contaminated their property. They were covered under a Homeowners Policy which contained a subrogation clause.1 The insurer paid for the cleanup resulting from the spill.
The insureds subsequently filed an assignment into bankruptcy after which they were assigned a trustee who replaced them on the title to the property. The trustee advised the insurer of this assignment and signed a disclaimer reciting the trustee's intention to sell the property as soon as it was remediated. However, the trustee disclaimed interest in insurance claims by the insureds for "loss or damage…to matrimonial household contents not affixed or enjoyed with the residential property or proceeds of personal property..."
The insurer continued to pay out the insureds' claims, spending over $800,000 to remediate the property. It then commenced an action against the appellants in the name of the insureds, claiming damages not restricted to those described in the disclaimer. It launched the action prior to the insureds' discharge from bankruptcy.
Trial & Divisional Court judgments
The appellants brought a summary judgment motion arguing that the insurer's action was a nullity given that the insureds lacked capacity to commence the action by virtue of their bankruptcy. The appellants' motion to strike the claim was dismissed in the trial judgment. The motion judge found that the insurer's right of subrogation was a "contingent right that vested at the time the policy was entered into” and that the insurer became the one with a real interest in the decision “once the [insureds] were fully indemnified."
Because subrogated claims are derivative in nature and an undischarged bankrupt is unable to bring an action to enforce property claims, the Divisional Court concluded that an insurer was also barred from making a derivative subrogation claim. However, the court dismissed the appeal because the insurer had a "vested contingent right to assume the [insured's] right to recover and to bring an action." This right had crystallized before the insureds' assignment into bankruptcy when the insurer had assumed liability for the insureds' losses.
Court of Appeal decision
This is how the appeal court addressed the three broad issues:
1. The insurer’s property interest in the insureds' cause of action
In the court's view, the cause of action did not vest in the insurer before the insureds' bankruptcy. When an insurer is subrogated to the claim of its insured, the claim nonetheless remains that of the insured in whose name and with whose rights the claim must be advanced. Subrogation is not the equivalent of assignment despite having similar aspects. This was a sophisticated insurer and it would have been a simple matter for it to include an assignment clause in the Homeowners Policy if it indeed intended that the insureds assign their cause of action to it. The trustee's disclaimer also operated as no more than a signal from the trustee to the insurer that insurance proceeds for damage to excluded property could be paid out directly to the insureds. The insureds' cause of action was not excluded in the disclaimer but was "property" that passed to and vested in the trustee at the time the insureds filed their assignment into bankruptcy, pursuant to s. 71 of the Bankruptcy and Insolvency Act.
2. The subrogation clause where the insureds are undischarged bankrupts
The insurer argued that a trustee acquires title to the bankrupt's assets subject to all equities existing at the date of bankruptcy. However, the court found that the jurisprudence was clear that an undischarged bankrupt lacks capacity to commence an action in their name if their cause of action vested in the trustee on their assignment or at any time before their discharge. Because the trustee acquired the insureds' cause of action subject to the insurer's right of subrogation, the insurer was entitled to commence the action in the trustee's name. This course of action would have given effect to both the objectives of the doctrine of subrogation and established principles of bankruptcy law. The court determined that upon bankruptcy, the subrogation clause in an insurance policy should be read as if the trustee's name appears in place of the bankrupt insured.
3. The request for a remedial order
Finally, the appeal court decided that the insurer was not entitled to a remedial order under the Bankruptcy and Insolvency Act. While the court acknowledged that it could vary a bankrupt's date of discharge under ss. 40(2) of the BIA, it chose not to do so in the circumstances at hand. In doing so, the court distinguished a previous case where the bankrupt had received a conditional discharge before commencing the action, with only administrative delay and backlog standing between the bankrupt and absolute discharge. In the present case, the insureds' date of discharge was months after the insurer had commenced its action. An order applied retroactively to correct an earlier ruling could also not be made under s. 38 of the BIA as the insurer had not complied with the procedure required by the provision; ie. requesting the trustee to take a proceeding against the appellants. Further, the first request for this order was now being made almost seven years after the limitation period for the action had expired. The court held that the claim should not be amended on the basis of correcting a "misnaming or misdescription of a party" as provided for in the Limitations Act, 2002. The insurer had chosen to commence a claim in the insureds' name and it could not be said that the decision was a "misnaming or misdescription." The appeal court allowed the appeal and dismissed the subrogated action commenced by the insurer in the name of the insureds.
In delivering this judgment, the Court of Appeal provided a helpful overview of the principles of bankruptcy and subrogation law. Moving forward, insurers contemplating bringing a subrogated action on behalf of bankrupt insureds should ensure that the right to the cause of action has not already vested in the trustee. If so, insurers should bring the claim in the trustee's name or risk having their subrogated claim dismissed for lack of capacity.
 Subrogation Clause: "We will be entitled to assume all your rights of recovery against others and bring action in your name to enforce these rights when we make payment or assume liability under this policy."