Insurers often rely on the faulty or improper workmanship exclusion under a Course of Construction (aka Contractors’ All Risk or Builders’ Risk) insurance policy to deny coverage for claims arising from imperfect workmanship. Specifically, the LEG 2/96 exclusion clause, developed by the London Engineering Group for large infrastructure projects, is relied upon by insurers.
Until August 2014, there had been no formal legal direction regarding the interpretation of the clause. Some assumed that insurers could deny coverage if workmanship had failed to meet the standard of perfection. Others assumed that the clause excluded everything that had resulted from faulty workmanship.
In Acciona Infrastructure Canada Inc. v. Allianz Global Risks US Insurance Company, 2014 BCSC 1568 (“Acciona”), the Plaintiffs were design-build contractors of a project to construct a 500-bed patient facility at Royal Jubilee Hospital in Victoria, British Columbia. They brought an action against their insurer for indemnity for losses alleged to have occurred as a result of deflection and cracking of the hospital’s concrete slab floors, which essentially resulted in the slabs being unlevel. The British Columbia Supreme Court found the cause of the deflection and cracking to be the failure of the formwork/reshoring procedures, which accounted for the unusually thin design of the slabs. It was not caused by faulty design. Though the slabs met the necessary building code requirements and design safety standards, they nevertheless required extensive repair and remediation work.
The first issue for the Court to decide was whether the provisions of the insurance policy required the loss to be fortuitous. The policy did not expressly contemplate that coverage was for accidents or fortuitous events only. Despite this, the Court held that the concept of fortuity had been incorporated into the wording of the policy because it was the very essence of insurance.
The second issue for the Court to resolve was whether the deflection and cracking fell within the purview of “direct physical loss or damage to the property insured.” The Plaintiffs argued that the over-deflection of the slabs had been caused by damage to the supporting rebar as a result of the slabs having been overloaded during construction. The insurers, on the other hand, argued that the deflection was the result of a defect in the slab, and was not fortuitous. They further argued that coverage under a builders’ risk policy should not extend to mistakes in construction.
Ultimately, the Court sided with the Plaintiffs, holding that the slabs had been left in a permanently altered state, and therefore had been damaged. The Court would not address the issue of whether the cause of the damage was one of design, or of faulty workmanship, reasoning that these issues ought to be considered in light of the policy’s exclusion clause.
The third and central issue for the Court to determine was whether the faulty or improper workmanship exclusion clause (LEG 2/96) applied. This was the first time that a Canadian court had been called upon to interpret this clause.
The insurers argued that the clause insured against damage that results from defects, but did not insure against the defects themselves. They also argued that the intent of the clause was to extend coverage for any consequential or resultant damage caused by the defective work, and they therefore denied the entire claim. The Plaintiffs, on the other hand, submitted that the clause should be interpreted narrowly, and that once there were findings of damage and defect, a determination should be made of the total costs to rectify the damage caused by the defect. Then, from that recoverable cost, the policy would exclude only the costs of repair that would have ameliorated the defect immediately prior to the damage occurring.
The Court ruled that workmanship is “faulty or improper” when it fails to meet the standard of perfection in relation to all foreseeable risks. However, the failure of the formwork and reshoring trades to account for the unusually thin slabs constituted a defect in workmanship, within the meaning of the clause, because the defects in the design were apparent at the time that the work had been carried out.
Even though the exclusion applied, it only excluded the costs that would have remedied or rectified the defect immediately before any consequential or resultant damage occurred. The Court still awarded the Plaintiffs the cost of rectifying and replacing the damaged property itself, reasoning that the excluded costs crystallized immediately prior to the damage occurring, and indemnity was thus limited to the costs that would have prevented the damage from happening.
The Acciona decision is noteworthy for insurers because it is the first time that a Canadian court has interpreted the improper workmanship exclusion. In the future, in order to rely on the clause, insurers will have to demonstrate more than just imperfect workmanship. They will have to prove that the workmanship fell below the applicable standard of care, and involved a lack of foresight that amounts to a defect. Furthermore, insurers should beware that even if they can prove that the workmanship was defective, they will not be able to deny the entire claim. They will be limited to denying only the costs which would have prevented the damage from happening; they will have to pay the costs associated with rectifying or replacing the damaged property itself.