The Traps And Perils Of Limitation Of Liability Clauses

In Swift v. Eleven Eleven Architecture Inc., the Alberta Court of Appeal recently considered the impact and scope of a limitation of liability clause in a consultant’s contract between an owner and the architects on a building project. The court arrived at three important conclusions.

First, the clause did not apply to and did not bar a claim by a co-owner of the property who had not signed the consultant’s contract.

Second, the clause did not apply to a negligent misrepresentation made by the sub-consultant engineers during the project.

Third, the architects could recover the full amount of the settlement payment made by it to the owners from the engineers on restitutionary principles.

This decision has important ramifications for architect and engineers, and indeed for anyone who is a party to a building contract containing a limitation of liability clauses.

Background

The owner Mr. Swift hired the architects to design a home on property owned by Mr. Swift and his wife, Mrs. Swift. The architects hired engineers as sub-consultants to design the structure of the home. The consultant contract dated April 29, 2005 was only between Mr. Swift and the architects, and Mrs. Swift was not a party to it. The consultant contract contained the following limitation of liability clause:

“3.8.1 With respect to the provision of services by the Designer to the Client under this Agreement, the Client agrees that any and all claims which the Client has or hereafter may have against the Designer which arise solely and directly out of the Designer’s duties and responsibilities pursuant to this Agreement (hereinafter referred to in this Article 3 as “claims”), whether such claims sound in contract or in tort, shall be limited to the amount of $500,000.00.”

The engineers designed the home to a Part 9 standard, not the higher Part 4 standard for seismic purposes, under the British Columbia building code. The contractor became concerned about the structural design of the building from a seismic standpoint and retained an engineer to review the matter. Ultimately the municipality stated to the parties that the building had to be designed to a class 4 standard. The engineers then advised that the building’s design met the Part 4 standard, when in fact it did not. The building of the home was delayed and further costs were incurred due to the structural mis-design. As a result, the owner incurred $1.9 million extra expenses and sued the architects and engineers. Before trial, the architects settled the owners’ claim against them for $1 million. Two claims proceeded to trial: the owners’ claim against the engineers; and the architects’ claim against the engineers to recover the $1 million the architects had paid to the owners.

Trial decision

The trial judge held that the limitation clause applied to the claim of both Mr. and Mrs. Swift as Mr. Swift had acted as Mrs. Swift’s agent in signing the consultant’s contract and that the limitation clause applied to all the Swift’s claims including the negligent misrepresentation claim against the engineers. The trial judge also decided that, by reason of the limitation clause the architect was only entitled to indemnity from the engineers for $500,000 of the $1 million they had paid the Swifts in settlement before trial.

Appeal Decision

Was Mrs. Swift bound by the limitation clause?

The Alberta Court of Appeal held that there was no evidence that Mr Swift had acted as agent for Mrs. Swift in signing the consultant’s contract and that she was not bound by the consultant’s contract and by the limitation of liability clause in it. The court noted that “Mr. Swift testified that he was signing the Agreement on his own behalf only. Ms. Swift testified that Mr. Swift did not have authority to sign an agreement or the Agreement on her behalf. The Architects testified that they did not believe that Mr. Swift was executing the Agreement on Ms. Swift’s behalf. This evidence, together with the language of the Agreement defining only Mr. Swift as the “client”, ought to have ended the discussion on actual authority.”

Moreover, no evidence ought to have been admitted to try to prove that Mrs. Swift was an undisclosed principal to the contract through Mr. Swift’s agency, for two reasons:

First, the consultant’s contract unambiguously showed that Mr. Swift was the only client.

Second, in order for an undisclosed principal to be liable on a contract, the surrounding circumstances must permit the possibility of identifying the undisclosed principal, by showing that the agent was not acting as the real and only principal. That was simply not the case here.

Scope of the limitation clause

The Alberta Court of Appeal agreed with the trial judge that the limitation clause applied to and protected the architects and those which it retained, including the engineers. However, it found that there was a good argument that the clause applied to each wrongful act, so that if there were multiple wrongful acts the client was entitled to multiple times the limit of damages. In light of its decision about the negligent misrepresentation, it held that it did not need to decide this issue.

Negligent Misrepresentation

The Alberta Court of Appeal held that the negligent misrepresentations made by the engineers during the project, that the structural design satisfied the Part 4 standard, was not covered by the limitation clause in the consultant’s agreement.  Even if the tort claims contemplated by the original consulting contract were limited by the limitation clause, the negligent misrepresentation claim arising from the conduct of the engineers during the project was not so limited. That conduct occurred in September 2006, long after the consultant contract had been made in April 2005. In response to inquiries from the architects, the municipality and another engineer, the engineers promised to bring the structural engineering of the building up to the Part 4 standard, and then confirmed that they had done so when they had not. That representation caused a delay in starting the remedial work and as construction progressed, it became more expensive to undertake the required work. The court held that “it would be unreasonable to conclude that such negligent misrepresentation was contemplated as being something that “arises solely and directly” out of [the architect’s] duties and responsibilities. This is particularly so given that the structural defects presented a real and substantial danger to its occupants.”

