Design, Build, Insure

A recent court case in British Columbia interprets, for the first time, a standard exclusion clause in a standard construction policy, potentially setting a precedent that brokers and insurers throughout Canada should note. In Acciona Infrastructure Canada Inc. v. Allianz Global Risks US Insurance Company et al, the province’s Supreme Court ruled that the insurer must pony up—to the tune of $8.5 million—to cover repairs of concrete slabs that were damaged during construction. The case could have ramifications even beyond our borders, because while the policy language is used in construction project insurance policies around the globe, the courts have not weighed in much on the proper interpretation of these clauses.

The project at the heart of Acciona was a public-private partnership: a $250-million extension of the Royal Jubilee Hospital in Victoria, B.C.—the biggest facility of its kind on Vancouver Island. The extension was an eight-storey concrete structure, with four wings linked at a central core. Apart from being massive, the structural design was quite complex: each floor consists of thin suspended slabs (250 mm thick) with large spans (over 9 m). During construction, the slabs “over-deflected” (engineer-speak for “bent too much”), which made them not level. To make the floors level—one of the project’s serviceability requirements—the slabs required extensive remediation.

After being denied coverage for its claim for all remedial costs under the project’s COC policy, the project’s design/build contractor, Acciona, commenced litigation. (Editor’s note: the article’s authors represented Acciona in court.)

In its judgment earlier this year, the British Columbia Supreme Court cited a Supreme Court of Canada case that summarized the principles that apply broadly to the interpretation of insurance policies. In that 2010 case, the Supreme Court wrote that “the primary interpretive principle is that when the language of the policy is unambiguous, the court should give effect to clear language, reading the contract as a whole.” But if the language is ambiguous, the courts should turn to “general rules of contract construction.” One of those rules is that the court should interpret the policy in a way that’s “consistent with the reasonable expectations of the parties,” as long as the actual text of the policy justifies that interpretation—that means no interpretations that come way out of left field. “Courts should also strive to ensure that similar insurance policies are construed consistently,” the Supreme Court wrote in its summary of construction insurance case law.

If none of these principles solve the ambiguity problem, it’s generally resolved in the insured’s favour—coverage provisions are interpreted broadly, and exclusion clauses narrowly—because the insurer chose the policy wording.

Establishing Coverage

In order to establish coverage under a COC policy, the insured must show that the loss falls under the policy’s “perils insured” provision. In Acciona, that provision contained a typical clause covering “all risks of direct physical loss of or damage to the property insured… except as hereinafter provided.”

Part of the reason the insurers disputed coverage was that they disagreed with the contractor over whether the suspended slabs’ over-deflections and related effects constituted “damage” within the insuring agreement. The contractors argued that the over-deflections and cracking was “physical loss” or damage within the meaning of the “perils insured” provision, pointing to the Canadian Oxford Dictionary’s definition of “damage.” The insurers, on the other hand, argued that the slabs’ over-deflections and cracking constituted defects—not damage— and that regardless, the loss was not fortuitous, so did not fall under the policy.

Overall, the court found that the contractors had established coverage under the insuring agreement. In particular, the court confirmed that the over-deflection and cracking of the concrete slabs constituted damage that was fortuitous, as it was unexpected or unintended. With that finding, the loss was covered under the perils insured clause, and the burden shifted to the insurers. If they wanted their denial of coverage to stick, they needed to show that a clause in the policy excluded the loss or damage that was otherwise covered. This brings us to the key issue in Acciona: the interpretation of a standard exclusion clause developed by the London Engineering Group, a UK insurance industry think tank. The group develops model policy wordings for its members for use in various insurance policies, including COC and “All Risks” policies, referred to as “LEG2/96.” This is one of three model “defects” exclusion clauses (the other are LEG 1/96 and 3/96). As the court wrote, “LEG 1/96 contains the broadest exclusion, and therefore the narrowest coverage, LEG 3/96 contains the narrowest exclusion and broadest coverage.” And LEG2/96? Well, it’s somewhere between the two extremes.

Prior to Acciona, no court in the world has interpreted LEG 2/96, although it had been commented on in various articles and papers. As worded, the LEG2/96 clause excludes “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.

“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.”

The Court interpreted the exclusion clause as having two distinct components, which “must be read together in order to give meaning to the clause as a whole”: a) “All costs rendered necessary by defects of material workmanship, design, plan, or specification;” and b) “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 court further interpreted the clause to conclude that the excluded costs are only the costs that would have fixed or prevented the defect “before any consequential or resulting damage occurred, but the exclusion does not extend to exclude the cost of rectifying or replacing the damaged property itself; the excluded costs crystallize immediately prior to the damage occurring and are thus limited to those costs that would have prevented the damage from happening.”

The court held that the exclusion was relevant, as the loss was caused by a defect in workmanship—namely, inadequate formwork and shoring/reshoring procedures used during the pouring of the slabs. The court then found that the “damage” in this case was the cracking and over-deflection of the concrete slabs. However, the court couldn’t quantify the costs of remedying or rectifying the defect before the damage occurred (“i.e. the costs of implementing proper formwork and shoring/reshoring procedures or incorporating additional camber into the formwork”) because there was no evidence. The court wrote simply that such costs “would have been minimal.” As such, the exclusion did not apply and the court held that all remedial costs to the concrete slabs, corresponding site general conditions, and profit were covered—totalling $8.5 million. Allianz has filed an appeal.

This case serves as a reminder for insurers that if they have language at their disposal that can make an exclusion clause unambiguous, “they should incorporate such language. Otherwise the normal principles of interpretation will apply, including the principle that coverage provisions will be interpreted broadly and exclusion clauses narrowly.” If the insurers had wanted the defects exclusion in the COC policy to be interpreted similarly to the “resulting damage” clauses that appear in Canadian insurance policies, they should have incorporated such readily available language in the policy.

The authors work in Borden Ladner Gervais LLP’s construction and engineering group in Vancouver, B.C.
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Copyright 2014 Rogers Publishing Ltd. This article first appeared in the November 2014 edition of Canadian Insurance Top Broker magazine

This story was originally published by Canadian Insurance Top Broker.