INDEMNITY COVERAGE UNDER A CGL POLICY AFTER PROGRESSIVE HOMES. by Thomas G. Heintzman, O.C., Q.C. 1

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1 INDEMNITY COVERAGE UNDER A CGL POLICY AFTER PROGRESSIVE HOMES by Thomas G. Heintzman, O.C., Q.C. 1 A: OVERVIEW The decision of the Supreme Court of Canada in Progressive Homes Ltd. v. Lombard General Insurance Co of Canada 2 is a seminal decision with respect to the application of CGL policies to the construction industry. While the immediate effect of the decision was with respect to the insurer s duty to defend the insured, in the course of its decision the Supreme Court implicitly rejected some of the long-standing positions of insurers about the ambit of the a commercial general insurance policy, particularly as the policy applies to construction projects. In an article in the recent edition of Skylines, the CBA National Construction Section s publication, the Progressive Homes decision has been well reviewed by Andrew Heal, particularly from the aspect of the insurer s duty to defend the insured. In this article, I will dig deeper into three indemnity coverage issues with which the Supreme Court was dealing in Progressive Homes. Those issues are: 1. Whether the events in question gave rise to an accident under the CGL policy; 2. Whether damage to property arising from damage to other parts of the property amounted to property damage under a CGL policy; 3. Whether the damage was excluded because it related to the insured s own work. I will then consider the decision of the British Columbia Court of Appeal in Bulldog Bag Ltd. v. AXA Pacific Insurance Company, 2011 BCCA 178 (CanLII). That decision appears to be the first by a Canadian court which analyzes and applies the Progressive Homes decision to the substantive indemnity coverage of a CGL policy. A CGL provides coverage for liability arising from bodily injury or property damage, but the discussion in this paper only relates to property damage coverage. Coverage for property damage arises if two conditions are satisfied. First there must be property damage. Property damage is usually defined to include three elements: physical injury to tangible property, including resulting loss of use of that property, or loss of use of tangible property that is not physically injured. 1 Thomas G. Heintzman is counsel in the Toronto office of McCarthy Tétrault and an arbitrator and mediator at Arbitration Place, Toronto. 2 [2010] 2 SCR 245 1

2 Second, there must be an event giving rise to coverage. That event is usually described in the policy as an occurrence or an accident. B: ELEMENTS OF THE DECISION IN PROGRESSIVE HOMES 1. Accident or Occurrence Canadian case law has debated the meaning and scope of these words. The debate has circulated around whether negligence or a result of negligence is included within the word accident. The modern origins of this debate in Canada are found in the 1952 decision of the Supreme Court of Canada in Andrews & George Co. v. Canadian Indemnity Co. 3 In that decision, Justice Rand wrote one of the judgments, and he expressly excluded the results of negligence from the concept of accident : To treat mistaken action of that nature as an accident would render the word superfluous. What is meant is something out of the ordinary or the likely, something fortuitous, unusual an unexpected, not in the ordinary course, guarded against.what [the parties] did not aim at were direct and unexpected damages from the daily risks which it was part of their business of production and sale to face and eliminate. Justices Kerwin and Estey did not agree and stated the matter this way:..the defective condition was unsuspected and undesired and, therefore, there was an accident which caused the damage to property to others. In 1975, the Supreme Court of Canada returned to the subject in Strait Towing Ltd v. Washington Iron Works (sub nom. Canadian Indemnity Co v. Walkem Machinery & Equipment Ltd. 4 In his judgment for the court, Justice Pigeon specifically stated that Justice Rand s statement about the meaning of the word accident clearly does not form part of the ratio decidendi. He dismissed the same conclusion of the Manitoba Court of Appeal, from which the appeal was taken. He said: With respect, this is a wholly erroneous view of the meaning of the word accident in a comprehensive business liability policy. On that basis, the insured would be denied recovery if the occurrence is the result of a calculated risk or of a dangerous operation. Such a construction of the word accident is contrary to the very principle of insurance which is protection against mishaps, risks and dangers.in everyday use, the word [accident] is applied as Halsbury says in the passage quoted, to any un-looked for mishap or occurrence.in construing the word accident in this policy, one should bear in mind that negligence is by far the most frequent source of exceptional liability which a businessman has to contend with. Therefore, a policy which wouldn t cover liability due to negligence could not properly be called comprehensive. (emphasis added) In 1976, in Pickford & Black Ltd. v Canadian General Insurance Co. 5 the Supreme Court quoted with approval from the judgment Justice Pigeon In Walkem Machinery, saying that any 3 [1953] SCR 19 4 [1976] 1 SCR [1977] 1 SCR 261 2

