Publication

In Fidler v. Sun Life Assurance Co. of Canada, 2006 SCC 30, the Supreme Court of Canada has confirmed that an award of damages for mental distress may be made in a breach of contract case where the object of the contract was to secure a psychological benefit such as "peace of mind". Such an award does not require that there be an independent actionable wrong beyond the breach of contract, instead the damages flow from the basic principles of compensatory contractual damages which require the parties to be restored to the position for which they contracted, whether tangible or intangible. As long as the promise in relation to state of mind is part of the bargain and in the reasonable contemplation of the contracting parties, damages for mental distress arising from the breach are recoverable. In the same case the Court overturned an award of $100,000 in punitive damages made for alleged bad faith conduct. The Court affirmed the principle that merely denying an insurance claim that ultimately succeeds will not, in itself, be an act of bad faith provided the decision to refuse coverage is based on a reasonable interpretation of the insurer's obligations under the policy. The Court's decision provides valuable guidance as to the damages principles that should be applied in cases involving breaches of "peace of mind" contracts and confirms lower court authorities regarding the circumstances in which punitive damages may be awarded for the denial of coverage under an insurance contract.

Connie Fidler became ill with an acute kidney infection known as pyelonephritis. She later developed chronic fatigue syndrome and fibromyalgia, both of which persisted. Ms. Fidler was covered by a group insurance policy with Sun Life which included a long-term disability insurance benefit provision. Sun Life began paying Ms. Fidler long-term disability benefits in January 1991 and continued to do so for several years.

In the summer of 1996, Sun Life hired private investigators to conduct video surveillance of Ms. Fidler. The investigators produced a video which depicted Ms. Fidler carrying out what the trial judge described as "errands or personal business activities" including such things as driving, light shopping, climbing in and out of the rear of her vehicle, walking short distances, and interacting with various people. In a "Lifestyle Questionnaire" filled out a few months before the surveillance, Ms. Fidler had stated that she "rarely" did these activities. Based on the video surveillance, Sun Life terminated Ms. Fidler's benefits. It did so without meeting Ms. Fidler in person and despite the fact that all her doctors still confirmed her total disability.

Ms. Fidler commenced an action against Sun Life, which included claims for aggravated and punitive damages. One week before the trial was set to begin, Sun Life concluded, based on the examination for discovery of Ms. Fidler, that she would probably be successful at trial. Sun Life offered to reinstate Ms. Fidler's long-term disability benefits and to pay her arrears going back over five years to the date of the discontinuance, as well as pre-judgment interest and costs. Ms. Fidler accepted these payments, but elected to proceed to trial on the issue of whether or not she was also entitled to aggravated and punitive damages.

The trial judge awarded Ms. Fidler $20,000 in aggravated damages for mental distress arising from Sun Life's breach of contract but concluded that since the insurer had not acted in bad faith, there should be no award of punitive damages. The British Columbia Court of Appeal unanimously upheld the award of aggravated damages, but found that the trial judge had erred in failing to find bad faith on the part of Sun Life and awarded Ms. Fidler $100,000 in punitive damages.

The Supreme Court of Canada first considered whether the damages for "mental distress" arising from a breach of contract were properly awarded. The Court concluded that damages for mental distress may, in appropriate cases, be awarded. The Court was careful to note that not all mental distress associated with a breach of contract is compensable. In normal commercial contracts, the likelihood of a breach of contract causing mental distress is not ordinarily within the reasonable contemplation of the parties and the law does not award damages for incidental frustration. For there to be an award for damages for "mental distress" the Court must be satisfied:

(1) that an object of the contract was to secure a psychological benefit that brings mental distress upon breach within the reasonable contemplation of the parties; and (2) that the degree of mental suffering caused by the breach was of a degree sufficient to warrant compensation.

