Contract Works and Contractor’s All Risk Policies comprise a critical component of risk allocation under modern construction contracts. Recovery under these policies can provide fertile ground for dispute, particularly when property is allegedly damaged in consequence of defective workmanship, material or design.
While coverage for each instance of loss is necessarily determined by reference to the particular policy wording, there had been a series of case authorities in Australia in relation to commonly encountered exclusion clauses which are instructive when advising on the likely attitude of the courts to such claims.
Increasingly, contract works policies utilised in major projects (whether written locally or by UK underwriters) are incorporating an exclusion from one of two ‘sets’ of clauses derived from UK industry bodies. While there is a limited but growing body of jurisprudence in relation to the interpretation of one set of these clauses in the UK (the London Market (DE) clauses), there has not been any reported judicial consideration of the operation of the other set of clauses (the London Engineering Group (LEG) defects wording) either in Australia or the UK.
This has led to speculation in some quarters as to how courts in Australia might interpret such clauses, particularly as it may be difficult to discern the legal basis to give effect to what is sometimes represented to be the drafter’s intention.
A recent decision by the Court of Appeal for British Columbia provides the first considered judicial analysis of the operation of an LEG 2 Defects Exclusion and it is to this case that we shall return in the second part of this newsletter.
London Market design clauses and the London Engineering Group ‘defects wording’
The London Market design clauses offer five distinct levels of coverage against defects in design, materials and workmanship. These clauses are also becoming increasingly common in contract works policies emanating from Australian underwriters.
By way of background, the current DE clauses were introduced in 1995 by a committee of leading building and civil engineering underwriters which revised the originals. They provide different levels of cover from 1 to 5 - 1 being no defect cover to 5 providing significant cover with respect to defects in design, plans, specifications, materials or workmanship.
In general terms DE2 and DE3 permit cover for damage to other property which is free of the defective condition and is damaged in consequence of the defect, but excludes damage to the defective property itself and any other property which is damaged to enable the replacement/repair to take place. The distinction between DE2 and DE3 is only that DE2 also excludes damage to property insured which relies for its support or stability upon the defective property, whereas DE3 omits that provision and thus allows cover in that respect.
It is also worth noting the clarifying rider which appears as a final paragraph of that clause, and which is sometimes not well understood.
It is provided in the Insurance Institute of London Construction Insurance Advanced Study Group Report 208B at page 164 as follows:
‘Additionally, a clarifying rider has been added to the end of all clauses (other than DE1) to remove any question of contention that defective property is per se "lost or damaged" property or that property which contains a defect is therefore "lost or damaged".’
In the UK case of C A Blackwell (Contractors) Ltd v Gerling Allegeneie Verisherungsag,1 the court was referred to the report by the Advanced Study Group of the Institute of Insurance (which gives a history of the defect exclusion clauses). While finding the report ‘instructive’ as to the purpose of defect exclusion clauses and how they have evolved, the court found that it could not be used as an aid to construction of the clause in question, which had to be construed according to its terms. The court concluded that the intention of those who drafted it and other similar clauses is neither relevant nor admissible.
The critical passage from the Court of Appeal's judgment in that case, in understanding the operation of the (most commonly encountered) DE 3 exclusion, was as follows:
‘What is important to note is that the exclusion is not of loss or damage caused by a defect in workmanship, etc…Provided the insurer can show that the property was in a defective condition, the exclusion applies.’
The London Engineering Group ‘defects wording’ is also commonly in use in both the UK and Australian market.
The ‘mid point’ of each of these sets of clauses is to be found respectively in DE 3 and LEG 2.
DE3 (1995): Limited Defective Condition Exclusion provides:
‘This policy excludes loss of or damage to and the cost necessary to replace repair or rectify:
- Property insured which is in a defective condition due to a defect in design plan specification materials or workmanship of such property insured or any part thereof;
- Property insured lost or damaged to enable the replacement repair or rectification of Property insured excluded by (i) above.
Exclusion (i) above shall not apply to other Property insured which is free of the defective condition but is damaged in consequence thereof.
For the purpose of the Policy and not merely this Exclusion the Property insured shall not be regarded as lost or damaged solely by virtue of the existence of any defect in design plan specification materials or workmanship in the Property insured or any part thereof.’
