January 22, 2007

Finding insurance coverage

What insurance coverage does a contractor really have under a standard policy?

There is often confusion regarding the coverage available to general contractors under a standard comprehensive general liability (“CGL”) insurance policy. In particular, an issue will often arise as to the extent in which claims for property damage to the building itself are covered by the general contractor’s CGL policy.

Traditionally, Courts have held that an entire building is the work product of a general contractor and that claims for property damage in respect of the building itself are excluded by the work/product exclusion contained in most contractors’ CGL policies; there is no coverage for what can be called “shoddy work”. In short, a CGL policy is not meant to take the place of a performance bond.

There is, however, a recent trend in the British Columbia Courts, fueled in large part by the leaky condominium crisis, to find sufficient coverage in a contractor’s CGL policy to trigger an insurer’s “duty to defend” (A “duty to defend” is an insurer’s obligation under an insurance policy to retain counsel to defend a claim made against its insured).

Legal services for complex construction claims are expensive. Given the extraordinary cost of defending claims, an insurer that has had its defence obligations triggered may be willing to make a significant contribution towards settling a claim arising from faulty construction. That is, even if an insurer is of the view that it has little exposure for the faulty construction itself, it may be willing to contribute to a settlement to save legal expenses. In the worst cases, efforts are made to include a CGL insurer for no other reason than to trigger this defence cost exposure - a practice often described in the insurance industry as “defence cost extortion”. Some CGL insurers, as a matter of principle, refuse to contribute to a settlement on this basis; however, there are CGL insurers who will, and do contribute in individual cases.

Broadly speaking, a contractor’s CGL policy is designed to insure the risk that the contractor’s work or product might cause bodily injury or property damage to another. That is, the CGL policy covers resultant damage. There are two types of “property loss” which CGL’s traditionally do not insure: losses which are purely economic in nature, and losses which arise from deficiencies in the contractor’s “own work or product”.

Purely economic losses, injuries only to one’s pocketbook and not to person or property, are generally not a type of loss covered in the standard definition of “property damage” under a CGL policy. An example of a typical definition is:

(1) physical injury to or destruction of tangible property which occurs during the policy period, including the loss of use thereof at any time resulting therefrom, or (2) loss of use of tangible property which has not been physically injured or destroyed provided such loss of use is caused by an accident occurring during the policy period.

Courts in British Columbia and elsewhere have found that the use of phrases in the definition of property damage such as “physical injury” and “destruction of tangible property” takes a loss which is purely economic outside of coverage of most CGL policies.

General contractors have unsuccessfully argued in construction cases that a defect in one part of a building’s structure has caused damage to other portions of the building’s structure in an attempt to avoid having a loss characterized as a purely economic one. This is the so called “complex structure theory”. This theory of loss was roundly rejected by the Supreme Court of Canada and this rejection was followed in an insurance case by the Manitoba Court of Appeal.

In addition to purely economic losses, the CGL policy has never been intended to cover the risk that the insured might have to make good its work or product where the work or product is defective. This “own work” or “product” limitation to coverage is generally the subject of an express exclusion, as follows:

This Insurance does not apply . . .

(f) to property damage to work performed by or on behalf of the Named Insured arising out of the work or any portion thereof, or out of materials, parts or equipment furnished in connection therewith.

Canadian Courts in interpreting the “own work” or “product” exclusion have generally refused to find coverage for a contractor for the cost of having to repair or replace the contractor’s own negligently performed work as opposed to the cost of redressing damages caused to others through the contractor’s carelessness. The underlying purpose of the exclusion is to avoid the possibility of unscrupulous contractors bidding for jobs, performing the work carelessly and at minimum cost to themselves, and then claiming from the insurer for the cost of redoing the work as it should have been done in the first place. Accordingly,

”work product” is subject to specific exclusions contained in the policy, whereas “pure economic losses” generally fall outside of the definition of what constitutes damage under a particular CGL policy.

The duty to defend of a CGL policy is much like any other insurance policy; the duty is generally coextensive with the duty to indemnify. There are, however, exceptions to this rule and a duty to defend can exist even where the insurer may not be called upon ultimately to indemnify an insured. The duty to defend arises where the claim alleges acts or omissions falling within the policy coverage, while the duty to indemnify arises only where such allegations are proven at trial. The mere possibility that a claim within the policy may succeed suffices to trigger a duty to defend. The duty to defend is therefore broader than the duty to indemnify.

Contractors faced with claims should always consider the potential applicability of their CGL policy. If their solicitor is involved, contractors should not assume that their solicitor has given the application of the policy due consideration. As the foregoing indicates, coverage under a CGL policy is not a straight-forward matter and your solicitor should be specifically asked to consider its application to any claim alleging construction defects.

Christopher Hirst and Norman Streu are partners within the construction and engineering practice of the Vancouver law firm, Alexander Holburn Beaudin & Lang LLP. Norm Streu is also past chair of the Vancouver Regional Construction Association.

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