Construction Deficiencies

The Supreme Court of Canada recently resolved divergent lines of case law, which had emerged across the country in respect of coverage for claims alleging construction deficiencies. In Progressive Homes Ltd. v. Lombard General Insurance Co., on review from the British Columbia Court of Appeal, the Supreme Court ruled that a duty to defend was owed by a CGL insurer to a general contractor faced with a claim for construction deficiencies in a series of buildings it had constructed.

Issues in contention

The owners of the four buildings in issue, alleging that the building envelopes had failed and were leaking, sued the general contractor, Progressive Homes. Progressive Homes tendered the claim to its CGL carrier, Lombard. Lombard, in denying coverage, relied on the BC Supreme Court’s decision in Swagger Construction Ltd. v. ING Insurance Company of Canada. That ruling supported the view that the damage alleged pertained only to structural elements, which formed part of the general contractor’s obligations under its construction contract, and therefore did not allege “property damage.” Lombard further cited Swagger for the premise that damage is the natural result of the alleged faulty workmanship, and therefore did not arise as the result of an “accident” or “occurrence”.

Lombard successfully defended its denial in BC Supreme Court, and a 2-1 majority in the British Columbia Court of Appeal affirmed that judgment. The analysis of the majority was premised in large measure on “general principles” of insurance law, which were used to guide the Court of Appeal’s interpretation of the words used in the insurance contract.

Standing in contrast to the BC decisions were decisions from Courts of Appeal of Ontario and Saskatchewan. In both Bridgewood Building Corp. v. Lombard General Insurance Co. of Canada and Westridge Construction Ltd. v. Zurich Insurance Co., in which coverage obligations had been found to be owed to general contractors facing allegations of construction defect on similar, if not identical, policy language.

Supreme Court of Canada

The Court specifically rejected the use of “general principles of insurance law,” and focused instead on the specific wording of the insurance policies in question. In this regard, the Court rejected the insurers’ contention that “property damage” could not be found where the damage alleged was limited to the building constructed by the general contractor, and its contention that faulty workmanship could not result in fortuitous, accidental damage.

Nature of property damage

Citing to the lower court rulings in Bridgewood and Westridge, Justice Rothstein, writing for the Court, found:

I cannot agree with Lombard’s interpretation of “property damage.” The focus of insurance policy interpretation should first and foremost be on the language of the policy at issue. General principles of tort law are no substitute for the language of the policy. I see no limitation to third-party property in the definition of “property damage.” Nor is the plain and ordinary meaning of the phrase “property damage” limited to damage to another person’s property.

In this respect, Rothstein rejected the B.C. courts application the “complex structure theory,” (set down in the Supreme Court’s decision in Winnipeg Condominium CorporationNo. 36 v. BirdConstructionCo.), statingboththat it was inappropriate to apply a tort principle in what was clearly a contract analysis, and that the determination of what constituted “property damage” had to look to the specific words used in the policy.

I would construe the definition of “property damage,” according to the plain language of the definition, to include damage to any tangible property. I do not agree with Lombard that the damage must be to third-party property. There is no such restriction in the definition.

In dicta Rothstein commented further that he saw no reason that Lombard’s definition of “property damage” did not also include the defective property itself. This was another clear rejection of “general principles,” and a tacit instruction to insurers who wish to exclude some part of “damage to tangible property” from coverage, to use express language to do so.

Accident

Not surprisingly, the Supreme Court also rejected the argument that faulty workmanship was not “fortuitous” and therefore not covered.

Fortuity is built into the definition of “accident” itself as the insured is required to show that the damage was “neither expected nor intended from the standpoint of the insured.” This definition is consistent with this Court’s core understanding of “accident”: “an unlooked-for mishap or an untoward event which is not expected or designed” . . . When an event is unlooked for, unexpected or not intended by the insured, it is fortuitous. . . . It will depend both on the circumstances of the defective workmanship alleged in the pleadings and the way in which “accident” is defined in the policy. I, therefore, cannot agree with Lombard’s view that faulty workmanship is never an accident.

The analysis of the accident/occurrence requirement must be assessed on a case-by-case basis, and not in light of rules of general application.

Exclusions

Having determined the requirements of the insuring agreement were met, the Court turned its attention to the “work performed” exclusions found in the policies. Rothstein reaffirmed the principles of construction that the Court had laid down in previous decisions, most particularly that so far as the language of the policy and commercial reason will allow, coverage grants should be interpreted broadly, while exclusions should be interpreted narrowly.

The Court’s analysis of the specific “work performed” exclusions used in the various policies issued to Progressive over a series of years warrants review as each exclusion (or close variants thereof) have been used widely in Canada. The Court’s analysis of the second exclusion, however, warrants particular scrutiny. That exclusion excluded: “‘Property damage’ to ‘that particular part of your work’ arising out of it or any part of it and included in the ‘products – completed operations hazard’.” The Court’s analysis of this exclusion could, in the writers’ view, if too narrowly applied, defeat the commercial expectations of the parties, and give a windfall to insureds. The Court wrote:

Unlike the standard form version of the “work performed” exclusion (clause (i)) reproduced above, this version expressly contemplates the division of the insured’s work into its component parts by the use of the phrase “that particular part of your work.” . . . It will have to be determined at trial which “particular parts” of the work caused the damage. Repairs to those defective parts will be excluded from coverage. . . .

Following on this analysis, the Court suggested it was appropriate to read the exclusion (if a case were concerned with water leakage through windows installed by the insured) as excluding “‘property damage’ to ‘the window’ arising out of ‘the window’ or any part of ‘the window’ and included in the ‘products-completed operations hazard’.”

In the weeks following the decision we have already seen insureds suggest that in fact the window itself which was defective, but the caulking that was improperly applied, or the window flashing that was improperly placed. If the Supreme Court’s analysis comes to be applied in lower courts so as to enable insureds to narrow “the particular part” in such a manner the purpose of the exclusion may well be defeated (it was a chemical component of the caulking which was flawed, so damage to the caulkin g is also covered). It may be that the wording of the exclusion allows such a literal interpretation, but the writers suggest that such a reading would be inconsistent with the reasonable commercial expectations of the parties. Courts have not been directed to read exclusions in the narrowest terms the words themselves can support, but, in terms that are consistent with the reasonable expectations of the parties.

As with all Supreme Court decisions, the true scope and effect of the Progressive Homes decision will only be felt as lower courts apply it across the country. The Court’s instruction, however, was clear: If insurers do not wish to cover particular kinds of damage, their policies must clearly express that intent.

David Mackenzie practices commercial and insurance litigation, with an emphasis on insurance coverage and complex multi-party disputes with Blaney McMurtry LLP in Toronto.