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September 2016

The Supreme Court Rules on Faulty Workmanship Exclusions and Interpreting Standard Form Contracts

Case Study: Ledcor Construction v. Northbridge

In Ledcor Construction Ltd. v. Northbridge Indemnity Insurance Co., 2016 SCC 37 (“Ledcor”), the Supreme Court of Canada clarified the construction of ‘faulty workmanship' exclusions in all-risk policies and the level of deference an appeal court must give regarding a lower court's interpretation of a contract.

The decision in Ledcor may be praised for providing greater clarity to insurers and insureds, but may also be an unwelcome development to those who embraced the Supreme Court's 2014 decision in Sattva Capital Corp. v. Creston Moly Corp.1 (“Sattva”) as a bar to extensive litigation over contractual interpretation.

Facts

The facts in Ledcor are not unusual. An office tower was being constructed, and the owner of the property on which it was being constructed held a ‘blanket' all-risk property insurance policy providing coverage to the owner and all actors and activities on the property. The policy contained an exclusion specifying the following:2

4(A) Exclusions
This policy section does not insure:

[ . . . ]

(b)        The cost of making good faulty workmanship, construction materials or design unless physical damage not otherwise excluded by this policy results, in which event this policy shall insure such resulting damage.

By the time the tower neared completion, its windows were marred by concrete splatter, paint specs, and construction dirt. Consequently, a contractor was hired to clean the windows of the office who in turn scratched the building's windows through use of inappropriate tools and methods. The windows had to be replaced at considerable expense. A dispute arose regarding which costs were covered under the policy, as it excluded coverage for “faulty workmanship” but also contained an exception that provided coverage for “resulting damage” that followed such workmanship.

Eventually, the dispute arrived at the Supreme Court, which addressed two issues: the degree to which an appeal court was obligated to defer to the interpretation of a contract by a lower court, and the proper interpretation of this rather common exclusion clause.

The contract in Sattva was distinct from the ‘take it or leave it' offers of a standard form contract.

Standard of Review

The standard of review is the amount of deference a higher court ought to give to the decisions of a lower court. If a standard of review is one of ‘reasonableness,' a higher court will defer to a lower court if the conclusions it had drawn in reaching its decisions were one of many reasonable conclusions.3 When the standard of review is ‘correctness,' however, a higher court is far more likely to overturn the decision of a lower court, as it must undertake its own analysis and determine if it agrees with the decision of the lower court; if it does not, it will substitute the lower court's decision with its own ‘correct' one.

In the 2014 decision of Sattva, the Supreme Court of Canada held that contractual interpretation involves issues of mixed fact and law, and that, accordingly, the standard of review regarding a lower court's interpretation of a contract will generally be reasonableness.4 As a result of Sattva, the standard of review of reasonableness was deemed to almost always apply when a superior court reviewed the interpretation of a contract made by a lower court, which would naturally limit the viability of an appeal from a lower court decision regarding the meaning of a contract.

In Ledcor, the Supreme Court of Canada noted that, since Sattva, appellate courts have reached inconsistent decisions as to whether the standard of review for standard form contracts is correctness or reasonableness.5 The majority opinion of the Supreme Court in Ledcor6 clarified this ambiguity by specifying that: “where an appeal involves the interpretation of a standard form contract, the interpretation at issue is of precedential value, and there is no meaningful factual matrix that is specific to the parties to assist the interpretation process, this interpretation is better characterized as a question of law subject to correctness review.”7

Justice Wagner found that the statements in Sattva were made in the context of a “complex commercial agreement between two sophisticated parties” much unlike the ‘take it or leave it' offers in a standard form contract in which the terms of a contract were not negotiated.8 Though factual circumstances such as market conditions have a role in the interpretation process,9 these are not 'fact-specific' in that "they will usually be the same for everyone who may be a party to a particular standard form contract," underscoring the need for consistent interpretation.10

In his conclusion regarding the issue, Justice Wagner further noted that a higher court may defer to a lower court's interpretation in circumstances such as when the factual matrix specific to the particular parties assists in interpretation, or where that contract was negotiated and modified so as to give the interpretation likely little or no precedential value.11

Interpretation of the Faulty Workmanship Exclusion Clause

As the policy's exclusion clause for “faulty workmanship” contained an exception for “resulting damage,” the actual dispute in Ledcor turned on whether the meaning of “faulty workmanship” in the insurance policy included not just the cost of cleaning the windows itself, but the cost of replacing the windows as well. The insurer, preferring the latter interpretation, argued that the exception to this exclusion only provided coverage to some consequential damage to other parts of the tower project.

Indemnity should be available for the most common source of loss on construction sites.

