Consequential loss goes to Ottawa Part II   

BY ROBERT KENNALEY

In June, we told you about a case which was headed to the Supreme Court of Canada, over the “own work exclusion” and the extent to which a contractor’s liability insurance policy should cover what is known as ‘consequential loss.’ We used the common example of the retaining wall and the Volkswagen to describe the issue: Where a retaining wall falls down, the liability policy will generally not cover the cost of repairing or rebuilding the wall because the contractor did what he intended to do in building the wall (and there is no “accident”). If the wall falls on a Volkswagen, however, it is said that the liability policy will generally respond to cover the car, because its damage is an unforeseen consequence of the construction deficiency, unrelated to the work itself. 

We pointed out our Courts have struggled to apply the concept of consequential loss in practice and that, accordingly, a recent case which has wound its way to the Supreme Court is compelling. The case, Ledcor v Northbridge Indemnity Insurance Company, involved an insurance policy which covered “direct physical loss or damage” to a construction project. As the construction was winding down, a company hired to clean the windows scratched them and they had to be replaced. The insurer denied coverage based on the ‘own work’ exclusion, arguing the damage was the ‘faulty workmanship’ of the insured and therefore not covered under the policy. 

The Alberta Court of Appeal developed a new test for determining whether or not physical damage was “resulting” damage, one based on “physical or systemic connectedness.” The theory was that resulting damage could not be physically connected to, or part of the system of, the faulty work itself. Based on that test, the Court held the damage was not sufficiently remote to be “resulting,” or “consequential.” The Court also held the purpose of the policy was to cover certain unexpected events and accidents, and in this case the damage was neither, having been directly caused by the intentional scraping and wiping motions of the cleaners’ work. In its view, a standard liability construction policy is not intended to provide a “warranty” that construction was performed properly.

In dealing with the matter, the Supreme Court of Canada firstly held that a new test was not necessary. The majority then held that, while the exclusion clause was ambiguous (with no definition of “resulting damage” having been provided), the general principles of contractual interpretation should suffice to address the issue. In applying those principles, it held, the faulty work exclusion was to be interpreted to only exclude the cost of redoing the faulty work itself — which in this case was the cost of re-cleaning the windows. Damage to the windows, and therefore the cost of their replacement, was held to be covered.

The majority went on to hold this interpretation was consistent with the reasonable expectations of the parties and reflected and promoted the purpose of the insurance policy. They held that any interpretation which denied coverage merely because the damage was part of the project on which the contractor was working, would undermine the purpose behind the policy and would deprive those who had purchased the insurance of the coverage for which they had contracted. 

The majority reviewed a number of prior decisions, which they found to be consistent with their finding. They also reviewed several that went the other way. They found that many of these involved faulty work by contractors hired to provide design. In a finding that is somewhat difficult to follow, the majority held that the denial of resulting damage claims in such cases made sense. The Court stated that “in faulty design cases, a contractor is obligated to design a given item, with the design being integral to the whole of that item. Thus, the cost of repairing the damages caused to that item will be included within the cost of redoing the faulty work, and the resulting damage exception will necessarily apply to damages caused to items other than the item being designed.” (Regardless, it appears the Court did not extend its interpretation of the exclusion to faulty design cases).

The majority also acknowledged the Courts have historically and generally applied the resulting damage exception narrowly. However, it found that this narrow application was not consistent and that “parties cannot therefore adequately predict what sort of damage will or will not be caught by the exclusion.” 

Justice Cromwell was the only Justice who did not entirely agree with the majority. He agreed with the result, but held that the application of the clause should not be made generally. He held that the question of what should, and should not, be considered “the cost of redoing the faulty work” should ultimately have to be decided on a case?by?case basis, on the facts of each particular case.

There is no question the Supreme Court’s decision is an important one. The majority expressly distanced themselves from a trend of cases which had only narrowly allowed resulting damage claims to succeed in the face of an “own work” or “faulty workmanship” exclusion. The Court also appears to have held that (generally speaking and with the possible exception of design cases), anything beyond the cost of repairing the contractor’s own faulty work should be covered as resulting damage. This will make it much easier for claims for the costs associated with construction defects on a project to succeed. Consider, for example, where a foundation wall is deficient, but the cost of repairing that deficiency necessitates a removal and replacement of the building above it. The Supreme Court of Canada’s decision will make it easier for claimants to argue everything but the repair of the wall should be covered as consequential loss.

Still, the Supreme Court of Canada decision was made on the wording of the policy in question. In this regard, there is truth to what Justice Cromwell had to say: insurance contracts will always have to be interpreted on the wording of the particular clauses at issue. It may be, for example, that insurance companies will change the wording of their ‘own work’ exclusions to more clearly exclude repairs to any of the contractor’s work. It may also be that a judge, on any given day, could interpret a slightly different but similar clause, differently. In the event that a claim involving potential resulting damage arises, care should be taken to review the language and facts in question in the context of what the Supreme Court of Canada has had to say in this case. Chances are the case will greatly assist the insured to obtain coverage. This case will be extremely helpful, if not determinative, in that regard.