Policyholders recently won a key victory at the Supreme Court of Canada in Ledcor Construction Ltd. v. Northbridge Indemnity Insurance Co. as the Supreme Court clarified the interpretation of a standard form faulty workmanship exclusion clause common in builder's risk policies. The decision has wide-reaching significance to other insurance coverage disputes and to contract law generally.
The Supreme Court confirmed that only the cost to redo the faulty work is precluded from coverage by such an exclusion. Builder's risk, or "course of construction" insurance policies seek to insure against certain defined risks which may occur during the construction process. Such policies generally provide coverage for the owner of the property under construction, the general contractor, and all contractors and subcontractors working on the project. The exclusion at issue in this decision excluded from coverage "the cost of making good faulty workmanship", but provided an exception for resultant damage (the "Exclusion Clause").
Background and Decisions Below
Ledcor Construction Limited ("Ledcor") was the general contractor for the construction of the EPCOR Tower ("Tower"), an office building in Edmonton owned by Station Lands Ltd. ("Station Lands"). The Tower's installed windows were dirtied during the construction process and Station Lands hired Bristol Cleaning ("Bristol") to clean the windows prior to completion of construction. Due to the use of improper tools and cleaning methods, Bristol's work caused scratching to the Tower's windows, which ultimately had to be replaced at a cost of approximately $2.5 million. Ledcor and Station Lands both claimed the cost against the Policy through their insurers at the time. The insurers denied the claim on the basis of the Exclusion Clause.
At trial, it was determined that Bristol's cleaning work constituted "workmanship" and that it had been faulty. However, the trial judge found the Exclusion Clause ambiguous and applied the rule of contra proferentem against the insurers, finding that the "cost of making good" encompassed only the cost of redoing the cleaning work and not the resultant damage.
The Alberta Court of Appeal reversed the trial judge's decision, declaring that the damage to the Tower's windows was excluded from coverage.
The Supreme Court of Canada Decision
Standard Form Contracts are Unique
The Supreme Court of Canada allowed the appeal. Before addressing the interpretation of the Exclusion Clause, Wagner J. (writing for the eight Justice majority) took the opportunity to clarify how its previous decision, Sattva Capital Corp. v. Creston Moly Corp., 2014 SCC 53, applies to the interpretation of standard form contracts. Sattva held that contractual interpretation is a question of mixed fact and law as it requires the application of contractual interpretation principles to the words of the written contract, considered in light of the factual matrix, and is therefore owed deference on appeal.
The Court in Sattva stated that the correctness standard of review is reserved for the rare occasion where it may be possible to identify an extricable question of law in contractual interpretation, such as the application of an incorrect principle, the failure to consider a required element of a legal test or the failure to consider a relevant factor.
The Supreme Court recognized an exception to its holding in Sattva, concluding that where the "appeal involves the interpretation of a standard form contract, the interpretation at issue is of precedential value, and there is no meaningful factual matrix specific to the particular parties to assist the interpretation process, this interpretation is better characterized as a question of law subject to correctness review" (para 46).
In recognizing this exception, the Supreme Court also noted that there may be certain circumstances under which the interpretation of a standard form contract may be a question of mixed fact and law, warranting deferential review on appeal. Such circumstances include cases where the factual matrix of a standard form contract that is specific to the particular parties assists in the interpretation, and situations where the parties negotiated and modified what was initially a standard form contract.
Cromwell J., concurring in the result, disagreed with the above exception. He concluded there is no reason to exclude standard form contracts from the general principles that apply to appellate review in civil cases and as such the applicable standard of review was palpable and overriding error. Applying this standard, Cromwell J. saw no reviewable error in the trial judge's analysis.
The Exclusion Clause was Ambiguous and Interpreted in Favour of the Insured
The Supreme Court then turned its attention to the proper interpretation of the Exclusion Clause. Both parties argued the Exclusion Clause was unambiguous, yet arrived at completely different conclusions as to its meaning. The insureds argued that only the cost of redoing the faulty work, i.e. the cleaning, was excluded from coverage. The insurers, on the other hand, argued that both the cost of redoing the work and the cost of repairing the property that is the subject of the faulty work, were excluded. The insurers contended that the resulting damage exception referred to consequential damage to some other part of the insured property or project.
The Supreme Court, while slightly favouring the interpretation of the insurers, found the clause had two plausible interpretations and was therefore ambiguous. Using general principles of contractual interpretation to resolve the ambiguity, the Supreme Court concluded "the faulty workmanship exclusion serves to exclude from coverage only the cost of redoing the faulty work, as the resulting damage exception covers costs or damages apart from the cost of redoing the faulty work" (para 63). As such, only the cost to reclean the windows was excluded; the replacement cost of the damaged windows was covered by the Policy.
The Supreme Court resolved the ambiguity in reliance on three general principles of contract interpretation, rendering resort to the contra proferentem rule unnecessary:
- First, the Supreme Court found support for its interpretation with reference to the reasonable expectations of the parties. The Supreme Court drew on the purpose behind builder's risk policies as a reflection of the reasonable expectations of the insurers and insureds. Such policies provide broad coverage for construction projects in order to reduce the need for litigation between the various contractors over liability for repairs. To preclude coverage under the faulty workmanship clause merely because the damage occurs on that part of the project the contractor was working on would undermine the purpose behind builder's risk policies.
- Second, this interpretation accords with the commercial context in which insurance contracts occur. The broad scope of coverage creates economies and certainty for both insureds and insurers. Such an interpretation does not transform the policy into a warranty, as the costs to redo the faulty work are excluded from coverage.
- Third, an interpretation limiting the scope of the faulty workmanship clause to the cost of redoing the faulty work is consistent with prior jurisprudence, including interpretations generally given by courts in faulty design cases.
This decision confirms that the faulty workmanship exclusion clause and the "resulting damage" exception to that exclusion is restricted to denying only the cost of redoing the faulty work. Resulting damage generally will not be excluded.
This decision also clarifies that, generally speaking, the interpretation of standard form insurance contracts is a question of law. This will make such interpretations more amenable to summary judgment and provide for less deference of such interpretations on appeal.
Finally, this decision serves as a good reminder of basic principles of interpretation employed to resolve ambiguity: to the extent it is supported by the language of the policy, the interpretation should be consistent with the reasonable expectations of the parties; it should not give rise to unrealistic results or those that do not accord with commercial reality; and it should be consistent with the interpretations of similar insurance policies. Resort to the contra proferentem rule will only be necessary if the ambiguity remains after applying these principles.
File No: 36452
Date of Decision: September 15, 2016
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