Canada: Interpreting Exclusions

Last Updated: January 17 2017
Article by Alison Scott and David De Groot

Ledcor Construction Ltd. v. Northbridge Indemnity Insurance Co.



In Ledcor Construction Ltd. v. Northbridge Indemnity Insurance Co., the Supreme Court of Canada (SCC) (a) clarified the standard of review for interpreting standard form contracts and (b) interpreted a faulty workmanship exclusion in a builders risk policy (the Policy). In construction and insurance, the former principle is important because of the prevalence of standard form contracts in those industries. The latter principle, while creating a simple interpretive framework, leaves factual uncertainty as to whether costs for physical damage in any given case are "to make good faulty workmanship" or are "resulting physical damage".

Facts

Station Lands Ltd. (Station) retained Ledcor to construct EPCOR Tower in Edmonton. During construction, the tower's windows were dirtied. Station hired Bristol Cleaning (Bristol) to "[p]rovide all necessary equipment, manpower, [and] materials required to complete a construction clean" of the building's windows". Unfortunately, Bristol used improper equipment and techniques and damaged the windows. Station and Ledcor claimed against the policy for the replacement costs of the windows. The insurers denied coverage based on the following exclusion:

This policy section does not insure:

(b) The cost of making good faulty workmanship, construction materials or design unless physical damage not otherwise excluded by this policy results, in which event this policy shall insure such resulting damage.

According to the insurers the cost of "making good faulty workmanship" included the cost to replace the windows and was excluded. Ledcor and Station claimed that only the cleaning was "faulty workmanship" and that the window damage was resulting physical damage and accordingly covered.

Trial and Appellate Decisions

The trial judge held the exclusion was ambiguous and both parties' interpretations were plausible. Applying the doctrine of contra proferentem (interpretation against the draftsman), he found in favour of the insureds.

The Alberta Court of Appeal applied a correctness standard of review and reversed the trial decision. According to the Court of Appeal, the exclusion had to exclude physical damage of some sort because it was an exception to coverage for physical loss and damage. To determine whether physical damage related to "the cost of making good faulty workmanship" or "resulting physical damage", the Court of Appeal created a three-part physical or systemic connectedness test. Applying this test, the Court of Appeal held that the damage to the windows related to the cost of making good faulty workmanship. Ledcor appealed to the SCC.

The SCC Decision

The Standard of Review

The SCC had previously held that, subject to certain exceptions, contractual interpretation was a question of mixed fact and law subject to the palpable and overriding error standard of review. However, appellate decisions had questioned whether that standard applied to standard form contracts. Resolving this dispute, the SCC held that because there is no meaningful fact-driven negotiation of standard form contracts, and because any interpretation will equally apply to future cases, the proper standard of review is correctness. In the construction and insurance industries, where participants frequently rely upon standard form contracts, this ruling widens the scope of appeals for contract disputes. Further, it highlights the need to know not only the terms of the contract but also the interpretations of those terms to avoid unexpected consequences.

Interpreting the Exclusion

After reaffirming the general rules for interpreting insurance policies, the SCC held that the exclusion was ambiguous. To resolve this ambiguity, the SCC reviewed the purpose of the policy to determine the parties' reasonable expectations as to the scope of the exclusion.

According to the SCC, the purpose of a builders' risk policy is to provide certainty, stability and peace of mind for construction projects through broad coverage. Given this purpose, the insurers' interpretation of the exclusion would "essentially deprive insureds the coverage for which they contracted", and therefore:

[T]he 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.

In addition, the SCC expressly rejected the physical or systemic connectedness test, holding that it was not necessary for the "cost of making good faulty workmanship" to include physically damaged property.

Overall, the SCC's legal framework for interpreting the exclusion is simple and concise.

Yet, even the SCC recognized that the "results that courts reach will be largely dictated by the particular circumstances of each case" and that "whether certain damage falls within the resulting damage exception to the faulty workmanship exclusion will greatly depend on the scope of the contractual obligation pursuant to which the faulty workmanship was carried out."

Accordingly, while Bristol's scope of work was narrow — to perform the labour to clean the windows —and the physical connectedness test unnecessarily imported a property component to Bristol's services, future cases may not have such defined distinctions. In fact, in many cases the distinction will not be factually clear. Accordingly, while the legal framework is now set, it is still possible to litigate the application of that framework based on the facts of any given project or contract.

For instance, while the SCC granted leave to appeal in Acciona1, a factually more complicated decision, the SCC, after Ledcor was decided, simply referred Acciona back to the British Columbia Court of Appeal for disposition in accordance with Ledcor. It will be interesting to see what the British Columbia Court of Appeal will do with the factually more difficult case of Acciona.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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