Insurer Not Guarantor of Building Code Violations09-Jan-17
On December 23, 2016, the Court of Appeal released Roth v Economical Mutual Insurance Company (“Roth”) which clarifies the interpretation of "Enforcement of Building By-laws" insurance coverage.
The matter involved a body shop, a portion of which was a 1950s wood frame building. Heavy rainfall resulted in water damage to the building and subsequent inspection by the Medicine Hat Planning and Building Services Department determined the building was structurally unsound. Economical insured the property and paid roughly $22,800 to cover the estimated costs related to the water damage.
The Plaintiff sued Economical for the cost of having to replace the building; a figure closer to $500,000. McLennan Ross lawyer Steve Livingstone acted for Economical with respect to the matter.
Except as otherwise provided, the policy insured “against all risks of direct physical loss or damage to the property insured”. There were standard exclusions for direct loss arising from bylaw enforcement, latent defects, faulty workmanship, etc. In addition, however, the policy contained an extension for Contingent Liability from Enforcement of Building By-laws.
At trial, although the structural problems pre-existed the insurance policy and were not caused by the insured peril (water damage from a storm sewer overflow), coverage was nonetheless found on the basis that the insured peril resulted in a municipality enforcing its bylaws.
As a result, Economical was faced with indemnifying a nearly $500,000 claim for demolition and replacement of the building, despite the insured peril not actually causing the issues necessitating replacement.
Court of Appeal Decision
The Court of Appeal reversed the trial decision, stating that “the enforcement of the minimum requirements of any by-law, regulation, ordinance or law” was not a stand-alone insured peril. Further, the Court stated:
... it is not enough that the damage was discovered by an inspection undertaken because of the insured peril. Rather, coverage exists where damage has been caused by a “peril insured against” and that damage requires remedial work or replacement to the standard mandated by the minimum requirements of any applicable by-law, regulation, ordinance or law in force at the time of the loss.
The Court used the example of an employee moving furniture to illustrate the absurdity of coverage being extended. If a hole was made in a wall while moving furniture, and through that hole one could see that a building was not structurally sound, the insured would be entitled to a new building that was building code compliant. The Court described this as “a recovery which could neither be sensibly sought nor anticipated at the time of the contract”.
The Court stated such an approach would force insurers to determine compliance with any by-laws before insuring any building, as they would be responsible for remedying deficiencies should any be discovered following an unrelated loss. This was noted to be practically impossible and would in effect turn insurers into guarantors of construction and building code violations.
The Court noted that the structural unsoundness of the building was not caused “as a result of an insured peril”, and was in fact excluded from coverage.
The law in both Canada and the U.S. is a patchwork of decisions that go either way, with coverage being extended in some instances and at other times not.
Prior to Roth, Alberta law was relatively scant on the topic. That being said, in the 2016 decision in 954470 Alberta Ltd (Centre South) v Sovereign General Insurance Co, (“Sovereign”), the Court held that the increased cost of roof repairs due to non-compliance with a local building code was as a result of the insured peril. Accordingly, the insurer not only had to repair the 7 water-damaged roof joists, a cost of just over $8,200, it also had to pay for installing supplementary roof joists at a cost of almost $527,500!
Despite stating explicitly that policy interpretation was the heart of the issue, the Court did not focus on the policy language, nor the parties’ reasonable expectations, in finding that causation was established. Manderscheid J. stated that but for the insured peril, the City would not have directed the Plaintiff to upgrade the roof, and as such, there was an unbroken chain of causation.
Much Needed Clarity
With Roth, the Court of Appeal has brought some much needed clarity and structure to this area of insurance contract interpretation. The Court stated that extending coverage to the Plaintiff was an absurd result, well outside the expectations of the parties.
The Court narrowed the concept of causation by finding that damage must result from the insured peril itself, and not simply be discovered as a result of the happening of the insured peril. This narrow, though sensible, approach to causation was based on the parties’ reasonable expectations, i.e., that only damage which was directly caused by an insured peril would be covered.
Had this same approach been applied in Sovereign, likely the result would have been different; given that the parties would not likely have expected non-compliant construction issues to be covered when only discovered following the happening of an insured peril.
Impact for Insurers
Roth has the potential to have a significant impact for insurers facing very large claims for pre-existing deficiencies or longstanding building code infractions which only happen to be discovered after damage is caused by an insured peril. If the reasoning in Roth is applied, no longer will insurers have to pay for those deficiencies which were never realistically contemplated by the parties as being part of the insured risk.