Construction Deficiency Denial Upheld (In BC This Time): Another Win for the Insurance Industry

Last Friday, the B.C. Supreme Court released Reasons for Judgement which could significantly limit, if not completely eliminate, insurance coverage for general contractors in construction deficiency cases.

Why? Because the no coverage decision in Swagger Construction v. ING Insurance follows the recent Ontario decision in A.R.G. Construction v. Allstate, which we previously reported, rather than the Court’s own 2000 decisions in AXA Pacific v. Guilford Marquis and Hearn/Actes v. Commonwealth. Guilford Marquis and Hearn/Actes were both pro-coverage decisions, and have had a strong influence on insurers’ contributions to the defence and settlement of ‘leaky condo’ litigation in British Columbia, over the past 5 years.

So, within a just a few months of each other, trial courts in Ontario and now B.C. have both denied coverage to general contractors for construction deficiency claims of the same sort which were previously upheld in B.C.

The basic facts and allegations in the Swagger litigation are quite straight forward. Swagger acted as the general contractor for the University of B.C., on a project known as the Forest Sciences Center. It was Swagger that commenced the action, in 1999, when it sued U.B.C. for construction delays and extras. U.B.C. then counterclaimed for defects in the construction of the building, which are alleged to have existed “at all material times”. The counterclaim was subsequently amended, to include allegations that such deficiencies have “caused [resulting] damage to exterior and interior building components”, including the building envelope, due to water leaks.

ING was the Wrap-Up insurer on the project. Zurich and American Home were Swagger’s subsequent CGL insurers. Swagger did not report the counterclaim to its insurers until 2004. Coverage was denied, and separate proceedings were brought to determine whether any duty to defend was owed.

Justice Smith’s decision to deny coverage was expressly based solely on the insuring agreements under the various policies. He did not consider it necessary to rely on any of the exclusion clauses. The relevant terms of the ING and Zurich insuring agreements included the following standard provisions:

The American Home insuring agreement, for one of its two policy years, used somewhat - but not materially - different wording.

In his decision, Justice Smith surveyed the previous caselaw - including the reasons in A.R.G. - in great detail. His reasons focussed mainly on two factors:

• the ostensible lack of “property damage”; and
• the ostensible lack of any “occurrence” or “accident”.

However, the decision could be open to appeal on both grounds.

First, Swagger did not argue that the allegedly defective work itself constituted “property damage”. So the focus of the decision was only on the alleged “resultant damage”, and related “loss of use”.

The judge held that since Swagger was the general contractor, the entire project - one, indivisible whole - consisted of its work. As such, even resulting damage was not to other property, and was therefore not covered under the insuring agreement. In essence, like A.R.G., the Swagger decision is based on the concept that liability insurance for a contractor is not a form of performance bond, and therefore does not insure against the ‘pure economic loss’ of repairing either defects in or resulting damage to its own work.

However, such reasoning does not squarely address why the "compensatory damages" provided for in the insuring agreement could not include “economic loss” due to “property damage” to one part of the project (ex. water leaking into the building, with all that entails) resulting from construction defects (ex. a building envelope which permits the leaking to occur in the first place). Could not leaking itself constitute “physical injury to tangible property”, let alone the “resulting” damage to “exterior and interior building components”, including the building envelope, due to leaks? It would seem that, like other cases, Swagger has confused tort concepts - such as "economic loss" and the now discreditted "complex structure" theory - with insurance coverage issues.

Second, Judge Smith also held that there was no “accident”, and therefore no “occurrence”, either. This was for much the same reasons as discussed above. Namely, it was all Swagger’s work that was damaged, or defective to begin with. But exactly why resulting damage - due to unintentional defects in such construction work - cannot constitute an occurrence is not at all clear from the reasons. Are ongoing water leaks not "continuous exposure to the same general conditions"?

Most of the cases relied upon on this point involved the incorporation of a defective component or part into a larger machine or structure. With respect to damage resulting from such defects, the judge both relied on A.R.G. and disregarded Hearn/Actes, essentially on grounds that the latter was wrongly decided.

So, we now have two conflicting decisions in B.C. and, combined with the A.R.G. decision out of Ontario, the weight of the authorities appears to have tilted in favour of insurers, and against coverage for general contractors in construction deficiency cases.

The time appears to have come for the B.C. Court of Appeal to fully address this very important issue.

In the meantime, members of Clark Wilson will updating our paper on “Insurance for Construction Deficiency Claims” [ http://www.cwilson.com/pubs/insurance/njt1/ ] to include this development, as well as speaking on this and other construction insurance topics, over the next few weeks, as follows:

• Clark Wilson Construction Group Insurance Seminar,
  Friday, September 16, Vancouver;
• Northern Alberta Risk and Insurance Management Society,
  October 5, in Edmonton; and
• Insurance Brokers Association of B.C.,
  October 13, in Burnaby.

Readers with questions concerning this or other insurance-related topics are welcome to contact Neo Tuytel ( phone: 604-643-3180; email: njt@cwilson.com )