What is the meaning of “faulty workmanship” in the context of a homeowners’ policy?  This was the question addressed by the Ontario Court of Appeal in Monk v. Farmers’ Mutual Insurance Company (Lindsay), 2015 ONCA 911.

In 2008, the insured homeowner hired a contractor to restore the exterior of her log home.  The restoration work required the use of water and it was the contractor’s responsibility to seal all areas where water might enter the home.  After the work was complete, the insured discovered damage to her home, including damage to the carpeting, bedroom wall, light fixtures, and windows.

At all material times, the home was insured by an all-risks homeowners’ policy issued by Farmers.  Farmers denied coverage for the damage to the home, on the basis of two exclusions:

We do not insure:
…
2. the cost of making good faulty material or workmanship;
…

We do not insure loss or damage to:
…
4. property
…

(ii) while being worked on, where the damage results from such process or work (but resulting damage to other insured property is covered).

(paras. 8-9)

The first exclusion was located under the heading “Losses Excluded,” the second under the heading “Property Excluded.”

As a result of Farmers’ denial, the insured commenced an action, alleging breach of the insurance contract.  Farmers responded with a motion for summary judgment, which was successful at first instance.

The motion judge found that most of the damage to the home was “caused, either directly or indirectly, by Pleasantview’s [the contractor’s] failure to follow industry standard practices and to take the protective measures required by the contract” (para. 14).  The motion judge therefore held that the insured’s claim was for repair of faulty workmanship, which was excluded by the policy terms.  Specifically, the motion judge interpreted the faulty workmanship exclusion (exclusion number 2, above) as excluding damage to the work contracted for itself, as well as “damages resulting from faulty workmanship related to the work” (para. 43 of the motion judge’s decision).  In support of this interpretation, the motion judge relied on the lack of an exception for resulting damage in the exclusion wording.

The motion judge also held that the resulting damage exception to the “property being worked on” exclusion did not create coverage for damage resulting from faulty workmanship.  All damage resulting from faulty workmanship was excluded.

On appeal, the principal issue was described by the Court as follows: “[d]id the motion judge err in concluding that the ‘faulty workmanship’ exclusion also excludes resulting damage, even though it does not specifically so state?” (para. 20).  The Court reviewed this issue on a correctness standard, as it involved the interpretation of a standard form insurance contract:

This is not a case in which the circumstances surrounding the contract are important to its interpretation, nor is it a case in which the interpretation of a contract has no impact beyond the parties to it.  The respondents’ submission that the “faulty workmanship” provision in this contract is not standard across the insurance industry misses the point: it is standard to the many customers of the respondent Farmers who purchased the same policy and it should be interpreted consistently. (para. 23)

The Court held that resulting damage was not obviously excluded from coverage by virtue of the faulty workmanship exclusion in this all-risks policy, which otherwise provides coverage for resulting damage.  The Court faulted Farmers’ choice of language, stating that “[i]f an insurer wants to exclude particular coverage, especially for something as well-known as resulting damage, it should do so specifically rather than by implication” (para. 34).  At law, exclusions are to be interpreted narrowly and so this faulty workmanship exclusion only excludes from coverage direct (not resulting) damage from faulty workmanship.

The Court further reasoned that if “faulty workmanship” was interpreted to include damage resulting therefrom, the two exclusion clauses would be in conflict as the faulty workmanship exclusion would exclude coverage for resulting damage, while the “property being worked on” exclusion would not.  The Court concluded that:

The motion judge’s suggestion that the absence of an exception for resulting damage from the “faulty workmanship” exclusion reflects Farmers’ intention not to provide coverage for such damage is misplaced. An insurer’s unilateral intention is not relevant to the interpretation of the insurance agreement. Nor is it appropriate to interpret the “property being worked on” exclusion in a manner that narrows the coverage that exclusion specifically preserves in order [to] interpret the “faulty workmanship” exclusion as broadly as possible.

In my view, resulting damage to insured property is covered by the policy whether or not that damage is the result of faulty workmanship. (paras. 40-41)

The appeal was therefore allowed and that aspect of Farmers’ summary judgment motion dealing with the exclusions was dismissed.

Key points and issues arising from the decision

1. The correctness standard of review applies to the interpretation of standard form insurance contracts.  This rule had its genesis in MacDonald v. Chicago Title Insurance Company of Canada, 2015 ONCA 842 and has now been followed in Monk.  To a degree, it is at odds with the Supreme Court of Canada’s decision in Sattva Capital Corp. v. Creston Moly Corp., 2014 SCC 53, where the Court decided that most exercises of contractual interpretation are questions of mixed law and fact (thus generally attracting the palpable and overriding error standard of review).  The leave application in MacDonald is currently being considered by the Supreme Court of Canada.
2. Assuming the Supreme Court of Canada does not overrule MacDonald, what constitutes a “standard form insurance contract,” the interpretation of which gives rise to the application of the correctness standard?  The Court of Appeal herein suggests that the policy wording need not be standardized across the insurance industry for the correctness standard to apply – the policy wording need only be standard to some of the customers of one insurer.  What seems to be evolving is a sliding scale from a manuscript policy (which would likely attract the palpable and overriding error standard of review) to policy wording which is standardized across the industry (which will attract the correctness standard).
3. In alignment with the principle that exclusions clauses are to be construed narrowly, the Court of Appeal’s decision places a heavy onus on insurers to clearly exclude coverage, with specificity.  In particular, if an insurer wants to exclude, from coverage, damage resulting from faulty workmanship, it must say so.  It cannot simply rely on the absence of an exception for resulting damage in its exclusion wording, even though that exception is commonplace in the insurance industry.
4. As in MacDonald, the Court held that “[a]n insurer’s unilateral intention is not relevant to the interpretation of the insurance agreement.”  This follows from the parol evidence rule and is undoubtedly correct.  However, query whether the “collective intentions” of the insurance industry, as expressed in the evolution of standard form IBC and ISO policy wordings, are also irrelevant to the interpretive exercise.