Contractors generally bear two main types of risks. First, the risk of being liable for providing deficient, shoddy or incomplete work or products, and second, the risk of being liable for bodily injury or property damage resulting from providing shoddy work or products.1 Broadly speaking, Commercial General Liability (CGL) insurance only protects against the second type of risk, as the first is a "business risk" within the control and responsibility of the contractor.
Modern CGL policies exclude coverage for these "business risks" in many ways, including by the impaired property exclusion. This particular exclusion clause is notoriously complex, spawning a body of case law, mostly in the United States, dealing with its interpretation and exclusion.
II. AN OVERVIEW OF CGL POLICIES
A. A Brief History
Commercial liability insurance is a creature of the 21st century. Developed in the 1930's, Comprehensive General Liability Insurance – later renamed Commercial General Liability insurance - responded to North America's rapid post-war industrialization and manufacturers' increased liability beyond their factory floors.2
While liability insurance is recognized as a type of insurance under the Insurance Acts of the respective provinces and territories in Canada, CGL policies are not subject to the same level of statutory regulation as the other recognized forms of insurance.3 As such, there is no mandatory uniform CGL policy for Canadian insurers and brokers. The same is true in the United States. Practically speaking, this means each insurance company providing CGL coverage is free to issue its own policy wording, subject only to approval of the Superintendent of Insurance for the province.4 It bears emphasizing then, that each CGL policy should be carefully read, as its interpretation will ultimately turn on its own, unique wording.
That being said, insurance industry organizations in Canada and the US create standard form CGL contracts as model policies, and update them from time to time.5 The standard form language is commonly adopted by insurers and brokers. The Insurance Services Office (ISO) in the US published the first standard form CGL in 1955, which was revised in 1966 and 1973.6 The Insurance Bureau of Canada (IBC) followed suit by producing standard 'Form 2100' in 1978, which largely adopted the wording of the 1973 ISO policy.7
The ISO overhauled its standard form CGL in 1986 to add a number of new exclusions, including the impaired property exclusion.8 The standard form's most recent modernization occurred in 2013.9 Once again, the IBC played copycat by making similar changes to its standard form in 1987 (Form 2001). The most recent standard form CGL policy in Canada is Form 2100, updated and issued by the IBC in 2005.10
B. What is Covered?
CGL policies are only intended to protect the insured in the event its performed work or provided products accidentally cause damage to someone else's person or property. The contractor's liability for its deficient, shoddy or incomplete work is generally not covered by CGL insurance. This risk allocation and cost sharing between the insured and the insurer is an underlying or organizing principle of CGL policies, oft-cited by courts when tasked with interpreting these particular contracts of insurance.11
In order to claim indemnification under a CGL policy, an insured must generally establish the following elements on a probability basis:12
- The claim must be with respect to the named insured or an entity coming within the definition of "persons insured";
- The claim must have occurred during the policy period and within the coverage territory;
- The claim must be due to an "occurrence" as defined;
- The insured's liability must constitute a legal obligation to pay compensatory damages with respect to "property damage" or "bodily injury" as defined.
C. What is Excluded?
Once an insured has brought itself within the policy's scope of coverage, it falls to the insurer to establish the applicability of an exclusion.
The essence of an insurance contract is to protect the insured from liability and costs that are fortuitous and outside of the insured's control. The competence of service provided and the quality of goods supplied are factors within the insured's control. Furthermore, the risk of incompetence is inherent, normal and foreseeable, and can be controlled through the insured's own preventative measures or product and safety controls. Put simply, the losses a contractor becomes liable for as a result of failing to uphold his side of the bargain is simply the anticipated cost of doing business; it is a "business risk". Accordingly, business risks are not properly passed off to an insurer; rather, it should be reflected in the cost of the good or service being rendered or ultimately borne by the provider. For these reasons, CGL insurers are not and should not be guarantors or warrantees of the insured's work or product quality, nor should CGL policies be treated as performance bonds.13
The intention and foundational principle behind the "business risk" exclusion clauses is to prevent the insured from receiving coverage for the costs associated with making good its work or product where the work or product is defective or not what was bargained for.14 Courts are very aware of this underlying limit on CGL coverage and it informs and guides coverage analysis. They have also affirmed the general exclusion of these types of business risks from CGL coverage:15
No matter how diligently and how assiduously a contractor attempts to control the workmanship and materials used on the project, when, in spite of those efforts, the projects fall short, the consequences of the failure is endemic in a commercial undertaking ... claims for damage to the product itself... [are] ... not covered under the contractor's comprehensive general liability policy...this type [of risk is] "business risk". ... Even though an examination of the CGL policies in this case ... will reveal no exclusions specifically designated as "business risk", in insurance law the scope of the phrase is well understood.
