Supreme Court of Canada Provides Guidance on ‘Faulty Workmanship’ Exclusions in All-Risk Insurance Policies
Article by Gordon A. Buck from Alexander Holburn Beaudin + Lang LLP
On September 15, 2016, the Supreme Court of Canada issued its highly-anticipated decision in Ledcor Construction Limited v. Northbridge Indemnity Insurance Company (“Ledcor“),1 which provides important guidance on the interpretation and application of standard “faulty workmanship” exclusions that typically appear in commercial all-risk insurance policies. While the Supreme Court decision brings greater certainty to an unsettled area of the law, it will have significant implications for both insureds and insurers going forward. The practical effect of the Supreme Court’s decision in Ledcor is to expand the scope of coverage that will be available under a commercial all-risk policy, even in cases involving faulty or improper workmanship.
The case arose out of the construction of the EPCOR Tower in Edmonton. During final construction clean-up, the sub-contractor hired to clean the windows used improper tools and methods which resulted in damage to the windows, necessitating their replacement. The owner and the general contractor claimed the cost of the window replacement under the builders’ risk insurance policy that the owner had placed for the project. The policy contained a standard exclusion for “the cost of making good faulty workmanship” but this exclusion was subject to an exception for “physical damage not otherwise excluded by this policy … in which event the policy shall insure such resulting damage”. The insurer denied coverage for the claim based on the exclusion, while the owner and the general contractor took the position that the cost to replace the windows was resultant damage arising from the sub-contractor’s faulty work, and therefore fell within the exception for resulting damage.
The trial judge in the Alberta Court of Queen’s Bench sided with the insureds, finding that although the sub-contractor’s cleaning work was faulty, the “making good” wording in the exclusion was ambiguous and therefore did not operate to exclude the cost of replacing the windows. The Alberta Court of Appeal allowed the insurer’s appeal, finding that the policy wording was not ambiguous, and concluding that the question of whether the window replacement was “resulting damage” should be resolved by applying a test of “physical or systemic connectedness” to the faulty work being carried out. The Court of Appeal concluded that in this case, the damage that occurred was to the very thing that was the subject of the faulty workmanship, and therefore the cost to replace the windows was excluded.
The Supreme Court of Canada allowed the insured’s appeal, and concluded that only the cost of re-doing the cleaning work would be excluded from coverage under the ‘faulty workmanship’ exception. The Supreme Court rejected the Court of Appeal’s “physical and systemic connectedness” test, and found that the exclusion clause was limited to the cost of re-doing the faulty work. The Supreme Court concluded that both the insured’s interpretation and the insurer’s interpretation of the ‘faulty workmanship’ exclusion and the ‘resulting damage’ exception were plausible on the wording of the policy, and therefore the exclusion was ambiguous.
The Supreme Court then concluded that the ambiguity should be resolved in favour of the insured, having regard to the reasonable expectations of the parties entering into the insurance contract. The Supreme Court noted that the purpose of builder’s risk policies was to provide broad coverage for projects while under construction, as well as broad coverage for all those involved in the project, in order to avoid disputes over responsibility for repair or replacement of components of the project. The Supreme Court concluded that to exclude coverage for the damage resulting to the part of the project being worked on would undermine the purpose of builder’s risk policies and would be contrary to the reasonable expectations of the parties.
In coming to its conclusion in Ledcor, the Supreme Court of Canada appears to have endorsed the approach taken by the British Columbia Court of Appeal in another case, Acciona Infrastructure Canada Inc. v. Allianz Global Risks US Insurance Co. (“Acciona“).2 There, the Court of Appeal held in favour of the insured in finding that the ‘faulty workmanship’ exclusion in a builder’s risk policy did not exclude the cost of repairing concrete slabs which over-deflected as a result of improper formwork and shoring procedures. The Court of Appeal in Acciona held that the only thing that was excluded from the loss was the cost of properly doing the formwork and re-shoring, while the damage to the slabs was covered as resultant damage arising from faulty workmanship.
In a broad sense, the Supreme Court of Canada’s decision in Ledcor can be read as a mere confirmation of the generally-accepted principle that coverage under a policy should be construed broadly, and exclusions construed narrowly. More specifically, however, the decision in Ledcor has now firmly established that the standard ‘faulty workmanship’ exclusions in commercial all-risk policies will only operate to exclude the cost of re-doing the faulty work.
As a practical matter, the effect of Ledcor will be to broaden coverage under all-risk policies, even in situations involving faulty workmanship or design. If insurers wish to exclude any damage that is in any way causally connected to faulty workmanship or faulty design, they will have to use clear language to that effect in the policy, or perhaps modify the wording of the exception providing coverage for resulting damage .
For their part, insureds under all-risk policies may wish to consider structuring their contractual arrangements to ensure that any work that poses a significant risk of causing damage to other parts of the project is subject to separate, discrete sub-contracts. The Supreme Court of Canada expressly noted in Ledcor that had the window cleaning company been responsible for installing the windows in good condition, as opposed to merely cleaning them, damage to the windows themselves during the installation process would have been excluded. It is possible, therefore, that coverage may depend at least in part on the scope of the insured’s work as defined by contract, and so insureds will want to give some thought as to whether there is a practical way to structure their contractual arrangements on a given project in order to minimize the application of the ‘faulty workmanship’ exclusion and thereby maximize potential coverage.