The LEG 2 model ‘Consequences’ Defects Exclusion operates differently to the DE 3 clause. It provides:
‘The Insurer shall not be liable in respect of:
All costs rendered necessary by defects of material, workmanship, design, plan or specification and should damage occur to any portion of the Insured Property containing any of the said defects, the cost of replacement or rectification which is hereby excluded is that cost which would have been incurred if replacement or rectification of the Insured Property had been put in hand immediately prior to the said damage.
For the purpose of the policy and not merely this exclusion, it is understood and agreed that any portion of the Insured Property shall not be regarded as damaged solely by virtue of the existence of any defect of material, workmanship, design, plan or specification.’
On one view, the relevant costs which are excluded under this clause (being costs rendered necessary by the defect) are those comprising the full cost of repair, reinstatement or replacement of the physical damage to the Property Insured (subject only to the operation of the proviso). A differing construction sometimes advanced by insureds is that cover is to be provided for the costs of repairing, reinstating or replacing damaged property, unless the costs have been ‘rendered necessary’ by a relevant defect.
Judicial interpretation of DE3 (1995): Limited Defective Condition Exclusion
The UK Authorities
The case of Skanska Construction Ltd v Egger2 concerned a floor slab which was completed at the end of October 1997 and shortly thereafter cracks were noticed. Temporary repairs to the slab were made between October 1997 and November 1998, by which time it was clear that the slab would have to be completely replaced.
In that case, the judge concluded that the DE3 exclusion would exclude cover for damage to the floor. The judge concluded that the phrase ‘loss and damage’ could not extend to rectification of the defects in themselves.
It is worthwhile to repeat verbatim what appears at  of the Court of Appeal judgment:
‘It was, faintly, argued, before us for the first time, that one of the respondents pleaded particulars of causation would lend itself to an argument that one part of the Works collapsed and damaged another ... The argument relates to one plea ... of failure by the appellants ‘to sufficiently compact the sub-base material underneath the slab with the sub-base having a typical air void content greater than 15%’. It was suggested, on that basis, that one part (the sub-base) collapsed and damaged another part (the slab above it). That argument was not only not raised below, it attempts to divide the indivisible ... I see no prospect of any court accepting that the sub-base "damaged" the [rest of the] slab above it within the meaning of clause 22(2).’ [writer emphasis]
Two more recent decisions in the UK have however, been determined very much in favour of the insured’s contentions in relation to the operation of a DE3 exclusion.
The first case is that of Seele Austria GMBH & Co KG v Tokio Marine Europe Insurance Ltd.3 That case concerned a claim brought against a contract works insurer in relation to damage to windows. Comments made by the Court of Appeal in relation to the wording contained within the DE3 exclusion are significant and are repeated below:
 ‘... The precise point at which a line is to be drawn between "insured property (a)" which is in a defective condition and "other Insured Property" which is free of the defective condition may be difficult to identify in some cases, particularly where the work being carried out by a single subcontractor is of a complex nature. However, I think the intention behind the rider was to provide cover in respect of damage accidentally caused in consequence of the defects to parts of the work which in commercial terms are to be regarded as separate and distinct from that part in which the defect exists. For this reason it is not right, in my view, to regard the whole façade as a single item of property for this purpose. In commercial terms, the plasterboard ceilings and the external cladding are each to be regarded as separate items of property ...’
That case was instructive, and demonstrated a willingness of the courts to make a division between the ‘Property Insured which is in a defective condition’ and ‘other Property Insured which is free of the defective condition’.
The approach in the UK at least, appears to now have been largely settled by the decision of the Court of Appeal in C A Blackwell (Contractors) Ltd v Gerling Allegemeine Verischerungs AG.4
That case considered the operation of the DE3 exclusion in the context of a contract to complete earthworks in the construction of part of a motorway.
After the initial earthworks comprising of basic cuttings or embankments, the road was to be constructed of three layers. These were:
- The sub-formation;
- The formation, which involved the spreading of imported material known as ‘capping’; and
- The laying of asphalt layers, which was the responsibility of the main contractor.
The Court of Appeal held that ‘Property Insured’ meant that part of the works which had suffered damage. If that part was wholly or partly defective, the exclusion applied. In that case, the court said that there was nothing defective about the sub-formation so that part of the works was not defective; nor was there anything intrinsically defective about the condition of the capping (save for a possible issue not herein relevant).