Business risk exclusions also serve the public policy goal of encouraging and incentivizing good workmanship. The rationale for these exclusions is best illustrated by the following passage:16
I am hesitant to think that a comprehensive general liability policy covers a contractor for the cost of having to repair or replace his own negligently done work as opposed to the cost of redressing damages caused to others through the contractor's carelessness. Were that the case a contractor could bid a job for $1 million, do it carelessly at minimal cost to itself, and then claim from the insurer the cost of redoing the work as it should have been done in the first place for $1 million.
D. The Principal Exclusions in Brief
The most common exclusion clauses discussed and applied in insurance litigation are as follows: 1) the contractual liability exclusion, 2) the "Your Work" exclusion, 3) the "Your Product" exclusion, 4) the recall or sistership exclusion, and 5) the impaired property exclusion.
The contractual liability exclusion prevents the insured from receiving coverage for liability it assumes under any contract or agreement with two exceptions. First, coverage will not be excluded if the insured becomes liable for property damage or bodily injury to a third party resulting from a breach of warranty. Second, coverage will not be excluded for liability the insured assumes under an "incidental contract" as defined, which is generally an assumption of the tortious liability of a third party.17
The "Your Work" or "work performed" clause excludes from coverage the risk that the insured may be required to correct a deficiency in the work performed by it or on its behalf under the contract. This exclusion applies if: (i) the insured's work is represented by tangible property, (ii) property damage occurs to the tangible work performed by or on behalf of the insured, and (iii) that property damage arises or results from the insured's work.18 Put simply, if the insured's negligent or deficient work under a contract results in property damage to the very work performed, the "Your Work" exclusion operates to deny the insured's recovery for any claim made against it in that respect.
The "Your Product" clause is a counterpart to the "Your Work" exclusion. This clause operates to deny coverage for the insured's liability for replacing or repairing the defective goods or products sold by it or on its behalf. The definition of an insured's product notably includes the warranties, representations, warnings and instructions that accompany the product as well. Thus, whenever the insured faces a claim related to its defective product or stemming from its representations concerning that product, this exclusion may be applicable. When the insured supplies a product of many components, and only one component fails or is damaged, the exclusion nonetheless applies to the entire product. However, where the insured's product is only one component incorporated into someone else's larger product, the exclusion only applies to property damage to the insured's component.19
The recall or "sistership" exclusion clause removes from the scope of coverage the costs associated with recalling the insured's defective product from the market and taking preventative action against similar defects occurring in the future.20
III. AN IN-DEPTH EXAMINATION OF THE IMPAIRED PROPERTY EXCLUSION
A. Standard Form Impaired Property Exclusion Clauses and Related Definitions
The following is the advisory or model wording for the impaired property exclusion clause found in the 2005 IBC standard form CGL policy (Form 2100):21
j. Damage to Impaired Property or Property Not Physically Injured
"Property damage" to "impaired property" or property that has not been physically injured, arising out of:
(1) A defect, deficiency, inadequacy or dangerous condition in "your product" or "your work"; or
(2) A delay or failure by you or anyone acting on your behalf to perform a contract or agreement in accordance with its terms.
This exclusion does not apply to the loss of use of other property arising out of sudden and accidental physical injury to "your product" or "your work" after it has been put to its intended use".
The wording of the impaired property exclusion in the IBC standard form CGL policy is identical to that contained in the 1986 American ISO standard form.22
Below are excerpts of the relevant defined terms contained in the impaired property exclusion, also found in the 2005 IBC standard form CGL policy (Form 2100):
13. "Impaired Property" means tangible property, other than "your product" or "your work", that cannot be used or is less useful because:
- It incorporates "your product" or "your work" that is known or thought to be defective, deficient, inadequate or dangerous; or
- You have failed to fulfill the terms of a contract or agreement;
if such property can be restored to use by:
- The repair, replacement, adjustment or removal of "your product" or "your work"; or
- Your fulfilling the terms of the contract or agreement.
25. "Property Damage" means:
- Physical injury to tangible property, including all resulting loss of use of that property; or
- Loss of use of tangible property that is not physically injured.
31. "Your Product":
- Any goods or products, other than real property, manufactured,
sold, handled, distributed or disposed of by:
- Others trading under your name; or
- A person or organization whose business or assets you have acquired; and
- Containers (other than vehicles), materials, parts or equipment furnished in connection with such goods or products.
- Warranties or representations made at any time with respect to the fitness, quality, durability, performance or use of "your product"; and
- The providing of or failure to provide warnings or instructions
- Does not include vending machines or other property rented to or located for the use of others but not sold.
32. "Your Work":
- Work or operations performed by you or on your behalf; and
- Materials, parts or equipment furnished in connection with such work or operations.