3 unlooked for mishap or occurrence.. is the proper test and that the damage due to shifting of cargo during shipment was due to an accident even if the shifting of the cargo arose in turn from the negligent storage by the stevedores at the time of loading. In 1978 in Mutual of Omaha Insurance Co. v. Stats, 6 the Supreme Court of Canada expressly held that the word accident included the negligence of the actor whose activities are being considered because to exclude from the word accident any act which involved negligence would be to exclude the very largest portion of the risks insured against. In 2003, in Martin v. American International Assurance Life Co., 7 the Supreme Court of Canada considered the meaning of the word accident in the context of an insurance policy covering death through accidental means. It adopted its decisions in Stats and Justice Pigeon s judgment in Walkem Machinery, holding that: death is not non-accidental merely because the insured could have prevented death by taking greater care, or that a mishap was reasonably foreseeable in the sense used in tort law. Nor does a death that is unintended become non-accidental merely because that person was engaged in a dangerous or risky activity.the jurisprudence assigns a generous meaning to accidental in the absence of language to the contrary in the insurance policy. In Progressive Homes, Lombard argued that, in the context of a building, the damage was not accidental. It asserted as follows: Lombard argues that when a building is constructed in a defective manner, the end result is a defective building, not an accident. It relies on case law that, in its view, supports its argument that faulty workmanship is not an accident It relies on Ryan J.A. s conclusion, in the court below, that this interpretation would offend the assumption that insurance provides for fortuitous contingent risk. Lombard argues that interpreting accident to include defective workmanship would convert CGL policies into performance bonds. In my opinion, these general propositions advanced by Lombard do not hold upon closer examination. Speaking for the court, Justice Rothstein held that whether the workmanship in question led to an accident depended on the specific facts of the case. But there was nothing to prevent faulty workmanship from falling within that word. He said: I, therefore, cannot agree with Lombard s view that faulty workmanship is never an accident. This Court s jurisprudence shows that there is no categorical bar to concluding in any particular case that defective workmanship is an accident. In Canadian Indemnity Co. v. Walkem Machinery& Equipment Ltd., 1975 CanLII 141 (SCC), [1976] 1 S.C.R. 309, at pp , the Court found that the negligent repair of a crane constituted an accident. Therefore, I see no impediment to concluding the same in the present case, unless of course it is not supported by the specific language of the policy. (emphasis added) Justice Rothstein also rejected Lombard s submission that so interpreting the word accident would eliminate the concept of fortuity in the CGL policy. He said: 6 [1978] 2 SCR [2003] 1 SCR 158 3

4 I cannot agree with Justice Ryan s conclusion that such an interpretation offends the assumption that insurance provides for fortuitous contingent risk. Fortuity is built into the definition of accident itself as the insured is required to show that the damage was neither expected nor intended from the standpoint of the Insured. This definition is consistent with this Court s core understanding of accident : an unlooked-for mishap or an untoward event which is not expected or designed When an event is unlooked for, unexpected or not intended by the insured, it is fortuitous. This is a requirement of coverage; therefore, it cannot be said that this offends any basic assumption of insurance law. Finally, Justice Rothstein rejected Lombard s submission that so interpreting the word accident would convert the CGL policy into a performance bond: I am not persuaded by Lombard s argument that equating faulty workmanship to an accident will convert CGL policies into performance bonds. There seems to be a fairly significant difference between a performance bond and the CGL policies at issue in this case: a performance bond ensures that a work is brought to completion.whereas the CGL policies in this case only cover damage to the insured s own work once completed. In other words, the CGL policy picks up where the performance bond leaves off and provides coverage once the work is completed. Justice Rothstein accordingly concluded that: Accident should be given the plain meaning prescribed to it in the policies and should apply when an event causes property damage neither expected nor intended by the insured. According to the definition, the accident need not be a sudden event. An accident can result from continuous or repeated exposure to conditions. Since the pleading against Progressive Homes did not allege intentional conduct but rather negligence, then the claim fell within the coverage provided by the policy. Accordingly a duty to defend arose. While the decision in Progressive Homes resulted in the duty to defend being found, it was an essential part of the logic in arriving at that decision, and therefore part of the ratio decidendi of the decision, that the word accident includes the result of negligent conduct. Accordingly, it appears that this issue is settled for similarly worded CGL policies under the law of Canada. 2. Damage to Property arising from another part of the Property Lombard argued that the damage to one part of a building from another part of the same building did not amount to property damage but only to economic loss. This submission based on the distinction in tort law between property damage and economic loss. Lombard asserted that the consequential property damage in this case was economic, not property, damage. The Supreme Court did not accept this submission and declined to bring principles of tort law into insurance contract law. Justice Rothstein said: I cannot agree with Lombard s interpretation of property damage. The focus of insurance policy interpretation should first and foremost be on the language of the policy at issue. General principles of tort law are no substitute for the language of the policy. I see no limitation to third- 4

