New Order in the COURT

Over the past decade, the insurance industry has had to deal with “leaky condominium” litigation in British Columbia. Condo projects in the Lower Mainland and Vancouver Island experienced terrible problems with water penetration. There have also been an increasing number of water ingress claims from universities and other publicly funded projects. The collective repair costs have been enormous. The costs of defending the resulting litigation, settling claims and resolving coverage disputes have been even greater.

Insurance policies considered by the courts in the aftermath of this litigation have largely relied on liability wordings contained in either the CGL or Builders Risk forms. While a liability policy is not intended to provide a warranty of workmanship, the courts have gone to considerable lengths to find coverage in instances where the alternative is an insolvent builder or contractor.

In fairness to the courts, it is rare when a problematic building has only one construction related issue. Often one deficiency will affect another part of the structure. The most common example of this is when water damage results from the failure of a roof. Also, delay in recognizing or fixing construction defects can lead to a situation where a structure becomes unstable or collapses.

The judiciary is then called upon to determine whether any of these scenarios fit within the Insuring Agreement of the CGL policy. If the loss does qualify as an “accident” or “occurrence,” the “business risks” exclusions remove much of the coverage that a contractor might be expected to have. For these reasons, the courts have ruled that when considering the duty to defend, policy wordings must be read liberally and exclusion clauses narrowly.

SWAGGER OVERTURNS POLICY READINGS

The recent ruling of the British Columbia Supreme Court in Swagger Construction Ltd. v. ING Insurance Co. of Canada is a small but significant victory for the Canadian insurance industry. In a decision sure to create a storm of controversy, Justice N.H. Smith has taken a bold step against judicial “social engineering” on the West Coast, ruling in favour of the insurers in a major construction defect claim.

The insured, Swagger Construction, contracted in February 1996 with the University of British Columbia to act as a general contractor for the construction of a building called the Forest Science Centre. In June of 1999, Swagger started an action against UBC for outstanding invoices. The university responded by issuing a counterclaim for breach of contract and negligent workmanship.

The original counterclaim against Swagger pleaded the project was not constructed in a “good and workmanlike” manner. It also alleged the building suffered from numerous construction deficiencies, and had not been built in accordance with the approved drawings and specifications.

Specifically, the university pleaded that it had to repair parts of the building damaged by the defective installation of the air/vapour barrier membrane. These damages were claimed both as a breach of the construction contract and in negligence.

The counterclaim was later amended to plead the costs of additional remedial work. Subsequent amendments added more particulars and increased the dollar amounts. In its final amendment, UBC pleaded the building had suffered “resultant damage and dangerous defects.” This included repairs related to the failure of the building envelope.

Most of the Swagger insurance policies defined “property damage” as meaning:

Physical injury to tangible property, including all resulting loss of use of that property; or Loss of use of tangible property that is not physically injured.

The damage alleged, of course, was damage to the very building that Swagger had contracted to build. There was no allegation of personal injury to anyone, or any allegation of damage to property other than the Forest Science Centre.

WHAT CAME BEFORE

Justice Smith began his analysis by reviewing the principles articulated in the historic decision of the British Columbia Supreme Court in Privest Properties Ltd. v Foundation Co. of Canada. Privest Properties involved the removal of asbestos from a building. Defence costs were sought under a number of CGL insurers with different policy language. Two of the critical policies defined property damage as “injury to tangible property.”

The Court in Privest found that a general contractor’s “work” is the project for which the contractor was engaged. After a thorough review of Canadian and American law, the court concluded that unless there has actually been personal injury or damage to other property, the cost of repairing or replacing defective work is considered to be “pure economic loss.” The mere presence of a defective product in an otherwise sound structure does not, in itself, constitute damage to property.

The end result was that the insurers were not required to provide a defence to the contractor.

