A financial safeguard for builders
Many construction projects proceed without incident. Unfortunately, experience shows that damage can occur during construction, leading to significant repair or replacement costs. Builder’s risk insurance is specifically designed to indemnify against property loss to buildings and structures while they are under construction.
In the leading case of Commonwealth Construction Company v. Imperial Oil Limited, the Supreme Court of Canada described the function of builder’s risk insurance (also known as course of construction insurance) as follows:
Whatever its label, its function is to provide to the owner the promise that the contractors will have the funds to rebuild in case of loss and to the contractors the protection against the crippling cost of starting afresh in such an event, the whole without resort to litigation in case of negligence by anyone connected with the construction, a risk accepted by the insurers at the outset.
The parties generally insured under a builder’s risk policy are the owner, the general contractor and all sub-contractors. The policy term runs from the beginning of construction through to completion of the project, which often is tied to occupancy of the building or structure in question.
When a loss does occur, the first question to be addressed is whether the damage falls within the scope of coverage afforded by the insuring agreement in the policy. In this regard, it is important to note that the risk typically insured under a builder’s risk policy is direct physical loss or damage to property in the course of construction. This means that existing buildings and structures, property not located on site and the contractor’s tools and equipment normally are not included within coverage.
While policy wordings will often vary, most builder’s risk policies are written on an “all risks” basis, the result of which is to provide very broad coverage narrowed only by the exclusions in the policy. In the case of an all-risks policy, the party looking for coverage need only show that the loss in question was fortuitous, meaning accidental, unintentional or unexpected. It is not necessary to prove the exact nature or cause of the loss. Less frequently, coverage will be provided on a “named perils” basis, meaning that the damage must be caused by one of the specific perils set out in the policy. Named perils coverage obviously is much less expansive than that afforded in an all-risks policy.
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Once it is determined that a loss falls within the insuring agreement in the policy, the next step is to determine whether any exclusions apply. It is a general principle of insurance law that exclusion clauses in a policy are to be narrowly construed. Risks that are typically excluded from coverage in a builder’s risk policy include faulty design, material or workmanship, latent defect, inherent vice and wear and tear. While a detailed analysis of these exclusions is beyond the scope of this article, a few general comments can be made.
The purpose of the exclusion relating to faulty material or workmanship is to remove from coverage the insured’s liability to repair or replace its defective or deficient work product. In the absence of this exclusion, the policy would be transformed into a performance bond or guarantee of the policyholder’s contractual performance. In addition, Canadian courts have consistently held that the term “faulty” is not limited to negligence but is broader and more encompassing. In other words, the exclusions might apply even when there has been no negligence on the part of the insured.
With respect to the exclusion for design flaws, the Supreme Court of Canada has held that a design is not “faulty or improper simply because it does not meet a standard of perfection in relation to all foreseeable risks.” In other words, the exclusion will not apply where it can be shown that the design in question met the foreseeable risks with the diligence and expertise that at the time were state of the art.
It is important to note that provisions excluding coverage for faulty or improper workmanship generally do not apply to “resultant damage” to the property. In this regard, the typical builder’s risk policy defines “resultant damage” as damage to some part of the insured property other than the part of the property that was faultily designed. In practical terms, this means that costs associated with repairing the defective property itself are excluded, while losses resulting from the defect or deficiency are brought back within coverage.
From a practical standpoint, it is often difficult to separate the part of the work that was the subject of faulty or improper material or workmanship from the rest of the work. Canadian courts have generally taken the view that, where an insured party undertakes work or supplied product that consists of several components, the exclusion dealing with faulty or improper materials, workmanship or design extends to the whole of the work or the entire project and the “resultant damage” exception does not apply.
Builder’s risk insurance is an effective means of safeguarding the financial interests of parties involved in construction. That said, these policies do not cover all property and every risk. In each case, interested parties are cautioned to carefully review the policy in question to determine the nature and extent of coverage available.
Dean Giles is a partner with Fillmore Riley LLP who practises primarily in the areas of general civil and commercial litigation and insurance law. You may contact him at deangiles@fillmoreriley.com.
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