Canada: Supreme Court Limits "Cost Of Making Good" Exclusion, But Leaves Residual Uncertainty

The Supreme Court of Canada has released its much-anticipated decision in Ledcor Construction Ltd. v. Northbridge Indemnity Insurance Co.¹ The case is notable in three ways. First, it continues a trend of the Court bringing real commercial sense to the interpretation of insurance policies. Second, it restricts the scope of the faulty workmanship exclusion to the actual cost of redoing the work. Third, it unfortunately provides unnecessary commentary that may result in some ongoing uncertainty, particularly in the area of faulty design.

The facts of the Ledcor decision are straightforward. A contractor was hired to clean the windows of the EPCOR Tower in Edmonton. At the time, the building was under construction and was insured under an all risks builders-risk wrap-up policy (the "Policy"). In the course of cleaning the windows, the contractor used improper materials and equipment, resulting in significant damage to them. The owner and general contractor claimed the cost of the windows' replacement under the Policy, which contained the following exclusion clause:

The insureds argued that this clause only excluded the cost of redoing the faulty work, which they said was the cost of re-cleaning the windows. The insurers argued that this clause excluded both the cost of redoing the faulty work and the cost to repair that part of the insured's property on which the work was being performed. The insurer argued that "resulting damage" applied to consequential damage to some other part of the insured's property.

The Court agreed with the insured and concluded that the exclusion only applied to the cost of redoing the work. In doing so, the Court noted that this result aligns with the commercial realities of construction projects, the very purpose of builders' risk policies, and the expectations of both insureds and insurers when they enter into such all risk policies.

The Court also made significant findings on broader questions of law. Most notably, the Court confirmed that trial judges interpreting standard-form insurance contracts are subject to a "correctness" standard. This means that their interpretation must be consistent across all cases involving that particular standard-form policy. As a result, policyholders with standard-form wording should always be aware of court cases interpreting their contracts.

In this case, the standard-form faulty workmanship exclusion (with a resulting damage exception) was held to exclude only the cost of redoing the faulty work. While this was an excellent result for the insured, and is generally favourable to policyholders, the Court went on to discuss a number of examples of prior appellate cases which may result in some residual uncertainty.

Most notably, the Court's interpretation of the exclusion clause places considerable emphasis on the work for which the contractor, or subcontractor, was hired to perform. As a result, the entire contractual obligation may greatly affect whether coverage is excluded.

For example, the Court referred to Ontario Hydro v. Royal Insurance², in which a contractor was responsible for designing a boiler system, acquiring the material and supervising the commissioning of the boiler. After installation, the contractor performed an acid wash of the superheater which caused extensive cracking to the tubing in the boilers. The judge in that case concluded that the cost of making good the faulty workmanship included the cost of the tubing and therefore excluded those costs from coverage. The Supreme Court appears to have agreed with this conclusion, because replacing the tubing was "necessary for the contractor to fulfill its contractual obligation". In the context of Ledcor, this means that if the window cleaner had also contracted to fabricate and install the windows, the claim may have been excluded.

The Court also considered "faulty design" cases where a contractor is engaged to both design and build an "item". The Court identified that where a contractor makes a mistake in the design of the "item" that is "integral to the whole of that item", the costs to repair or replace that "item" would be excluded from coverage. For example, the Court referred to Simcoe & Erie General Insurance Co. v. Royal Insurance Co. of Canada³, where an engineer was hired to design and oversee the construction of a bridge. Because the engineer made a design error that was fundamental to the whole of the bridge, and because "making good" the design involved replacing the entire structure, the exclusion applied. Unfortunately, it is not clear from the passage, whether the Court turned its mind to cases were a particular part of the design resulted in damage to other parts. In other words, it is not clear whether the Court's reference to the "item" was to a particular component of the structure or if it would always apply to the entire structure.

Ultimately, the take-away for policyholders in this case is that, when someone is contracted to perform a particular task, a "cost of making good" exclusion of this type will only exclude the cost of redoing that particular contractor's work. This interpretation will favour cases where the scope of work is limited. Where the contractor's project scope is broad and undefined, the costs of redoing that particular contractor's work will remain a live legal issue. This is especially true in faulty design cases where the question of whether the fault was "integral to the whole" is ambiguous.

Overall, this decision is a well-reasoned interpretation of the exclusion. In a case where a window washer caused resulting damage, the exclusion was correctly limited to the cost of rewashing the windows, and the actual damage was covered. While we recognize some of the Court's references to prior decisions may be relied on by insurers to undermine the general application of this principle, the insured will be able to rely on the clear and unequivocal statement by the Court that the exclusion only applies to what is involved in actually re-doing the specific work.

Footnotes

1. 2016 SCC 37

2. [1981] O.J. No. 215 (QL)

3. [1982] 3 W.W.R. 628.RE

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