It rains in Vancouver. Correction — it rains a lot in Vancouver. A building envelope consultant (Ricketts D., P.Eng., Leaky Condos — Why the Technology Didn’t Work) described the situation this way:
…the coastal area of BC has one of the wettest climates in North America; during the October to March rainy season, wetting periods are long and drying periods are short. In addition, the location and orientation of buildings on many sites results in more exposure to wind-driven rain. Similarly, the building form (lack of overhangs) can mean that walls are exposed to greater wetting, even on sites with relatively low exposure to wind-driven rain.
Combine the impact of the weather, a multi-unit residential building boom, a suspect building code and the spectre of large profits and you create an atmosphere for building performance problems.
While this paper examines the issues relevant to the leaky building crisis, the same issues are important in any claim where the damages relate to poor performance of a building. In addition, it is foolish to assume that the leaky building problem is limited to British Columbia. Building envelope failures are prevalent in all areas of the United States and we may see similar problems in other areas of Canada, albeit to a lesser degree.
In British Columbia and more particularly in the Vancouver area, there has been a spate of building envelope failures which create challenging insurance issues. The issues are complicated by the following:
(a) Sympathies – There is a tremendous amount of sympathy for the people who have purchased leaky condos. This is to be contrasted with the sympathy generated by insurers;
(b) The Availability of Designers’ E&O Coverage – There is very little coverage available for actions which have not already been commenced;
(c) The Number of Parties – This is a construction setting and therefore there are a number of parties, usually a minimum of 10 to 12;
(d) The Parties – Primarily contractors and subcontractors;
(e) The Cost of Litigating – In view of the number of parties and the prevalence of documents in construction disputes the cost of litigating the issues is enormous;
(f) The Lack of Judicial Consideration – While there are hundreds of leaky building actions only one has proceeded to trial and it dealt with municipal liability not with the division of responsibility between construction and design.
All of the above factors make it particularly difficult for insurers to formulate a strategy for dealing with these claims. To date, the approach by insurers has not been consistent.
An insurer’s approach will depend upon whether it is considering the claim in the context of a single insured under a commercial general liability (“CGL”) policy or it is attempting to deal with a number of insureds seeking coverage under a wrap-up liability policy.
In the case of a wrap-up liability policy, the issues are complicated by the fact that as many as 10 or 12 trade contractors may seek coverage under the policy.
Many contractors will not have reported the claim in a timely manner. Therefore, the insured’s own corporate lawyer may have been defending the matter for a period of time before involving the wrap-up insurer. Alternatively, the claim may have only been reported to the insured’s CGL carrier.
While prejudice may not be a significant issue, the wrap-up insurer as a “latecomer” to the dispute may not be able to select counsel of its choice or may inherit counsel selected by the CGL carrier.
To further complicate matters, there is usually a rush to retain counsel when actions are commenced in light of the number of parties and the insurer may not be able to retain counsel familiar with the insurer’s defence procedures and billing requirements.
THE SOLUTION – “MANAGING THE RISK”
Identify Those Entitled to Coverage
This one seems obvious but it should be reviewed. Most wrap-up policies do not provide coverage to the following:
(a) material suppliers – those who do not perform construction or installation operations at the site;
(b) consultants such as architects and engineers – those who provide professional services.
In summary, a typical wrap-up policy will cover the general contractor and those subcontractors who perform work on the project site.
Insured Project Exclusion
Some wrap-up policies exclude property damage to the actual insured project.
An example of such an exclusion is as follows:
This insurance does not apply to “property damage” to the insured project referred to in item #5 of the Declarations including:
1. Property of every kind and description either forming part of or to form part of the project and any material or supplies used in the construction of the insured project; and
2. Loss of revenue or additional expenses sustained by the Insured resulting from the delay or interruption of the operations of the project.
Consider Whether the Action Triggers Coverage Within the Insuring Agreement
In British Columbia, the New Home Warranty Program has funded a number of repairs of leaky condominiums. Builders who were originally involved in the construction signed agreements with New Home Warranty which provided that the builder would indemnify New Home Warranty for any claims brought against the Warranty Program.
If an action is brought by New Home Warranty against an insured, either in New Home’s name or as a subrogated claim in the name of the owners, that is a claim for indemnity pursuant to the agreements between New Home Warranty and the builder. It is not a claim for “property damage” as a result of an “occurrence”.
