Court Denies Coverage for Property Damage “Connected” to Faulty Workmanship

Author: Corbin Devlin 

 The Alberta Court of Appeal has issued an important decision that narrows the scope of all risks insurance coverage.  The court was grappling with the question whether damage to a project resulted from “poor workmanship” or is “resulting damage.” The “cost of making good” poor workmanship is excluded from coverage under the typical all risks policy, while resulting damage is covered.

Scratched Windows
 
The claim arose during the construction of the EPCOR Tower in Edmonton (Ledcor Construction Limited v Northbridge Indemnity Insurance Company). The subcontractor Bristol was hired to clean the exterior of the building when the project was nearly complete. Bristol scratched the windows on the tower by using inappropriate tools and methods, and the glass had to be replaced at great expense. 

The insurer denied that the replacement cost was covered by the all risks insurance policy. In 2013, a judge determined the replacement of the glass was covered.  In particular, the trial judge found that the insurance policy was not clear as to whether replacing the glass was a cost of making good faulty workmanship, or a cost of repairing resulting damage. The trial judge said that any ambiguity in the insurance policy must be resolved in favour of the claimant. The cost of replacing the glass was therefore covered.

A Reversal
 
Now, the Alberta Court of Appeal has reversed this decision by the trial judge, saying that the all risks policy is not ambiguous at all.  The court says that the “dividing line” between poor workmanship and resulting damage is determined by “physical or systemic connectedness”. Some property damage caused by faulty workmanship may still be covered. But the damage was excluded from coverage in this case because the scratched windows are too closely connected to the window cleaning work. 

The Court expresses a principle of general application as follows: “The exclusion (considered together with the exception) excludes from coverage the cost of redoing the work. But it also excludes damage connected to that work, such as any damage caused to the very object or part of the work on which the faulty workmanship is being applied. In this case, the cost of redoing the exterior cleaning of the EPCOR Tower is admittedly excluded. Also excluded is the damage to the windows being worked on at the time, which damage was directly caused by the cleaning activities that constituted the faulty workmanship. This damage was not only foreseeable, but it was highly likely (even inevitable) that this type of damage would result if the work was done in a faulty way. That type of damage is presumptively not within the scope of the insurance policy; the policy is not a construction warranty agreement.”

Connected and Foreseeable
 
Other words, the Court is saying that property damage is excluded from all risks insurance coverage if the damage is the foreseeable and direct result of faulty workmanship. Sounds straighforward? To interpret the policy in this particular case required a trial and a detailed examination of the nature of the work, the various parts of the project, the foreseeability of the damage, and other factors. The question of “physical or systemic connectedness” still leaves plenty of room for disputes over the scope of coverage.

There is no doubt the Court has endorsed a narrower interpretation of all risks insurance coverage.  But it is important to note that the specific wording of all risks policies may vary, and different circumstances might result in an interpretation more favourable to the claimant, in cases of property damage caused by faulty workmanship.

"Incorporation by Reference" – More Dangerous Than it Sounds

Author: Corbin Devlin 

 It is common, almost universal, to find a clause in a construction subcontract that incorporates the prime contract by reference. However, the effects of such a clause can vary greatly. Too often, these provisions are considered boilerplate and they not given the consideration they deserve, by general contractors and subcontractors alike.

Alternate Approaches
 
These “incorporation by reference” clauses usually leave unanswered questions, particularly whether they are effective to incorporate the general conditions of the prime contract (e.g. payment terms, liquidated damages, dispute resolution, warranty…?) and if so, just exactly how the general conditions of the prime contract apply to the subcontractor.

The most comprehensive clause is one that not only incorporates the prime contract but also expressly binds the subcontractor to all prime contract terms; e.g. “any reference to Owner in the prime contract is interpreted as a reference to the Contractor, and any reference to Contractor is interpreted as a reference to the Subcontractor.” Such language is favored by some general contractors – it is no doubt very protective of the general contractor. CCA1 uses similar language. While such a clause might seem quite explicit, the cases show that such a clause actually leaves much room for dispute when it comes to the legal effect of the prime contract general conditions on the subcontractor. The general contractor’s relationship with the subcontractor is not a mirror image of the owner’s relationship with the general contractor, and so this type of clause leaves room for ambiguity. Ambiguity eventually leads to dispute, which does not benefit the general or the sub.

Another common approach is a relatively simple clause that states, in essence, “the prime contract is incorporated by reference.” This approach is less comprehensive from the owner's perspective. There is a body of case law that indicates such a clause really just incorporates those aspects of the prime contract that have clear application to the subcontractor; i.e. the drawings, specifications and schedule – but typically not the general conditions. Such a clause is therefore less ambiguous than our first example, although it is still open to dispute.

Another approach is to reference (or attach) specific provisions of the prime contract into the subcontract. This selective approach leaves much less room for ambiguity. It requires more work at the drafting stage, and is therefore much less common.

The best practice (in strict legal terms) may be to avoid incorporation by reference completely, by writing a subcontract that reinforces and coordinates with the relevant terms of the prime contract. But such a fulsome approach is usually quite impractical.

The Subcontractor Who Never Sees the Prime Contract 
 
It is all too common that the subcontractor does not actually obtain or review the prime contract terms and conditions that are supposedly incorporated by reference. In such cases, the proper interpretation of the subcontract may depend on whether the subcontractor is in fact given access to the prime contract, or the relevant parts of it.

Sometimes a subcontractor is not given access to the prime contract. There is case authority suggesting that it will invalidate the “incorporation by reference” clause if the general contract denies the subcontractor access to the prime contract. Similarly, if a subcontractor is only given access to parts of the prime contract, the subcontractor has a good legal argument that the “incorporation by reference” is limited to those parts. 

Of course, it is a different scenario if the prime contract terms and conditions are made available to the subcontractor, but  fails to avail itself of the opportunity. Every time a subcontractor agrees to a clause that incorporates the prime contract by reference, without reviewing the prime contract terms and conditions, that subcontractor incurs a considerable legal risk.