The SCC Schools Insurance Company on Insurance Policy Drafting in Progressive Homes Ltd v Lombard General Insurance

For the two little pigs that built their homes out of straw and sticks, the Supreme Court of Canada’s (“SCC”) latest decision in Progressive Homes Ltd v Lombard General Insurance Co of Canada, [2010] 2 SCR 245 [Progressive Homes] presents a happy ending to their harrowing tale of home destruction arising out defective workmanship. In Progressive Homes, the SCC held that an insurer had a duty to defend claims for damage to new homes arising out of defective workmanship, despite the insurer’s protests that the damage did not fall within the coverage of the policies. In coming to this decision, the SCC reaffirmed the duty of insurers to defend claims against the insured and outlined the method for interpreting commercial general liability insurance policies. Based on the SCC’s interpretation of the insurance policies in question, this decision is likely to affect how insurance policies for construction companies are drafted.

Huffing and Puffing was Unnecessary to Blow these Houses Down

This case arose out of four actions that were initiated by the British Columbia Housing Management Commission (“BC Housing”) against Progressive Homes Ltd. (“Progressive”) for breach of contract and negligence. BC Housing hired Progressive to build housing complexes. In summary, BC Housing’s pleadings alleged that defective workmanship made four of the buildings susceptible to water damage, which in turn, caused rot, infestation and deterioration in the buildings. Progressive alleged that sub-contractors were responsible for the defective workmanship. Progressive’s insurer, Lombard General Insurance Co. of Canada (“Lombard”) initially defended Progressive against the claims, though it ultimately withdrew.

Lombard withdrew on the basis that it did not have a duty to defend because the damage was not covered under any of the five insurance policies entered into by the parties. To support its position, Lombard relied upon the decision in Swagger Construction Ltd v ING Insurance Company of Canada et al, 2005 BCSC 1269 which found that similar damage was not covered by a similar insurance policy.

A Brief Summary of the Insurance Policies

Progressive and Lombard had entered into five insurance policies. According to these policies, Lombard had a duty to “defend in the name and on behalf of the Insured and at the cost of the Insurer any civil action which may at any time be brought against the Insured on account of such bodily injury or property damage.” “Property damage” was defined in that same policy as:

(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. [Emphasis added]

“Accident” was defined in the first policy as including “continuous or repeated exposure to conditions which result in property damage neither expected nor intended from the standpoint of the Insured.” In subsequent policies, the term “occurrence” was used in lieu of “accident.” “Occurrence” was defined as meaning “an accident, including continuous or repeated exposure to substantially the same general harmful conditions.” Lombard attempted to escape its duty to defend by arguing that the damage was not “property damage,” and thus did not fall within the policies’ coverage. It also argued that defective workmanship fell within the exclusions to coverage.

Before getting into the SCC’s interpretation of the policies, a brief explanation of insurance law is required. According to Nichols v American Home Assurance Co, [1990] 1 SCR 801, “an insurer has a duty to defend a claim where the  facts alleged in the pleadings, if proven to be true, would require the insurer to indemnify the insured for the claim.” In Progressive Homes, the SCC stated that the duty arises independently of actual liability; all that is required to trigger the duty is the “mere possibility that a claim falls within the insurance policy.” The main issue in Progressive Homes was whether the damage arising out of the defective workmanship fell within the definition of “property damage.”  If the damage did not fall within that definition, then the above duty would not exist.

The Interpretation of “property damage”

Lombard argued that there was no duty to defend because the water damage did not fall within the definition of “property damage”  established by the SCC in Winnipeg Condominium Corporation No 36 v Bird Construction Co[1995] 1 SCR 85 [Winnipeg Condominium]. In Winnipeg Condominium, the SCC held that a piece of cladding that fell off a building constructed by Bird Construction constituted recoverable economic loss, and not property damage. Since the SCC found that damage to other parts of the same building was not property damage in Winnipeg Condominium, Lombard reasoned that property damage only occurs when third-party property is affected. Notwithstanding the fact that Winnipeg Condominium dealt with tort law principles, Lombard adopted this line of reasoning because in a related action for indemnification by Bird Construction’s insurer, the Manitoba Court of Appeal held that the absence of a claim for property damage meant that the latter did not have a duty to indemnify the insured.

The SCC rejected Lombard’s attempt to replace the wording of the insurance policies with tort principles. Instead, it applied the established approach to insurance policy interpretation. According to Non-Marine Underwriters, Lloyd’s of London v Scalera, [2000] 1 SCR 551, the primary interpretative principle is that “when the language of the policy is unambiguous, the court should give effect to clear language, reading the contract as a whole.” Where ambiguity exists, general contract principles are to be applied in a manner that is consistent with the reasonable expectations of the parties. If general contract principles fail to resolve the ambiguity, then the courts are to apply the contra proferentem rule against the insurer. This rule dictates that an ambiguous term will be construed against the party that imposed it.

Using these principles, the unanimous SCC determined that there was nothing in the wording of the policies that explicitly limited property damage to third-party property damage. Damage to “tangible property,” as stated in the insurance policies, included damage arising out of defective workmanship by sub-contractors.

Defective Workmanship can be an “accident”

Lombard’s other argument that the defective workmanship did not fall within the definition of “accident” was also rejected by the SCC. Recall that the definition of “property damage” uses the term “accident” in it. If Lombard could establish that defective workmanship was not an “accident,” then no duty would exist. The SCC made it clear that the assumption that defective workmanship was not an accident did not colour the interpretation of the policies. It stated,

whether defective workmanship is an accident is necessarily a case‑specific determination.  It will depend both on the circumstances of the defective workmanship alleged in the pleadings and the way in which ‘accident’ is defined in the policy…This Court’s jurisprudence shows that there is no categorical bar to concluding in any particular case that defective workmanship is an accident.

The policies were drafted in a manner that did not exclude defective workmanship as an “accident.” In fact, defective workmanship fell within the parties’ definition of “accident” because it was not “expected or intended by the insured.”

Lombard gets Schooled on Legal Drafting

The above summary of the SCC’s decision has the underlying theme of defective legal drafting. In failing to adhere to precedent on the interpretation of insurance contracts, Lombard drafted insurance policies that essentially indemnified a general contractor for the defective workmanship of sub-contractors. At first blush, this result seems to be contrary to public policy considerations rooted in contract law and consumer protection. First, consumers may be negatively affected if indemnification reduces the incentive for contractors to do quality work. Second, the risk allocation agreed upon by the parties may not adequately account for indemnification arising out of defective workmanship by third parties to the insurance contract. Notwithstanding the favourable light that these considerations cast on Lombard’s position, they could not save Lombard from its defective legal drafting. Maintaining certainty in industry-specific contract interpretation requires that parties exercise prudence in legal drafting and take responsibility for their own defects.

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