Expanding CGL Coverage for Construction Losses

Two recent cases further the trend of expanding CGL coverage for construction losses. In the first, the Ontario Superior Court held a CGL insurer responsible for warranty covered damages. In the second, the Saskatchewan Court of Appeal ruled that faulty workmanship and product exclusions are not effective if the faulty work or products are not the sole cause of the loss.

Mandatory Construction Warranties and the CGL

Some Canadian provinces have legislation compelling builders and vendors of new homes to provide warranties against major structural defects or building envelope failure. These builders and vendors usually hold CGL policies covering sums the builder/ vendor is “legally obligated to pay as damages” for property loss while excluding coverage for liability “assumed in a contract” and “voluntary payments”. Are these builders and vendors covered by their CGL policies if they carry out or pay for warranty covered repairs before they are sued and without prior approval of their CGL insurers? The Ontario Superior Court of Justice has recently addressed these issues in Bridgewood Building Corp. (Riverfield) v. Lombard General Insurance Co. of Canada and Beige Valley Developments v. Lombard General Insurance Co. of Canada. The decisions in both cases are contained in one judgement.

The Ontario New Home Warranty Act compels Ontario builders to register with the Ontario New Home Warranty Plan (the “Plan”). The Plan requires builders to offer certain statutory warranties concerning the homes they build. In the Bridgewood and Beige cases, two Ontario builders were registered with the Plan and held CGL policies issued by Lombard General Insurance Co. of Canada. The builders constructed a number of homes containing defective concrete supplied by subcontractors. The faulty concrete caused foundations to shift, resulting in cracks to the exterior brick and stone wall finishes and damage to framing and drywall. The builders moved swiftly to address the needed repairs and provided alternate accommodations to the occupants but did not obtain prior approval from Lombard.

In the subsequent disputes over CGL coverage, Lombard argued the claim (1) did not fall within the basic insuring agreement because builders had not been “legally obligated to pay as damages” the repair and accommodation costs, (2) fell within the exclusion for liability “assumed in a contract”, and (3) fell within the exclusion for “voluntary payments”.

Lombard did not rely on its “work” or “product” exclusions. The “product” exclusion did not apply because the definition of “product” did not include real property. The exclusions for “work” were of no use because they either did not apply to property falling within the products-completed operations hazard or did not apply to work performed by a subcontractor

Regarding “legally obligated to pay”, Lombard argued this required some demonstration of fault on the part of the builders or a determination that they were legally obligated to pay in order to trigger coverage under the CGL. The judge noted the phrase “legally obligated to pay” should be construed broadly to include statutorily imposed warranty obligations. The judge drew a parallel with American cases in which courts considered the costs of cleaning up environmental damage under statutory compulsion to be “sums which the insured shall become legally obligated to pay as damages.”

Regarding the exclusion for liability “assumed in a contract”, Lombard argued that because the Plan required vendors and builders to extend warranties to purchasers of new homes, this constituted liability “assumed in a contract”. The judge disagreed, saying that builders obligations under the New Home Warranty Act and the Plan were merely reflected in the warranties provided to the homeowners.

The judge then addressed the exclusion for “voluntary payments”. Lombard argued the builders’ actions constituted “voluntary payments” unless the builders could demonstrate that, had an action been commenced against them, there was a likelihood they would have been found liable. The judge found there was no such requirement, noting the builders were required to take prompt action due to their obligations under the Plan. The judge said that, under Lombard’s interpretation of the exclusion, the builders would be required to breach the statute by refusing to repair, run the risk that the houses would collapse or cause personal injury and have their licences to carry on business placed in jeopardy. The judge found such an interpretation to be contrary to both public policy and common sense and one that would not have been in accordance with the reasonable expectations of the parties.

Lombard argued that if coverage was extended in these cases, the liability policy would effectively become “enormously expanded” and the floodgates would be opened to claims including building code infractions, repair of chipped tiles, drywall repair and essentially all of the builders’ work. In considering this position, the judge noted Lombard’s election not to rely on the “work” and “product” exclusions and expressed the view that the facts of the case, combined with the requirements of the New Home Warranty Act raised public policy considerations that served to outweigh Lombard’s concerns. The judge also noted that Lombard specifically targeted this insurance program to builders and vendors of new homes. If Lombard had wanted to ensure coverage would not be extended to claims resulting from the Plan, it was open to Lombard to use clearer and more precise language to achieve that objective.

Lombard is appealing the judgement.

