Construction Deficiencies and the CGL Policy - The Ontario Court of Appeal Weighs In

In 2005, there were a number of cases addressing whether CGL polices covered developers and general contractors for construction deficiency claims. Now, in a strongly worded and persuasive decision, the Ontario Court of Appeal has ruled against underwriters and in favour of the builders.

The caselaw history leading to the Court of Appeal decision merits some review. However, if you prefer to skip to the latest judgement, just skim down to the "Bridgewood and Beige Valley Appeals" heading below.

ARG Construction

In January, 2005, we told you about the Ontario case, ARG Construction Corp. v. Allstate Insurance Co. of Canada. You can find the Insurable Interest Bulletin about ARG in our archives at:
http://www.cwilson.com/insurance/
reviews/insrev93.shtml

ARG Construction was a general contractor. One of its buildings developed leak problems and the owner sued. ARG sought coverage from its CGL insurer but was denied. ARG sued the insurer and lost. The court reviewed the various policy provisions, all of which were standard form wordings, and noted that a liability policy was not to be a performance bond, and that to allow an insured to be indemnified for the cost of remediating its own flawed work would be contrary to public policy.

Bridgewood, Beige Valley and Westridge

In July, 2005, we told you about three more cases, Bridgewood Building. v. Lombard General Insurance, Beige Valley Developments. v Lombard and Westridge Construction Ltd. v. Zurich Insurance. The relevant Insurable Interest Bulletin is available at:
http://www.cwilson.com/insurance/
reviews/insrev102.shtml

Bridgewood and Beige Valley were Ontario builders insured by Lombard and their cases were heard together. The builders constructed a number of homes containing defective concrete supplied by subcontractors. Faced with warranty claims, the builders moved swiftly to address the necessary repairs and provided alternate accommodations to the occupants. Lombard refused to reimburse the builders for these costs and the builders sued. At trial, Lombard resisted coverage on various grounds, underscoring all of them with the so-called principle that liability policies are not performance bonds and the public policy argument that extending coverage to shoddy workmanship or products would serve to encourage same. The Court was not convinced by these arguments and held the CGL policies covered the loss in those particular cases.

Westridge was a Saskatchewan case concerning CGL policy coverage for a rusting swine barn roof. Westridge Construction built the barn but the prefabricated metal building material was supplied by a subcontractor. The roof lacked proper rust protection and corroded. The owner sued Westridge. Denied coverage by its CGL insurers, Westridge sued but lost at trial level. The trial judge said it was a fundamental principle of insurance law that a CGL policy is not intended to be a performance bond. The Saskatchewan Court of Appeal overturned the trial judge, saying he had wrongly focused on general principles rather than the terms of the insurance policy itself. The Court of Appeal found that corrosion caused by moisture in the barn was an "occurrence" under the insuring agreement and the faulty workmanship exclusion did not remove coverage because moisture conditions and not just poor workmanship contributed to the loss.

Swagger Construction

On September, 2005, we told you about the British Columbia case, Swagger Construction v. ING Insurance. You can find this Bulletin in our archives at: http://www.cwilson.com/insurance/
reviews/insrev104.shtml

Swagger built the Forest Science Centre for the University of British Columbia. The building leaked and the University sued Swagger. Swagger sued to get coverage from its CGL insurers but lost at trial. The trial judge ruled the loss was not "physical property damage" nor an "occurrence" of the sort required by the CGL insuring agreement. The trial judge conceded he was bound to follow the policy wording but saw no language that could be stretched to depart from the usual purpose of the CGL policy - that is, the usual purpose not to act as a performance bond. Having found no coverage in the insuring agreements, the judge did not think it was crucial to examine the exclusions. However, he briefly considered the work exclusions and concluded these too would remove the loss from coverage.

Bridgewood and Beige Valley Appeals

Lombard appealed its losses in the Bridgewood and Beige Valley cases. On April 5, 2006, the Ontario Court of Appeal released a judgement upholding the trial decision. Although the Court did not expressly refer to the ARG or Swagger decisions, its ruling firmly rejects the reasoning in those cases.