- Warranties or representations made at any time with respect to the fitness, quality, durability, performance or use of "your work", and
- The providing of or failure to provide warnings or instructions.
Some policies or insurers may still be utilizing the language contained in the older 1987 IBC standard form (Form 2001). Accordingly, the impaired property exclusion clause contained in that standard form CGL policy is appended below for comparison sake:23
This insurance does not apply to:
(k) to loss of use of tangible property which has not been physically injured or destroyed resulting from
- a delay in or lack of performance by or on behalf of the Named Insured of any contract or agreement, or
- the failure of the Named Insured's products or work performed by or on behalf of the Named Insured to meet the level of performance, quality, fitness or durability warranted or represented by the Named Insured;
but this exclusion does not apply to loss of use of other tangible property resulting from the sudden and accidental physical injury to or destruction of the Named Insured's products or work performed by or on behalf of the Named Insured after such products or work have been put to use by any person or organization other than an Insured;
B. Components of the Impaired Property Exclusion
The impaired property clause contemplates a situation where the insured's faulty work or product is incorporated into another person's larger product and thereby causes that larger product to become unusable or less usable. It is clearly aimed at narrowing the insured's scope of coverage for one type of "property damage" it causes to a third party - defined as "loss of use but not physical injury" – from the incorporation of its work or products. The general purpose of the impaired property exclusion is to prevent the insured from recovering the cost of repairing or replacing the defective product, redoing the shoddy work, or being responsible for the claimant's economic losses resulting from the lost use of its product.
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1 Heather A Sanderson et al., Commercial General Liability Insurance, (Markham & Vancouver: Butterworths Canada, 2000) at 141 [Sanderson].
2 Sanderson at 3.
3 Sanderson at 5.
4 Sanderson at 6. See for e.g. Alberta's Insurance Act, RSA 1980, c I-5, s 537, which provides: "The Superintendent may require an insurer to file with him a copy of any form of policy or of the form of application for any policy or of any endorsement or rider or advertising material issued or used by the insurer".
5 Sanderson at 6.
6 Sanderson at 6, 148.
7 Sanderson at 148.
8 Caroline B Newcombe, "The Impaired Property Exclusion" (2002) 52:3 FDCC Quarterly 365, online: < http://www.thefederation.org/documents/Newcombe-Sp02.htm> [Newcombe].
9 "ISO General Liability Form Revisions – Effective April 1, 2013" online: < https://www.marsh.com/us/insights/research/iso-general-liability-form-revisions.html.
10 Gordon G Hilliker, Liability Insurance Law in Canada, 6th ed (Toronto: LexisNexis, 2016) at 247 and 417 [Hilliker].
11 See for e.g. Weedo v Stone-E-Brick Inc, 405 A.2d 788 at p 791 (NJ 1979), cited as the leading authority in Cansulex v Reed Stenhouse (1986), 70 BCLR 273, 18 CCLI 24 (BCSC), where the Court delineated the drastic difference in the contractor's responsibilities for bearing losses depending on the nature of the risk at issue:
The accidental injury to property or persons substantially caused by his unworkmanlike performance exposes the contractor to almost limitless liabilities. While it may be true that the same neglectful craftsmanship can be the cause of both a business expense of repair and a loss represented by damage to persons and property, the two consequences are vastly different in relation to sharing the cost of such risks as a matter of insurance underwriting.
12 Sanderson at 151. See Trafalgar Insurance Co v Imperial Oil Ltd (2001), 57 OR (3d) 425, 154 OAC 7 at para 18 for the onus on the insured to establish that the claim falls within the policy's scope of coverage.
13 Hilliker at 142.
14 Hilliker at 271.
15 Knutson Construction Co v St Paul Fire & Marine Insurance Co, 396 N.W.2d 229, 233-34 at p 235 (Minn. 1986), cited with approval in Privest Properties v Foundation Co of Canada Ltd (1991), 57 BCLR (2d) 88, 6 CCLI (2d) 23 (BCSC)
16 Quintette Coal Ltd v Bow Valley Resource Services Ltd (1987), 21 BCLR (2d) 203, 1987 CanLII 2410 at para 5 (BCSC).
17 Hiliker at 248-249.
18 Hilliker at 274-275.
19 Hilliker at 272-273.
20 Hilliker at 279.
21 See Hilliker Appendix E at 417-438 for a full copy of the 2005 IBC standard form CGL (Form 2100).
22 See Newcombe at 365-366 for an excerpt of the exclusion clause in the 1986 ISO standard form.
23 See Hilliker Appendix B at 409-411 for a copy of the 1987 IBC standard form CGL (Form 2001).
- Any goods or products, other than real property, manufactured, sold, handled, distributed or disposed of by:
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