When the claim is brought entirely for indemnity and not for indemnity and property damage, the claim is outside of coverage under either a CGL or a wrap-up policy.
The Applicable Exclusions
If you have proceeded through the analysis to this point you are likely considering a claim that can be described as follows:
(a) It is within coverage in that it alleges property damage as a result of an occurrence;
(b) It is brought by a general contractor or a subcontractor who actually performed work on the project; and
(c) The policy in question does not contain a “insured project” exclusion.
Having reached this point, you are left with a consideration of the well-known work/product exclusion which states:
This Policy does not apply to:
. . .
8. damage to or destruction including loss of use of:
. . .
(c) that particular part of the Insured’s products out of which an accident arises
(d) that particular part of work performed by or on behalf of the Insured out of which an accident arises due to faulty workmanship.
. . .
In the case of the general contractor, the insurer may take the position that the building itself is the insured’s “product” and that the loss arises out of faulty workmanship. This position has been accepted in other cases in British Columbia (Privest Properties Ltd. v. Foundation Company of Canada (1991), 57 B.C.L.R. (2d) 88, 6 C.C.L.I. (2d) 23 (S.C.) and Pier Mac Petroleum Installation Ltd. v. AXA Pacific Insurance Company (1977), 41 B.C.L.R. (3d) 326, 47 C.C.L.I. (2d) 229 (S.C.). However, those cases did not involve leaky condominiums.
In two recent decisions, the British Columbia Supreme Court has considered these issues in relation to the spate of leaky building cases in the province.
The Metro-Can and Hearn/Actes Decisions
The issue was first considered in the decision of AXA Pacific Insurance Company Ltd. v. Guildford Marquis Towers; Metro-Can Construction (GM) Ltd. v. AXA Pacific Insurance Company Ltd. (2000) B.C.S.C. 197 (“Metro-Can”).
In Metro-Can, Bauman J. found that the exclusion (slightly different than the one set out above) resulted in an ambiguity on the face of the policy. The learned judge admitted into evidence certain promotional material which was forwarded by AXA Pacific to its insureds in September of 1990 and concluded that there was a defence obligation and coverage for certain allegations. Bauman J. observed that to find otherwise would result in no coverage being afforded to a general contractor.
The Metro-Can case is under appeal.
In the second case on this issue F.W. Hearn/Actes – A Joint Venture Ltd. v. Commonwealth Insurance Company (2000) B.C.S.C. 764 (“F.W. Hearn/Actes”), the court came to a similar conclusion. In that case, the general contractor went bankrupt while constructing a student housing residence at the University of British Columbia. Following the construction, the contractor brought an action for extra work and delays in completion of the project. Subsequently, the project was experiencing significant water ingress and the University advanced a counterclaim seeking damages for faulty workmanship and materials.
The judge relied heavily upon the conclusions of Bauman J. in Metro-Can in finding that there was an ambiguity in the wrap-up liability policy. As a result of the ambiguity, the judge found that the insurer had an obligation to defend the general contractor. This result was unusual in that the particular exclusion under consideration was identical to the one found to exclude coverage in the Privest case.
The F.W. Hearn/Actes decision is under appeal.
It is acknowledged that these decisions deal with the duty to defend and not the duty to indemnify. However, by extending the defence obligation in this manner the courts in British Columbia are extending CGL and wrap-up coverage to the type of risk normally underwritten by a performance bond.
Spencer J., in the decision of Quintette Coal Ltd. v. Bow Valley Resource Services Ltd. (Quintette Coal Ltd. v Bow Valley Resource Services Ltd. (1987), 21 B.C.L.R. (2d) 203 (B.C.S.C.) at p. 207) stated the view in the following way:
I am hesitant to think that a comprehensive general liability policy covers a contractor for the cost of having to repair or replace his own negligently done work as opposed to the cost of redressing damages caused to others through the contractor’s carelessness. Were that the case a contractor could bid a job for $1 million, do it carelessly at minimal cost to itself, and then claim from the insurer the cost of redoing the work as it should have been done in the first place for $1 million. I respectfully adopt that view from the judgment in Poole Const. Ltd. v Guardian Assur. Co.,  I.L.R. 1-879 at 635, 4 A.R. 417 (T.D.)