5 party property in the definition of property damage. Nor is the plain and ordinary meaning of the phrase property damage limited to damage to another person s property.i would construe the definition of property damage, according to the plain language of the definition, to include damage to any tangible property. I do not agree with Lombard that the damage must be to thirdparty property. There is no such restriction in the definition. (emphasis added) Interestingly, Justice Rothstein also relied upon the exclusion for work performed in arriving at this conclusion: The plain meaning of property damage is consistent with reading the policy as a whole. Qualifying the meaning of property damage to mean third-party property would leave little or no work for the work performed exclusion (discussed in more detail below). Lombard argues that the exclusion clauses do not create coverage. This is true. But reading the insurance policy as a whole is not the same as conjuring up coverage when there was none in the first place. Consistency with the exclusion clauses is a further indicator that the plain meaning of property damage is the definition intended by the parties. Finally, and even though it was not argued in the appeal, Justice Rothstein held that defective property could constitute property damage. Again, he reached this conclusion based not only on the plain meaning of those words but also by reference to an exclusion: While this point was not contested and nothing turns on it in this appeal, it is not obvious to me that defective property cannot also be property damage. In particular, it may be open to argument that a defect could not amount to a physical injury, especially where the harm to the property is physical in the sense that it is visible or apparent Moreover, where a defect renders the property entirely useless it may be arguable that defective property may be covered under loss of use, the second portion of the definition of property damage.. not barring defective property from the definition of property damage at the outset gives meaning to the exclusion clauses discussed below. Specifically, the second version of the policies expressly excludes coverage for defects. This would be redundant if defects were excluded from property damage at the outset. While perfect mutual exclusivity in an insurance contract is not required, this redundancy supports the view that the definition of property damage may not categorically exclude defective property. (emphasis added) Again, while the final decision was that Lombard had a duty to defend, it was a necessary step in court s reasoning that damage to other property on or in the same site or building due to other property on the same site or building fell within the policy. Accordingly, this matter should be now settled under Canadian law for CGL policies with the same wording. 3. The Work Performed Exclusions (a) Work performed by the Contractor or Subcontractor Exclusions with respect to work performed are common in CGL policies. They are also expressed in different ways in different policies, and in the Progressive Homes case, there were two different forms of work performed exclusions. In the first version of the policy the original work performed exclusion was modified by what was called a General Liability Broad Form Extension Endorsement. The 5

6 original policy excluded 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. That clause was replaced by clause (Z) in the Broad Form Extension Endorsement, which excluded property damage to work performed by the Named Insured arising out of the work or any portion thereof, or out of materials, parts or equipment furnished in connection therewith. Justice Rothstein found that the clause (Z) exclusion did not apply to property damage caused by a subcontractor, or to the subcontractors work, whether caused by the subcontractor, another subcontractor or the insured contractor. He reasoned as follows: The clause (Z) exclusion is limited to work performed by the insured. Unlike the clause that it replaced, it does not apply to work performed on behalf of the insured. The plain language is unambiguous and only excludes damage caused by Progressive to its own completed work. Justice Rothstein said that he would have arrived at the same result by the application of the contra proferentem principle, especially since the insured would have expected different coverage from different wording. (b) The Particular Part of the Work exclusion The work performed exclusion relied upon by Lombard in another policy excluded: Property damage to that particular part of your work arising out of it or any part of it and included in the products - completed operations hazard. (emphasis added) Justice Rothstein noted the words particular part of your work and said: Unlike the standard form version of the work performed exclusion (clause (i)) reproduced above, this version expressly contemplates the division of the insured s work into its component parts by the use of the phrase that particular part of your work This means that coverage for repairing defective components would be excluded, while coverage for resulting damage would not Again, I find there is a possibility of coverage under the second version of the policy. It will have to be determined at trial which particular parts of the work caused the damage. Repairs to those defective parts will be excluded from coverage under this version, regardless of whether they were the result of Progressive s own work or the work of subcontractors. If, as Lombard alleges, the buildings are wholly defective, then the exclusion will apply and Lombard will not have to indemnify Progressive. (emphasis added) Once again, this logic was a necessary step in the court s finding that there was a duty to defend. Accordingly, under similar language in CGL policies, a work performed exclusion should not exclude property damage arising from damage caused to one part of the work by defective components in another part. C; APPLICATION OF PROGRESSIVE HOMES IN BULLDOG BAG (a) What is the binding effect of the Progressive Homes decision? 6

