Builders risk coverage extended to “service providers” and not just to those who “construct” under Builders’ Risk policies
The Supreme Court of Canada’s recent decision, Ledcor Construction Ltd v. Northbridge Indemnity Insurance Co., 2016 SCC 37, impacts the construction and the insurance industries. The decision addresses whether a “service provider” is afforded the same protection under a Builders’ Risk policy as a “constructor” of a physical object by clarifying when the exception to the faulty workmanship exclusion applies.
Station Lands Ltd. and Ledcor Construction Limited (collectively the “Insureds”) had “all risk” (aka Builders’ Risk) policies through their respective insurers for losses suffered during construction of a new skyscraper in Edmonton (the “Tower”).
The Insureds hired a cleaning contractor to remove concrete spatter and other debris from the Tower’s exterior windows, however the contractor used inappropriate tools and cleaning methods, causing scratches and other damage. The Insureds claimed against the Builders’ Risk policies for the replacement of the damaged windows.
The insurers denied, relying on the “faulty workmanship” exclusion:
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.
The issue at trial and upon appeal was whether the insurance policies excluded the damage that occurred to the windows or if the Insureds fell within the exception to the exclusion.
At trial, the Court held that the insurance provision was ambiguous. As such, the provision was interpreted against the insurers and coverage was extended to the Insureds.
Upon appeal, the Alberta Court of Appeal (“ABCA”) reviewed the decision on the standard of correctness on the basis that an insurance policy is a highly specialized form of contract, and the interpretation of such policies has general importance beyond any particular dispute.
Regarding coverage for the faulty work, the ABCA developed a new “physical or systemic connectedness” test that incorporated elements of causation and foreseeability. Ultimately the ABCA held that the damage to the Windows was directly caused by the cleaning activities that constituted the faulty workmanship, and coverage under was denied.
The Supreme Court of Canada (SCC) decision
The SCC responded to two primary issues in the decision.
- What is the proper standard of review for standard form contracts?
- What is the correct approach to interpreting the “all risks” coverage, in particular the faulty workmanship provision in question?
In responding to the above questions the SCC held that, generally, interpretation of standard form contracts is a question of law, and therefore subject to review on a standard of correctness. In select circumstances, depending on if the factual matrix of a standard form contract assists in interpreting the contract, more deference may be warranted. The Court also states that if the parties negotiated and modified the initial standard form contract, this may warrant a higher level of deference because the interpretation will have no precedential value to others.
Regarding the proper approach to interpretation, the governing principles for interpreting insurance policies can be found in Progressive Homes Ltd. v. Lombard General Insurance Co. of Canada,  2 SCR 245, 2010 SCC 33. Where the policy is unambiguous, effect should be given to that clear language, reading the contract as a whole. Where there is ambiguity, the interpretation should be consistent with the reasonable expectations of the parties, so long as it is supported by the language of the policy, and should not yield unrealistic results. If the ambiguity remains, the principal of contra proferentum can be applied to construe the policy against the drafter.
The policy in this instance was ambiguous. Therefore, the SCC looked to the reasonable expectations of the parties. Builders’ risk policies have high premiums, which are paid in order to receive broad coverage. Such policies provide certainty and stability by granting coverage, which in turn reduces the need for litigation. The Court held that the interpretation—that was consistent with the reasonable expectations of the parties—was that the “faulty workmanship exclusion serves to exclude from coverage only the cost of redoing the faulty work” (at para 63, see also para 95). The faulty work was improperly cleaning the windows. As a result, the policy does not cover the cost of re-cleaning the windows, but does cover the replacement cost of the windows.
In any event, if the Court could not resolve the ambiguity through general interpretation principals, the principal of contra proferentum would apply and the Court would reach the same conclusion that coverage existed.
The SCC further held that the ABCA’s physical or systemic connectedness test was unnecessary.
In the end, the Appeals were allowed and costs throughout were awarded to the Insureds.
From the trial decision up to the SCC decision, two concerns continually surfaced. First, that insurance policies should not act as a warranty of a contractor’s work. Second, a finding in favour of the Insureds would encourage project owners to compartmentalize or split up work on a project, because coverage would depend on how work was divided up between the various contractors.
To address the first concern, the SCC clarified that its decision does not turn all risk policies into warranties of faulty work. The cost of redoing any faulty work is still excluded from coverage and the SCC’s decision should not be construed as permitting contractors to perform their work improperly. Contractors are also precluded from collecting initial payment for completing the faulty work and then receiving further payment to replace the faulty work (see para 80).
Regarding the second issue, the SCC specifically dismissed it because any such concerns do not reflect the commercial reality surrounding construction projects (see para 82). From a cost/benefit perspective, any coverage benefits that the project owner could derive from dividing or compartmentalizing the work would be negated by the risk of delays or complications from over-splitting the work between contractors.
Further, this decision will impact the litigation of standard form insurance policies. When courts are faced with interpreting such policies, they will now be bound by decisions regarding proper interpretation from higher courts because interpreting standard form contacts is now established as a question of law, to be given precedential weight.