The SCC has overturned the Alberta Court of Appeal judgment in its much anticipated consideration of Ledcor Construction Limited v. Northbridge Indemnity Insurance Company, 2016 S.C.C. 37. The case involved a coverage dispute over whether the faulty workmanship exclusion in a builders risk policy (the “Exclusion”) excludes only the cost of redoing the faulty work or whether it also excludes repairing or replacing that part of the project on which the contractor performed the faulty work. The SCC found that only the cost of redoing the faulty work is excluded but the hefty cost of replacing the damaged property is covered. The SCC found this interpretation to best accord with the general rules of contractual interpretation, the parties’ reasonable expectations and the commercial atmosphere in which such policies are sold.
Station Lands Ltd. (“Station Lands”) retained Ledcor Construction Ltd. (“Ledcor”) as construction manager for the construction of the EPCOR Tower in Edmonton. Station Lands obtained an “All Risks” policy (the “Policy”) from Northbridge Indemnity Insurance Company and other insurers (the “Insurers”) for the project. Ledcor and all other contractors involved in the project were additional insureds. The Exclusion in issue read as follows:
This policy section does not insure:
- The cost of making good faulty workmanship, construction materials or design unless physical damage not otherwise excluded by this policy results, in which event this policy shall insure such resulting damage.
A trade contractor named Bristol Cleaning (“Bristol”) was retained by Station Lands to do a “construction clean” of the building’s exterior at a cost of about $45,000. In carrying out its work, Bristol caused damage to the windows. The glass had to be replaced at a cost of about $2.5 million. Station Lands and Ledcor claimed the replacement costs under the Policy. The Insurers claimed the Exclusion applied to the replacement cost of the windows and a coverage action ensued.
At the Court of Appeal
The appellate court reasoned that because the initial grant of coverage extends to “physical loss or damage”, the Exclusion must exclude from coverage some physical loss or damage. The appellate court then focused on what physical damage is excluded as the “cost of making good faulty workmanship” and what physical damage was covered as “resulting damage”. To establish a dividing line, the appellate court devised the physical or systemic connectedness test. The primary considerations were: 1) the extent or degree to which the damage was to a portion of the project actually being worked on at the time, or was collateral damage to other areas; 2) the extent to which the damage was a natural or foreseeable consequence of the work itself; and 3) whether the damage was within the purview of normal risks of poor workmanship, or whether it was unexpected and fortuitous.
The appellate court concluded that the damage to the windows and the cost of their replacement was excluded from coverage, as the damage was physically or systematically connected to the very work the contractor had performed. The damage was caused directly by the scraping and wiping motions involved in cleaning the windows. The contractor intentionally applied these motions to the windows, therefore the damage was not accidental or fortuitous. Fixing or replacing the windows would be “making good the faulty workmanship” and these costs were excluded from coverage.
At the SCC
Contrary to the appellate court, the SCC found that the Exclusion need not encompass physical damage. The SCC found that although exclusions should be read in light of the initial grant of coverage, perfect mutual exclusivity between the Exclusion and the initial grant of coverage is not required. Of note for the court was that the policy contains other exclusions that do not pertain to “physical loss or damage” (e.g., exclusions stemming from contractual breach and government imposed penalties). As a result, the SCC held that the new physical or systemic connectedness test was unnecessary and built on a flawed premise.
The SCC said the general rules of contractual interpretation will answer whether the damaged windows are covered. The SCC found the Exclusion is ambiguous as the word “damage” figures only in the exception to the exclusion leaving it open to interpret that “making good faulty workmanship” means to redo the faulty work only.
To resolve the ambiguity, the SCC turned to consider the reasonable expectations of the parties as to the meaning of the Exclusion. The purpose of the builders’ risk policy is to provide broad coverage for construction projects – which by their nature are susceptible to accidents and errors. There is a high possibility of damage by one tradesman to the property of another and to the construction as a whole. Allocating risk in the builders’ risk policy can allow the projects to proceed without the risk of litigation about liability for damage among the contractors. The expectation of broad coverage is furthered by a narrow interpretation of the Exclusion that only excludes coverage for the cost of redoing the faulty work/recleaning the windows.
The SCC also considered the need to avoid interpretations that would bring about a commercially unrealistic result. The SCC found that recovery for damage to the windows in the circumstances of this case must have been anticipated when the policy was purchased. Interpreting the Exclusion to only preclude the cost of redoing the faulty work aligns with commercial reality and leads to a sensible result. The court found that this interpretation does not transform the policy into a construction warranty and encourage contractors to perform their work improperly or negligently. Contractors would still want to guard against faulty work to ensure they are paid.
In summary, the SCC held that the Exclusion only excludes coverage for the cost of redoing the faulty work – re-cleaning the windows. The Insurers were obliged to cover the significant cost to replace the windows. To avoid this outcome in the future and restrict coverage for faulty workmanship, policies must clarify the “cost of making good” language and the definition of “faulty workmanship”. Insurers may consider “particular part” language whereby damage to that particular part of the project on which the faulty work is performed is excluded. Insurers could go so far as to remove coverage for resulting damage. Foremost for the industry is whether such amendments would defeat the broad coverage insureds are seeking for “certainty, stability and peace of mind” on construction projects.
To see our first article regarding this Court of Appeal decision, click here.