Builders take note: BCCA upholds interpretation of common defective workmanship exclusion

A unanimous panel of the B.C. Court of Appeal recently upheld a 2014 B.C. Supreme Court decision which interpreted, for the first time, the “LEG 2/96” exclusion clause for defective workmanship common in some Course of Construction insurance policies.

shutterstock_300502271The LEG 2/96 is one of three model defective workmanship exclusion clauses developed by the London Engineering Group, a U.K. think tank that develops policy wording for the insurance industry. By way of comparison, the LEG 1/96 contains the broadest exclusion by excluding recovery for all loss or damage due to defects of workmanship or design. The LEG 3/96 is the narrowest exclusion, as it only excludes the costs incurred to improve the original material, workmanship, or design. The LEG 2/96 falls in the middle and excludes:

all costs rendered necessary by defects of material workmanship, design, plan, or specification, and should damage occur to any portion of the Insured Property containing any of the said defects the cost of replacement or rectification which is hereby excluded is that cost which would have been incurred if replacement or rectification of the Insured Property had been put in hand immediately prior to the said damage.

For the purpose of this policy and not merely this exclusion it is understood and agreed that any portion of the Insured Property shall not be regarded as damaged solely by virtue of the existence of any defect of material workmanship, design, plan or specification.

Course of Construction, or “Builder’s Risk,” insurance policies seek to insure against certain defined risks which may occur during the construction process.

Background and Decision Below

The Plaintiffs were hired to design and build the new Patient Care Centre, an eight story reinforced concrete structure, at the Royal Jubilee Hospital in Victoria. A subcontractor was hired to design and build the concrete framework, including constructing the thin concrete slabs that comprised the flooring. During construction these slabs over-deflected, causing concave recessions in the middle of some of the slabs, as well as cracking in the slabs, support walls and columns. Although found to be structurally safe, the slabs were functionally defective as they created an uneven flooring surface which did not meet the serviceability requirement under the contract. The Plaintiff claimed indemnification from its Insurers under their Course of Construction Policy (the “Policy”) for the costs of repairing the damage. The Insurers argued that all of the damage was excluded from coverage by virtue of the LEG 2/96 exclusion clause included in the Policy.

At trial, Justice Skolrood made a key finding of fact, namely that the design of the slabs was not defective. Rather, the defect was found in the faulty formwork and re-shoring procedures used during construction and the damage was the resulting over-deflection and cracking of the slabs.

Rejecting the Insurers arguments on the issue, Justice Skolrood found the over-deflection constituted damage for the purpose of the Policy, as the slabs were left in an altered physical state. Such damage was fortuitous as the slabs were not designed to deflect to the point of rendering them unfit for their intended purpose. As a result, the loss fell under the “Perils Insured” provision of the Policy and was within the scope of coverage, subject to any exclusion clauses.

This brought the analysis to the central issue in the case – whether the LEG 2/96 exclusion applied. Justice Skolrood found that, while the clause was intended to exclude the costs of the defect, the exclusion is limited to the costs that would have been incurred to remedy the defect immediately before any resulting damage occurred. Thus, the exclusion does not operate to exclude the cost of remedying the damaged property itself; rather, “the excluded costs crystallize immediately prior to the damage occurring and are thus limited to those costs that would have prevented the damage from happening.”

Having found that the defect was in the defective formwork and shoring procedures, such preventative costs in this case would be the cost of implementing proper procedures, which would have been minimal. Thus, the exclusion was held not to apply to the cost of repairing the damage to the slabs themselves, and the Plaintiffs were entitled to recover $8.5 million in this regard.  Read more.

This article was originally posted on the Canadian Appeals Monitor blog on November 27, 2015.

Builder's Risk Course of Construction Insurance LEG 2/96 exclusion clause

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