Ledcor Construction: The First and Large Exception to Sattva
Canadians routinely open bank accounts, take out loans, sign insurance, and wireless agreements. To facilitate these daily processes, companies often use standard form contracts. You do not need legal training to realize that such contracts are “take it or leave it” prepositions. However, for a business such as a construction company signing an insurance policy, standard form contracts can involve high premiums and coverage in the millions of dollars.
In Ledcor Construction Ltd v Northbridge Indemnity Insurance Co, 2016 SCC 37 [Ledcor] the Supreme Court of Canada (“SCC”) looked at the interpretation of a construction insurance standard form contract, often called a builders’ risk insurance policy. More specifically, the SCC looked at an exclusionary clause that denied coverage for the “cost of making good faulty workmanship” but nonetheless covered “physical damage” that “results” from such faulty workmanship.
Two important contract law issues emerge from Ledcor. The first, which will have consequences for all industries that use standard form contracts, is the standard of review that appellate courts should give such contracts. The second issue is confined to the construction industry. It clarifies the scope of “faulty workmanship” exclusions found in builders’ risk policies.
Station Lands Ltd (“Station”) was the owner of a building under construction. Station purchased a builders’ risk policy that covered all cases of direct physical loss or damage during construction, with some exceptions. The policy had a clause that excluded “the cost of making good faulty workmanship … unless physical damage not otherwise excluded by this policy results, in which event this policy shall insure such resulting damage” (Ledcor, para 10). The general contractor of the building, who along with other subcontractors was covered under the insurance policy, was Ledcor Construction Limited (“Ledcor”).
During construction, the windows of the building were dirtied and Bristol Cleaning (“Bristol”) was hired to clean them. In the course of the cleaning, the windows were badly damaged due to Bristol’s work. The replacement cost was $2.5 million. Station and Ledcor claimed the cost of the replacement of the windows under their builders’ risk policy. The insurers, however, denied coverage on the basis of the “cost of making good faulty workmanship” exclusion in their policy.
Trial and Appellate Decisions
At trial, after determining that the work performed by Bristol amounted to faulty workmanship, the trial judge found the clause ambiguous and applied the contra proferentem rule against the insurers (para 12). The trial judge found that “the cost of making good” applied only to the cost of re-doing the cleaning. According to the trial judge, the cost of replacing the windows was resulting damage and should be covered as it did not fall under the exclusionary clause.
The Alberta Court of Appeal (“Court of Appeal”) overturned the trial judge’s decision under the correctness standard. It held that the rule of contra preferentem was incorrectly applied by the trial judge as the clause was not ambiguous (para 13). According to the Court of Appeal, the issue was the dividing line between the damage that was excluded as the “cost of making good faulty workmanship” and the physical damage that was covered as “resulting damage.” The Court of Appeal devised a three-part test to determine physical or systemic connectedness and reasoned that the damage excluded physical loss as part of the “cost of making good faulty workmanship.”
Standard of Review
The first issue before the SCC was the standard of appellate review to be applied to a trial judges’ interpretation of a standard form insurance contract. In Sattva Capital Corp v Creston Moly Corp, 2014 SCC 53 [Sattva], Justice Rothstein held that “contractual interpretation involves issues of mixed fact and law, as it is an exercise in which the principles of contractual interpretation are applied to the words of the written contract, considered in light of the factual matrix” (para 50) (TheCourt.ca’s analysis of Sattva can be found here). In Ledcor, Justice Wagner stated that where an appeal involves the interpretation of a standard form contract, the interpretation at issue is of precedential value and the interpretation is better characterized as a question of law. It is thus subject to correctness review instead (para 24).
In distinguishing the holding in Sattva, Justice Wagner relied on two factors that do not apply to standard form contracts. First, the factual matrix for a regular contract is an important consideration in contractual interpretation (Sattva, paras 47-49). However, the factual matrix is often less relevant for a standard form contract, where the parties do not negotiate the terms (Ledcor, para 28). Second, Sattva stated that contractual interpretation does not fit within the definition of a pure question of law as it normally only affects the parties to the dispute. However, Justice Wagner noted that since standard form agreements may be identical through an entire industry, the interpretation of a standard form contract could very well be of “interest to judges and lawyers in the future” and as such the interpretation itself has precedential value (para 43). Therefore, the SCC found that Sattva should not be read as holding that contractual interpretation is always a question of mixed fact and law, which warrants deference on appeal.
Having established the standard of appellate review for standard form contracts, the SCC moved on to the interpretation of the exclusionary clause in the contract under review. The SCC found that the exclusion deals with a form of pure economic loss stemming from contractual breach, not necessarily physical loss (para 57). Unlike the Court of Appeal, the SCC deemed the language of the exclusionary clause to be ambiguous. Parties’ reasonable expectations with respect to the meaning of a contractual provision will often be gleaned from the circumstances surrounding the contract’s formation. The parties in this case had given no thought to the cleaning of the windows. However, a broader analysis of the insurance policy would show that the purpose behind builders’ risk policies is to provide broad coverage for construction projects (para 66).
An interpretation of the exclusionary clause that precludes from coverage any and all damage resulting from a contractor’s faulty workmanship merely because the damage results to that part of the project on which the contractor was working would undermine the purpose behind the entire policy (para 70). As such, the SCC found that the position of Ledcor on the meaning of the clause better reflected the purpose of the builders’ risk policies.
Some commentators have hailed Ledcor as a victory for policy holders. In my opinion, the victory for policy holders emerging from Ledcor is quite limited. For example, had Bristol been involved in the installation of the windows, the resulting damage would fall under the exclusion clause and as such, the costs of the window replacement would not have been covered (para 85). Insurers can still significantly change the terms of their standard form contracts to take into account the narrow interpretation of the exclusion.
The question of the standard of review for standard form contracts emerging from Ledcor will have broader consequences. Justice Wagner stated that where the appeal involves the interpretation of a standard form contract, the interpretation at issue is of precedential value. As such, there is no meaningful factual matrix specific to the particular parties to assist the interpretation process and this interpretation is better characterized as a question of law (para 46). Even after distinguishing Sattva, the SCC acknowledged that there will be cases where the factual matrix will be important in standard form contract interpretation. Will this lead to parties arguing that their case is an exception to the standard form exception? What about cases where a different standard may apply to different parts of the policy?