A lot of business owners assume their liability insurer only steps in once someone proves they did something wrong. In fact, your insurer's duty to defend, meaning its obligation to hire and pay for lawyers on your behalf, does not depend on you being at fault, and it does not depend on the claim being true.
The Supreme Court of Canada laid out the test in Nichols v. American Home Assurance in 1990: if the facts alleged in the lawsuit, assumed to be true, could possibly fall within your coverage, your insurer has to defend you. So if someone sues you over something your policy covers, you get a defence even if their claim later turns out to be false or even fraudulent. Whether it holds up gets decided in the lawsuit, not before your insurer agrees to defend you.
Say you are an Edmonton renovation contractor, and a year after a basement job the homeowner sues over water damage, naming you along with the plumber and the drywall crew. Even if you are certain the leak had nothing to do with your work, your commercial general liability policy, or CGL, may still have to defend you, because water damage to someone else's property is the kind of claim it is built for. The Supreme Court applied the same reasoning to a general contractor facing water damage claims in Progressive Homes v. Lombard in 2010.
That matters because defending a lawsuit you eventually win can still cost a great deal. On the CGL wordings I see, defence costs are paid on top of your policy limit rather than out of it, though the duty to defend ends once the limit has been used up paying judgments or settlements.
The duty is broad, but it is not unlimited. If what is alleged falls clearly outside your policy, such as a dispute over an unpaid invoice, there is no duty to defend at all, true or not. That is why the fit between your policy and the work you actually do matters so much. Professional liability policies follow the same principle, though it is worth checking whether defence costs there sit inside or outside the limit.
The one way that defence can come back on you is your own conduct. If a policy is voided because something was misrepresented when it was bought, an insurer may seek its defence costs back, which is one more reason to be complete and accurate on every application.
This is general information, not legal advice. If you would like to know how your own policy would respond, I am always glad to walk through it with you. I work with businesses across Alberta.
Mandy Stierman, Founder and Principal Broker
Velocity Insurance Inc. | www.velocityinsurance.ca