This article is a part of our Insurance Coverage Series. Other articles in this series include:
1. " The Interpretation of Exclusion Clauses in Insurance Contracts - Post Ledcor" by Carsten Jensen QC, FCIArb
2. " Fortuity as an Essential Element of "All Risk" Insurance Policies" by Robyn Graham
3. " Insurance Contracts and Insurance Estoppels" by Robyn Graham
Most insurance policies share a similar alternating structure. They set out the type of coverage, followed by specific exclusions, with some exclusions containing exceptions.
For example, standard form all-risk insurance policies typically cover damage to specific property but exclude the cost of making good faulty workmanship, materials, or design, with an exception for any resulting damage.
The consequences of faulty workmanship, materials, or design will oftentimes be significant, so it is important to understand how the "resulting damage" exception is interpreted at common law. The insured has the onus of proving that an exception to an exclusion clause applies, and exceptions should be interpreted broadly.
The "resulting damage" exception was the focus of the leading insurance coverage decision, Ledcor Construction Ltd v Northbridge Indemnity Insurance Co, 2016 SCC 37. The builders' risk insurance policy in Ledcor used the following language, similar to many other policies:
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. [Emphasis added]
In Ledcor, a contractor was hired to clean the windows of a building under construction. The contractor scratched the windows, which ultimately needed to be replaced. The insureds argued that only the cost of redoing the faulty work -- cleaning the windows -- was excluded from coverage, but the consequence of the faulty work -- replacement of the windows -- was covered as "resulting damage". The insurers denied coverage and argued that "resulting damage" is consequential damage to some other part of the insured property or project.
The Supreme Court applied general principles of contract interpretation and found the insured's interpretation to be consistent with the reasonable expectations of the parties and commercial reality: the faulty workmanship exclusion applies only to the cost of redoing the faulty work, and the resulting damage exception covers other costs apart from redoing the faulty work. As a result, the replacement cost of the windows fell within the exception and was covered.
Another case that considered the "faulty workmanship" exclusion and the "resulting damage" exception is Condominium Corporation No. 9312374 v Aviva Insurance Company of Canada, 2020 ABCA 166. A contractor was providing repair work to the parkade membrane but cut too deeply into the slab, causing damage to the structural integrity of the parkade. At issue was whether the damage to the structural integrity of the insured's parkade was covered under the policy.
Aviva argued that the negligent cutting and resulting damage to the slab was all attributable to faulty workmanship and caught by the exclusion, so the exception should not apply. According to Aviva, since the property damage involved a single peril of faulty workmanship which caused a single instance of damage, to be brought back into coverage under the exception the faulty workmanship must cause a second, resultant peril and a separate, distinct damage. The Alberta Court of Appeal disagreed.
The Court applied the interpretive principles outlined in Ledcor: the reasonable expectations of the parties, the commercial reality, and the narrow interpretation of exclusions to coverage. The Court found that Aviva's broad reading of the exclusion clause would exclude not only the cost of making good the faulty workmanship, but also the consequences of the faulty workmanship, and that interpretation does not accord with the reasonable expectation of the parties, the commercial reality nor the wording of the exclusion itself. It is not the role of the courts to read in additional words or otherwise rewrite the term under consideration.
As with builders' risk policies, the purpose behind multi-peril or all-risk policies is to provide broad coverage for fortuitous loss, affording the insured certainty, stability and peace of mind. Insurers are prepared to insure risks relating to problems caused by faulty workmanship, but they are not prepared to insure the quality of the workmanship itself. The scope of contracted work defines the limits of the faulty workmanship exclusion and coverage for resulting damage.
In Aviva, it was expressly agreed that the scope was limited to the parkade membrane and did not include any work that would impact the structural integrity of the concrete slab. The parties reasonably expected that the cost of making good the faulty workmanship -- determined by the scope of work contracted for -- would be excluded, but that the consequences of that faulty workmanship would be covered. Therefore, the cost of making good the repair work to the parkade membrane was excluded, but the resulting damage to structural integrity was covered. The Court stated that this interpretation fulfils the reasonable expectation of the parties: broad coverage for fortuitous or unexpected loss or damage.
The "resulting damage" exception was more recently considered by the Ontario Court of Appeal in MDS Inc. v Factory Mutual Insurance Company, 2021 ONCA 594 (leave denied by SCC), in the context of an all-risk insurance policy which covered property damage and a supplier's business interruption. The policy excluded losses caused by corrosion, with an exception for resulting damage:
This Policy excludes the following, but, if physical damage not excluded by this Policy results, then only that resulting damage is insured:
3) deterioration, depletion, rust, corrosion or erosion, wear and tear, inherent vice or latent defect. [Emphasis added]
The insured had agreed to buy isotopes from a supplier at a reactor which later had a leak caused by corrosion that shut down the reactor for 15 months. The insured lost its supplier of radioisotopes and submitted a claim for lost profits.
The trial judge held that the exception to the corrosion exclusion should be interpreted broadly to include not just physical damage caused by the corrosion, but also economic loss caused by the inability to use the insured property during the shutdown. The question on appeal was whether the lost profits from the supplier's business interruption fell within the "resulting damage" exception.
The Ontario Court of Appeal noted that although exceptions are interpreted broadly, particularly in all-risk policies, this does not mean that clear wording should be altered. The exception to the exclusion for corrosion was restricted to "resulting physical damage" to insured property or that of its suppliers. The plain meaning of physical damage does not include economic loss.
Further, a contextual analysis of the policy did not support a broader interpretation, as other provisions specifically addressed loss of use and loss of profits, including business interruption coverage arising from covered perils. Since the property damage itself was excluded because it was caused by corrosion, business interruption coverage was similarly excluded because the loss of profits arose from an uninsured peril.
Finally, the preponderance of cases in Canada, the United States, and the United Kingdom have not interpreted resulting physical damage to extend beyond physical repairs to include loss of use. On the contrary, they have held that where loss of use is to be included as resulting physical damage, this must be made clear in the policy.
The Court concluded that the exception to the corrosion exclusion for resulting physical damage includes physical damage, but not damage resulting from loss of use. While economic loss may result from physical damage, it is not physical damage. As a result, the insured's claim for lost profits did not fall under the exception and was therefore excluded from coverage.
The foregoing outcomes demonstrate that the specific wording of exclusions and exceptions is especially important to the determination of coverage on the facts of each case. The lawyers at JSS Barristers have significant experience with the interpretation of insurance policies.
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.