Introduction
The following paper will provide an overview of builder’s risk insurance and examine the following three issues that commonly arise in coverage interpretations:
1. Who is an insured under a builder’s risk policy?
2. When is a builder’s risk policy terminated? and
3. What is the effect of the faulty work/design exclusion?
Property insurance on construction projects is usually referred to as “Builder’s Risk Insurance”, sometimes known as “Course of Construction Insurance” and less frequently as “All Risks Insurance”.
As the risks of damage to property are significantly different in nature when a project is undergoing construction, the standard property insurance policy coverages usually will not cover losses associated with buildings under construction. A builder’s risk policy is the main vehicle for providing first party property coverage for structures under construction.
Generally speaking, the builder’s risk insurance policy compensates the insured for physical loss or damage to all permanent construction and temporary works necessary to facilitate construction (hence it is referred to as first party insurance). A main distinction between first and third party coverage is the triggering event. First party coverage is triggered simply by physical loss or damage to property. Third party liability insurance is triggered once a party claims the insured is responsible for physical loss or damage.
The monetary limits of the builder’s risk insurance should be at least sufficient to cover the replacement cost of the project plus the cost for debris removal (this insurance also covers the cost of the debris removal following any insured damage). The amount of the policy should therefore be in excess of the contract price and should include the value of any material supplied by the owner or other parties. In the case of an addition to an existing structure, the value should include the cost of replacing the existing structure.
For coverage to apply under a builder’s risk policy, there must be physical loss of or damage to property. Builder’s risk policies typically contain exclusions for any type of consequential or indirect loss. This would include losses due to delays in construction caused by the structure being damaged by an insured. Owners can incur significant damages if the project is delayed. These time element or soft cost damages can be covered under loss of use insurance, which can be purchased by way of an endorsement to the builder’s risk policy.
Who is an Insured under a Builder’s Risk Policy?
Over the past few decades, Canadian courts have expanded the scope of coverage under builder’s risk insurance policies. The law has developed to the point that today, if an owner or general contractor of a construction project purchases a builder’s risk policy, that policy will in most instances include as unnamed insureds all contractors and sub-contractors who supply materials or labour to the project. As a consequence, the builder’s risk insurer typically cannot bring a subrogated claim against any of the contractors or sub-contractors involved in the project. In other words, an insurer who pays out on a policy cannot then recover its losses from a party who should have been covered in the first instance.
A. Commonwealth Construction
The starting point for this development is the Supreme Court of Canada case Commonwealth Construction Company v. Imperial Oil Limited (1976), 69 D.L.R. (3d) 558 (S.C.C.) which held that all contractors and subcontractors have an insurable interest in a construction project, and as a result, they may be considered unnamed insureds in a builder’s risk policy. In that case, an oil company was engaged in the construction of a fertilizer plant. The policy covered the oil company, its subsidiaries and any of their contractors and sub-contractors. Commonwealth Construction, a sub-contractor, was responsible for a fire that caused damage to the property being used in a project and the insurer sought to be subrogated to the alleged rights of the oil company against the sub-contractor. The Supreme Court of Canada held that, in a project such as this, the interests of the principal contractor and the subcontractors were so inseparably interconnected that they were all considered as one (or at least joint insureds) for the purposes of insurance. Consequently, an action between two of the joint insureds would be tantamount to a party suing itself and this would not support a right of subrogation.
As de Grandpre J. wrote (at 562):
On any construction site, and especially when the building being erected is a complex chemical plant, there is ever present the possibility of damage by one tradesman to the property of another and to the construction as a whole. Should this possibility become reality, the question of negligence in the absence of complete property coverage would have to be debated in court. By recognizing in all tradesmen an insurable interest based on that very real possibility, which itself has its source in the contractual arrangements opening the doors of the job site to the tradesmen, the courts would apply to the construction field the principle expressed so long ago in the area of bailment. Thus all parties whose joint efforts have one common goal, e.g. the completion of the construction, would be spared the necessity of fighting between themselves should an accident occur involving the possible responsibility of one of them.
De Grandpre J. further wrote (at 566):
As already noted, the multi-peril policy under consideration is called in the contract between Imperial and Wellman-Lord a course of construction insurance. In England, it is usually called a “Contractors’ all risks insurance” and in the United States, it is referred to as “Builders’ risk policy”. Whatever its label, its function is to provide to the owner the promise that the contractors will have the funds to rebuild in case of loss and to the contractors the protection against the crippling cost of starting afresh in such an event, the whole without resort to litigation in case of negligence by anyone connected with the construction, a risk accepted by the insurers at the outset.
It is significant to note that the policy under consideration in Commonwealth Construction listed the named insured as “Imperial Oil… and any of their contractors and sub-contractors.” As a result, the case does not stand for the general proposition that all contractors will be included as unnamed insureds in all builder’s risk policies. Although Commonwealth Construction is distinguishable given that the insurance policy in that case defined the “insured” to specifically include sub-contractors, the analysis by the Supreme Court of Canada regarding the intent of the construction contract regarding insurance has informed the law on the issue of who is an unnamed insured. The Supreme Court of Canada found that the intent of all the parties to a construction contract was to obtain a builder’s risk policy. That type of policy’s function is to provide to the owner the promise that the contractors would have funds to rebuild in case of loss and to the contractors the protection against the crippling cost of starting afresh in such an event, without resort to litigation in case of negligence by anyone connected with the construction.