The Court of Appeal said:
‘... it is I think important to construe the exclusion clause without regard to its application to the facts of this case. Its purpose is clear. It prevents the insurer from having to pay for the replacement, repair or rectification of property which was already in a defective condition at the time the fortuity covered by the policy occurred. If the defect is one of design, plan, specification, materials or workmanship the property would have to be repaired, etc by the contractor or others in any event.’5
 ‘What is important to note is that the exclusion is not of loss or damage caused by defect in workmanship, etc. The cause of the loss or damage is irrelevant. Provided the insurer can show that the property was in a defective condition the exclusion applies ... All this is, I think, self-evident from the wording of the exclusion. What is more difficult is to discern how wide the words "Property Insured" are intended to be.’
It was submitted by the insurer’s counsel that that expression had a very wide meaning and that one should not attempt to ‘divide the indivisible’. That counsel also referred the court to the two cases previously mentioned of Walker Civil Engineering, and Skanska Construction. In relation to this the Court of Appeal said:
 ‘... [the Walker clause] ... was a clause which, unlike the DE3 clause, excluded liability for damage caused by the defect. The Court held that "part" did not refer to a part such as a tank, it referred to the part of the work being carried out by the contractor. I do not see how this aids the construction of the DE3 clause. Nor do I gain any assistance from the other case relied on ... [Skanska Construction], which was concerned with the contractor’s obligation to insured, assumed in its contract with the employer.’
The Court of Appeal continued:
 ‘So, returning to the wording of the clause in this case, the first thing to note is that it draws a distinction between "Property Insured or any party thereof" and "other Property Insured". This suggests, and indeed requires, divisibility. Division is easy in some cases. The Institute report gives the example of a steel framed building with its roof, cladding and dwarf brick walls completed which collapses because the nuts and bolts used in the construction of the steel framework are defective. Under the DE3 wording, damage to the steel framework is excluded but damage to the roof, cladding and dwarf brick walls is covered. I agree that this is the effect of the clause in that sort of case. By analogy, one might argue in this case, that the Property Insured refers to the entirety of the earthworks. That cannot be what was intended by this wording. I think it must be restricted to that part of the works which has suffered damage. If that part is wholly or partly defective the exclusion applies.’
The Court went on to conclude:
 ‘So how should one apply the exclusion construed in this way to the facts of this case? There was nothing defective about the sub-formation so that part of the works was not defective; nor was there anything intrinsically defective about the condition of the capping ...’
 ‘But the failure, if there was one, to implement other measures which were designed to protect the capping such as the use of punts and bowsers and the means to channel and dispose of the water on the verges, cannot be characterised as a defect in the condition of the capping ... If I am wrong about this and one can characterise the works contemplated by these measures as Property Insured and the failure to carry them out made it defective, I would distinguish, as the Judge did, between this property and the capping and sub- formation (other property), so that the exclusion does not apply because of the limitation.’
Judicial Interpretation of LEG 2 (1996)
The Acciona Infrastructure Canada Inc.6 case
This case was an appeal from a judgment at trial in favour of the plaintiff contractors who had sought indemnity from their insurers for losses and costs incurred to repair damage to concrete slabs forming part of a new patient care centre.
The insurers on appeal argued that the trial judge erred in finding that the damage to the concrete slabs constituted ‘direct physical loss of or damage to the property insured’ within the meaning of the policy, and that the damage was not excluded by a defects exclusion in the policy which was in relevant respects in the form of LEG 2.
The trial judge held that the over-deflection, bending and cracking was fortuitous damage which fell within the Perils Insured Clause and the Court of Appeal concluded that the judge did not err in making this finding.
The Court of Appeal summarised the trial judges’ findings in relation to the Defects Exclusion as follows:7
 ‘The Judge found that the Defects Exclusion was intended to exclude defects without excluding damage that results from such defects, but was designed to do so in a manner that avoids the "metaphysical" debates that arise when a court must determine where a defect ends and resulting damage begins. The Defects Exclusion accomplishes this goal "by crystallizing the quantum of damage that is excluded at the moment just before any consequential damage resulting from defective work occurs"’ .
