December 20, 2016 by David Miachika and Alexander Bjornson
Builders’ Risk (or Course of Construction) insurance policies are commonplace on construction projects. Although they provide coverage for physical loss or damage to ongoing construction works, these policies typically include a “defects” exclusion for faulty or defective workmanship, materials or design. The meaning of a common defects exclusion for the “cost of making good faulty workmanship” was explored in the recent Supreme Court of Canada (SCC) decision of Ledcor Construction Ltd. vs. Northbridge Indemnity Insurance Company.
Ledcor was the construction manager on an office tower project. Near completion, Bristol Cleaning was hired as a subcontractor to clean exterior windows. Bristol used improper tools and methods, which scratched the windows, resulting in an estimated $2.5 million of damage. Ledcor and the owner claimed for window replacement costs under a Builders’ Risk policy placed to cover the project, but were denied coverage on the basis of a defect’s exclusion on the “cost of making good faulty workmanship.”
The issue was whether the clause excluded the cost of replacing the windows or only excluded the cost of redoing the faulty work. The SCC unanimously held that only the cost of redoing the faulty cleaning work was excluded and thus replacement costs should be covered. This decision follows the trend in Canada of interpreting such policies to provide broad coverage for losses and narrowly construe exclusion clauses. This is an important decision for those in the construction industry who seek coverage for losses during construction, and offers three major takeaways for owners and contractors:
These types of exclusion clauses were traditionally broadly applied by the courts, resulting in narrow coverage for damage. More recently, Canadian courts have returned to first principles of interpretation that focus on the ordinary meaning of the policy language and the reasonable expectations of the parties, resulting in broad coverage for such losses.
Here, the Court stated the purpose of Builders’ Risk policies is to provide broad coverage for construction projects, and with it “certainty, stability, and peace of mind.” The Court found this purpose is furthered by an interpretation of the exclusion clause that only excludes the cost of redoing the faulty work itself. A broader interpretation would undermine the ordinary meaning of the policy wording as well as the purpose behind the policies. In considering the parties’ reasonable expectations, the Court noted the parties expect to receive broad coverage for such losses in exchange for paying relatively high premiums. Despite containing various exclusions, “contractors believe indemnity will be available in the event of an accident or damage on the construction site arising as a result of a party’s carelessness or negligent acts.”
The Court also considered the scope of the parties’ contractual obligations. Here, Bristol’s obligation was limited to cleaning the windows, so only the cost of re-cleaning the windows was excluded under the policy. Had Bristol been responsible for installing the windows and the windows damaged in the installation process, reinstallation would likely have been excluded by the exclusion clause.
This reasoning supports a common practice in the construction industry, whereby significant portions of the work are parcelled out to subcontractors. As such, general contractors who hire subcontractors to perform distinct portions of the work, will have broader coverage for damage caused to the project by those subcontractors.
In a previous SCC decision, the Court made clear that appeal courts should only overturn contractual interpretations where the interpretation contained a “palpable and overriding error.” In other words, where parties litigate the interpretation of a contract, any appeal court should be extremely deferential to a trial judge’s decision.
However, the Court clarified where an appeal involves the interpretation of a standard form contract (such as a Builders’ Risk policy, which has not been negotiated), the issue has precedential value as there are typically no factual issues impacting the policy interpretation. Such a decision will be subject to the wider standard of appellate review, namely “correctness.” This means far more appeals are likely to reconsider the finding of a trial court on the interpretation of a standard form insurance policy.
One final point of importance – the “faulty workmanship” exclusion considered in Ledcor is less commonly used in current Builders’ Risk policies as graduated defects exclusions such as the LEG and DE forms are more common. However, the Court’s clear directive on the purpose of Builders’ Risk policies and the reasonable expectations of the parties should only enhance the finding of coverage for construction losses under current policy language.
This article is provided for general information only. It may not be relied upon as legal advice. David Miachika is a partner at Borden Ladner Gervais (BLG). Alexander Bjornson is an associate at BLG. The authors thank Morgan Baker, articling student, for her assistance. Send comments to email@example.com.