Lombard argued the insuring agreements did not cover the losses, saying it was settled law that CGL policies are not intended to cover repair or replacement costs arising out of an insureds own defective work or product. This is, in essence, the performance bond argument which is raised time and again in all these construction coverage cases.

The Court of Appeal followed the rule espoused by the Saskatchewan Court of appeal in Westridge: the actual policy wording must take precedence over general insurance principles. Standing alone, any general principle that a liability policy is not a performance bond, cannot preclude coverage for claims respecting an insureds own defective work or product if the policy provisions evidence a contrary intent. Instead, the general principle is merely an interpretive aid that can be helpful, but not necessarily decisive, in determining the scope and extent of risk that the insurer has agreed to cover in any given case.

Although it was not invoked by Lombard, who had argued the case based on general principles alone, the Ontario Court of Appeal considered the work exclusion when interpreting the coverage agreement. The Court particularly noted the exception if the damaged work or the work out of which the damage arises was performed on the insureds behalf by a subcontractor. On a plain reading, this provision suggested coverage was available if the exception was engaged.

When challenged by the Court to address the issue, Lombard argued that an exception to an exclusion cannot restore coverage which did not exist in the first place. The Court of Appeal ruled there was coverage in the insuring agreement and so the exception to the exclusion did not create coverage. Lombards position that there was no coverage in the insuring agreement was problematic for several reasons. First, it defied the basic principle of contract interpretation that all terms are presumed to have a purpose. If Lombards position was accepted, the work exclusion was redundant and the exception meaningless. Second, Lombards position "turned the contra proferentem principle on its head" by in effect asking the Court to construe ambiguities in the insurance policy against the insured. Third, it ignored the historical evolution of the work exclusion and the reasonable expectation of the parties flowing from this. The Court reviewed the history of the exclusion and noted the subcontractor exception was added to the standard CGL policy in 1986 because more projects were being completed with subcontractors and contractors were unhappy that the work exclusion precluded coverage for the work done by these subcontractors.

Lombard next argued that finding coverage would provide general contractors with a windfall. For low premiums, they were able to obtain insurance that permits, indeed encourages them, to hire inexpensive subcontractors, comforted in the knowledge they will be fully indemnified if the subcontractors do bad work. Insurers never intended to underwrite this "business risk". The Court of Appeal also rejected this argument for three reasons.

First, it accepted the logic from previous cases which said the business risk doctrine is less applicable to a claim by a general contractor for the defective work of its subcontractor. A general contractor has minimal control over the work of its subcontractors and providing coverage to the general contractor will not relieve the subcontractor of ultimate responsibility.

Second, Lombards position failed to account for practical business realities. General contractors would go out of business if they routinely hired incompetent subcontractors. "The marketplace can be trusted to look after unscrupulous general contractors who for the sake of a fast dollar, are prepared to risk their reputation by providing defective work product on a regular basis".

Third, "and most important", if insurance companies do not wish to indemnify general contractors for the faults of their subcontractors, "they need only say so in clear and unambiguous policy language". Standard industry endorsements designed to accomplish just that have been available for years.

In the end, the Ontario Court of Appeal ruled the trial judge was correct and Bridgewood and Beige Valley were covered for the losses. The full text of the appeal judgement can be found here:
http://www.ontariocourts.on.ca/decisions/
2006/April/C43430.htm

This decision is a major obstacle for insurers seeking to rely on the ARG and Swagger cases to deny coverage for poor workmanship- related liability claims. The judges in those cases did not consider the work exclusions in interpreting the insuring agreements, a weakness pointed out in various articles and commentary concerning the cases. Further, the Ontario Court of Appeal in Bridgewood and Beige Valley squarely and persuasively addressed the performance bond argument which heavily influenced the ARG and Swagger courts. Finally, the Bridgewood and Beige Valley decisions are from an appeal court, as is the contractor-friendly Westridge judgment. The insurer-friendly ARG and Swagger decisions come from lower courts and may receive less weight in future cases.

If you have any questions about this article, please contact Glen Boswall ( rgb@cwilson.com ; 604.643.3125), Nigel Kent ( npk@cwilson.com ; 604.643.3135 ), or Neo Tutyel ( njt@cwilson.com ; 604.643.3180 ).