Accordingly, Mr. Swift was entitled to recover the full $1.9 million loss from the engineers. Since he had recovered $1 million from the architects, he was entitled to the further $900,000 from the engineers.

Indemnity

The Alberta Court of Appeal held that the architects were entitled to a full indemnity from the engineers based, not on contract or contributory negligence principles, but upon restitutionary principles. The architects had settled the Swifts’ claim against them for $1 million, and the courts favoured settlements. Since the architects’ liability only arose due to the engineers’ fault, the engineers should indemnify the architects for that full amount.

Comments

There are many issues and questions arising from this decision which could be analyzed. But for the moment, the following advice appears to arise from the decision:

  1. A consultant or contractor which is proposing to enter into an agreement with an owner will want to ensure that it contracts with all the owners and that the owner represents that there are no other owners. In the alternative, the consultant or contractor will want to insert into the agreement a stipulation that the owner is acting as agent on behalf of all the owners which are bound by the contract.  Otherwise, an owner which has not signed the contract is not bound by it and may bring proceedings without regard to the provisions of the contract, including the limitation of liability clause.
  2.  If it is proposed to include a limitation of liability clause in a building or consultant’s contract, then consideration should be given to whether the wording applies to negligent conduct undertaken during the project. According to this decision, unless the clause refers to that sort of conduct the clause will not apply to it. This result may be desirable from the owner’s standpoint and undesirable from the contractor’s or consultant’s standpoint.
  3. Consultants may want to ensure that the contract between them deals with the impact of liability upon one of them caused by the other, or at least devise an insurance regime that provides adequate protection, not just against liability for the wrongful acts of each consultant but for the liability for the wrongful acts of one consultant which are imposed on the others by way of restitutionary principles.

Whether or not one agrees with the conclusions of the Alberta Court of Appeal in this decision, it is certainly a wake-up call about the frailties and hidden traps of limitation clauses in building and consultants’ contracts.

See Heintzman and Goldsmith on Canadian Building Contracts, 4th ed., chapter 6, parts 2(b)(i)(C) and (ii)(C). 
Swift v. Eleven Eleven Architecture Inc.
2014 CarswellAlta 153, 2014 ABCA 49.

Building contracts – limitation clauses – negligent misrepresentation – architects and engineers

Thomas G. Heintzman O.C., Q.C., FCIArb                                                                                   March 30, 2014

www.heintzmanadr.com

www.constructionlawcanada.com

What are “Making Good”, “Faulty Workmanship” and “Resulting Damage” under a Builders’ Risk Policy?

The decision in Ledcor Construction Ltd. v. Nortbridge Indemnity Insurance Company is another attempt by a Canadian court to deal with the ambiguity in the Builders’ risk insurance policy. The wonder is that insurers and builders do not eliminate the exclusion for faulty workmanship, or clarify what the words “making good”, faulty workmanship” and “resulting damage” mean in this policy.  Instead they leave it up to courts to settle the issue on an ad hoc basis. And it’s no wonder that, in that situation, the courts must find that these ambiguous words provide, and do not exclude, coverage.

Coverage In A Builders’ Risk Policy

There are three elements in the coverage clause of a standard Builders’ Risk policy.

The first element is the “coverage wording”. This element defines, at its broadest, what the policy covers. The policy in the Ledcor case provided very broad coverage for property involved in construction. The policy said that there was coverage for property “undergoing site preparation, demolition, construction, reconstruction, fabrication, insulation, erection, repair or testing…”.  The case law makes it clear that this sort of coverage wording includes coverage for property damage arising from the negligence of the insured unless the policy says otherwise.

The second element of the coverage clause in a Builders’ Risk policy is the “exclusion wording”. In the Ledcor case, the wording took coverage away for “making good faulty workmanship, construction or design.” So the “exclusion wording” is apparently intended to exclude the repair of negligent workmanship. The insurers justify the inclusion of this exclusion on the basis that a property damage policy is not a professional liability policy, and that if coverage for negligence is to be obtained, it should be obtained in a separate policy, or by a further premium and amended wording in the Builders’ Risk policy.

The third element in the coverage clause in a Builders’ Risk policy is the “exemption wording.”  This wording in the policy in the Ledcor case exempted the exclusion if “physical damage not otherwise excluded by this this policy results.”  In this event, the exemption wording said that “this policy shall cover such resulting damage.”

What is one to make of this “wheels within wheels”? It’s like peeling an onion, or taking a Russian doll apart, layer by layer. Except that these layers are words, not physical layers. How does one know where one layer ends and the next begins?  The answer to that question is very important because the insured could make a decision to buy other coverage if it knew where the gap is in the Builders’ Risk policy. Since the insurer doesn’t tell the insured, the insured has to figure it out by reading the cases. And since the insurers don’t tell the insured, the courts inevitably decide the cases in favour of the insureds in case of doubt, of which there is almost always a lot.

