Commercial general liability policies are carried by most contractors and trades in the construction industry. Additionally, it is also not unusual for major projects to be covered by what’s known as wrap-liability insurance—insurance which includes coverage for liability for compensatory damages because of “property damage”.
The term “property damage” is generally defined in these policies as “physical injury to or destruction of tangible property”. So the basic insurance coverage afforded by these policies—in addition to defence coverage—is to compensate the insured against any liability for damages arising from physical injury to, or destruction of, tangible property.
Of course, as with all policies of insurance, there are exclusions from coverage. One of the ones that most often surfaces is the work product exclusion, which generally reads as follows:
“This policy does not apply to any liability for injury to, or destruction of, or loss of use of that particular part of any property out of which any injury or destruction arises, or the restoration, repair or replacement of which has been made or is necessary by reason of faulty workmanship thereon by or on behalf of the Insured.”
In other words, this insurance does not provide indemnity coverage to repair or replace work product that has been physically damaged or causes physical damage to other property when the work product is inherently defective. To the extent clarity is possible in interpreting insurance policies, at least this much is clear.
One of the main issues arising in interpreting this exclusion is whether there is indemnity coverage for costs incurred in repairing the faulty work product when the costs are attributable to demolishing other parts of the project in order to get at and repair the faulty part.
The argument that such costs are covered is frequently raised on behalf of contractors who are faced with the work product exclusion. For the reasons outlined below, the argument is frequently found to be without merit.
Perhaps the strongest and most logical opposing argument to this interpretation is that if the insured was afforded indemnity coverage for such costs, it would turn the liability policy into a performance bond, something clearly not within the reasonable expectations of either the insurer or the insured.
If it was otherwise, for example, if an insured installed the wrong windows in a high-rise building and in replacing them had, as a matter of necessity to replace the windows, damaged the window openings, it would amount to a commercial absurdity that the insured would be entitled to the cost of rebuilding the window openings which, logically, would be part and parcel of the cost of repairing, replacing or making good the faulty installation. In short, it would be a windfall for an insured to be able to recover the cost of repairing property damage necessarily caused by the insured itself in carrying out repairs to a faulty work product.
This rationale for rejecting the indemnity for demolition costs has been adopted by the courts in Canada in a number of cases, including Alie v. Bertrand & Frere Construction Co. Ltd. and AXA Insurance (Canada) v. Ani-Wall Concrete Forming Inc. In both cases, the Court observed it is commonly understood that commercial general liability policies are intended to cover tort liability for injury to other persons or damage to their property,not the costs of repairing or replacing the insured’s defective work or product.
Similar reasoning has also been applied in the case of interpreting the faulty workmanship exclusion found in the course of construction or builders risk policies. By way of example in the Sayers case, below, damage caused to concrete slabs and electrical conduits in order to repair physical damage caused by freezing water in the conduit was all deemed to be part of the cost of making good faulty workmanship and, therefore, was excluded by the faulty workmanship exclusion. (See: Sayers and Associates Ltd. v. Insurance Corp. of Ireland; Poole-Pritchard Canadian Ltd. v. Underwriting Members of Lloyds; and Simcoe & Erie General Insurance Co. v. Royal Insurance Co. of Canada.)
Notwithstanding what appears to be a clear argument reflecting the reasonable expectations of both insured and insurer, exceptions to the work product exclusion will continue to be argued with the possibility that one day a contrary novel argument will be accepted, followed by attempts to amend policy wordings to foreclose such a result.