Supreme Court Provides a Window to Uniform Interpretation of Standard Form Insurance Contracts

The Supreme Court of Canada has provided guidance to the insurance industry on the interpretation of standard form insurance contracts in the recent decision of Ledcor Construction Ltd. v. Northbridge.

Ledcor Construction (“Ledcor”) was a general contractor in charge of building an office tower in Calgary.  Ledcor hired a sub-contractor to complete a “construction clean” of the windows of the building.  The sub-contractor used improper tools and methods to clean the windows and ended up causing $2.5 million in damage to the windows, which had to be replaced.

Ledcor and the building’s owner made a claim under their builders’ risk policy (“Policy”) for the cost of replacing the windows.  The Policy excluded coverage for  “the cost of making good faulty workmanship” but provided an exception to the exclusion in cases where “physical damage not otherwise excluded by this policy results” from faulty workmanship.

The insurers denied coverage based on the faulty workmanship exclusion: they argued cost of replacing the windows was the cost of making good faulty workmanship.  The insurers argued that the exception for physical damage resulting from faulty workmanship did not apply because the physical damage at issue was physical damage to the very thing the sub-contractor had been hired to work on.  The insurer’s view was that the exception to the exclusion would only be triggered if there was incidental damage caused to some other part of the project.  Ledcor and the building’s owner argued that any physical damage caused by faulty workmanship was covered and that it was just the cost of redoing the work (washing the windows, in this case) that was not covered.

The Alberta Court of Queen’s Bench found in favour of Ledcor and the building’s owner, holding that the exclusion and exception were ambiguous and so should be interpreted against the insurers. The Alberta Court of Appeal overturned this decision.  They found that the exclusion and exception were not ambiguous and interpreted the exclusion and exception largely in line with the position of the insurers.

The Supreme Court of Canada overturned the Court of Appeal and found that Ledcor and the building’s owner were entitled to be indemnified for the $2.5 million replacement cost of the windows.

Standard of Review for Standard Form Contracts

The first issue considered by the Supreme Court was the level of deference that an appellate court should pay to a trial or motions judge’s interpretation of a standard form contract.

In its 2014 decision of Sattva Capital Corp v. Creston Moly Corp., the Supreme Court restated the law of contractual interpretation, holding that appellate courts should be highly deferential to trial and motions judges’ contractual interpretation findings.  The Sattva Court held that since contractual interpretation is highly fact specific, the analysis of the trial or motions judge should only be overturned if the judge made a palpable and overriding error.  The Court provided for a very limited exception to this deferential standard of review for the “rare” extricable questions of pure law that arise in the interpretation process.  In these rare instances an appellate standard of correctness was appropriate.

Since Sattva, provincial appellate court decisions have been split as to whether the interpretation of standard form contracts were subject to the deferential standard of appellate review set out in Sattva.  The Ledcor case gave the Supreme Court the opportunity to resolve the debate: the interpretation of standard form contracts are an exception to the general rule of deference established in Sattva and are subject to an appellate standard of review of correctness.

The Court reasoned that an exception to the general rule in Sattva was appropriate since a) in standard form contract cases the motion or trial judge is not conducting an individualized analysis of the “factual matrix” because there are generally contracts of adhesion, and b) because standard form contracts are widely used, there is precedential value to their interpretation which gives their interpretation a character of a question of law.  The Court observed that consistency was particularly important in standard form insurance contracts, and that ambiguous insurance policies ought to be interpreted in a consistent way by different courts.

Interpreting the Policy: Claim is Covered

The Court then turned to consider the interpretation of the Policy’s exclusion and exception.  The  Court held that the exclusion and exception were ambiguous.  Accordingly, they interpreted the Policy with regard to general rules of contractual construction, including the reasonable expectations of the parties.

In considering the reasonable expectations of the parties, the Court relied heavily on the purpose behind builders’ risk policies: to provide broad coverage that limits the need to resort to private litigation, making construction projects grind to a halt.  The Supreme Court relied on numerous academic articles concerning the nature of builders’ risk policies in coming to this conclusion on the purpose of the policy.

Based on the reasonable expectations of the parties, the Court held that the exclusion only excluded the cost of redoing the sub-contractor’s work.  Since the sub-contractor here was only hired to clean the windows, it was only the cost of re-cleaning the windows that was excluded from the policy.  The replacement cost of the windows was covered.

Interestingly, the Court held that if the windows had been broken by the sub-contractor who was hired to install the windows, the replacement cost of the windows would not have been covered.  In that situation, “redoing the work” would mean installing the windows in good condition.  Broken windows in that situation would not have been “resulting damage” caused by the sub-contractor, and would have fallen under the exclusion against making good faulty workmanship.

Take-away for Insurers

Although the result in this case was unfavourable to the insurers, the insurance industry can take comfort that the Supreme Court adopted an approach that will ensure the consistent interpretation of insurance contracts by the courts going forward. This outcome was not guaranteed in light of the principles of contractual interpretation laid down by the Court its earlier Sattva decision.  A strict application of Sattva (which had been employed by some provincial appellate courts) would have prevented appellate courts from harmonizing inconsistent lower court interpretations of the same policy language.

Also, the Supreme Court’s emphasis on considering the history and purpose of a type of policy in interpreting coverage and exclusions will allow insurers to guard against inventive policy interpretations by insureds that are inconsistent with the history and purpose of the type of policy at issue in future cases.