Justice Wagner found that the language of the exclusion clause was ambiguous and did not clearly point to one interpretation of the clause over the other, and so he applied the general legal principles of contractual interpretation.12 On each count, Justice Wagner favoured the interpretation of the insureds.

Perhaps most notably, Justice Wagner found that the reasonable expectation of the parties to the agreement would be “broad coverage,” as “certainty, stability, and peace of mind” is the purpose of ‘builders' risk' policies.13 He determined that the purpose of such broad coverage is furthered by an interpretation of the exclusion clause that only excludes the cost of redoing the faulty work itself, and approved of commentary that indicated that faulty exclusion workmanships are intended to be narrow.14 Justice Wagner further found that it would deprive the insured of the coverage they had contracted for if indemnity was unavailable for the most common source of loss on construction sites: damage or accidents resulting from a party's carelessness or negligent acts.15

Conclusion

The decision in Ledcor may be of great assistance to parties seeking to appeal a lower court's interpretation of standard form contracts, as it reduces the deference accorded by a superior court to that interpretation. However, it also creates the potential disadvantage that another decision unfavourable to the disputing party will form binding precedent, and offers less room to maneuver. Whereas previous to Ledcor, it may have been possible to argue that the factual matrix surrounding the formation of an agreement required each court to decide on the meaning of a contractual term independent of that term's interpreted meaning in other decisions, this avenue now appears to be largely closed. Furthermore, Ledcor creates additional litigation risk to successful parties in an interpretation dispute, as it is predictable that virtually any appellant in such a dispute will argue that their contract is a ‘standard form contract' or otherwise meets the criteria so as to make the standard of review set out in Sattva inapplicable.

The impact of Ledcor on future decisions will be clearer when insurers seek to dispute the meaning of faulty workmanship exclusions in all-risk insurance policies going forward. It is now clear that an exclusion such as that relied upon by the insurer in Ledcor will be construed narrowly, and an exception to an exclusion seized upon. This is particularly the case for all-risk policies such as the ‘builders' risk' policy analyzed by the Supreme Court of Canada in the instant case. Ledcor provides more ammunition for those asserting coverage obligations despite ‘faulty workmanship' exclusions, and offers yet another indicator that exclusions in all-risk policies will continue to be interpreted as narrowly as possible to favour the insured.

Thus, while Ledcor may provide greater certainty to the insurance industry regarding the scope of coverage in an all-risk policy, it has undermined the certainty provided for in Sattva that a matter of contractual interpretation by a lower court is, for most intents and purposes, the final word.


1 [2014] 2 SCR 633
2 Ledcor Construction Limited v Northbridge Indemnity Insurance Company, 2015 ABCA 121 (CanLII), para. [4]
3 The ‘reasonableness standard of review typically arises when the determination made by the lower court is mainly or exclusively factual.
4 Sattva Capital Corp. v. Creston Molly Corp, 2014 SCC 53, para. [106] ; per paragraph [54], an ‘extricable question of law' (such as whether the lower court applied an incorrect principle, failed to consider a required element of a legal test, or failed to consider a relevant factor) could still be reviewed on the standard of review of correctness, but these were “inherently rare” per para. [55].
5 Ledcor Construction Ltd. v. Northbridge Indemnity Insurance Co., 2016 SCC 37, paras [24] and [25]
6 Justice Cromwell dissented regarding this issue and posited that the standard of review set out in Sattva ought to apply equally to standard form contracts; Ledcor Construction Ltd. v. Northbridge Indemnity Insurance Co., 2016 SCC 37, paras [114] to [125]
7 Ledcor Construction Ltd. v. Northbridge Indemnity Insurance Co., 2016 SCC 37, para. [24]
8 Ibid., para. [25]; Justice Wagner noted that in insurance contracts, negotiations are typically regarding matters of cost premiums, and the conditions of coverage are not negotiated at all at paras [27] – [29].
9 Examples of elements with a role in the interpretation process are the purpose of the contract, the nature of the relationship it creates, and the market in which it operates; see Ledcor Construction Ltd. v. Northbridge Indemnity Insurance Co., 2016 SCC 37, para. [30]
10 Ledcor Construction Ltd. v. Northbridge Indemnity Insurance Co., 2016 SCC 37, para. [30]
11Ibid., para. [48]
12 Ibid., para. [63]; these criteria are the reasonable expectation of the parties, that the interpretation not yield unrealistic results, and was consistent with prior jurisprudence.
13 Ibid., para. [66]; Notably, while Justice Wagner refers to the policy as a “'builders' risk' policy” he appears to dismiss any distinction between policies identified as ‘builders' risk' and any other common all-risk property insurance at para. [1]; further, note that the “work product” or “business risk” exceptions in other policies may also be susceptible to the same scrutiny, as noted in para. [83]
14 Ibid., para. [72]
15 Ibid., para. [70]


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