Insurer’s Liability: E&O Fraud Endorsement Does Not Extend to Trust Deposits
In 2069586 Ontario Inc. v. Sovereign General Insurance Company, 2025 ONSC 4468, the Ontario Superior Court of Justice granted reverse summary judgment in favour of the defendant Sovereign General Insurance Company (“Sovereign”), dismissing the action against them.
Justice McCarthy concluded that the plaintiffs had no right to recover under the Sovereign Errors and Omissions (E&O) policy, finding that the intentional, dishonest or criminal act exclusion under the policy applied and that the fraud exception/limitation to the exclusion did not. Justice McCarthy reasoned that the fraud exception under the policy applied to liabilities arising from an insured’s fraudulent acts in advancing or securing mortgage funds, and did not extend to trust arrangements within the broader mortgage agreement.
Background:
The Mortgage Agreement and Underlying Action
In July 2016, the plaintiffs entered into a mortgage agreement with Community Life Projects Inc. (“Community Life”) and Aztec Financial Corp. (“Aztec”) in order to fund a development project in Whitby, Ontario. Community Life was the lender and Aztec acted as the mortgage broker.
As a condition of the agreement, the plaintiffs paid a $459,975.00 advance into Aztec’s trust account. These funds were to be held in trust and returned to the plaintiffs on a later date. The trust funds were not secured by a mortgage.
The funds were not returned, and the plaintiffs commenced an action against Community Life and Aztec for breach of contract, breach of trust, fraud and conversion. The plaintiffs obtained default judgment against Aztec and Community Life, and received partial payment of $114,196.26, leaving $353,520.92 owing (“the remnant judgment”). The plaintiffs commenced a separate action against Sovereign seeking payment of the remnant judgment pursuant to Aztec’s Errors and Omissions policy of insurance.
The E&O Policy and Endorsements
Sovereign issued an Errors and Omissions insurance policy to Aztec that was active between February 4, 2016 and February 4, 2017 (“The Policy”). The Policy grant of coverage set out that Sovereign would pay all sums that Aztec became legally obligated to pay as damagesbecause of a wrongful actthat “arises solely out of, or in connection with, the rendering or failure to render professional services” within the policy period.[1]
The Policy contained an intentional, dishonest, fraudulent or criminal act exclusion. However, as required by O. Reg. 408/07 under the Mortgage Brokerages, Lenders and Administrators Act[2] (MBLA), the policy included an endorsement providing an exception or limitation to the exclusion, granting coverage for dishonest or fraudulent acts of an insured in favour of third persons who are not parties to the insurance contract (“the Fraud Endorsement”). The Fraud Endorsement read as follows (emphasis added):
Endorsement Number 2 – Insureds Licensed in the Province of Ontario
…
(6) Dishonest or Fraudulent Act
Dishonest or fraud coverage afforded under this endorsement shall apply to claims, in excess of the deductible, for which an Insured is legally liable to a third party for failure to advance or secure mortgage funds as a result of any dishonest or fraudulent act by one or more Insureds acting directly or in collusion with others in the conduct of the business of the Named Insuredas a licensed mortgage broker in the Province of Ontario while this coverage is in force and for which a claim is made against the Insured during the term of this policy, subject to the following provisions:
A. The amount payable under this policy by virtue of this endorsement shall in no event exceed the amount of mortgage funds which would have been advanced or secured but for the Insured’s dishonest or fraudulent act;
B. In the event of the failure of the Named Insured to pay a claim upon demand of any third party, then the Insurer shall make payment, after investigating coverage, directly to such third party and shall be entitled to reimbursement from an Insured for the amount of the applicable deductible and any other amount incurred by the Insurer.
C. The coverage afforded under this policy by virtue of this endorsement shall not:
(i) benefit any person committing, making or condoning any such dishonest or fraudulent act;
(ii) benefit any creditor of any Insured hereunder;
(iii) apply to a claim which is covered by the policy to which the endorsement is attached;
(iv) apply to a claim arising out of the insolvency of an Insured or any affiliate of the Insured.
Analysis: Aztec’s fraudulent act did not involve a failure to advance or secure mortgage funds
The plaintiffs conceded that they had no right of action as afforded by s. 132(1) of the Insurance Act, RSO 1990, C. I. 8, as the injury was pure economic loss, rather than injury or damage to a person or property.[3] The analysis then focused on the plaintiffs’ direct right of action against Sovereign under the Policy.
Justice McCarthy found that Aztec and Community Life had been deemed to admit that they breached a trust arrangement and deliberately deceived the plaintiffs in order to acquire the trust funds by virtue of the default judgment.[4] Justice McCarthy reasoned that these facts triggered the intentional, dishonest, fraudulent or criminal act exclusion under the Policy.
Justice McCarthy then turned to the Fraud Endorsement under the Policy. Justice McCarthy found that the endorsement afforded coverage for claims “for which an Insuredis legally liable to a third party for failure to advance or secure mortgage funds as a result of any dishonest or fraudulent act by one or more Insureds”. Justice McCarthy concluded that Aztec’s liability in the underlying action arose from its failure to hold and repay trust funds in accordance with the trust agreement, rather than failing to advance or secure mortgage funds.[5]
Justice McCarthy, citing the Mortgages Act, RSO 1990, c. M.40, determined that “mortgage funds” were akin to “mortgage money”, which is defined as “money or money’s worth secured by a mortgage”. Justice McCarthy emphasized that: (1) the trust funds were not secured by a mortgage; and (2) there was no provision in the agreement to secure the trust funds with a mortgage.
Justice McCarthy concluded that there was no genuine issue for trial and dismissed the plaintiffs’ action against Sovereign.
Takeaway:
The FSCO Guidelines established in March 2008 outline an intention to offer third parties coverage and a direct right of action against an E&O insurer of a mortgage lender for losses resulting from fraudulent acts of the insured, within the minimum limits of an E&O policy. The insurer, in turn, is afforded a right to subrogate against the insured for those amounts. This serves the public policy objective of encouraging development by safeguarding innocent borrowers from fraud.
This decision recognizes that, despite these objectives, an insurer may be entitled to limit coverage to innocent third party borrowers to situations where the insured’s fraud is committed in the course of advancing or securing mortgage funds, and not trust arrangements in the broader mortgage agreement.
[1] 2069586 Ontario Inc. v. Sovereign General Insurance Company, 2025 ONSC 4468 [206] at para 15.
[2] Mortgage Brokerages: Licensing, O Reg 408/07, s 1, https://canlii.ca/t/s84#sec1.
[3] 206, supra note 1 at para 20.
[4] Ibid at para 24.
[5] Ibid at para 30.