 ‘The Insurers sought to apply the Defects Exclusion to the whole of the loss, arguing that the over-deflection, bending and cracking was the manifestation of a defective design. The contractor responded that the Policy required a sequential analysis of the claim. First there must be a finding of damage under the Policy. The Defects Exclusion has no application unless the damage can be said to have been caused by a defect of one of the listed types. A determination must then be made of the total cost to repair or rectify the damage; then, from this recoverable cost, the Policy excludes only those costs of repair that would have remedied the defect immediately prior to the occurrence of the damage.’
 ‘The Judge accepted this was the correct analytical framework. He held the failure to take steps in the formwork and shoring/re-shoring procedures or to addressing any way the complex design of the forms was defective workmanship within the meaning of clause 5(b) of the Policy. He then held:
 The "damage" in issue here is the cracking and over deflection of the concrete slabs. The "defect in material workmanship" is the improper formwork and shoring/re-shoring procedures adopted that resulted in the damage to the slabs. Applying clause 5(b), the excluded costs are those that would have remedied or rectified the defect before the cracking and over deflections occurred i.e. the costs of implementing proper formwork and shoring/re-shoring procedures or incorporating additional camber into the formwork.’
 ‘The trial Judge noted there was no evidence of the cost of implementing proper formwork and shoring/re-shoring procedures. He concluded such costs would have been minimal (that is, no more than the defective procedures that were in fact implemented). Accordingly, he found that none of the claim was excluded by the Defects Exclusion.’
The ground of appeal by insurers was that the trial judge erred in holding that only the ‘preventative or avoidance costs’, which in this case were nil, were excluded from coverage by the Defects Exclusion.
The insurers argued that the judge approached the interpretation of the exclusion influenced by the approach taken to by the courts in the ‘resulting damage’ cases, which grapple with the distinction between defects in the insured’s own work, usually excluded, and damage resulting from those defects, often covered.
They argued that the enquiry mandated by the LEG 2 exclusion is temporal rather than causative, and that the proper enquiry, rather than being directed to distinctions between defects and resulting or consequential damage is one directed to identification and exclusion of costs that would have been incurred if the defect had been recognised and repaired or replaced before it caused any property damage. It was suggested by the insurers that this enquiry would lead to the exclusion of the entire claim.
The Court of Appeal did not agree with the insurers that the trial judge adopted the approach of the resulting damage cases, finding that the trial judge’s reference to the costs that would necessarily have been incurred to rectify the defective workmanship immediately before ‘consequential or resulting damage’ occurred was descriptive of the effect of the application of the Defects Exclusion to the circumstances of the case and not inappropriate reliance upon the ‘resulting damage’ case law.8
Rather the Court of Appeal said that the trial judge interpreted the Defects Exclusion to exclude from coverage the costs that would have been necessary to rectify a defect in workmanship immediately before that defect caused damage to the Insured property.9
The Court of Appeal said that the trial judge’s critical finding was that defects in the framing and shoring workmanship resulted in damage to the slabs (which was not challenged on appeal) and that in light of that finding the floor slabs cannot be considered to be a ‘portion of the insured property containing any of the said defects’ within the meaning of the Defects Exclusion. The Court of Appeal thus concluded:10
 ‘In other words, there was no defect in the slabs that could have been rectified in order to prevent the over-deflection, bending and cracking. The defect was in the workmanship. The Judge found that if the defect in the workmanship had been identified early enough, there would have been no material additional costs to implementing appropriate workmanship. There was no evidence of such costs. It was a coincidence, in this case, that the necessary rectification costs were equivalent to the avoidance costs – but this does not mean the Judge misinterpreted the Defects Exclusion to generally exclude only avoidance costs.’
The Court of Appeal next addressed the insurer’s contention that the Defects Exclusion requires a determination of the cost of ‘replacing’ the defective work, saying that this submission did not give adequate weight to the fact that the Defects Exclusion refers to ‘the cost of replacement or rectification’, suggesting that rectification costs could be seen as the costs of implementing proper formwork and shoring/re-shoring procedures and that such costs, the costs of ‘doing the job right’, represent ‘the moral hazard’ the insurers intended to avoid by the Defects Exclusion.11
Insurers then argued that the trial judge had failed to give proper weight to the commercial context, saying that it made little commercial sense to exclude from coverage only the minimal cost of preventative measures, so that could not be what the parties intended, and that the intention was that damage caused by those actions under the control of the insured and for which they were contractually responsible would not be visited upon the Insurer.