B. Expansion of Coverage
The next significant case on the issue of who is an insured is C.P. Limited v. Base-Fort Security Services (B.C.) Ltd. (1991), 52 B.C.L.R. (2d) 393 (C.A.). C.P. Limited, a company hired to provide security services to a construction site, sought to be included as an unnamed insured in a builder’s risk policy. The Court held that the security company was not an unnamed insured because its services were not an integral part of the project. As reasoned by the British Columbia Court of Appeal, although Commonwealth Construction dealt with insurable interests, the principles regarding the issue of whether a sub-contractor is an insured within the policy are the same as those on the issue of insurable interest. The Court of Appeal looked to what the contracting parties must have had in mind at the time the insurance was obtained, based on the words in the construction contract, and reasoned that the “insureds” are those persons without whose contribution to the project in its entirety, the project itself could not be completed. To be deemed an insured, that party’s contributions must therefore be “an integral and necessary part of the construction process”.
The British Columbia Court of Appeal reaffirmed this evolving test in the case of Sylvan Industries Ltd. v. Fairview Sheet Metal Works Ltd. (1994), 89 B.C.L.R. (2d) 18 (C.A.) by ruling that sub-contractors are, by necessary implication, unnamed insureds in a builder’s risk policy issued to an owner as the only named insured. On the issue of the insurer’s intention, the Court of Appeal held that intention must be looked at in the legal context in which the policy was written. The Court then concluded:
Given the special nature of builders’ risk policies, the judicial pronouncements on the commercial necessity for inclusiveness, and the language of this policy, I am of the opinion that the trial judge reached the right conclusion when he found that contractors and subcontractors were unnamed insureds by necessary implication.
Even though the sub-contractor in this case had a contractual responsibility to obtain builder’s risk insurance, and failed to do so, it was still found to be an insured under the owner’s builder’s risk policy which did not specifically include sub-contractors.
To make the logical leap from the Commonwealth Construction case to include subcontractors as “unnamed” insureds in builder’s risk policies, the British Columbia Court of Appeal relied upon the reasoning in Timcon Construction Ltd. v. Riddle, McCann, Rattenbury & Associates Ltd. (1981), 16 Alta. L.R. (2d) 134 (Q.B.). In Timcon Construction the trial judge found that since the value of all of the property forming part of the completed project was included in the amount insured and the “property insured” as per the wording of the insuring agreement referred to various types of property during a construction project, the policy insured such property whether owned by the insured or anyone else. The British Columbia Court of Appeal took from this that the insurer had to consider the legal context in which the policy is written and ought to have been aware that this type of insurance has as its primary purpose the simplification of insurance coverage on complicated projects and serves the salutary purpose of reducing the overall cost of insurance on this type of project. It went on to establish that “it is insurance from which owners, contractors and subcontractors can derive comfort and security when participating in these types of projects.”
The trial judge in Esagonal Construction Limited v. Traina, [1994] I.L.R. 1-3091 (Ont. Gen. Div.) questioned the reasoning in Commonwealth Constuction, Timcon, and Sylvan by pointing out that in many of the cases regarding builder’s risk policies the policies actually named the subcontractor or added the category of subcontractor and those that did not applied “hop, skip and jump logic.” In particular, with respect to the linkage between the legal context and policy interpretation in Commonwealth Constuction, Timcon, and Sylvan, he noted:
While it is quite obvious that it is generally desirable to have the risk borne (and therefore premiums paid for comprehensive coverage of all involved in a project) by the most appropriate party to achieve the overall benefits mentioned just above (ed. premium costs and avoiding litigation confusion) this benefit cannot in itself change the interpretation which would otherwise be given to a contract of insurance.
In that case, the unnamed subcontractor supplied steel beams to a housing project and one of its workers started a fire. The trial judge ignored the Commonwealth Construction line of reasoning and focused on the fact that the beams damaged in the fire constituted other property, which would be covered by the policy. That fact made the subcontractor an insured and the trial judge concluded that the waiver of subrogation clause applied.
Another example where a sub-contractor was found to be an unnamed insured because it owned some of the property insured by the builder’s risk policy is Earl A. Redmond Inc. v. Blair LaPierre Inc. (1995), 27 C.C.L.I. (2d) 201 (P.E.I.S.C.T.D.). In that case, a builder’s risk policy was issued to the owner and general contractor. When a fire damaged the building under construction, the insurer paid the claim, however, the insurer also paid about $6,000 to a sub-contractor who had lost some property in the fire. It was that same sub-contractor that the insurer brought a subrogated action against. Because the sub-contractor was an unnamed insured, the Court dismissed the subrogated action.
There is a comment in the Earl A. Redmond case which suggests that unnamed insureds in a builder’s risk policy include not only contractors that are supplying materials to the project, but also those contractors who are supplying labour (at 209):
…courts have clearly signalled that a property insurer having issued a Builders’ All Risk policy cannot maintain a subrogated claim against a subtrade if the latter contributed materials or labour to the project and the policy contains a waiver of subrogation clause
The case Janeland Development Inc. v. Michelin Masonry Inc., [1996] I.L.R. 3922 (Ont. Gen. Div.) appears to have further extended the scope of unnamed insureds under a builder’s risk policy. This case involved the collapse of a wall during the construction of a commercial building. The general contractor obtained a builder’s risk policy and after the loss, its insurer brought a subrogated action against the masonry sub-contractor. The policy did not expressly extend to sub-contractors. The Court did not focus on whether the sub-contractor owned any of the property or not. Rather, the Court simply summarized the law as set out in Sylvan [supra], and Esagonal Construction [supra], and then concluded that the sub-contractor was an unnamed insured under the builder’s risk policy. In closing, the Court wrote (Janeland Development, at 3925):
This determination is in keeping with the court’s desire to reduce litigation which flows from losses of this type. It also recognizes the reality of complex industrial life and provides comfort and security to owners, builders and sub-contractors involved in commercial projects.
