Supreme Court of Canada Expands Coverage Under Builders Risk Policy

In September, the Supreme Court of Canada released reasons in a much-anticipated decision called Ledcor Construction Ltd. v. Northbridge Indemnity Insurance Co. In this important decision for both the insurance and construction industries, Canada’s highest court ruled on the meaning of an exclusion clause for “faulty workmanship” in a builder’s risk insurance policy.

The result expands the types of claims that will be covered in such policies, which are common in the construction industry. The Supreme Court also confirmed the appro­priate standard of review when considering decisions regarding the interpretation of standard form insurance contracts.

Background Facts

The underlying dispute arose during the construction cleanup phase of the EPCOR office tower in Edmonton, Alberta, in 2001. At that time, a subcontractor who had been hired to clean the windows of the building caused extensive damage, requir­ing the windows to be replaced at a cost of $2.5 million.

Both the owner and the general contractor (Ledcor) claimed the cost of the window replacement under the builder’s risk insur­ance policy,which provided coverage to the owner, the general contractor and all subcontractors working on the project. The policy covered all “direct  physical loss or damage” to the building. As is common, the policy contained an exclusion for “the cost of making good faulty workmanship”. As is also common, there was an excep­tion to the exclusion clause for “resultant damage” so that physical damage not otherwise excluded was covered.

Both the owner and Ledcor sued when the insurers denied coverage on the basis of the exclusion.

Trial & Appellate Decisions

The trial court considered the issue of whether the cost of replacing the damaged windows was excluded from coverage under the “faulty workmanship” exclusion or it was included due to the resultant dam­age exception. The trial judge found that the exclusion clause was ambiguous and applied the contra proferentum rule, which requires ambiguity to be decided against the insurer, to find in favour of the insured parties thereby allowing coverage.

The Court of Appeal later overturned the decision of the trial judge after finding that the language of the policy excluded cover­age for the damage.

The Court reasoned that because the base coverage was for “physical loss or damage”, the exclusion clause needed to exclude some physical loss, otherwise it would be redundant. The key was determining the dividing line between physical damage excluded as “faulty workmanship” and that covered as “resulting damage”. The Court found that the exclusion could not just be limited to the cost of redoing the faulty work (in this case, window cleaning), but must also include repairing the damage caused by faulty work, so the exclusion applied. This would seem to ignore the exception for resultant damage.

Supreme Court of Canada Decision

In a unanimous decision, the Supreme Court of Canada agreed with the trial judge that the damage to the windows was covered by the policy and overturned the appeal. The Court agreed that the wording of the exclusion clause was ambiguous but found that the general rules of contractual interpretation resolved the ambiguity.

In its plain, ordinary meaning, the exclu­sion for “the cost of making good faulty workmanship” means “the cost of redoing the work”, however the resultant damage exception includes the cost of repairing the damage caused by the faulty workmanship.

Importantly, the Court noted that if one interprets the exclusion clause to exclude coverage for all damage resulting from faulty workmanship just because that damage results to that part of the project on which the contractor worked, the purpose of builder’s risk insurance is undermined. Finally, the Court noted that its decision matched the parties’ reason­able expectations, based on the purpose of builder’s risk policies, and aligned with commercial reality.

On the question of the appropriate stan­dard of review, the Court confirmed that the standard was “correctness”. This was because the policy here was a standard form contract.

Conclusion

The implications of this decision for the insurance and construction industries are still significant despite the fact that the language in the policy at issue was rather old. Canada’s highest court has now clari­fied that the “faulty workmanship” exclu­sion in applicable builder’s risk policies will only exclude the cost of redoing the faulty work, not the damage that results.

This decision continues the point made in Progressive Homes Ltd. v. Lombard General Insurance Co. of Canada, namely that where policy wording is unambiguous, the courts should give effect to clear language and read the policy as a whole. As such, this decision ultimately expands the scope of coverage available in builder’s risk policies. Insurers and other interested parties may therefore want to revisit their policy wording to determine the significance of any ambiguities.

In addition, the Court’s finding that the interpretation of standard form contracts is a pure question of law is also a significant consequence for all industries that use standard form contracts.

Because appellate courts are more likely to overturn questions of law—rather than questions of mixed fact and law, or questions of fact—parties unhappy with a trial judge’s decision now have added incentive to try their luck on an appeal. The unintended result of this decision could therefore actually be an increase in litigation.

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