BC Court of Appeal decision opens insurers to claims for defective workmanship
A decision of the British Columbia Court of Appeal, released earlier today, has greatly increased the likelihood of insurance claims being advanced for defective workmanship and/or design in common construction project policies.
In Acciona Infrastructure Canada Inc. v. Allianz Global Risks US Insurance Company, 2015 BCCA 347, the Court of Appeal was asked to review a trial court decision on the application of the design/workmanship exclusion which appears in most Course of Construction (“COC” or “Builder’s Risk”) Policies.
At Trial, the plaintiff, a contractor for a hospital project in Victoria, BC, brought a claim under its COC policy after discovering that the concrete slabs were seriously deflected and cracked. While there was no chance that the building foundation would fail, extensive remediation, at a cost of more than $14,952,439 for losses and costs were incurred to bring the project back into the design specification.
The purpose of a COC policy is to cover builders for the cost of repairs during the course of a project’s construction and some period of time thereafter. Coverage is triggered if the loss is accidental, and is then subject to a number of exclusions.
Acciona sought compensation for the cost of the repairs. The insurer denied the claim on the basis that the concrete slabs were defective, not damaged, and as a result, fell under the common exclusion for “defects in material workmanship or design.”
The Policy adopted the now common “defects in workmanship” clause found in the LEG2/96 Exclusion:
The insurer(s) shall not be liable in respect of all costs rendered necessary by defects of material workmanship design plan or specification and should damage occur to any portion of the Insured Property (Contract Works) containing any of the said defects the cost of replacement or rectification which is hereby excluded is that cost which would have been incurred if replacement or rectification of the said portion of the Insured Property (Contract Works) has been put in hand immediately prior to the said damage.
For the purpose of this policy and not merely this exclusion it is understood and agreed that any portion of the Insured Property (Contract Works) shall not be regarded as damaged solely by virtue of the existence of any defect of material workmanship design plan or specification.
What makes the LEG2/96 wording unique is that it attempts to avoid the dilemma of determining where defects in workmanship end and resultant damage begins. The Exclusion accomplishes this goal “by crystallizing the quantum of damage that is excluded at the moment just before any consequential damage resulting from defective work occurs.”
At Trial, Justice Skolrood found that the foundation deflected as a result of improper concrete form work during the construction and that the damage was “fortuitous” (not expected or intended). As a result, the policy was triggered. Based on the wording of the exclusion, coverage would apply, with the only excluded costs being the amount it would have cost to fix the problem, before it was discovered (which was agreed to be negligible). Approximately half of the claim was allowed in the amount of $8,514,931.
The Court of Appeal dealt with the contentions by the insurers that the deflection of the slab did not constitute “direct physical loss of or damage to the property insured” and that the exclusion clause “requires the parties to determine and exclude from insured claims the hypothetical cost that would have been incurred if the defect had been recognized, and repair or replacement had been put in hand, before any property damage.”
The Court dealt with the first issue by upholding the Trial Judge’s decision that the rebar contained within the slab was installed correctly and undamaged before the faulty shoring caused it to become deformed. As a result, a previously undamaged portion of the project became damaged as a result of a fortuitous act. Failure to allow for damage to a work in progress runs counter to very purpose of a policy of insurance meant to cover the a project during its construction.
The second argument, that the Trial Judge also misinterpreted the exclusion clause by holding that only “preventative or avoidance costs” were excluded from coverage, was also dismissed by the Court. The Appellate Court held that it was coincidental that sufficient preventative measures would not have added to the costs in the case, and that if circumstances had been different, the costs might have been substantial.
The Court also found that other versions of the LEG2/96 clause (the LEG 1 and LEG 3, to name two) provided different language on this particular issue and were available to the insurer. In particular, the LEG 1 wording simply excludes “all damage due to defects of material workmanship design plan or specification.” That was an option that the parties could have chosen but did not (presumably for an increased premium). According the Court of Appeal (and the Trial Judge), the fact that the defects in the workmanship could have been repaired prior to it occurring (the LEG 2 wording) for the same cost as doing it correctly the first time (the LEG 3 wording) is simply a coincidence.
The significant outcome of the decision is that it allows judges in B.C. to subdivide construction projects into increasingly smaller parcels and by extension find that damage caused by faulty design or workmanship in one area can damage another portion of the project.
The BC Court of Appeal decision in Acciona is directly opposite to a decision of the Alberta Court of Appeal in Ledcor Construction Limited v. Northbridge Indemnity Insurance Company 2015 ABCA 121. In Ledcor, the Alberta Court held that work which is physically or systemically connected to the very work being carried on is not covered. That court held that the primary considerations to a claim would be the extent to which damage was to a portion of the project actually being worked on at the time; the nature of the work done; the extent to which the damage was a foreseeable consequence of the work itself and whether the damage was in the purview of normal risks of poor workmanship or it was unexpected. None of those considerations were directly addressed in Acciona.
Since COC policies are placed throughout the country, this divergence between the Courts of Appeal in B.C. and Alberta creates uncertainty in how the same commercial insurance contracts will be adjudicated in different parts of the country. As a result, an appeal to the Supreme Court of Canada is likely.
Until a Supreme Court of Canada case is heard and decided, insurers looking to place COC policies in B.C. should consider the prospect of a significant increase in exposure to claims arising from damage caused by defects in material workmanship or design and to use particular care in the use of the LEG 2 wording.
If you have additional questions about the interpretation of insurance policies or want more information about Watson Goepel LLP’s insurance law practice, please contact Andrew N. Epstein.