A further case which affirmed the foregoing line of cases is Madison Developments Ltd. v. Plan Electric Co. (1997), 152 D.L.R. (4th) 653 (Ont. C.A.). In that case, the general contractor took out a builder’s risk policy, as he was required to do under the terms of the construction contract with the owner. The builder’s risk policy did not expressly extend to sub-contractors. The contract which the general contactor had with its sub-contractor required the latter to obtain its own insurance to cover its own materials. Notwithstanding this term in the sub-contract, the Court still held that both the sub-contractor and its employees were unnamed insureds in the builder’s risk policy.
The Court in Madison addressed an argument by the subrogating insurer that the waiver of subrogation clause only extended to sub-contractors when the sub-contractor suffered its own property damage in the loss. This in essence was the principle set out in cases such as Esagonal and Earl A. Redmond. The Ontario Court of Appeal’s response to this argument indicates that property damage sustained by a sub-contractor is not the only thing which will cause the sub-contractor to be deemed an unnamed insured. Rather, the Court suggests that all contractors and sub-contractors are unnamed insureds. The Court wrote (Madison at 662):
The respondents urge that it is intended to waive subrogation only where the loss is incurred to the subcontractors’ property. Another possible interpretation is that it is a general waiver against persons whose property is covered by the policy. We are not forced to choose between these alternatives, but the latter would be consistent with my express views as to the general intent of the parties to avoid litigation over fire damage occasioned during the course of construction.
In 529198 Alberta Ltd. v. Thibeault Masonry Ltd., [2001] A.J. No. 1684 (QL) (Alta. Q.B.), the Court held that a masonry sub-contractor was an unnamed insured in a builder’s risk policy “by necessary implication” even though the policy did not specifically list contractors or sub-contractors as unnamed insureds. The significance of this decision is that it asserts a general proposition that all sub-contractors on all construction projects have the benefit of a builder’s risk policy taken out by the owner or general contractor.
In Thibeault Masonry the plaintiff acted as its own general contractor respecting the construction of a two phase condominium complex. Thibeault was the masonry sub-contractor. A fire caused by Thibeault damaged phase two. The plaintiff had obtained a builder’s risk policy from State Farm. The plaintiff purchased the policy to fulfill a requirement imposed by the bank who was financing the construction project. The policy listed the plaintiff as the named insured, and the bank as the loss payee. The policy did not expressly extend coverage to contractors or sub-contractors. After the loss, State Farm paid out on this policy, and then brought a subrogated action against Thibeault. The Court concluded that Thibeault was an unnamed insured (Thibeault Masonry at paras. 22 and 27):
Turning then to the language of the policy, the property coverage – specifically the phrase “buildings while in the course of construction” – is at issue. A plain reading of the phrase “buildings while in the course of construction” would seem to include the work of the Defendant and other subcontractors on the Project. A construction project is necessarily the sum of materials, supplies and labour of the subcontractors performing work on the project. 529 always contemplated that subcontractors would complete the work on the Project, and any damage or loss to the property in the course of construction would therefore be at the hands of its subcontractors. Further, the entire value of the Project was insured. It is an agreed fact that the value of Thibeault’s work on the Project was included in that amount. In my opinion this fact and the plain meaning of “buildings while in the course of construction”, are sufficient to find that Thibeault is an unnamed insured under the State Farm Policy, especially in light of the commercial purposes of such policies.
A broad interpretation of the property coverages, which includes the work of subcontractors, is in harmony with the commercial context of builders’ risk insurance. Finding that subcontractors are insured under the policy advances its purposes of avoiding multiple coverage and of quickly providing funds for rebuilding without resort to litigation amongst the numerous subcontractors who work on one particular project. If subcontractors are not insureds under builders’ risk insurance policies, the absurd result would be that each subcontractor would be required to carry insurance for the value of the entire project, resulting in unnecessary multiple coverage. Eighteen subcontractors worked on Dana Village Phase II, which, if the Plaintiff’s interpretation is followed, would result in the necessity of the full value of the Project being insured eighteen times.
A glimpse of what the future may hold in terms of further expansion of the principle of waiver of subrogation in construction cases was provided in Saskatchewan Institute of Applied Science and Technology v. Hagblom Construction (1984) Ltd. (2003), [2005] 1 W.W.R. 390 (Sask. Q.B.). In that case, the Court recognized a defendant’s right to plead that custom and industry practice preclude subrogation, even in the absence of a builder’s risk policy. That case dealt with an application by the defendants to amend their statement of defence to plead that there was a custom in the construction industry for the owner to carry insurance for the benefit of all parties involved in a project and that this custom included an agreement of waiver of subrogation.
Finally, a case that takes the waiver of subrogation principle outside the realm of subrogated claims by insurers is Active Fire Protection 2000 Ltd. v. B.W.K. Construction Co., [2005] O.J. No. 2892 (QL) (Ont. C.A.). In that case, the Court held that a contractor’s contractual obligation to obtain insurance, even though it did not carry through with purchasing insurance coverage, precluded the contractor from bringing a claim against a sub-contractor in relation to a loss that occurred during construction.