7 The broad scope of an insurer s duty to defend adopted by the Supreme Court of Canada in Progressive Homes has been picked up and applied in numerous lower court decisions in Canada. Important as that duty is, the fundamental importance of Progressive Homes relates to the indemnity coverage provided by a CGL policy. After that decision was released, the question remained: would lower courts consider that Progressive Homes was only a decision about the duty to defend, and everything else was obiter? As stated above, in my view the Supreme Court s decision about the duty to defend was necessarily based upon its decision regarding indemnity coverage. So, its decision regarding the coverage in a CGL policy should be considered as part of the ratio decidendi of the decision, and therefore binding on lower courts. Would lower courts see it this way? The decision of the British Columbia Court of Appeal in Bulldog Bag Ltd. v. AXA Pacific Insurance Company, 2011 BCCA 178 (CanLII) appears to be the only decision so far which has directly considered and applied the Progressive Homes decision to the substantive coverage of a CGL policy. In doing so, the B.C. Court of appeal resoundingly recognized that the Supreme Court s decision in Progressive Homes had fundamentally changed the law relating to the coverage in a CGL policy. In the very first paragraph of the Court of Appeal s decision, it said In its recent decision in Progressive the Supreme Court of Canada reversed a line of insurance cases that had taken a narrow view of the scope of coverage under commercial and general liability ( CGL ) policies commonly used in Canada and the U.S..the Court determined that property damage in such policies is not limited to damage to third-party property and can include damage from part of a building to another part, previously regarded as irrecoverable pure economic loss (para. 36); that the term accident may, depending on the facts of each case, include the consequences of defective workmanship (paras. 39, 46); and that, again depending on context, the own product/work exclusion is to be construed narrowly or contra proferentem, such that it may be limited to damage caused by the insured to its own work and not extend to resulting damage. (emphasis added) (b) Background facts of Bulldog Bag Bulldog manufactured plastic packaging and sold it to Sure-Gro, with emblem and other printing on it in accordance with Sure-Gro s instructions. Sure-Gro used the packaging for manure and soil products which it sold to Canadian Tire. The ink later came off the packaging, so Bulldog had to supply new packaging and Sure-Gro had to retrieve, re-package re-deliver the manure and soil products to Canadian Tire. Bulldog paid Sure-Gro s claim against it for about $824,000 and sought recovery from its CGL insurer. Bulldog conceded that about $86,000 was the cost of the initially defective bags and did not seek coverage for that amount. So its net insurance claim was about $732,000. Reversing the trial judge s decision, which was based on the case law prior to Progressive Homes, the Court of Appeal held that Bulldog s claim was covered under its CGL policy. Because of the decision in Progressive Homes, AXA reversed its position at trial and now conceded that Bulldog s claim fell within the initial coverage in the policy. AXA conceded that so far as the scope of property damage it was no longer necessary to show damage to third party property, that the faulty workmanship that resulted in the defective bags qualifies as an 7