In Privest (supra at paragraph 208 and 209) the Court quoted from a decision of the United States Court of Appeals, 7th Circuit in Ohio Casualty Insurance Co. v. Bazzi Construction Co. as follows:
Comprehensive general liability policies… are intended to protect the insured from liability for injury or damage to the persons or property of others; they are not intended to pay the costs associated with repairing or replacing the insured’s defective work and products …
There is a policy reason for this. If the insurance proceeds could be used to pay for the repairing or replacing of defective work and products, a contractor or subcontractor could receive initial payment for its work and then receive further payment from the insurer to repair or replace it. Equally repugnant on policy grounds is the notion that the presence of insurance obviates the obligation to perform the job initially in a good and workmanlike manner.
More recently in Pier Mac (supra, at para. 25), the same principle has been stated as follows:
I am, however, satisfied … and in the context of the whole of the Insurance Policy that it was intended by the parties to be a general liability insurance policy and not a performance bond …
The majority view in the United States is similar to the passages set out above and supports the view that liability policies should not extend to the cost of correcting or replacing the general contractor’s work. The prevalent view is that those risks are business risks. The leading American decision of Weedo v. Stone-E-Brick, Inc. (Weedo v. Stone-E-Brick, Inc. 81 N.J. 233, 405 A.(2d) 788 (1979) illustrates the intent of the liability coverage with the following example:
When a craftsman applies stucco to an exterior wall of a home in a faulty manner and discolouration, peeling and chipping result, the poorly-performed work will perforce have to be replaced or repaired by the tradesman or by a surety. On the other hand, should the stucco peel and fall from the wall, and thereby cause injury to the homeowner or his neighbour standing below or to a passing automobile, an occurrence of harm arises which is the proper subject of risk-sharing as provided by the type of policy before us in this case. The happenstance and extent of the latter liability is entirely unpredictable. The neighbour could suffer a scratched arm or a fatal blow to the skull from the peeling stonework. Whether the liability of the businessman is predicated upon warranty theory or, preferably and more accurately, upon tort concepts, injury to persons and damage to other property constitute the risks intended to be covered under the CGL (Weedo, supra at page 791).
Conclusion on the Work/Product Exclusion
In spite of these policy arguments, in British Columbia it will be difficult to rely upon the work/product exclusion in light of the two recent decisions which have expanded the duty to defend.
When an insurer is considering a claim by a general contractor under a wrap-up policy, the insurer will be faced with extending coverage to the general contractor for essentially all loss or damage except “that particular part” of the insured’s own work.
Similarly, in respect of subcontractors all damage will be covered except for the work performed by the subcontractor. Arguably, the result could be different if the exclusion does not contain the narrow “that particular part” language. However, the issue has not yet been determined by the Courts and the two decisions in Metro-Can and F.W. Hearn/Actes would not appear to provide much support to the argument.
HOW CAN THE INSURER REDUCE ITS EXPOSURE?
Recently, in a claim relating to the student housing residences at the University of British Columbia, the wrap-up insurer went forward with a strategy to minimize defence costs by retaining one firm to provide the following assistance:
(a) Reviewing all parties’ documents and organizing them in sub-categories applicable to each of the insured trades;
(b) Obtaining and organizing discovery transcripts;
(c) Reviewing expert reports and providing advice respecting the retainer of experts;
(d) Undertaking an analysis of defence costs and indemnity for each contractor;
(e) Making arrangements with CGL carriers for contribution towards defence costs.
By proceeding with these activities with one firm the insurer avoided the cost of paying for the same activities to be performed by each defence counsel. Of course, the key to this arrangement is cooperation and it is essential to reach agreements with insureds at the outset and to obtain their commitment to the process. However, many smaller firms welcome the assistance and expertise of a firm with the resources to organize the file.
By proceeding in this manner, the insurer has to be careful not to be seen to be hampering defence counsel. However, the approach can be effective as it conserves the resources which are normally spent on defence counsel with a view to using those resources to attempt to bring about a settlement.
One final word of caution. If a settlement is not achieved then the insurer has to be content with the case proceeding with assigned counsel and the “co-ordinating” counsel would only have a role as an advisor to the insurer.
Prepared by former Associate, Lyle E. Braaten