In Active Fire Protection, the contractor entered into a contract with the Town of Whitby to renovate a building. The contractor then entered into a sub-contract with BWK for the installation of sprinkler equipment. During construction, a flood occurred which BWK admitted was caused by its negligence. The contractor paid the Town for the damage and then brought an action against BWK to recover the amount paid to the Town. BWK argued that the contractor’s action was barred because of its contractual obligation to insure. Relying on Madison [supra], the Court of Appeal held that the contractor’s commitment to obtain insurance acted as a voluntary assumption of the risk of loss or damage caused by the perils to be insured against and as a result, the contractor was barred from bringing this claim against the sub-contractor BWK.
The Court’s reasoning for extending the waiver of subrogation principle to a case which did not actually involve a subrogated insurance claim was as follows (Active Fire Protection at para. 29):
Finally, the appellant argues that the Madison principle does not apply here because, unlike in Madison, this case is not concerned with an insurer’s subrogation rights. I disagree. Although the issues in Madison arose in the factual context of a dispute regarding subrogation rights, this court’s interpretation in Madison of the ambit of the protection afforded by the insurance covenants in issue was not restricted to situations involving contested subrogation rights. The critical issue here, as also engaged in Madison, is whether the respondent subcontractor is entitled under the contractual bargain made between the parties to derive the benefit of the insurance obligations undertaken by the appellant general contractor. In my view, the contractual arrangements between the parties establish this entitlement.
C. Consultants
Trizec Equities Ltd. v. Ellis-Don Management Services Ltd., [1988] Carswell Alta. 143 (Alta. Q.B.) addressed the issue of whether a consultant was afforded coverage under a builder’s risk policy. In this case, the consultant sought coverage as an unnamed insured under an all risks/course of construction policy. The Court held that the consultant was not entitled to coverage under the course of construction policy, as this policy was a property based policy. Insurance for professionals, such as engineers, is based on liability arising out of an error, omission or negligent act in design or advice. The Court reasoned that there are different underwriting considerations respecting property based coverage and errors and omissions based coverage and, as such, that the course of construction policy afforded no coverage to the consultant. It is important to note, however, that the terms of the construction contract may extend coverage under a builder’s risk policy to consultants. As such, the policy, as well as the construction contract, must be reviewed in order to determine whether coverage is afforded to consultants.
D. Expansion of what is insured
In a recent decision, Medicine Hat College v. Starks Plumbing and Heating Ltd., [2008] A.W.L.D. 552 the Alberta Court of Appeal addressed “what” is covered for a project involving an addition to an existing structure. Medicine Hat College decided to expand its existing facilities by undergoing a series of renovations. A builder’s risk policy was obtained which provided coverage for property loss up to $9.5 million, which reflected the cost of construction for the addition and renovation project. During the course of construction, a main source gas line and gas regulator was relocated to permit the construction of a new entrance. An explosion then occurred in the mechanical room, caused by the improper reconnection of the new gas line. The problem was that the mechanical room that was destroyed was part of the original structure and did not form part of the renovation project.
It was argued that since the mechanical room was not part of the construction project (there were no changes made to the mechanical room), it was not covered under the policy. It was further argued that the limit of $9.5 million in coverage reflected only the cost of new construction and therefore the parties must have contemplated only new construction was covered.
The Court held, however, that the original structure was covered. The Court of Appeal relied on the general principle that a builder’s risk policy is insurance from which owners, contractors and subcontractors can derive comfort and security when participating in these types of projects. All parties involved in the construction of the project therefore had an insurable interest not only in the addition being undertaken to the existing structure but the existing structure itself. If the damage was caused to an entirely separate existing structure, the result would likely differ.
E. Summary
In light of all the above cases, the emerging trend appears to be that in any case where there is a builder’s risk policy, and where a loss occurs during construction, the insurer will typically not be able to bring a subrogated claim against contractors or sub-contractors involved in supplying materials or labour to the project. Likewise, all such parties will be afforded coverage as insureds under the policy. The overriding rationale for the prohibition of subrogation by a builder’s risk insurer against those involved in a construction project is linked to public policy considerations involving economics and business efficacy. The reasonable expectation of the parties who entered into the builder’s risk policy was to insure the property without regard to which contractor or subcontractor was responsible. By upholding a waiver of subrogation in construction cases, the courts intend to promote insurance funds being made available quickly following a loss, to limit the amount of litigation that arises from a loss, and to avoid the need for each and every contractor and sub-contractor to purchase its own insurance for the value of the entire project.
Termination of the Policy
Typically, builder’s risk insurance remains in place during “construction”. While this period of time is often readily ascertainable, this issue can become more difficult where the construction contract provides for things such as warranty periods, performance guarantees and further contemplated work.
A typical policy provides as follows:
Cessation of Coverage
This form ceases to insure the project:
(a) on the commencement of use or occupancy of any part or section of the project unless such use or occupancy is for:
(i) construction purposes
(ii) office or habitational purposes;
(iii) installing, testing or storing equipment and machinery:
(b) when left unattended for more than thirty (30) consecutive days or when construction activity has ceased for more than thirty (30) consecutive days;
(c) on the expiration of this insurance
whichever first occurs.
The potential difficulties with determining whether coverage under a builder’s risk policy has terminated are illustrated in Sherritt Gordon Ltd. v. Dresser Canada Inc., (1996) 41 Alta. L.R. (3d) 135 (Alta C.A.). At issue in this case was whether the policy barred subrogation.
Sherritt involved the expansion of an ammonia plant. The defendant installed a compressor in the fall of 1982. The plant expansion became operational in May 1983. After an incident on October 5, 1983, the compressor began to operate in an unusual manner. The plant was shut down on October 14, 1983, with operations resuming on October 22, 1983. On March 27, 1984, a part failed in the compressor, causing property damage and business interruption loss. At the time of the loss, the defendant had a number of ongoing performance guarantees and warranties under the original construction contract that were not yet fulfilled (in other words, the original construction contract was not yet complete).