The Court of Appeal said that it disagreed with this for two reasons. Firstly, it said it was coincidental that sufficient preventative measures would not have added to the cost in this case and that if circumstances had been different, the costs may have been substantial. The Court of Appeal suggested that for this argument to be persuasive the insurers would have to establish that the parties intended that wherever physical property damage occurred in the course of construction as a result of faulty workmanship, a significant portion of the claim would be excluded and that this was not established.
Secondly, the Court of Appeal said that if the parties had intended to exclude all damage ‘caused by those actions under the control of the Insured’ they could have used simple and direct language to that effect. The court contrasted the exclusion in the parties contract with the LEG 1 Outright Defect Exclusion, noting that in the present case the clear intention of the parties was not to exclude all damages caused by actions under the contractor’s control, but rather to exclude certain specified costs only while covering the balance of costs arising from damage to insured property.
Finally the Court of Appeal considered reliance by insurers on extrinsic aids to suggest that the trial judge’s interpretation of the Defects Exclusion was erroneous, but was not persuaded that the trial judge erred. The Court of Appeal said:12
 ‘The Defect Exclusion is the LEG 2 model clause developed by the London Engineering Group. A similar model clause, LEG 3, excludes, the "cost incurred to improve the original material workmanship design plan or specification". The Insurers argue that LEG 2 should provide a broader exclusion than LEG 3, which carries a lower premium, but the Judge interpreted the Defects Exclusion such that it is equivalent in effect to LEG 3.’
The Court of Appeal then noted the reliance placed by insurers on an article to which the court was directed in which the author opined when discussing the decision under appeal:
‘…To the extent that cracking and over-deflection constitute physical damage, the cost of repair or rectification must be considered as at the date after construction and just prior to that damage. This should, on the wording of the exclusion comprise the cost of repairing/rectifying the defective slabs, so that cracking and over deflection would not occur. If no such repair could be undertaken, the exclusion would have to apply to the full costs of replacing the defective slabs.’13
The Court of Appeal then went on to say:14
 ‘In my view, the trial Judge did not do what the author is critical of him for doing. The author refers to ‘the cost of repairing/rectifying the defective slabs’, but the trial Judge did not find that the slabs were ‘defective’. The Judge expressly found that the slabs were properly designed; the defect that resulted in damage to the slabs was embodied in the supporting structures and workmanship. Accordingly, the Defects Exclusion did not exclude the cost of rectifying ‘defective slabs’ (which were not defective); it excluded the cost of rectifying defective workmanship. The slabs were not a part of the insured property containing the defects.’
 ‘In the circumstances of this case, the facts that the LEG 2 wording excludes no more of the loss than does the LEG 3 wording, and that the LEG 2 wording affords the same coverage as a policy with a ‘resulting damage’ exclusion, do no imply the Judge misread the Defects Exclusion. In my view, it was open to the Judge to find that the only costs excluded by the Defects Exclusion were costs that would necessarily have been expended to replace or rectify the defective workmanship immediately before that defective workmanship caused the over-deflection, bending and cracking of the concrete floor slabs.
The Insurers urge upon this Court an interpretation of LEG 2 that will produce a different result than LEG 3, yet they do not seek to distinguish LEG 2 from LEG 1, an outright exclusion that excludes ‘loss or damage due to defects of material workmanship design plan or specification’. In my view, the trial Judge’s construction of the Defects Exclusion was in accord with the words chosen by the Insurers and Contractor in the commercial context in which the Policy was written.’
The Court of Appeal conclude by considering two scenarios postulated by the author of the aforementioned article, and said:16
 ‘In my opinion, given the Judge’s findings of fact, the case at bar most closely resembles the author’s first scenario. Inserting the appropriate findings of fact into that example, the author might have concluded as follows:
Up to the moment of the over-deflection of the concrete slabs, the defect in the workmanship could have been repaired by incurring the costs of adjusting or supplementing the support structures. Accordingly, those are the only costs that fall within the exclusion, on the LEG 2 wording. Those are the same costs (possibly subject to additional costs such as mobilization/demobilization), that would have been incurred to do the job correctly in the first place. That is not why those costs are excluded; they are excluded because they are the costs that would have been incurred, just prior to the over-deflection, to repair or rectify that portion of the property suffering from the defective workmanship.
