Two recent court decisions have examined important fault exclusion clauses in ‘course of construction’ or ‘builder’s risk’ insurance policies. However, with conflicting conclusions, the construction and insurance industries may have to wait for further clarity in interpreting and applying these faulty or improper workmanship, design or material exclusion clauses.

Design/Workmanship Exclusion

The purpose of ‘course of construction’ (COC) or ‘builder’s risk’ insurance is to cover builders for costs related to repairs or replacements during the course of a construction project, or for a specified period after construction is complete. Damage or loss covered under such a policy must have resulted from a fortuitous event, that is, it must be accidental. Damage or loss that is intended or expected will not be covered.

Coverage is further limited by a substantial list of exclusions. Understanding and properly interpreting such exclusions is critical, as large amounts may be at issue that may, if uninsured, significantly impact project costs.

The LEG2/96 Exclusion Clause

One such exclusion which has received a great deal of attention in the past couple of years is the LEG2/96 exclusion clause (named after the London Engineering Group who developed it) in the context of faulty workmanship. The clause reads as follows:

The insurer(s) 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 (Contract Works) 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 said portion of the Insured Property (Contract Works) has been put in hand immediately prior to the said damage.

For the purpose of this policy and not merely this exclusion it is understood and agreed that any portion of the Insured Property (Contract Works) shall not be regarded as damaged solely by virtue of the existence of any defect of material workmanship design plan or specification.1

The recent decision of Acciona Infrastructure Canada Inc. v. Allianz Global Risks US Insurance Co. 2014 BCSC 1568 is the first case in Canada to have examined this clause. The Alberta Court of Appeal in Ledcor Construction Limited v. Northbridge Indemnity Insurance Company 2015 ABCA 121 also recently examined a faulty/design faulty workmanship exclusion. Both cases are discussed below:

The Acciona Decision

In Acciona, the plaintiff was a joint venture Design/Build Contractor for a hospital extension project. During construction it was discovered that the concrete slabs being used in the extension were experiencing “over-deflections”.

Acciona claimed recovery of the cost of remediation under its COC policy. The insurance company denied coverage on the grounds that the slabs were defective in themselves rather than physically damaged.

Skolrood J. held that the cracking and over-deflections were “defects in material workmanship or design” and that the exclusion under LEG2/96 therefore applied. The LEG2/96 clause did not, however, extend to exclude the cost of rectifying or replacing the damaged property itself, and Acciona was found to be entitled to recover $8,514,931.00. 2

The Ledcor Decision

In Ledcor, a cleaning company damaged windows during the final clean-up of the site, necessitating costly replacement.

At trial, it was held that the damage was covered by the builders’ risks insurance policy and not excluded by the faulty workmanship exclusion. The trial judge applied the doctrine of contra preferentum in finding in favour of the insured, as he found both parties’ interpretations of the faulty design/workmanship exclusion plausible and the related case law inconclusive and inconsistent. 3

On appeal, however, it was held that damage was indeed excluded. The main issue the court examined on appeal was whether damage to the windows was due to "poor workmanship" or was "resulting damage".4

As in Acciona, the owner’s policy, which covered the cleaning company as an additional insured, excluded the cost of “making good” the faulty workmanship, construction materials, or design. According to the Court of Appeal, the policy’s intent was not to cover these instances, but rather the cost to the owner of any unexpected events during the course of construction. 

The Alberta Court of Appeal held that the proper interpretation of the exclusion was that damage which was physically or systemically connected to the work being carried out was not covered.5 Therefore, the cost of replacing the windows was excluded. The Court considered the work done by the cleaning company to be included in the scope of “workmanship” despite no physical product being created, as the policy covered the entire project and every contractor.6

Analysis and Conclusion

It can be seen from the discussion above that the Courts in Acciona and Ledcor came to completely opposite holdings. In Acciona, it was held that the “faulty workmanship” exclusion did not apply, while in Ledcor, it was held that it did.

In Acciona, the slab and faulty installation were connected, but the court focused on the purpose of the exclusion clause, which it viewed only as a means to eliminate recovery of the cost of the faulty work, and not the resultant damage.

In Ledcor, however, the appeal court did not allow for the damages claimed as it was held that they were connected to the faulty work in question. It should be noted that it is not stated anywhere in Ledcor that the builders’ risk policy at issue stated that damage caused by one contractor to the work of another was not covered. To interpret the policy in this way would seem to defeat one of the very functions of a builders’ risk policy, which is designed, in part, to cover such situations.

These two very different lines of reasoning do not provide guidance or comfort to those in the construction industry seeking to understand how the courts might interpret the LEG2/96 clause and its exclusions, which are being used increasingly. Nevertheless, the following general observations may be useful in understanding possible deficiencies in the wording and application of such exclusion clauses and help to reflect on how it may be interpreted moving forward:

  • Skolrood J.’s reasoning in Acciona seems to suggest that it is possible to separate faulty workmanship from resultant damage. In practice, the nature of such an exercise would seem to depend on the specific context of the project in question, as seen in Acciona where Skolrood J.’s reasoning was aimed at the specific context of a hospital project. Such context-specific reasoning does not yield certainty as to how to assess other disputed claims under the LEG2/96 clause.
  • The LEG2/96 clause excludes, as stated above, the costs of remediating the damage if “replacement or rectification...[had] been put in place immediately prior to the said damage.”7 However, it will not always be possible to calculate the cost of repair prior to damage. In some cases, it might also be determined that repair prior to damage was not even possible. How would that cost then be calculated; or would it not be possible to claim for the cost of resulting damages altogether?
  • The fact that the trial judge in Ledcor found both interpretations of the exclusion clause plausible and applied the doctrine of contra preferentum in finding in favour of the insured should indicate to insurers that judges in the future may come to the same conclusion. Insurers should look to the language of such exclusion clauses with a view to making them less ambiguous and clarifying their scope.
  • It appears that Acciona has raised the standard of what an insurer has to prove in order to deny damages, including in cases in which the insurer intends to claim that the work at issue suffered from lack of foresight that amounted to a defect.

A notice of appeal was filed on behalf of the insurers on September 12, 2014 in the Acciona matter. The appeal decision has yet to be released. It is hoped that the decision will provide some further direction on how the LEG2/96 clause should be interpreted.