Actions against a bankrupt’s insurer can proceed notwithstanding denial of coverage

Hemeon v. District of West Hants, 2008 NSSC 234 examines the interplay between section 69.4 of Canada’s Bankruptcy and Insolvency Act, R.S.C. 1985, c. B-3 (the “BIA”), and section 28 of Nova Scotia’s Insurance Act, R.S.N.S. 1989, c. 231.

The BIA provides for an automatic stay of proceedings in all litigation against a person who makes an assignment in bankruptcy, but then permits that stay to be lifted if the applicant can demonstrate that it will be “materially prejudiced” by the stay, or that lifting the is “equitable on other grounds”.

The Insurance Act provides that if a person obtains judgment against another for which there is insurance, and execution against the judgment debtor is returned unsatisfied, then the judgment creditor can bring the same action against the insurer, and the insurer will be liable up to the face value of the policy.

Although the case is based on Nova Scotia legislation, most provincial insurance legislation contains provisions similar to those interpreted in this case.

In Hemeon, the plaintiff applied to have the stay in her action against the insured lifted, so that she could proceed against the insurer, since there would not be any recovery against the insured, given that he had made an assignment in bankruptcy.

The bankrupt insured conceded that the case law supported a lifting of the stay where the applicant can recover against the insurer under the relevant Insurance Act provisions, since an absolute discharge order only relieves a bankrupt from the obligation to satisfy his debt – it does not erase the underlying obligation.

He opposed the application, however, stating the cases do not apply where the insurer has denied liability under the policy. Instead, the plaintiff must establish insurance coverage as a pre-condition to lifting the stay.

R.W. Cregan, sitting as a Registrar in Bankruptcy for the Nova Scotia Supreme Court, found that lack of coverage is simply a defence that an insurer may raise against the plaintiff’s action. Therefore, the appropriate time to raise that defence is in the context of the litigation, and not during the stay application.

Registrar Cregan reviewed the relevant case law, and noted that the applicant is not required to demonstrate a prima facie case against the bankrupt insured. Section 69.4 of the BIA provides only that the applicant must demonstrate “material prejudice” or that there are other good reasons that weigh in favour of lifting the stay.

There is sufficient “material prejudice” where the plaintiff might be entitled to recover against the insurer, and is being prevented from doing so by the BIA’s stay of proceedings.

The case is consistent with Canadian decisions concerning when the stay of proceedings should be listed, and indeed, relies upon the leading decision on that point, namely Re Advocate Mines, [1984] O.J. No. 2330 (Ont. S.C.).

There does not appear to be any good policy reason to prevent a plaintiff from proceeding in the face of a denial of insurance coverage, since recovery will not come from the bankrupt’s estate if the plaintiff is successful.

Instead, the insurer is best advised to proceed to have the coverage issue determined as quickly as possible, whether by way of summary judgment or bifurcation of the trial.