Canadian Underwriter

Pyrrhic victory for Intact in faulty workmanship coverage dispute

May 27, 2020   by Greg Meckbach

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Intact Insurance has convinced an Alberta court that the “faulty workmanship” exclusion applies in a disputed commercial fire claim but the carrier still has to pay more than $600,000 to a bakery, mainly because the judge rejected Intact’s definition of “oven.”

Bowness Real Estate Corp v AXA Pacific Insurance Company, released this past Wednesday by the Alberta Court of Queen’s Bench, arose in 2012 after a crouton-making machine caught fire twice. The end result is Intact was found not to have acted in bad faith, is not on the hook for $8.37 million a bakery claimed in lost profits and two fires ultimately resulted from faulty workmanship in the custom-made house-sized bread crumb toaster. Though the claimant argued at trial it should get $1.4 million because the machine was damaged beyond repair, Justice Bernette Ho ruled the client should only get about $264,000 to cover the cost of losing the machine itself. [That does not include business interruption].

The first fire happened in June, 2012 in Calgary at Crumbz, which makes croutons and bread crumbs and bread cube stuffing for grocery stores. At the time, there was a fire in the chamber of a large machine which the company had custom-made in China and installed in February, 2012. The city fire department put the blaze out. There was some damage to the machine as well as heavy smoke damage inside the building.

AXA had issued a commercial policy to Crumbz in 2011. That policy was replaced in July, 2012 by a nearly identical Intact policy as a result of Intact’s acquisition of AXA’s Canadian operations.

The machine that caught fire was about 48 feet long, 24 feet high, and eight feet wide. It consisted of a number of conveyor belts and chambers that dried, toasted and cooled the bread crumbs.

On Aug. 16, 2012, after the Intact policy came into effect, the crouton dryer caught fire for a second time. The damage was contained to the dryer but the second fire damaged the machine itself beyond repair.

Crumbz president Shams-Tabriz Habib made a claim with Intact but was told by an independent adjuster the crouton maker was not insured. According to the adjuster, the combustion chambers appeared to have “inferior or improper materials” or were improperly designed, or both.

During the coverage dispute that followed, the court heard from engineers on both sides. Ultimately Justice Ho concluded the faulty workmanship exclusion applied to the property portion of the claim. She noted the plaintiff’s expert witness agreed, on cross examination, that carbon steel should not have been used to make tubes that formed part of the crouton maker. An insurer’s expert said carbon steel can turn into graphite (and therefore fail) at temperatures of more than 420 Celsius.

In the 38-page ruling the judge discussed three different exclusions in the property policy: Faulty or improper design or improper material; Inherent vice and latent defect; and Wear and tear.

Although the faulty workmanship exclusion applies to the property policy, Intact is not off the hook completely. This is because the policy also included equipment breakdown and business interruption. In 2011 – when Crumbz was asking a broker about product recall coverage – the broker advised Crumbz that the “gold standard” would be the AXA policy that Crumbz ended up buying. In addition to product recall, that policy also included business interruption and equipment breakdown.

In addition to denying property coverage, Intact also denied equipment breakdown coverage because it said a “wear and tear” exclusion applied. The policy stipulates that breakdown due to wear and tear is not an accident. But Justice Ho said the graphitization of the steel tubes was not wear and tear because it was not a gradual wear process under normal operating conditions, and the failure occurred only four months after the dryer was installed.

Intact also argued the crouton maker is an oven. The equipment breakdown policy stipulates that “equipment” does not include “any oven, stove, furnace, kiln, heating element or incinerator.”

The equipment breakdown policy does not go on to define oven, Justice Ho wrote, noting that in coverage disputes exclusions should be interpreted broadly.

If the Merriam-Webster Dictionary definition of oven (a chamber used for baking, heating, or drying) applies, then the machine would be an oven, wrote Justice Ho. But the Collins Dictionary defines oven as “a device for cooking that is like a box with a door.” This is a much more narrow definition in which an oven has to be enclosed.

A household toaster is not normally considered an “oven,” added Justice Ho.

She found that the crouton dryer was not used to bake any products from scratch but instead was used only to toast and dry bread crumbs and croutons.

“This functional distinction is, in my view, significant to the determination that the crouton dryer was a toaster and applying a plain language reading of the exclusion supports the conclusion that the crouton dryer was not an oven.”

The business interruption claim – based in large part on assumptions of future sales and gross profit – was $454,000. But that is for a 12-month period. Justice Ho found that BI should only be claimed for 36 weeks because that is the time she found it should have taken for Crumbz to source and install a replacement crouton dryer. Therefore she pegged the BI damages at $314,000. Crumbz did not actually get a new crouton dryer but declared bankruptcy in December, 2012.

Crumbs claimed Intact was responsible for this bankruptcy and therefore responsible for lost profit of $8.37 million but Justice Ho disagreed. Denying a claim is not in itself bad faith, even if the court rules that coverage should not have been denied.

Instead, the court would have to find  “marked departure from ordinary standards of decency” before finding the insurer in bad faith, wrote Justice Ho.

The total damages also included the Canadian equivalent of US$188,600 to replace the crouton dryer. At today’s exchange rate, that is about $264,000.

It also includes $25,000 for temporary repairs undertake after the June fire plus $16,700 in professional fees for the claimant to hire his own accounting expert to quantify the BI loss.

The claimant also wanted to claim professional fees for his own engineering expert to testify against Intact, but Justice Ho found that was not insurable. By contrast, hiring an accountant to calculate the business interruption loss was.

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