Supreme Court of Canada to hear appeal over faulty workmanship exclusion in builder’s risk insurance policy

The Supreme Court of Canada is scheduled to hear an appeal from a construction contractor arising from a disputed claim on a builder’s risk policy with a faulty workmanship exclusion, the highest court announced Friday.

Ledcor Construction, a general contractor, was a named insured under a policy issued by Northbridge Insurance to Stations Lands Ltd., project owner of the EPCOR Tower in Edmonton. Windows on the building had to be replaced after they were damaged while being cleaned by a subcontractor.

The policy had an exclusion for “the cost of making good faulty workmanship, construction materials or design unless physical damage not otherwise excluded” by the policy.

In 2013, the Court of Queen’s Bench of Alberta ruled that the faulty workmanship policy was ambiguous. Mr. Justice Terry Clackson applied the contra proferentem principal, which essentially means – in a breach of contract lawsuit – that the contract is read against the party that drafted the contract. So Justice Clackson ruled that Northbridge’s policy should cover the cost of replacing the windows damaged by cleaning.

But his ruling was overturned in a decision released March 27, 2015.

“Merely because the application of the policy to particular fact situations might be tricky does not mean that there is ‘ambiguity’ in the policy wording,” wrote Mr. Justice Jean Côté, Justice Jack Watson and Mr. Justice Frans Slatter of the Alberta Court of Appeal.

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Ledor has appealed to the Supreme Court of Canada, which has scheduled a hearing March 30. The highest court granted Ledcor leave to appeal in September, 2015.

The Alberta Court of Appeal cited Supreme Court of Canada ruling – cited as Canadian National Railway Co. v. Royal and Sun Alliance Insurance Co. of Canada – released in 2008.

In 1993, CN Rail had a builder’s risk policy that covered direct physical loss and damage, excluding the “cost of making good … faulty or improper design.” That policy was written by RSA, Axa Assurances Inc., Continental Casualty Company of Canada, Reliance Insurance Company, Aviva Canada Inc. and St. Paul Fire and Marine Insurance Company.

CN was building a tunnel underneath the St. Clair River between Sarnia, Ont. and Port Huron, Mich. Work stopped when dirt penetrated the cutting head of a tunnel boring machine. In 2004, an Ontario court ruled that the insurers were liable to CN for $29.6 million. The ruling was reversed on appeal in 2007 but restored the following year by Canada’s highest court, in a divided ruling.

All seven Supreme Court of Canada judges agreed that the exclusion was unambigous.

CN argued that the terms of the policy “should also be read contra proferentem,” wrote Mr. Justice Ian Binnie on behalf of the majority. “However, while the language of the exception was fairly standard for an ‘all risks’ policy, the entire policy had been negotiated between sophisticated parties. It was a ‘manuscript policy”‘ rather than a policy of adhesion.”

The dissenting judges found that “the term “faulty or improper design” is not ambiguous,” wrote Mr. Justice Marshall Rothstein. “It is not open to alternative interpretations.”

In Ledcor vs Northbridge, the “central issue is whether the damage resulted from “poor workmanship” or is “resulting damage,'” the Alberta Court of Appeal found.

“Because the base coverage is for ‘physical loss’, the exclusion ‘cost of making good faulty workmanship’ must exclude some physical loss, or the exclusion would be redundant,” the Alberta Court of Appeal wrote. “The clause then continues with the proviso that ‘resulting damage’ that is ‘physical damage not otherwise excluded’ is nevertheless covered. The key is to determine the dividing line between the physical loss that is excluded because it is the ‘cost of making good’ and that which is covered because it is ‘resulting damage.'”

The appeal court added that Northbridge’s policy was “not a construction warranty agreement.”

Another disputed claim before the courts, arising from a defective workmanship exclusion, involves a course of construction project issued to Acciona Lark Joint Venture (ALJV) – a joint venture of Acciona Infrastructure Canada Inc. and Lark Projects (2004) Ltd. ALJV was general contractor of a hospital construction project in 2009 in Victoria, British Columbia. It was insured for course of construction by Allianz Global Risks US Insurance Company, Zurich Insurance Company Ltd., Temple Insurance Company and GCAN Insurance Company.

After some concrete slabs were poured, they were found to be deflecting, cracking and bending. That constituted direct physical loss of or damage to insured property, the Supreme Court of B.C. found in a decision released in August, 2014.

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ALJV was awarded $8.5 million (including $7.149 million in costs relating to repair of the slabs) but denied $4 million in damages for increased sub-contractor costs. Both the contractor and insurers appealed, but B.C.’s appeal court sided with the lower court. Allianz has filed for leave to appeal with the Supreme Court of Canada. As of Jan. 18, 2016, all materials for Allianz’s applciation for leave to appeal had been filed.

The exclusion in ALJV’s policy is commonly known as LEG 2/96 and devised by the London Engineering Group. The exclusion clause was for:

“all costs rendered necessary by defects of material workmanship, design, plan, or specification, and should damage occur to any portion of the Insured Property containing any of the said defects the cost of replacement or rectification which is hereby excluded is that cost which would have been incurred if replacement or rectification of the Insured Property had been put in hand immediately prior to the said damage.”

The exclusion clause also stipulated that “For the purpose of this policy and not merely this exclusion it is understood and agreed that any portion of the Insured Property shall not be regarded as damaged solely by virtue of the existence of any defect of material workmanship, design, plan or specification.”

In ruling mainly in favour of Acciona, the B.C. Supreme Court cited the 2010 Supreme Court of Canada ruling in Progressive Homes Ltd. v. Lombard General Insurance Co. of Canada.

“In Progressive Homes, the Supreme Court [of Canada] rejected the argument advanced by the insurer that loss resulting from faulty workmanship can never be an accident or be fortuitous,” Mr. Justice Ronald Skolrood of the Supreme Court of B.C wrote in ALJV.

Progressive Homes had been sued – for negligence and breach of contract – by the B.C. Housing Commission, which claimed that “significant water damage caused rot, infestation and deterioration” to four condominium developments. Progressive Homes had commercial general liability policies with Lombard. Those policies required Lombard “to defend and indemnify Progressive when Progressive is legally obligated to pay damages because of property damage caused by an occurrence or accident.”

Progressive Homes was initially unsuccessful in applying to the courts for a declaration that Lombard owed a duty to defend. The B.C. Supreme Court in 2007 ruled that defective construction is not an “accident” unless it causes damage to a third party.

The original CGL policy sold to Progressive Homes had an exclusion for “property damage to work performed by or on behalf of the Named Insured arising out of the work or any portion thereof, or out of materials, parts or equipment furnished in connection therewith.”

In a later CGL policy, there was an exclusion “with respect to the completed operations hazard to property damage to work performed by the Named Insured arising out of the work or any portion thereof, or out of materials, parts or equipment furnished in connection therewith.”

Two of the three B.C. Court of Appeal judges hearing Progressive Homes’ appeal found that “work performed” by a subcontractor could be covered by the CGL policy but “only if the damage was caused by a distinct item installed by a subcontractor, such as a boiler exploding.”

But a unanimous decision, the Supreme Court of Canada ruled that Lombard must defend Progressive Homes.

The question of whether defective workmanship is an accident “will depend both on the circumstances of the defective workmanship alleged in the pleadings and the way in which ‘accident’ is defined in the policy,” Justice Rothstein wrote on behalf of the Supreme Court of Canada.

Accident was defined in the first CGL policy as “continuous or repeated exposure to conditions which result in property damage neither expected nor intended from the standpoint of the Insured.”