Faulty Or Improper Material, Workmanship, And Design – Interpreting The Exclusion Clause In Construction Insurance Policies

Builder's risk (also known as course of construction) insurance policies almost always contain some form of exclusion relating to the cost of repairing or replacing faulty or improper material, workmanship, and design. This exclusion is usually qualified by an exception to the exclusion, or 're-inclusion', for "resultant damage" to insured property. The application of this exclusion is a frequent source of disagreement as between insurers and insureds on construction projects.

The typical wording for this exclusion is:

This Form does not insure:

(a) the cost of making good

(i) faulty or improper material;

(ii) faulty or improper workmanship;

(iii) faulty or improper design;

provided, however, to the extent otherwise insured and not otherwise excluded under this Form, resultant damage to the property shall be insured.

(a) Faulty or Improper Design

The faulty or improper design aspect of the exclusion was considered by the Supreme Court of Canada in Canadian National Railway v Royal & SunAlliance Insurance Co. of Canada, 2008 SCC 66.

This case related to a builder's risk insurance policy issued to CNR with respect to the construction of a railway tunnel under the St. Clair River between Sarnia, Ontario and Port Huron, Michigan in the autumn of 1993. The claim arose from the failure of a 'tunnel boring machine' ("TBM"), a massive piece of equipment with a cutting head 32 feet in diameter and a body 278 feet long. The TBM was halted when dirt penetrated its cutting head and threatened the integrity of the main bearing that drove the machine forward. In the result, the project was delayed by 229 days. The Court was required to consider whether the failure of the TBM was captured by the "faulty or improper design" exclusion.

The majority of the Court held that a design would not be "faulty or improper" provided it complied with the state of the art at the material time. Binnie J. wrote for the majority that:

[53] ...In my view, the words "faulty or improper" require the insurers to go beyond simply showing a failure in circumstances of foreseeable risk. The words "faulty or improper", and in particular the word "improper", require the insurers to establish that the design fell below a "realistic" standard. Such a standard can require no more than that the design comply with the state of the art. A standard of perfection in relation to all foreseeable risks, in my view, was not required by the words used by the parties. It was for the insurers to demonstrate that the exclusion applies.

In other words, if an innovative design fails despite being in compliance with the state of the art known at the material time, it will not be excluded from coverage under the builder's risk policy.

In the...