The trial judge held that the defendant was not a named insured for the purposes of the action on the basis that construction was “virtually complete”, stating:
Here, the project was virtually complete. The facility had been operating for a significant period of time. A major portion of the damages involves loss due to business disruption. The negligence was not something that arose as a result of construction, or as part of the construction process. Both the peril and the damage at issue here are of an operating nature, and therefore come within the operating portion of the policy. I do not think that Dresser can come within that coverage.
The Alberta Court of Appeal overturned the trial judge’s decision on this issue.
In the Court of Appeal’s view, the facts showed the construction was still ongoing at the time of loss. The Court of Appeal reasoned that due to the fact that the defendant had continuing contractual obligations to remedy deficiencies, construction was not complete at the time of the breakdown. The Court of Appeal also stated the following:
So long as some construction was still ongoing, everyone had every motive to keep the insurance alive for the benefit of all contractors and trades, even those who had finished. If one workman caused a fire or explosion, it would likely damage the work and materials furnished by all the other contractors and trades. A completed machine is as liable to be damaged by fire or explosion as an unfinished one. No company would want its entire insurance coverage to depend upon the mysteries of when title passed and risk ended under a construction contract (or a contract for sale of goods).
and
The [Trial Judge’s] reasons for judgment say that the insurance should be interpreted as not covering contractors’ property after construction was virtually complete. Whether that was intended as a general proposition of law and a general principle of interpreting construction insurance, or whether it was confined to the facts of this case, is unclear. We have grave doubts about the correctness of either general proposition, for reasons given above. But we need not decide that finally, given our factual conclusion that in this case, construction was neither complete nor virtually complete at the relevant time.
The Alberta Court of Appeal further refined the above approach in Daishowa-Marubeni International Ltd. v. Toshiba International Corp., 2003 ABCA 257. In this case, the wording used in the policy was more restrictive in respect of coverage in that it only extended coverage during certain specified construction activities. Further, this decision suggests that in order to determine whether coverage is in effect at any given time, one must look at the policy, the construction contract and the current state of the construction.
In a recent decision, the Yukon Court examined whether “construction” continued through the one-year warranty period following substantial completion. In Yukon Energy Corporation v. Narrow Gauge Contracting Limited, 2010 YKSC 38, the Court concluded that the definition of “course of construction” in that particular policy, read in conjunction with the warranty period language provided in the Instructions to Tenderers, extended coverage for at least one year after substantial completion.
In summary, if any form of construction is ongoing or potentially ongoing one should look closely at whether coverage should respond to a claim. The Courts are leaning more and more towards the expansion of coverage if any form of construction is ongoing to support the principle that builder’s risk policies are intended, simply, to cover resultant loss to property caused during construction.
Faulty Work/Design Exclusion
The following is the relevant exclusion clause from a typical builder’s risk policy:
A. Perils Excluded
This does not insure:
(a) the cost of making good:
(i) faulty or improper material;
(ii) faulty or improper workmanship;
(iii) faulty or improper design;
This exclusion has been the subject of a great deal of litigation. It is common that where there is damage to property during construction, it usually arises as a result of faulty material, faulty workmanship or faulty design rather than a named peril or one covered by the “all risks” insuring agreement. The word “faulty” does not require negligence but simply requires that the damage was caused by a failure in materials, workmanship or design. There typically is very little damage to property caused by perils during construction other than the result of materials, workmanship or design. As a consequence, the scope of coverage provided by most builder’s risk policies may be minimal if the faulty work/design exclusion is applied.
As a general rule, the courts in Canada have interpreted faulty work and design exclusions broadly. Likewise, the resultant damage exception to the exclusion has been narrowly interpreted, with various courts refusing to separate out related components of a construction project.
The leading cases in Canada include BC Rail Ltd. v. American Home Assurance Co.(1991), 54 B.C.L.R. (2d) 228 (B.C.C.A.), British Columbia v. Royal Insurance Co. of Canada (1991), 60 B.C.L.R. (2d) 109 (B.C.C.A.), Triple Five Corp. v. Simcoe & Erie Group, [1997] S.C.C.A. No. 263, Pentagon Construction (1969) Co. v. United States Fidelity and Guaranty Co., [1976] 1 W.W.R. 55 reversed [1977] 4 W.W.R. 351 (B.C.C.A), and Simcoe & Erie General Insurance Co. v. Royal Assurance Co. of Canada, [1982] 3 W.W.R. 628 (Alta T.D.). Much has been written on whether the court is entitled to look at a component part of the work to determine whether it is faulty or rather whether it must look at whether that component part affects the totality of the project thereby rendering the project faulty. A review of the law reveals that whether a building can be so-called divided into its component parts to determine coverage will depend on the circumstances of each case.
The Alberta case of Simcoe & Erie General Insurance Co. v. Royal Insurance Co. of Canada [supra], involved the collapse of a bridge designed to be used in the construction of a light rail transit system. It was determined that the collpase was caused by a design error. The Court decided that the design error was an error affecting the whole work, namely, the bridge; that the bridge was an integral whole; and that it would be improper to separate the bridge into separate items of property, namely substructure and superstructure, and so regard one of the parts (the superstructure) as excluded from coverage through being damaged by faulty design, and the other part (the substructure) as being excepted from the exclusion as being resultant damage. Only damage to the stored rails constituted resultant damage. Damage here occurred to an integral part of the very property that was subject to the faulty design.
As stated at p. 636:
Is the design error the failure to design a stable bridge, or can there be “design” in stages, or aspects, which is capable of being plucked out of the overall concept, as the plaintiff contends?
