In a decision released September 15, 2016 the Supreme Court of Canada ruled on the interpretation of the exclusion found in most all-risk policies for the cost of making good faulty workmanship. The Supreme Court of Canada simplified the analysis, yet narrowed the interpretation of that exclusion clause such that it will likely apply less frequently than in the past.

In Ledcor Construction Ltd. v Northbridge Indemnity Insurance Co., 2016 SCC 37, the Supreme Court of Canada overturned the Alberta Court of Appeal in a case arising from faulty workmanship on the windows of an office tower.  During construction, the contractor hired to clean the windows scratched the windows beyond repair.  The cleaners used improper tools and methods in carrying out their work, and as a result the scratched windows had to be replaced.  The building’s owner and the general contractor in charge of the construction project claimed the cost of replacing the windows against a builders’ risk insurance policy covering all contractors involved in the construction project.  The insurers denied coverage based on the exclusion for the “cost of making good faulty workmanship”.

This case allowed the Supreme Court an opportunity to review the interpretation of an exclusion clause in a common form of all-risk property insurance, generally referred to as “builders’ risk”, “contractor’s risk”, “all risks”, “multi-risks”, or “course of construction” insurance.  This type of insurance covers physical damage on a construction site.  Such a policy is usually issued to the owner of the property under construction and the general contractor, but provides coverage to other contractors and subcontractors working on the project as well.  The exclusion clause at the heart of this case was a standard form clause that denies coverage for the “cost of making good faulty workmanship”, but as an exception to that exclusion, nonetheless covers “physical damage” that resulted from the faulty workmanship.

The Supreme Court found that the language of the exclusion clause was ambiguous, but the general principles of contractual interpretation led to the conclusion that the exclusion clause served to exclude from coverage only the cost of redoing the faulty work.  This means that the insurer was not required to indemnify the insureds for the cost of re-cleaning the windows, but the damage to the windows, and therefore the cost of replacing the windows, was covered.  Given that the general rules of contract construction resolved the ambiguity in the exclusion clause, it was not necessary to turn to the contra proferentem rule, which is a rule of contract interpretation that means ambiguity in a contract will be interpreted against the party responsible for drafting the contract.

The Supreme Court’s reasoning included that its interpretation is consistent with the reasonable expectations of the parties, and reflects and promotes the purpose of builders’ risk policies.  Broad coverage provided in exchange for relatively high premiums provides certainty, stability, and peace of mind, and ensures construction projects do not grind to a halt because of disputes and potential litigation about liability amongst various contractors involved for replacement or repair of items damaged in the course of construction.  Previous interpretation of the exclusion clause that precluded from coverage any damages resulting from a contractor’s faulty workmanship merely because the damage resulted to the part of the project on which the contractor was working undermined the purpose of builders’ risk policies, and deprived insureds of the coverage for which they contracted.  Moreover, the Court held that interpreting the exclusion clause to preclude from coverage only the cost of redoing the faulty work aligns with commercial reality and leads to sensible results, given the purpose underlying builders’ risk policies to spread the risk involved in construction projects. That policy purpose recognizes the importance of keeping to a minimum the difficulties that are bound to be created by the large number of participants in a major construction project.

Common interpretations of comprehensive general liability insurance policies provided the Supreme Court a useful analogy for interpreting the exclusion clause at issue in this case. The Supreme Court held that precluding from coverage only the cost of redoing the faulty work breaks no new ground in the world of insurance because it mirrors the approach Courts have adopted when construing similar exclusions found in comprehensive general liability insurance policies.  Those policies cover the risk that the insured’s work might cause bodily injury or property damage but they generally contain a “work product”, and, or “business risk” exception, which excludes from coverage the cost of redoing the insured’s work.

In coming to these conclusions, the Supreme Court rejected the test from the Alberta Court of Appeal’s decision. As a result of the above, the exclusion clause included in such all-risk policies will now be interpreted more narrowly than contemplated in the Alberta Court of Appeal’s decision.  The only expense that will be excluded through such standard clauses in builders’ risk policies will be the actual cost of redoing the work.  In this case, this means the actual cost of re-cleaning the windows would be excluded from coverage, however, the cost of replacing the windows because the contractor hired to clean the windows damaged them beyond repair in the course of cleaning the windows will be covered.

While this case appears to be consistent with the interpretation of commercial general liability policies, and creates a simpler interpretation of the exclusion clause commonly found in builders’ risk policies, it is likely that the insurance industry will now see more frequent instances in which indemnification must occur for damage caused during the course of construction.