8 accident or occurrence under the CGL policy, and that the failure of the ink was neither expected nor intended and resulted in property damage. (c) The reasons and effect of the Bulldog Bag decision As a result, the major impact of the decision in Progressive Homes was conceded by the insurer and did not form part of the reasoning of the B.C. Court of Appeal. For this reason, I suppose, it is possible for another insurer to contest these implications of the Progressive Homes decision. But since those concessions formed a central basis for the reasoning in the Bulldog Bag case, and since the B.C. Court of Appeal clearly announced in the opening paragraph of its decision that Progressive Homes had change the law, it would seem very difficult for another CGL insurer to argue to the contrary. Instead, AXA argued that the exclusion clause in the policy applied. That clause read as follows: This insurance does not apply under Insuring Agreement 1(c) to claims for property damage to: (a) goods or products manufactured or sold by the Insured; or (b) work done by or on behalf of the Insured where the cause of the occurrence is a defect in such work, but this exclusion shall only apply to that part of such work that is defective. (emphasis added) AXA acknowledged that para. (b) did not apply, since it dealt with work done and not goods or products. However, it argued that the proviso in para. (b) did not appear in clause (a) and was not an apt proviso for para. (a) since that paragraph did not refer to work, but rather to goods or products.) AXA also argued that while the Progressive Homes had changed the law regarding the interpretation of CGL policies, it had not changed the basic principle in the earlier cases to the effect that those policies are not intended to pay the costs associated with repairing or replacing the insured s defective work and products. The Court of Appeal disagreed. It said: Bearing in mind that exclusion clauses are to be read narrowly and in a manner consistent with the parties reasonable expectations, I find that the clause operates to exclude claims for damage to Bulldog s bags, including loss of use thereof, but cannot be extended to compensation for Sure-Gro s costs separating those bags from its products, repackaging in different bags, and salvaging the old product some months later. To deny coverage would, as Mr. Ward suggested, be a perversion of Progressive Homes. The Court of Appeal also pointed out that, even prior to Progressive Homes, the own product exclusion had been held not to apply to loss incurred by the insured s customer as a result of defects in the insured s own product. 8

9 Finally, the Court of Appeal held that its conclusion was supported by the reference in Progressive Homes to one of the work performed exclusions in that case. Referring to paragraph 68 of the decision in Progressive Homes, the Court of Appeal said: At para. 68, the Court ruled that this clause excluded only coverage for defective property and that Coverage would remain for resulting damage. As Bulldog notes, the language of clause 6(a) in the case at bar is even more favourable to the insured than the foregoing version of the exclusion in Progressive Homes here, the clause does not purport to exclude coverage for claims that flow from the plaintiff s defective work or work product, and excludes only coverage for property damage to goods supplied by the insured. (emphasis added) Finally, AXA argued that Bulldog s claim was not covered due to a clause which excluded claims arising from loss of use of tangible property that has not been physically injured or destroyed. The Court of Appeal held that the product that remained stuck to the plastic of the defective bags was physically injured or destroyed, at least in the sense that it had ceased to be useable for its intended purpose. D: CONCLUSION Now that one Canadian Court of Appeal has considered and applied the Progressive Homes decision to the indemnity coverage under a CGL policy, it is safe to predict that other courts will do so as well. In the result, a fundamental change in the scope of CGL policies has occurred. The change is at two levels. First, at the conceptual level: a. The policy will be interpreted in accordance with the plain meaning of the words in the policy, and contra proferentem in the event of ambiguity. b. No longer will pre-conceptions or in terrorem arguments be applied. Such arguments, that by so interpreting the policy it will be turned into a performance bond or another type of insurance, will not be given weight. Rather, the court will apply the plain words of the policy. c. If the common meaning of those words provides coverage, then the policy will apply unless the insurer demonstrates that an exclusion apply. Second, at the level of the particular coverage: a. If the policy covers damage arising from an accident or occurrence then the policy will cover damage arising from the insured s negligence unless that coverage is specifically excluded. b. If the policy excludes damage to the insured s own work, the policy will cover damage to other property, even if arising from the insured s own work, again unless coverage for that damage is specifically excluded. c. If the policy excludes damage arising from damage performed by the insured contractor, it will not exclude damage arising from work performed by a subcontractor or others. 9

10 d. If the policy excludes damage to a particular part of the work, it will not exclude damage to other parts of the work, even if caused by the damage to the excluded portion of the work. e. The coverage in the policy for damage will be read widely and will apply to damage arising from a defective product or to a product if it is rendered unfit for its intended use. Each of these latter conclusions are sensible since, as Justice Rothstein effectively held in Progressive Homes, the plain meaning of the words in question ( accident, damage, by, part etc.) may include the event or loss in question. If the insurer wished to unambiguously provide otherwise, it should do so expressly. 10