With all due respect to the arguments advanced on behalf of the plaintiff, it appears abundantly clear to me that “design” encompasses the totality of the superstructure and that each and every part of the superstructure was integral to the whole, and what, in fact, overturned into the Elbow River was the whole structure. The “design” was, in my view, fundamental to the whole, and when the design was in error the whole of the superstructure was doomed to fail, and did indeed fail.
The product of the work made necessary by the faulty or defective design was the steps which were required to be taken to replace the totally failed structure with a new bridge. This truly was not resultant damage, but the cost to replae faulty design and/or workmanship and so coverage was not afforded.
However, in Foundation Co. v. Aetna Casualty Co., [1976] I.L.R. 1-757 (Alta. T.D) the Court found that faulty compaction of soil materials was not an integral part of the whole project. This case involved the faulty compaction of material underlying a concrete slab floor, which resulted in the collapse of the floor in a building under construction. The insured incurred costs in replacing the floor and all of the many attachments.
The defendant insurer argued that the collapse of the floor was due to faulty compaction, and the cost of replacing same fell within the faulty workmanship/design exclusion or the wear, tear, inherent vice exclusion.
The Court found that the exclusion clause only protected the insurer in relation to the cost involved in replacing or correcting the faulty compaction which underlay the slab including the material and workmanship required to compact it. The cost to replace the collapsed floor and related damage was covered. In summary, damage that resulted from poor compaction work would not exclude damage caused to other parts of the building.
In recent years, insurers have taken steps to market a narrow form of this exclusion. One attempt provides an expansive definition of resultant damage which includes damage to the insured property except for the cost of repairing or replacing the part or component of the insured property which was faulty. Another attempt at providing expansive coverage has been to limit the exclusion to the component part or individual item that is defective.
Since the effect of the faulty work/design exclusion is fact specific to each case, attached is an appendix of key authorities, which outline how the courts have considered this exclusion in varying circumstances.
APPENDIX
Simcoe & Erie General Insurance Co. v. Royal Insurance Co. of Canada, [1982] 3 W.W.R. 628 (Alta. Q.B.)
The City of Calgary undertook construction of a light rail transit system (“LRT”). Part of the LRT system included the design and construction of bridges. The City of Calgary obtained both comprehensive general liability and all risk insurance. The engineers who designed the bridges had their own insurance and were unnamed insureds under the City of Calgary policies.
During the construction of a bridge, rails for another bridge were stored on top of it. Because of a design error in the superstructure of the bridge, the bridge collapsed by overturning. The substructure of the bridge had no design error but it also collapsed. The stored rails were destroyed. The engineers’ insurer paid for the cost of redesigning and constructing a new bridge.
The case arose as a result of the designer’s insurer, the comprehensive general liability insurer and the all risk insurer wanting to know which policy should respond. The parties agreed that the superstructure failed because of design error.
The all risk/course of construction policy read as follows:
This Policy Does Not Cover:…
(b) Cost of making good faulty or defective workmanship, material, design, plan or specification, but this exclusion shall not apply to physical damage resulting from such faulty or defective workmanship, design, plan or specification.
It was decided that the design error was a design error affecting the whole work, namely, the bridge; that the bridge was an integral whole; and that it would be improper to separate the bridge into separate items of property, namely substructure and superstructure, and so regard one of the parts (the superstructure) as excluded from coverage through being damaged by faulty design, and the other part (the substructure) as being excepted from the exclusion as being resultant damage. Only damage to the stored rails constituted resultant damage. Damage here occurred to an integral part of the very property that was subject to the faulty design.
As stated at p. 636:
Is the design error the failure to design a stable bridge, or can there be “design” in stages, or aspects, which is capable of being plucked out of the overall concept, as the plaintiff contends?
With all due respect to the arguments advanced on behalf of the plaintiff, it appears abundantly clear to me that “design” encompasses the totality of the superstructure and that each and every part of the superstructure was integral to the whole, and what, in fact, overturned into the Elbow River was the whole structure. The “design” was, in my view, fundamental to the whole, and when the design was in error the whole of the superstructure was doomed to fail, and did indeed fail.
The product of the work made necessary by the faulty or defective design was the steps which were required to be taken to replace the totally failed structure with a new bridge. The entire loss, but for the rails, was be considered the cost of making good faulty or defective design. The word design in the context of the case comprehends the totality of the scheme, plans and specifications for the bridge. The design was faulty in that the bridge was unstable under its own dead weight.
The result is that all aspects of the excavation and foundation construction comprise and are integral to the whole of the superstructure in the above case.
Bird Construction Co. Ltd. v. United States Fire Insurance Co. (1985), 24 D.L.R. (4th) 104 (Sask. C.A.)
The policy contained the following exclusions:
“cost of making good faulty or defective workmanship or material, but this exclusion shall not apply to damage resulting from such faulty or defective workmanship or material” and
“loss or damage directly or indirectly caused by failure, defect, error, or omission in design, plan or specification.”
Damage was caused to a steel roof truss when it fell to the ground in the course of being lifted into place during erection. A procedure had been developed to erect and install the truss. The trial judge found that the erection procedure was part of the design and that the cause of the accident was faulty erection procedure. The Court of Appeal found that the erection procedure was not part of the design as the plans and specifications did not contain any directions for the erection of the trusses. The plans only included the design and specification for the trusses.
