In a highly anticipated ruling, the Supreme Court of Canada has held that a "faulty workmanship" exclusion in a "Builder's Risk" insurance policy precludes from coverage the cost of recleaning the windows of a building (held excluded faulty work) but not the cost of replacing the damaged windows (held covered resulting damage).
Importantly, the Supreme Court of Canada has rejected the Court of Appeal's test of physical or systemic connectedness to determine whether property damage is excluded as the cost of making good faulty workmanship or covered as resulting damage.
The dispute in Ledcor Construction Limited et al. v. Northbridge Indemnity Insurance Company et al. (2016 SCC 37) arose from the insurers’ denial of coverage for damages caused by the improper cleaning of windows of an office building under construction. The subcontractor hired to clean the windows scratched them by using inappropriate tools and cleaning methods. The building's owner and the general contractor sought the cost of replacing the windows under the project's "Builder's Risk" or "All Risk" insurance policy. It excluded from coverage the "cost of making good faulty workmanship", with the exception of "resulting damages" (an undefined term). The insurers denied coverage on the basis that replacing the windows was "making good faulty workmanship".
Lower courts' decision
The trial judge found that the exclusion was ambiguous in that it wasn’t clear whether it encompassed only the cost of redoing the cleaning work or also the damage to the windows, as they were the very thing on which the subcontractor had performed the faulty workmanship. The trial judge therefore applied the rule of contra proferentem against the insurers and held that the exclusion withdrew coverage for the cost of having the cleaning redone only. The damaged windows constituted resulting damages that were not withdrawn from coverage by the exclusion.
Applying a correctness standard of review to the interpretation of the insurance policy, the Court of Appeal reversed the trial decision and found that the degree of “physical or systemic connectedness” is the key to determining the boundary between "making good faulty workmanship" and "resulting damages". The test considers the connection between the damages and the part of the project being worked on, the nature of the work being done, and the likelihood of the damages happening.
Applying this test, the Court of Appeal held that not only the cost of redoing the cleaning was excluded, but also the damage to the windows being worked on at the time. In short, there was no covered resulting damage.
The Supreme Court’s decision
Writing for the majority, Justice Richard Wagner rejected the physical or connectedness test set by the Court of Appeal (viewed as unnecessary) and restored the trial decision. Applying the general principles of contract interpretation, as the exclusion was held ambiguous, Justice Wagner found that the exclusion serves to exclude from coverage only the cost of redoing the faulty work. The resulting damage exception covers costs or damages apart from the cost of redoing the faulty work. Thus, only the cost of recleaning the windows was withdrawn from coverage.
Justice Wagner noted that this interpretation aligns with the parties' reasonable expectations, informed by the purpose behind builders' risk polices (i.e. to offer broad coverage), and the commercial reality of construction sites. It is also consistent with prior jurisprudence.
The decision also confirmed that the appropriate standard of review was correctness. Justice Wagner explained that where an appeal involves the interpretation of a standard form contract, the interpretation at issue is of precedential value and there is no meaningful factual matrix that is specific to the particular parties to assist the interpretation. Thus, the interpretation is better characterized as a question of law. This is an exception to the general rule that contractual interpretation is a question of mixed fact and law, subject to deferential review on appeal, as held by the Supreme Court of Canada's decision in Sattva Capital Corp. v. Creston Moly Corp., 2014 SCC 53.
Consequences of Ledcor
The Ledcor ruling sheds light on the boundary between "making good faulty workmanship" and "resulting damage", especially when the alleged faulty work causes damage to the very object of the work or part of the work on which it is applied (the windows in that case).
The decision will also make it easier for insured and insurers to appeal contractual interpretation decisions now that the standard of review has been relaxed for standard forms.