Background To The Ledcor Case

Ledcor was the general contractor on a construction project. In the concluding portion of the project, Ledcor retained Bristol to clean the outside of the building. During the cleaning, Bristol scratched and damaged the windows of the building. The windows had to be replaced at considerable cost.  Ledcor and the owner made a claim under the policy.

There did not seem to be any dispute that the damage fell within the coverage element of the policy. There were two issues:

Did the exclusion wording apply? The insurer said Yes, because the scratching of the windows was due to faulty work. The insured said No because the exclusion clause is intended to apply to the costs of having the faulty work re-done, but not to the resultant damage of the faulty workmanship.

Second, did the exemption wording apply? Yes said the insured because the claim was based on resulting physical damage. No said the insurer because the damage in this case was not resulting physical damage, but damage caused directly by the window cleaner.

Decision of the Court

The Alberta Court of Queen’s Bench concluded that the work done by the window cleaning company, Bristol, fell within the words “faulty workmanship” in the exclusion wording. The court compared the present situation to the facts in another case in which the acid cleaning of a boiler was held to fall within the words “faulty workmanship” and the court in the Ledcor case agreed that both cleaning exercises amounted to “faulty workmanship”.

The court held, however, that the words “making good” are ambiguous. They could refer only to re-doing the work that was faulty, which is what the insured asserted. Or they could refer to the damage done by the faulty workmanship, which is what the insurer asserted. In the boiler case, the cleaning was part of the very installation of the boiler, and therefore arguably part of “making good” the work if that meant re-doing the work, including installing a new boiler.  But “re-doing the work” in the present case did not include installing new windows.

The court also considered the words “resultant damage” in the exemption wording and reasoned that these words must have been intended to complement the words “making good” in the exemption wording, so that the exclusion referred to “direct damage of the faulty workmanship as opposed to the indirect consequences.”

The court concluded that both of the interpretations advanced by the parties were reasonable. On balance the one suggested by the insured was somewhat more logical for two reasons.

First, since Builders’ Risk policies are intended “provide coverage for virtually any event which might occur by way of negligence, third party action or act of God, one could conclude that an exclusion as suggested by the [insurers] is inconsistent.

Second, “Bristol, as a sub-contractor, is an additional insured under the policy. Subrogation by the insurers against Bristol can be waived at the option of the [insureds]. Again, all of that suggests broad coverage inconsistent with what the [insurers] say is the effect of the exclusion.”

The Alberta Court of Queen’s Bench held that, at best, the clause was ambiguous and should be interpreted contra proferentem against the insurer.  Therefore, there was coverage under the policy.

Discussion

This decision illustrates the need for insurers and insureds to refine the meaning of the coverage, exclusion and exemption wording of Builders’ Risk policies, or the futility of doing so.  The Ledcor decision means that the policy exclusion does not apply in two situations.

First, if the person who did the faulty work installed something, and whatever was installed caused damage to some other part of the construction, then the damage to that other part is not excluded. That sort of damage is “resultant damage” and not “direct damage” and therefore falls within the exception to the exclusion. One only has to review the decided cases to know how difficult it can be to determine in that sort of situation whether the damage is “direct” or “resultant”.

Second, and this is the nub of the Ledcor decision, if the person who did the faulty work did not construct or install anything, then the claim does not arise from “making good” that work, or is “resultant damage” and not “direct damage.”

However, if the person who did the faulty work also constructed or installed something upon which it did the faulty work (as in the boiler case), then if the “making good” requires the property to be re-installed, then there may be no coverage due to the exclusion.

Two further points can be made about this decision:

First, this decision is a very good example of the rule of interpretation that the words, and all the words, in a contract must be given meaning. Here the key words were “making good”. What do those words mean and why were they used? The insurer really wanted to read the exemption to read as follows: “physical damage arising from faulty workmanship….” instead of “making good faulty workmanship….”  After all, the policy covered “physical damage” and the exemption referred to “physical damage”.   But for some reason, the exemption doesn’t. It refers to “making good”. So the parties must have meant something different by those words than “physical damage.” The court concluded that they can’t and don’t mean “physical damage” because the parties didn’t use those words. Rather, in that context, the words must mean re-doing the work, not repairing the damaged property, at least in the absence of any other or better explanation of what the words mean.  

Second, this decision perhaps demonstrates the futility of the exemption for faulty workmanship. Surely contractors and their advisors do not go through the mental gymnastics to figure out all these permutations and combinations involved in coverage.  And should they have to, especially when all the parties to the construction project are intended to be covered by the policy? Would it not be better simply to eliminate the exemption for faulty workmanship? Since the policy covers all the sub-contractors on the project, would there really be much, if any, additional risk or premium?

Ledcor Construction Ltd. v. Nortbridge Indemnity Insurance Company, 2013 ABQB 585

Builders’Risk Policy – Construction – Sub-Contractors – Contractors – Damages – Insurance – Exclusion Clauses

Thomas G. Heintzman O.C., Q.C., FCIArb                                                        December 27, 2013

www.heintzmanadr.com

www.constructionlawcanada.com