CGL insurers should be concerned but not alarmed by the Bridgewood case. The damages suffered by the homeowners were the type of resulting damages held to be covered by contractor CGL policies in numerous prior cases including the relatively recent case of Alie v. Bertrand & Frere Construction Co. Ltd. Because of the leaky condominium crisis, liability insurers in British Columbia have been responding to construction warranty based claims for years. Lombard’s concern that the case will open the floodgates to claims including building code infractions, repair of chipped tiles, drywall repair and essentially all of the builders’ work will not likely come true. The requirement for an occurrence to trigger coverage would eliminate most of such claims. Almost without exception, Canadian and American case law states that faulty workmanship, without resulting damage, is not an accident.

Concurrent Causes of Loss and the Construction CGL Policy

Readers are probably aware of the shift in the law resulting from the 2001 Supreme Court of Canada case, Derksen v. 539938 Ontario Ltd.

The Court in the case ruled that where there are concurrent causes of a loss, there is no presumption that all coverage is ousted if one of the concurrent causes is an excluded peril. Without citing the Derksen decision, the Saskatchewan Court of Appeal appears to have extended the principle in another June 2005 decision involving CGL coverage for construction deficiencies.

Westridge Construction Ltd. v. Zurich Insurance Company and Sovereign General Insurance Company concerned CGL coverage for the rusting roof of a barn constructed by Westridge Construction. The owner, Genex Swine Group Inc. (yes, that is the real name), contracted with Westridge for construction of the barn. Westridge subcontracted with another company for the supply of the prefabricated metal building. That company further subcontracted the supply to another company. The roof later corroded. The owner sued Westridge for breach of contract and in tort, the latter including allegations of negligent misrepresentation with respect to recommendations for the work and materials, and failure to warn how the work or material might be unsuitable for use in a hog barn.

Westridge Construction demanded coverage from five different liability insurers on risk between 1994 and 2001. Three insurers acknowledged an obligation to defend the action. Sovereign and Zurich denied coverage and were sued by Westridge. The trial judge dismissed the suit, finding that the true nature of the claims against Westridge was that the company failed in its contractual duty to build and deliver a hog barn suitable for the purposes intended. The claims in negligence were all “derivative” of the contractual claim, and there was no suggestion of any duty of care owed by Westridge to Genex as a result of any relationship between the parties beyond that arising from the contract between them. The judge noted it is a fundamental principle of insurance law that a CGL policy is not intended to be a performance bond. In other words, the CGL policy is not a means for a contractor (or supplier of goods) to cover expenses to correct its own faulty or defective workmanship or materials. Westridge appealed.

The Saskatchewan Court of Appeal saw things differently, finding the trial judge had mischaracterized the nature of the claim and had erroneously focused on general insurance principles rather than the exact terms of the Sovereign and Zurich insurance policies.

Regarding the nature of the claim, the Court of Appeal ruled that the claims in contract and tort arose from different facts. The failures to advise and warn were therefore independent of any contractual duties. The concept of “derivative” claims therefore did not apply.

Turning to the terms of the policies, the Court of Appeal found that the corrosion fell within the meaning of “occurrence” in the insuring agreements. In both policies, “occurrence” was defined to include continuous or repeated exposure to substantially the same harmful conditions. The moisture in the air was the harmful condition that damaged the barn and so there was an "occurrence".

The Court of Appeal’s treatment of the policy exclusions was more interesting. The Court rejected the insurers argument based on “professional services” and “product” exclusions. Regarding “product”, the court noted that this exclusion specifically excepts real property, which includes the barn in question. The Court accepted that faulty workmanship was excluded but noted the allegations for negligent misrepresentation and failure to warn did not arise from faulty workmanship. In addition, the Court of Appeal applied the Derksen logic to the “work” exclusions, although without citing the Derksen case. The Court ruled the faulty workmanship exclusions did not apply because the corrosion did not arise solely from the work, but also from the effect of the conditions prevailing in the barn over a period of time. As in Derksen, there was no presumption that all coverage is ousted if only one of the concurrent causes of loss was an excluded peril.

Since Derksen has been around since 2001, it is somewhat surprising no counsel or court had has previously applied it to the exclusions in a construction CGL case. Insurers issuing new policies should therefore take care to include wording allowing them to deny coverage if an excluded peril is only one of several concurrent causes of loss.

Readers wishing more information on CGL policies, construction warranties, or any other insurance topic may call Glen Boswall at 604-643-3125 (direct line) or e-mail him at rgb@cwilson.com.

You are also welcome to review detailed papers by Glen and other Clark Wilson lawyers, regarding construction CGL and design professionals E&O liability coverage.