Canada: What Does Your Client's Course Of Construction Policy Really Cover?

BC court interprets standard exclusion clause for first time after Design/Build Contractor denied coverage; awarded $8.5 million in insurable losses.

A recent case in British Columbia interprets a standard exclusion clause in a Course of Construction (COO) Policy for the first time: Acciona Infrastructure Canada Inc. v. Allianz Global Risks US Insurance Company et al, 2014 BCSC 1568 ("Acciona"). While standard policy language is used in construction project insurance policies around the globe, there is minimal judicial commentary on the proper interpretation of these clauses by Canadian or other courts.

In Acciona, the Project was a $250 million P3 hospital extension of the Royal Jubilee Hospital in Victoria, BC, the largest primary patient care health facility on Vancouver Island. The Project was an eight storey concrete structure, comprising four wings connected to a central core. The structural design was complex with each floor consisting of thin suspended slabs (250 mm thick) with large spans (over 9 m). During construction, the slabs 'over deflected;' this resulted in the slabs throughout the facility not being level as planned. The slabs required extensive remediation to meet the Project's serviceability requirements of level floors. After being denied coverage for its claim for all remedial costs under the Project's COO Policy, the Design/Build Contractor of the Project commenced litigation. As the dispute surrounded coverage under the COC Policy, it required the Court to interpret and apply the language of the Policy.

The Court in Acciona summarized the principles that apply to the interpretation of insurance policies generally, including that: the primary interpretive principle is that when the language of the policy is unambiguous, the court should give effect to clear language, reading the contract as a whole; where the language of the insurance policy is ambiguous, the courts rely on general rules of contract construction; courts should avoid interpretations that would give rise to an unrealistic result or that would not have been in the contemplation of the parties at the time the policy was concluded; courts should also strive to ensure that similar insurance policies are construed consistently; and ambiguity in the language of an insurance policy is generally resolved in the insured's favour (coverage provisions are interpreted broadly, and exclusion clauses narrowly) given that the insurer chose the policy wording.

In order to establish coverage under a COC Policy, the insured must show that the loss falls under the "Perils Insured" provision in the policy. In Acciona, the "Perils Insured" provision of the Policy contained a typical clause covering "ALL RISKS of direct physical loss of or damage to the property insured ... except as hereinafter provided." In this case, coverage was disputed by the insurers, in part, as the parties disagreed as to whether the over deflections and related effects to the suspended slabs constituted "damage" within the insuring agreement. The contractors argued that the over deflections and cracking was "physical loss" or damage within the meaning of the Perils Insured, defining "damage" as "harm or injury impairing the value or usefulness of something." The insurers argued that the over deflections and cracking of the slabs constituted defects in the slabs, and that regardless, the loss was not fortuitous, so did not fall under the Policy.

Overall, the Court found that the contractors had established coverage under the insuring agreement. In particular, the Court confirmed that the over deflection and cracking of the concrete slabs constituted damage that was fortuitous as it was unexpected or unintended. As such, the loss was covered under the Perils Insured clause in the Policy. Given this initial finding of coverage under the Policy, the burden shifted to the insurers; if the insurers wanted to successfully maintain its denial of coverage, it needed to establish that an exclusion clause in the Policy excluded the loss or damage that otherwise fell within the Policy coverage.

This leads to the key issue in Acciona: the interpretation of a standard exclusion clause developed by the London Engineering Group, a UK think tank for the insurance industry which develops model policy wordings for its members for use in various insurance policies including COC and All Risks policies, referred to as "LEG2/96." This is one of three model "defects" exclusion clauses (LEG 1/96, 2/96 and 3/96). LEG 1/96 contains the broadest exclusion, and therefore the narrowest coverage, LEG 3/96 contains the narrowest exclusion and broadest coverage. LEG 2/96 falls in the middle. Prior to Acciona, LEG 2/96 had not been interpreted by any court in the world, although it had been commented on in various articles and papers. As worded, the LEG2/96 clause excludes:

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 this 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.

The Court interpreted the exclusion clause has having the following distinct components which must be read together in order to give meaning to the clause as a whole:

  1. All costs rendered necessary by defects of material workmanship, design, plan, or specification; and
  2. "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 nand immediately prior to the said damage."

The Court further interpreted the clause to conclude that: the excluded costs are only those costs that would have remedied or rectified the defect immediately before any consequential or resulting damage occurred, but the exclusion does not extend to exclude the cost of rectifying or replacing the damaged property itself; and the excluded costs crystallize immediately prior to the damage occurring and are thus limited to those costs that would have prevented the damage from happening.

The Court held that the exclusion was relevant as the loss was caused by a defect in workmanship, namely inadequate formwork and shoring/ reshoring procedures used during the pouring of the slabs. The Court then found that the 'damage' in this case was the cracking and over deflection of the concrete slabs. However, there was no evidence on which to quantify the costs that would have remedied or rectified the defect (i.e. the costs of implement proper formwork and shoring/reshoring procedures or incorporating additional camber into the formwork) except to say that they would have been minimal. As such, the exclusion did not apply and the Court held that all remedial costs to the concrete slabs, corresponding site General Conditions, and profit were covered — totaling $8.5 million.

This case serves as a reminder for insurers that when they have language available to them that will remove an ambiguity from the meaning of an exclusion clause or will clearly specify the scope of an exclusion, they should incorporate such language. Otherwise, normal principles of interpretation will apply, including the principle that coverage provisions will be interpreted broadly and exclusion clauses narrowly. Had the insurers intended the defects exclusion in the COO Policy to be interpreted similarly to the more typical `resulting damage' clauses that appear in Canadian insurance policies, they should have incorporated such readily available language in the Policy.

This article was first published in Canadian Insurance Top Broker in the January 2015 issue.

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