It did find that there had been faulty workmanship. It rejected the insured’s argument that the cost of replacing the truss which it had incurred fell within the exception to the exclusion because the damage to the truss had resulted from faulty workmanship and not from a defect in the truss itself. The purpose of the exclusion is to make it perfectly clear that the insurer will not indemnify the insured for loss or costs incurred by the insured’s faulty workmanship, or as a result of the use of faulty material. The exception to the exclusion is damage “resulting from” the faulty workmanship. That is a reference to something different than the cost of repairing the faulty work.
B.C. Rail Ltd. v. American Home Assurance Co. (1991), 54 B.C.L.R. (2d) 228 (C.A.)
A portion of the insured’s railway was tucked into steep rock bluffs on a hillside. Ballast was continually being lost and the insured had to raise the track at least once a year to replace it. For a permanent repair, the insured designed and created a new grade under the direction of one of its engineers, placing new fill over the existing fill. A landslide occurred a few months after the work was completed. The insured spent $600,000 on a temporary bridge, incurred rerouting costs of $456,340 and built a permanent concrete and steel bridge for $1.2 million. The policy excluded coverage for physical loss or damage caused by faulty workmanship or error in design, subject to the exception that “damage resulting from any of the preceding is hereby covered.” The trial judge found no error in design.
The Court of Appeal found that an “error” may include a “mistake in judgment or incorrect belief as to the existence of matters of fact.” The engineer knew of the possible dangers of construction on certain soil types and had made the assumption, without conducting tests, that such soil was not present despite indications that it could be present. The Court found the design to be “flawed” because it was based on the consultant’s assumption that the sub-stratum of the fill was on colluvium, and that assumption was found to be a “mistake in judgment” based on “incorrect belief as to the existence of matters of fact”. The Court said that even though the consultant may not have been negligent, that was not a question which it was necessary to decide, as it was still an “error in design” within the meaning of the policy. The insured’s engineer, by assuming that the fill substratum rested on soil that would not slip, made such an error.
The loss was not recoverable under the exception to the exclusion clause as “damage resulting” since that phrase referred to something different than the cost of repairing the very thing that had been designed.
The re-routing costs, being consequential economic loss, were not recoverable because the policy insured against risks of “physical loss.”
The insured tried to argue that all permanent repair costs not associated with the cost to recontruct the sliver fill itself are recoverable as “damage resulting”. The insurer argued that the reason for the error in design exclusion is to avoid the policy becoming a warranty of the soundness of the insured’s project designs. An all risk policy is only intended to cover fortuitous events and risks. To interpret the clause to encompass the cost of repairing that which has been designed, would render the exclusion meaningless. Damage resulting from error in design must refer to something different than the cost of repairing the very thing that has been designed.
The majority considered Bird Const. Co. [supra], Poole Const. Ltd. v. Guardian Assur. Co., [1977] I.L.R. 1-879, 4 A.R. 417 (T.D.), Sayers & Assoc. Ltd. v. Ins. Corp. of Ireland, [1981] I.L.R. 1-1436, 126 D.L.R. (3d) 681 (Ont. C.A.), Simcoe & Erie [supra]. Those decisions posed an “insuperable obstacle” to the insured’s claim for the cost of the temporary wooden-piled trestle and of the concrete and steel bridge. The insured relied on Landru v. Inter City Contractors Ltd. (1987), 24 C.L.R. 95, 54 Sask. R. 53 (Q.B.) and Foundation Co. of Can. v. Aetna Casualty Co., [1976] I.L.R. 1-757 (Alta. T.D.). The Court of Appeal noted that in both cases the damage caused by faulty workmanship was sustained by some part of the insured’s property other than the very part which was the subject of the faulty workmanship. It also noted that Poole [supra] expressly disagreed with Foundation Co. [supra].
Triple Five Corp. v. Simcoe & Erie Group (1997), 145 D.L.R. (4th) 236 (Alta. C.A.)
A car left the track of a roller coaster due to the fact that the tracks at several points had been incorrectly spaced which put dangerous stresses on the wheel assembly of the cars during operation. The insurer denied coverage for repair to the roller-coaster and for business interruption on the basis of the design error and latent defect exclusions.
The insured appealed on a variety of issues, including that the design exclusion was not applicable to resultant damage. The insured argued that the property containing the defect was the trackage, and not the cars. If this was so, then the insured would get coverage for the physical damage to the cars and some of the business interruption claim. The trial judge had granted coverage for other property of the mall which the car hit.
The Alberta Court of Appeal found that the exception to the exclusion did not operate. It formulated a test of “otherness” – whether two properties are a single integrated structure – raising a question of fact whether two things are so closely interrelated as to be one. The trial judge found that the cars and track together were intrinsically one entity, a roller-coaster.
Canadian National Railway v. Royal & Sun Alliance Insurance Co. of Canada, [2008] 3 S.C.R. 453
The Supreme Court of Canada’s decision in Canadian National Railway v. Royal & Sun Alliance Insurance Co. of Canada, has injected a nuance into the analysis of “faulty design.” Prior to this case, the accepted test for “faulty design” was whether the thing designed worked for its intended purpose or not. The focus was not on the negligence of the designer, but the functionality of the design, given exposure to foreseeable conditions.
This was the approach followed by the B.C. Court of Appeal in B.C. Rail Ltd. v. American Home Assurance Co. [supra].
