Insurers, contractors, and construction project owners should take note of a recent Supreme Court of Canada decision interpreting a common form of property insurance. In Ledcor Construction Ltd. v. Northbridge Indemnity Insurance Co., the Court analyzed whether a contractor’s builders’ risk insurance policy should cover certain damage to a building under construction. The Ledcor decision is significant because of its focus on a commonly litigated insurance clause: the “faulty workmanship” exclusion under a builders’ risk insurance policy.
Station Lands Ltd. (“Station Lands”) is the owner of EPCOR Tower (the “Tower”) in Edmonton, Alberta. Station Lands engaged Ledcor Construction Ltd. (“Ledcor”), as construction manager during the Tower’s construction. The Tower’s windows required cleaning prior to construction completion and to perform this work, Station Lands engaged Bristol Cleaning (“Bristol”). Bristol used “improper tools and methods” in order to clean the windows, resulting in significant damage, to the point that the windows needed to be replaced at an estimated cost of $2.5 million. Station Lands and Ledcor claimed this cost against Station Lands’ builders’ risk insurance policy, but the insurers denied the claim by relying on the following exclusion clause:
This policy does not insure …
(b) 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.
Position of Each Party
The insurers argued that the claim was for the cost of making good faulty workmanship, and not resulting damage. They stated that clause 4(A)(b) excluded from coverage both the cost of re-performing the faulty work (i.e. re-cleaning the windows) and the cost of repairing the insured property damaged by the faulty work (i.e. replacing the damaged windows), and that only damage to some other part of the insured property caused by the faulty window cleaning would have been “resulting damage” covered under the policy. The insurers pointed to existing case law in support of the notion that “resulting damage” must be damage to some property other than that which was being worked on (in this case, the windows).
The policyholders argued that the “cost of making good faulty workmanship” equates to the cost of redoing the faulty work, or re-cleaning the windows. Therefore, only this cost would be excluded from coverage under the policy, and the cost of replacing the windows would be “resulting damage” which is covered.
Supreme Court Decision
The Supreme Court slightly favoured the interpretation of the exclusion clause presented by the insureds, but nevertheless held that the clause was ambiguous. To resolve the ambiguity, the Court relied on general principles of contractual interpretation to find an interpretation that accords with the “reasonable expectations of the parties”, and avoid “unrealistic results”. In its analysis, the Court made the following points:
- The purpose of builders’ risk policies is to provide broad coverage (in exchange for relatively high premiums) to construction projects which are susceptible to accidents and errors.
- The policies provide certainty and stability and reduce the need for private litigation, which could cause construction projects to “grind to a halt”.
- Builders’ risk coverage is generally mandatory on construction projects. Contractors expect that coverage under the policy will be available for damage arising from negligence, which is the most common source of loss in construction projects.
- In this case, excluding only the cost of redoing the faulty work from coverage strikes the right balance between two extremes: (i) enabling insurers to pocket premiums without risk, and (ii) allowing the insured to obtain a recovery which could not have been anticipated when it obtained the policy.
The Supreme Court ultimately held that the exclusion clause cited above only served to exclude from coverage the cost of redoing the faulty work, or re-cleaning the windows. The Court considered the actual damage to the windows “resulting damage”, and the cost to replace the windows recoverable under the policy.
Ramifications of Ledcor for the Construction Insurance Industry
Liability to rectify damage caused by faulty or defective workmanship is a major financial risk for building contractors. The lengthy list of Canadian cases concerning the faulty workmanship exclusion demonstrates that coverage under builders’ risk insurance can often be denied for losses caused by contractor negligence. Before Ledcor, policies with exclusion clauses written similarly to 4(A)(b) cited above were often understood to exclude coverage in instances of faulty workmanship for damage to the part of the project being worked on, but cover damage to other parts of the project resulting from the faulty workmanship. Ledcor narrowly construes the faulty workmanship exclusion and in turn, provides a very insured-friendly interpretation of the builders’ risk insurance policy.
It is difficult to predict how the insurance industry will respond to Ledcor. Insurers may adjust premiums in response to a perceived greater risk of claims, or we may start seeing modified wording in exclusion clauses which more precisely defines what is included and excluded from the scope of coverage.
Contrary to the Supreme Court’s emphasis on the builders’ risk policy in question being a “standard form contract”, there are different variations of the faulty workmanship exclusion being offered in Canadian policies. Some of these variations would have certainly produced a different result in Ledcor. In particular, the “LEG” and “DE” wordings, which originate from two different groups of London underwriters, are standard formulations of the faulty workmanship exclusion clause which are becoming more common in Canada. Through the three different “LEG” variations, and the five different “DE” variations of the faulty workmanship exclusion, insurers are able to offer different levels of faulty workmanship coverage for varying premiums. More insurers may choose to adopt such an approach in response to Ledcor.
While the Ledcor decision is favourable to the policyholder, cases concerning coverage for faulty workmanship are generally fact-specific and dependent on the precise policy wording. Owners and contractors should take note of how the faulty workmanship exclusion is worded in their policies to determine how broadly or narrowly they would be covered in instances of faulty workmanship.