The Court noted that these questions require sensitivity to the particular facts of each case and that while the mental distress as a consequence of the breach must reasonably be contemplated by the parties to attract damages, it need not be the dominant aspect or the "very essence" of the bargain. Referring to these as "peace of mind" cases, the Court held that these cases should not be viewed as an exception to the general rule of the non-availability of damages for mental distress in contract law, but rather as an application of the reasonable forseeability principle that applies generally to determine the availability of damages for breach of contract. Compensatory damages are designed to restore parties to the position they contracted for whether tangible or intangible. Thus when the parties enter into a contract the object of which is some psychological benefit, mental distress damages arising from the breach of contract should in principle be recoverable when established to have been within the reasonable contemplation of the parties at the time the contract was made.

The Court further held that an "independent actionable wrong" is not required to recover damages for mental distress. Such a prerequisite would only be required if the damages were sought for aggravating circumstances that extended beyond the reasonable expectations of the parties when the contract was concluded. The Court made a clear distinction between damages for mental distress and aggravated damages, which arise out of aggravating circumstances and require there be a separate cause of action, not only a breach of the contract.

The Court concluded that in the case before it, the first branch of the test was satisfied, finding that a disability insurance contract is not "a mere commercial contract" but is "a contract for benefits that are both tangible, such as payments, and intangible, such as knowledge of income security in the event of disability. If disability occurs and the insurer does not pay when it ought to have done so in accordance with the terms of the policy, the insurer has breached this reasonable expectation of security."

As for the second branch, the Court cited the trial judge's finding that Ms. Fidler had suffered significant additional distress and discomfort due to the loss of disability coverage and concluded that the mental distress at issue in the present case was sufficient to warrant compensation.

In considering the punitive damages award, the Supreme Court of Canada referred to the general test for awarding punitive damages, set out in Whiten v. Pilot Insurance Co., [2002] 1 S.C.R. 595, 2002 SCC 18 at para. 36:

Punitive damages are awarded against a defendant in exceptional cases for "malicious, oppressive and high-handed" misconduct that "offends the court's sense of decency": [.] The test thus limits the award to misconduct that represents a marked departure from ordinary standards of decent behaviour. Because their objective is to punish the defendant rather than compensate a plaintiff (whose just compensation will already have been assessed), punitive damages straddle the frontier between civil law (compensation) and criminal law (punishment).

The Court noted that for there to be an award of punitive damages, in addition to requiring conduct that constitutes a marked departure from ordinary standards, in the context of a breach of contract case, the conduct must also be independently actionable. In cases that deal with the denial of insurance benefits, an insurer's breach of its contractual duty to act in good faith is independently actionable.

The Court agreed with the Court of Appeal's concerns that Sun Life's conduct was problematic, in so far as Sun Life terminated benefits that related to an unobservable disability without any medical evidence indicating an ability to return to work. The five-year denial of benefits without medical support was, according to the Court at the least, inappropriate. That being said, the Court reaffirmed the principle that an insurer will not necessarily breach the duty of good faith by incorrectly denying a claim that is eventually conceded, or judicially determined to be legitimate. In making a decision as to whether to refuse payment the insurer must assess the merits of the claim in a balanced and reasonable manner. A decision to deny coverage should be based on a reasonable interpretation of the insurer's obligations under the policy. The legal standard does not require an insurer to necessarily be correct in making a decision to dispute its obligation to pay a claim. The mere denial of a claim that ultimately succeeds is not, in itself, an act of bad faith.

As such, the Court disagreed with the Court of Appeal's punitive damages award and set it aside stating that the question was whether the denial was the result of the "overwhelmingly inadequate handling of the claim, or the introduction of improper considerations in the claims process." Relying on the trial judge's review of the evidence, Sun Life's conduct was not so unreasonable as it faced contradictory and uncertain evidence regarding Ms. Fidler's condition. Sun Life did not act in bad faith, instead the termination of benefits ".was the product of a real, albeit incorrect, doubt as to whether Ms. Fidler was incapable of performing any work, as required under the terms of the policy."