In interpreting the phrase “faulty design,” the Court of Appeal referred at length to the Australia High Court decision in Manufacturers’ Mutual Insurance Ltd. v. Queensland Govt. Ry., [1969] 1 Lloyd’s Rep. 214 (Australia H.C.), where “fault” was defined as follows:
Here we are not concerned with the word “fault” or “faulty” as an attribute, importing blame, of a person, or a personified thing. We are concerned with the word “faulty” as descriptive of an inanimate thing. The words “fault” and “faulty” have a different sense. They, again according to their derivation, connote a falling short; but not now a falling short in conduct or behaviour. They designate an objective quality of a thing. It is not up to a required standard. It is “faulty”, because it has defects, flaws or deficiencies…
(at para. 44)
B.C. Rail attempted to distinguish Queensland on the basis that the wording of the AHA exclusion spoke of “error in design” rather than “fault.” The Court of Appeal rejected this argument, observing that the operative word in the exclusion was “design”, not “designing”, and accordingly the focus was not on the acts or omissions of the designer, but rather the adequacy of the design for its intended purpose. The Court’s conclusions are expressed at paras. 52 and 53 as follows:
In both Queensland Ry. and Simcoe & Erie the Courts held that no elements of negligence or blameworthiness were necessary to entitle the insurer to invoke the exclusion clauses there under consideration. Both cases recognize the distinction to be drawn between “designing” and “design,” and strongly suggest that only in the case of the former, i.e., “designing,” does negligence or blameworthiness constitute an essential factor…
But here the design itself was “flawed.” It was based on Mr. Leighton’s assumption that the substratum of the fill was on the colluvium and not on lacustrine soils. That assumption was a “mistake in judgment” based on an “incorrect belief as to the existence of matters of fact,” and even though he may not have been negligent, a question which I do not find it necessary to decide, it was an “error in design” within the meaning of the policy.
In Foundation Co. of Canada Ltd. v. American Home Assurance Co. (1995), 25 O.R. (3d) 36 (Ont. Gen. Div.), Wilson J. considered the “faulty design” exclusion in circumstances where a cofferdam was damaged by a blow-in caused by “the unforeseeable and rare combination of a pocket of gas and slickenside.” The insurer in Foundation argued that the exclusion was triggered simply by the failure of the cofferdam to function as designed, and that it was not necessary to consider whether the failure arose from a “foreseeable” risk. The contractor disputed this interpretation, and argued that “[t]here must be an element of foreseeability of the event giving rise to the loss before a design can be found to be faulty or defective.”
Wilson J. agreed with the insured that the results in Queensland and B.C. Rail were distinguishable on the basis that the impugned designs were inadequate to meet the demands of foreseeable circumstances. In Foundation, the damage arose from an unforeseeable and rare combination of factors. Wilson J. held that in the circumstances the insurer was not able to meet the burden of showing that the loss was caused by faulty design.
The relevant part of the decision reads as follows:
The onus is … upon the insurer to prove that the exclusion applies. To determine whether the onus of faulty or defective design has been met, the words should be given their plain and ordinary meaning. I reiterate the essence of the definitions of faulty or defective. “Faulty” implies containing faults, imperfect, unsound. “Defective” implies a product is not fit for its ordinary purpose. All foreseeable risks must be taken into account in a design. It is not the test of “reasonably foreseeable risks” applicable in the law of negligence.
The design of the cofferdam was sound and fit for its intended purpose, but not for the unforeseeable and rare combination of a pocket of gas and slickenslide. The design of the cofferdam did not cause the blow-in. The designer took into account all foreseeable potential risk factors…
(paras. 151-152)
The Canadian National Railway case adds a further gloss to the analysis of “faulty design.” In Canadian National Railway, the insured had sought to design and build a customized tunnel boring machine for construction of a railway under the Sarnia river. When construction was about 14% complete, the TBM was halted to address an unanticipated problem (viz., dirt penetrating the machine’s cutting head and threatening the integrity of the main bearing that drove the machine forward), with the result that construction was delayed for 229 days.
The trial judge found that despite the machine’s failure, the innovative design “accommodated” within the then limits of the state of engineering knowledge all foreseeable risks encountered in the digging of the tunnel. The trial judge acknowledged that the design proved to be defective, but found that it was not “improper” or “faulty” according to the state of the art at the time the design was finalized. The trial judge concluded that the design not only addressed all reasonably foreseeable risks but all foreseeable risks however unlikely or remote.
The Ontario Court of Appeal in a 2-1 decision reversed the trial judge, holding that in the circumstances there was a failure attributable to “design,” and accordingly the exclusion applied.
The Supreme Court of Canada divided 4-3 in reversing the Ontario Court of Appeal.
The majority of the Supreme Court viewed the Foundation [supra], decision as breaking with the Queensland line of authority, and introducing the concept of foreseeability into the “faulty design” analysis. This is explained at para. 49 of the decision. It appears that the concept of foreseeability seized upon by the majority is context specific, and referable to the state of the art (in this case, the state of engineering knowledge) at the relevant time:
The insurers take the view that a design that fails in circumstances of foreseeable risk would per se trigger the exemption…
In my view, the words “faulty or improper” require the insurers to go beyond simply showing a failure in circumstances of foreseeable risk. The words “faulty or improper,” and in particular the word “improper,” require the insurers to establish that the design fell below a “realistic” standard. Such a standard can require no more than that the design comply with the state of the art. A standard of perfection in relation to all foreseeable risks, in my view, was not required by the words used by the parties. It was for the insurers to demonstrate that the exclusion applies.
While the majority endorses a context-specific approach to the test for “faulty design,” it is evident from the reasons that the exclusion will apply in the vast majority of claims involving a flawed design. Binnie J.’s comments at para. 55 of the decision make this clear:
The insurers are entitled to the benefit of the exemption unless the design [meets] the very highest standards of the day and failure occurred simply because engineering knowledge was inadequate to the task at hand.
Written by former associate, David Plunkett