Legal counsel for Swagger relied on the subsequent decision of the British Columbia Supreme Court in AXA Pacific Insurance Co. v. Guildford Marquis Towers Ltd. This case involved claims for construction defects that resulted in substantial water infiltration into interior walls. There was a specific claim for repairing parts of the building that were damaged by defects in other parts – such as, for example, repairing drywall damaged by water entering through defective joists or caulking. The court granted coverage on the basis that this category of damage did not include parts of the buildings that formed “a single indivisible unit” of structural elements with the defective parts of the building.

Swagger also relied on another B.C. decision, F.W. Hearn/Actes v. Common- wealth Insurance Co. This case also involved a construction contract at UBC and alleged deficiencies in the contractor’s performance.

The Court in Hearn/Actes not only held there was an occurrence, but ruled there was a duty to defend because the claims fell within “the liberal interpretation of damage to property now specifically adopted by our courts.”

Both of these cases were predicated on the concept that there may be a distinction between the structural and non-structural elements of a building. The Supreme Court of Canada had, in fact, previously suggested there might be a distinction between a part of a structure that “does not perform its proper function in sustaining the other parts, and some distinct item incorporated in the structure which positively malfunctions.” An example of the latter would be a defective boiler exploding and damaging the structure of a building.

The distinction also works in the other direction: a defect in the structure may lead to damage to parts of the building that have no structural function and do not form part of an indivisible unit of structural elements. For example, a failure of the building envelope might cause water damage to building elements that have a cosmetic or functional purpose but are of no structural significance. Examples of such building elements would be carpeting and drywall.

OTHER JURISDICTIONS

Justice Smith observed that in the AXA Pacific decision, the motions judge did not have to decide whether this distinction was relevant but simply relied on the specific policy language to find that a duty to defend existed. He agreed, however, that the policy language in Hearn/Actes appeared to be the same as the policies at issue in the Swagger application.

He noted other courts across Canada had taken an approach that was more consistent with the decision in Privest Properties. In the Ontario Court of Appeal decision in Celestica Inc. v. ACE INA Insurance, for example, the insured provided defective transformers that were incorporated into photocopy machines. The transformers had to be replaced. The Court held that mere defective design or manufacture did not constitute an “occurrence” or “accident.”

Counsel for Swagger submitted that the H
earn/Actes and AXA Pacific decisions indicated the law in British Columbia had diverged from the law in other provinces. The law in British Columbia called for a “wider and more liberal” interpretation of insurance policies, Swagger argued. This certainly seemed to be the reality of the situation to lawyers in other provinces.

B.C. LAW ALIGNED

Considering these seemingly divergent approaches, Justice Smith turned his attention to the facts before him. Rejecting the idea that the “leaky condo” cases articulated a special judicial approach, he could not find any reason why the law in British Columbia should be different from the rest of the country. He noted:

I was not directed to any statutes that mandate a different approach, or to any differences in the prevailing conditions or practices within the industry. In the absence of such differences, insurers and contractors, many of whom carry on business across the country, should be able to expect reasonable consistency in the law.

Justice Smith went on to find the clear intention of the policy was to extend the effect of the “work/product exclusion,” as well as the basic definition of property damage, to any claim arising under the completed operations hazard. He noted that although the completed operations hazard extended the time for which coverage is provided, it did not change the nature of the coverage.

Justice Smith admitted the language of the CGL policy was “somewhat tortuous,” but he could not find any ambiguity in it. Accordingly, he rejected the approach taken in Hearn/Actes and found that there was no obligation to defend Swagger Construction for the construction deficiencies in the UBC project.

The decision in Swagger Construction will undoubtedly involve an appeal to the British Columbia Court of Appeal, inasmuch as it appears to diverge from the prior Hearn/Actes and AXA Pacific decisions. At the same time, Justice Smith clearly returned to the principles of law articulated in Privest Properties, rather than following the decisions of another jurisdiction.

The basic principle set out in Privest is that for the purpose of CGL policies, damage to “tangible property” does not include the cost of remedying defects in the insured’s own work. The policy is not intended to be a means for a contractor to cover the expenses of its own defective workmanship or materials. Most importantly, it is not intended to be a performance bond.