Ontario Court of Appeal has the Last Word on Subrogated Claims in Bankruptcy

by Michael Nowina and Ben Sakamoto of Baker & McKenzie LLP

In an appeal involving the intersection of bankruptcy law and the doctrine of subrogation, a five judge panel of the Ontario Court of Appeal granted summary judgment dismissing a subrogated claim in Douglas v. Stan Fergusson Fuels Ltd., 2018 ONCA 192. The majority ruled that because the cause of action vested in the bankruptcy trustee at the time of bankruptcy the subrogation clause did not permit the insurer to commence the action in bankrupt’s name and it would be inappropriate, in the circumstances, to fix the procedural impediments to the insurer’s subrogated action. On January 31, 2019, the Supreme Court of Canada denied leave to appeal.

Key Takeaway

  • An undischarged bankrupt lacks the capacity to commence an action in his/her own name where the cause of action is vested in the trustee in bankruptcy. However, the right of subrogation survives insofar as the bankruptcy trustee acquires the bankrupt insured’s cause of action subject to the insurer’s right of subrogation.

Background

After a fuel oil spill at the Kingston area property of Wendy and Art Douglas, their insurer acknowledged responsibility to cover the relevant cleanup costs under a homeowners policy which contained a subrogation clause in favour of the insurer. At the time of the spill, Wendy Douglas had no ownership interest in the property because she had filed for bankruptcy and had been discharged with the stipulation that her interest in the property remained vested in her bankruptcy trustee. About a year after the spill, Art Douglas also filed for an assignment in bankruptcy and was replaced by the same bankruptcy trustee on title for the property. Before Mr. Douglas’ assignment, the bankruptcy trustee delivered a disclaimer to the insurer stating the bankruptcy trustee’s intention to sell the property and disclaiming any interest in the personal content claims filed by the Douglases. Ultimately, the insurer paid for the cleanup costs and paid out the personal content claims directly to the Douglases. Once it was remediated, the trustee sold the property and the proceeds were distributed to creditors.

Insurer runs afoul of bankruptcy principles

The insurer’s problems began when it commenced an action against the parties allegedly responsible for the oil spill in the name of the Douglases. These defendants brought a motion to strike the claim on the basis that the Douglases (and therefore their insurer) lacked the capacity to bring the claim in light of their bankruptcies. The motion judge refused to strike the claim and 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, at common law, the dominus litis once the Douglases were fully indemnified.

The defendants appealed to the Divisional Court which found that because subrogated claims are derivative in nature and an undischarged bankrupt is unable to bring an action to enforce property claims, so too was an insurer barred from commencing its derivative subrogated claim. However, the Divisional Court dismissed the appeal, finding that the insurer had a vested contingent right that crystallized when the insurer assumed liability for the loss, before Art Douglas’s assignment into bankruptcy.

Court of Appeal Decision

The defendants brought a further appeal to the Ontario Court of Appeal on the grounds that the Divisional Court had erred in its application of the principle of subrogation. A five-judge panel of the Court of Appeal was convened to permit the Court, if warranted, to over-rule its decision in Mariner Foods Ltd. v. Leo-Progress Enterprises Inc., 2017 ONCA 7 (“Mariner Foods”) to the extent that it stood for the principle that a subrogated claim brought by an insurer is not affected by a bankruptcy.

Justice Hoy, writing for the majority, provided an overview of the intersection of bankruptcy law and the doctrine of subrogation. Justice Hoy broke the appeal down into three questions:

  1. Had the insurer acquired a property interest in Art Douglas’s cause of action at the time that he made his assignment into bankruptcy, such that the cause of action did not vest in the trustee?
  2. If not, did the subrogation clause in the insurance policy permit the insurer to commence an action in the name of Art Douglas, who was an undischarged bankrupt?
  3. If the answer to the first two questions was “no”, could the Court make an order under the Bankruptcy and Insolvency Act or the Rules of Civil Procedure to remedy the procedural impediment to the insurer’s subrogated action?

In answering the first question, Justice Hoy found that the cause of action did not vest in the insurer prior to the bankruptcy. A subrogated claim ultimately remains the claim of the insured in whose name, and with whose rights, the claim must be advanced. Subrogation is not equivalent to assignment and Justice Hoy found that the prior decision in Mariner Foods had wrongly conflated the principles of subrogation and assignment.

In answering the second question, Justice Hoy found that the subrogation clause did not permit the insurer to commence the action in Art Douglas’ name. An undischarged bankrupt lacks the capacity to commence an action in his/her own name where the cause of action is vested in the trustee in bankruptcy. However, it had been open to the insurer to commence the subrogated claim in the trustee’s name. In other words, the right of subrogation will survive bankruptcy insofar as the trustee acquires the bankrupt insured’s cause of action subject to the insurer’s right of subrogation.

In answering the third question, the Court of Appeal refused to make an order to remedy the procedural impediments to the insurer’s subrogated action and therefore granted summary judgement dismissing the action. The majority found that because the question of misnomer was not raised before the motion judge, the Court should not make an order to substitute the name of the bankruptcy trustee as plaintiff. The majority noted that there were a number of options available to the insurer, a sophisticated party, that would have prevented or circumvented the issue at the centre of the appeal.

The dissent agreed with the majority’s legal analysis, but did not concur in the result. The dissenting judges held that it would have been more appropriate to remit the matter back to the motion judge for a fresh consideration of whether it would be appropriate to regularize the action by substituting the bankruptcy trustee as plaintiff.

This decision serves as a reminder of the importance of ensuring that parties to a proceeding are properly named, and raising all relief sought at first instance.

Close Menu