This conclusion, of course, is precisely that of the trial Judge.’
The Court of Appeal thus concluded that the trial judge did not err in interpreting the Defects Exclusion to exclude only costs of implementing proper workmanship immediately before the defective workmanship caused over-deflection, bending and cracking.17 On the evidence before the judge, those costs were nil.
Analysis of the Court Of Appeal Decision
There are three initial observations which have been made in relation to a Defect Exclusion in the form of LEG 2.18
- The exclusion is of liability to indemnify ‘in respect of…costs’. There is nothing on the face of that wording which would preclude those relevant costs as comprising the full cost of repairs, reinstatement or replacement of the physical damage to insured property.
- The exclusion operates when those costs are ‘rendered necessary by defects’ of particular kinds. Arguably if a cost would not have been incurred but for the defect, it is a cost rendered necessary by that defect.
- Where the damage occurs to ‘any portion of the Property Insured containing any of the said defects’, there is a formula provided for calculation of the costs of replacement and repair which appears to require consideration of the portion containing the defect separately to other damage to insured property.
Bearing these matters in mind, the writer respectfully discerns some inherent difficulties with the approach taken by both the Judge at first instance and the Court of Appeal in Acciona.
Even if one were to accept that the Court of Appeal was correct in deciding that the inquiry mandated by the Defects Exclusion is causative rather than temporal (as to which, see the further comments below), the problem with the Court of Appeal's reasoning should become immediately apparent when one considers their finding that ‘the floor slabs cannot be considered to be a "portion of the insured property containing any of the said defects".’ Having made that finding, the Court of Appeal (respectfully) appears to have overlooked the fact that the precondition to the operation of the hypothetical basis for the calculation of the cost of replacement and repair is that ‘… damage occur to any portion of the Insured Property containing any of the said defects’.
It should also be borne in mind that the last paragraph of the exclusion expressly provides that any defect of material, workmanship, design plan or specification is not itself damage for the purposes of the policy by virtue of the existence of the defect. Notwithstanding this, in equating ‘rectification costs’ with ‘avoidance costs’ the Court of Appeal’s approach arguably had the effect of providing the contractor with full indemnification in respect of its defective work which was not only expressly excluded by the opening line of the exclusion (‘all costs rendered necessary by defects of material workmanship design plan or specification…’) but which did not even constitute damage for the purpose of the policy.
Given the presumed intention of the drafters of the clause, for the exclusion to operate so as to exclude the costs of rectification of the defective workmanship or design but claw back into cover so called ‘resultant damage’, a question certainly arises as to how this is achieved by the clause other than in relation to Property Insured which is damaged but which already contains a defect brought about by such a defect in design or workmanship.
One might well have thought that characterisation was in any event apposite to the circumstances of this case, however the trial judge expressly found that the slabs were properly designed and that the defect that resulted in damage to the slabs was embodied in the supporting structures and workmanship. The Court of Appeal affirmed this, finding that ‘..the Defect Exclusion did not exclude the cost of rectifying "defective slabs" (which were not defective); it excluded the cost of rectifying defective workmanship’.
This respectfully appears at odds with the sound approach previously taken in that jurisdiction in cases such as Sayers & Assoc v Insurance Corp Of Ireland19 in which the Ontario Court of Appeal said:
‘The damage to the equipment was the product of the failure to take protective measures, and so that fault rendered the appellant’s performance of its contractual obligations "faulty workmanship". The damage to the ducts and the switching gear was not, therefore, "damage resulting from such faulty …workmanship…", so as to come within the exception to the exclusion.’
Another concern relates to the Court of Appeal's embrace of a ‘causal’ rather than ‘temporal’ enquiry which it found to be mandated by the Defects Exclusion. This is encapsulated by the Court of Appeal’s comment that ‘there was no defect in the slabs that could have been rectified in order to prevent the over-deflection, bending and cracking. The defect was in the workmanship’. The judge found (as was accepted by the Court of Appeal) that if the defect in workmanship had been identified early enough, there would have been no material additional costs to implementing appropriate workmanship.
