Defence & Indemnity - February 2017: I. INSURANCE ISSUES B.

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B. The wording “as a result of a peril insured against” in an insurance policy will be interpreted to include damage that happens as a direct result of the insured peril (increased cost to bring a damaged building up to code) but will not include damage or perils that were simply discovered due to the insured peril.


Roth v. Economical Mutual Insurance Company, 2016 ABCA 399 [4216

 
I. FACTS AND ISSUES
 
In 2012, Inner-City owned a building in Medicine Hat (the Insured Premises) which was used as a body shop and consisted of two parts: a 4,000 square foot steel frame main shop and a 1,100 square foot wood frame building. In March 2012, Economical issued a commercial insurance policy to Inner-City and the policy consisted of a Commercial Building, Equipment and Stock Form coverage policy (the Policy) as well as an Express on Premises Extension rider (the Extension).
 
The Policy contained exclusions against both damage arising from the enforcement of any by-law regulation etc. as well the cost of making good faulty or improper material or workmanship. The Extension, however, brought back into coverage any increase in the cost of repairing, replacing or constructing the buildings or structures due to the enforcement of the minimum requirements of any by-law, regulation which regulates zoning, demolition, repair or construction of damaged buildings or structures:

3. Contingent Liability from Enforcement of Building By-laws:

This form shall, as a result of a peril insured against, extend to indemnify the insured for:

(A)     loss occasioned by the demolition of any undamaged portion of the buildings or structures;
 
(B)     cost of demolishing, and clearing the site of any undamaged portion of the buildings or structures; or

(C)     any increase in the cost of repairing, replacing, construction or reconstructing the buildings, or structures on the same site or on an adjacent site, of like height, floor area and style, and for the like occupancy;

arising from the enforcement of the minimum requirements of any by-law, regulation, ordinance or law which:

(i)      regulates zoning or the demolition, repair or construction of damaged buildings or structures; and
 
(ii)     is in force at the time of such loss or damage.

 
                                                               (emphasis added by the Court)
 
In July 2012 heavy rainfall caused a storm sewer overflow which resulted in limited water damage to the wood frame building. As a result of this, an adjuster was sent to examine the damage. The adjustor removed a small section of drywall to assess the damage and in doing so discovered building code violations with the wood frame building. This information led to a full inspection by the City of Medicine Hat and it was determined the building was structurally unsound.
 
During this time period, Inner City agreed to sell the Insured Premises to Energy Plus, though at a reduced rate due to the wood frame building needing to be rebuilt. Economical made two small payments to represent the costs of repairing the water damaged portions of the building, as well as the costs of the company which completed the inner demolition. Inner City and Energy Plus brought an action against Economical claiming the cost of replacing the wood frame building, based on the wording of the Extension.
 
The trial judge found in favor of the plaintiff insureds, ruling that though the Policy clearly excluded coverage, the Extension clearly brought back coverage, given a “plain and unambiguous reading of the policy”. The trial judge interpreted the Extension phrase of “as a result of a peril insured against” to mean that once the water damage had taken place, the Policy is extended to indemnify for the insured peril of bylaw enforcement. The judge accepted the position that “as a result” refers to the insured peril causing not the bylaw infractions themselves, but simply the discovery of them.
 
For the appeal, the parties agreed that the problems of rectifying building code deficiencies and bringing the building up to current code were in no way caused by the storm of 2012 and in fact predated the insurance policy. They also agreed that the 2012 storm overflow was an insured peril and that it caused the discovery of the building code violations.
 
II. HELD: Appeal allowed; Economical did not have to provide coverage for the cost of upgrading the building

1. The trial judge’s interpretation was held to be contrary to the reasonable expectations of the parties.

  1. The law is clear that the interpretation of an insurance contract should be consistent with the reasonable expectations of the parties
  2. The trial judge’s interpretation would force the insurer, before extending coverage, to determine whether the property complied with all relevant bylaws as it would be responsible for the costs of remedying any and all deficiencies unearthed as part of subsequent damage
  3. Courts should give effect to unambiguous language in an insurance policy and the Court of Appeal held that the clause was not ambiguous, thus contra proferentem did not apply in this case.
  4. The Court of Appeal gave the example that, under the trial judge’s interpretation, if an employee accidentally caused a hole in the drywall and the interior of the building was exposed and found to be faulty, the insured would automatically be entitled to a new building constructed to new code
  5. This interpretation and result were not reasonable in the Court of Appeal’s view

2. The Policy with the Extension was held to cover damage caused by perils, not age discovered by perils

  1. The cost of rebuilding the wood frame was not a loss resulting from an insured peril; the water damage to the drywall was
  2. The quality of the structure was discovered due to the insured peril, not caused by the insured peril
  3. Coverage only exists where damage has been caused by a “peril insured against” and that damage requires 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

III. COMMENTARY

Exclusion clauses that have similar wording will not cover damage discovered by an insured peril and will only cover damage caused by an insured peril. This is an important decision for insurers, as the trial decision opened up a large area of risk for similar policies in the future. This decision has provided some clarity for insurers and should give them confidence that they will not have to investigate buildings to ensure they are up to the relevant code before issuing insurance policies.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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