The insurance industry will be interested in Ledcor Construction Ltd v. Northbridge Indemnity Insurance Co 1 because of principles the Supreme Court of Canada applied to the "faulty workmanship" exclusion in a Builders' Risk policy. The Court held that the exclusion does not preclude coverage "merely because the damage results to that part of the project on which the contractor was working."
The decision also establishes that insurance contracts need to be interpreted consistently because they are standard form contracts. This was noted to be an exception to the Court's decision in Sattva 2 where it was decided that the interpretation of a contract was reviewed on a reasonableness standard on appeal: this meant that there would be no "correct" interpretation of a contract. The Court recognized that standard insurance contracts cannot be given different meaning in different situations.
The claim arose from scratched windows. A contractor was hired to clean the windows of a recently-completed office tower. In carrying out the work, the contractor scratched the windows resulting in some $2 million in costs to replace damaged windows.
The owner and the general contractor claimed against the project all-risk Builders’ Risk policy. The insurers denied the claim, relying on the exclusion clause, which provided that the policy did not insure:
The cost of making good faulty workmanship…unless physical damage not otherwise excluded by this policy results, in which event this policy shall insure such resulting damage.
The Alberta Court of Queen’s Bench found that the window-cleaning was “faulty workmanship” and that the exclusion clause did not exclude the damage that the cleaning caused. The Court of Appeal reversed that decision on the grounds that the coverage was for physical loss or damage and therefore the exclusion had to be interpreted to exclude from coverage some kind of physical loss. The Court of Appeal developed a test of physical connectedness to find the boundary between faulty workmanship and resulting damage.
The Supreme Court’s Decision
The Supreme Court concluded that the damaged glass was covered as resultant damage. It rejected the lower court’s conclusion that the covered damage could not be to the part of the building that the contractor was working on. It found the physical connectedness test to be unnecessary.
Because the Supreme Court found the exclusion clause to be ambiguous it applied well established principles for the interpretation of insurance contracts. It looked to the broader purpose of the policy for guidance, noting that all-risk coverage is meant to be broad and faulty workmanship exclusions are meant to be narrow.
The insurers argued that case law supported the conclusion that resultant damage did not include damage to the part of the project on which the contractor was working. The decision includes a helpful review of a number of cases where similar issues were considered. The Supreme Court held:
…an interpretation…that precludes from coverage any and all damage from a contractor’s faulty workmanship merely because the damage results to part of the project on which the contractor was working would….undermine the purpose behind builders’ risk policies.
This interpretation is said to coincide with the builders’ realistic expectations and ensures that courts do not arrive at an unrealistic result.
Although the Supreme Court provides useful guidance on the interpretation of the exclusion clause, the decision is more significant for the decision that carves out an exception to its recent decision in Sattva Capital Corp v Creston Moly Corp 3 that contractual interpretation is a question of mixed fact and law which means that interpretations must be “reasonable” but not “correct”. Insurers and courts alike recognized that this meant that policy wordings could be given different meanings in different contexts.
The Supreme Court noted that insurance contracts “are generally determined by the standard form contract” and concluded that interpretation of standard form contracts is “a question of law in most circumstances”.
The foregoing means that previous precedent will guide the interpretation of insurance contracts. Unlike other contracts, the factual circumstances in which the contract is signed are largely unimportant since insurance coverage conditions are usually very similar amongst customers. To ensure consistency and predictability for insurers and their customers, courts need to interpret the same contractual language the same way. This is possible when trial courts interpret contractual language on a correctness standard, rather than the less precise reasonableness standard.
Concerns for Insurers
While the decision appears to settle the question of how policies should be interpreted and the value of precedent cases, some concern arises from the fact that the Supreme Court concludes that these principles apply in “most circumstances”. It is arguable that in cases where an insurer negotiates the terms of the policy, as opposed to presenting standard language, the contract is no longer a “standard form” to which the correctness standard applies.
Another issue to watch arises from the Supreme Court’s reliance on the purpose of the policy in interpreting the policy. Courts have increasingly taken the view that policy language determines the outcome on the basis that the insurer has the power to draft the language to meet the intention. This case suggests that the purpose of a policy or class of policies might be argued in establishing the reasonable interpretation of policy wordings.
The Supreme Court’s focus on the purpose behind builders’ risk policies means that insurers may want to review exclusion clauses in those policies to ensure that they are clear in their intention so that Courts are not required to inquire into the purpose that underlies the policy.
The Supreme Court settled the issue of whether or not the exception to the faulty workmanship exclusion that covers resultant damage can include damage to the part of the project that the insured is working on – it can. The Supreme Court also creates an exception to Sattva that should be welcome to insurers, clarifying that the standard of correctness applies in interpreting standard form insurance contracts. This will reduce the likelihood of inconsistent interpretations of the same or similar wordings in different cases. As such, existing precedent remains a useful tool in interpreting insurance contracts.