This approach however seemingly ignores the fact that while a defect in workmanship can bring about a defective condition of Property Insured, the quality of the work is not itself Property Insured, and it is the costs of repairing or rectifying damage to the Property Insured, which are the subject of the operation of the LEG 2 Defects Exclusion.
Further, as the writer referred to in the Court of Appeal’s judgment opined:
‘…the cost of repair or rectification must be considered …just prior to that damage. This should, on the wording of the exclusion, comprise the cost of repairing/rectifying the defective slabs, so that the cracking and over-deflection would not occur. If no such repair could be undertaken, the exclusion would have to apply to the full cost of replacing the defective slabs.’
This is in fact entirely consistent with the approach taken by the Australian courts when confronted with a similar (but not identical) exclusion in the case of Rickard Constructions Pty Ltd v Rickard Hails Moretti Pty Ltd20 which was an appeal from a decision of McDougal J.21 The claim against the insurer at first instance (and on appeal) failed in part because the trial judge said that the onus was on the insured to prove what would have been necessary to rectify the defective workmanship immediately prior [writer’s emphasis] to the collapse of the pavement and what costs would have been incurred on that rectification.
There are a number of other curious aspects to the Court of Appeal’s decision. Speculation as to the ‘moral hazard’ which insurers intended to avoid might be thought to be an unreliable guide to the construction of a clause in a policy of insurance.
The Court of Appeal noted that it was coincidental that sufficient preventative measures would not have added to the cost but that in other circumstances the costs may have been substantial. The Court of Appeal suggested that to be persuasive in insurer’s argument that:
‘damage caused by those actions under the control of the Insured and for which they were contractually responsible would not be visited upon the Insured’,
‘..would have to establish that the parties intended that, wherever physical property damage occurred in the course of construction as a result of faulty workmanship, a significant portion of the claim would be excluded’.
This respectfully is a startling proposition and one for which the writer sees no warrant.
Further, while the Court of Appeal suggested that if the parties had intended to exclude all damage ‘caused by those actions under the control of the Insured’ they could have used simple and direct language to that effect such as the LEG 1 Exclusion, this would appear to take out of context the insurer’s contention which was presumably premised upon actions under the contractor’s control resulting in damage excluded by operation of the Defects Exclusion. This further ignores the potential operation of the ‘claw back’ which is not found in LEG 1.
In the course of acknowledging that in the circumstances of this case the LEG 2 wording excluded no more loss than would an LEG 3 wording (thought to exclude only ‘betterment’), the Court of Appeal noted that insurers urged upon the court an interpretation of LEG 2 that would produce a different result than LEG 3. The Court of Appeal went on to say:
‘…yet they do not seek to distinguish LEG 2 from LEG 1, an outright exclusion that excludes loss or damage due to defects of material workmanship design plan or specification’.
Such criticism seems odd with respect, given that LEG 2 contains 99 additional words which the Court of Appeal might have readily inferred had some further work to do.
While Acciona is a decision of Court of Appeal for British Columbia, as it emenates from a common law jurisdiction it may be persuasive in Australia. This was observed in All Covers and Accessories Pty Ltd v Sidawi22 where Victorian Associate Justice Mukhtar on appeal relied on a decision of the Court of Appeal for British Columbia, observing and following High Court of Australia authority in Cook v Cook:23
‘Of course decisions of the Canadian Court of Appeal like any precedents of other legal systems are not binding, but are to be afforded a status depending on the degree of persuasion of their reasoning.’
The writer would respectfully suggest that the reasoning of the Court of Appeal in this instance may not find favour with courts in this country. As it seemingly represents the only reported judicial authority in relation to the interpretation and operation of a LEG 2 exclusion, parties to policies of insurance containing an exclusion in identical or like terms should however be aware of the possible implications of this decision.
It should be noted that the decision of the judge at first instance and on appeal was made against the backdrop of a finding that the failure by the contractor to take steps in the formwork and shoring/reshoring procedures or to address in any way the complex design of the forms was defective workmanship. In so finding the judge rejected insurers contention that the over-deflection, bending and cracking was the manifestation of a defective design.
Irrespective of whether this was the appropriate characterisation of what occurred, it means that the decision might for the time being at least be confined to instances where there is a finding of defective workmanship.