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Strict review of standard texts is SCC’s direction
By Cristin Schmitz
September 30 2016 issue

The Supreme Court’s edict that appellate courts must strictly review lower courts’ interpretations of standard form contracts will expand the scope of appellate scrutiny of contracts in many industries, counsel say.

On Sept. 15 the top court recognized the first exception to its holding two years ago in Sattva Capital Corp. v. Creston Moly Corp. 2014 SCC 53, that contractual interpretation by lower courts is a question of mixed law and fact, which is thus subject to appellate reversal only when the lower court makes a “palpable and overriding error.” The high court partially returned to the pre-Sattva state of the law, by carving out a large exception for standard form contracts — which are pervasive in the commercial world.

In a case involving a dispute between a general contractor and a building owner, on one side, and their insurers over the meaning of a “faulty workmanship” exclusion clause in a standard form “all risks” builders’ insurance policy, the judges held that the stricter, non-deferential standard of “correctness” should have been applied below to the appeal of the trial decision. They went on to overturn the Alberta Court of Appeal’s ruling last year in favour of the insurers: Ledcor Construction Ltd. v. Northbridge Indemnity Insurance Co. 2016 SCC 37.

“Where, like here, the appeal involves the interpretation of a standard form contract, the interpretation at issue is of precedential value, and there is no meaningful factual matrix that is specific to the particular parties to assist the interpretation process, this interpretation is better characterized as a question of law, subject to correctness review,” Justice Richard Wagner held for the court (Justice Thomas Cromwell dissented on this legal point, but agreed with his eight colleagues on the appeal’s disposition).

The Supreme Court’s holding that trial courts’ interpretations of standard form contracts are reversible if they are incorrect is important for the construction and insurance industries, but its impact goes much further than that, said counsel for the successful appellant builder, Eugene Meehan of Ottawa’s Supreme Advocacy. “Standard form contracts are everywhere, from dropping off your laundry, to buying a car, insuring that car, buying a house, insuring that house, and booking a trip to come to Ottawa to argue one’s next Supreme Court appeal,” he observed.

He noted Justice Wagner’s judgment brings “significant clarity to an area that demonstrably needed it because there was much disagreement in various Courts of Appeal across the country.”

Importantly, the court did add the proviso that, depending on the circumstances, interpreting standard form contracts may be a question of mixed fact and law — subject to deferential review on appeal. If, for example, there is a meaningful factual matrix specific to the parties, that factual matrix can be considered by the court, Meehan said. “For example construction contracts often start with a base standard contract, and then have negotiated subclause/riders that are often agreed to later if and when circumstances change. Paragraph 48 [of the judgment] will be seen as a necessary and appropriate escape valve for judges when needed — judicial discretion at the trial level is preserved, where necessary,” he explained by e-mail.

Osgoode Hall Law School professor John McCamus, author of The Law of Contracts, told The Lawyers Weekly that the restoration of the appellate courts’ larger pre-Sattva role in deciding what standard form contracts mean is “on balance a good thing because appellate jurisprudence on matters of contractual interpretation offers important guidance to commercial lawyers.”

McCamus suggested the next question to be settled is whether the Ledcor exception to Sattva will be expanded to cover the many standard form clauses — that are used over and over by commercial lawyers — in what are otherwise specifically negotiated commercial contracts. “It would be useful to have appellate jurisprudence interpreting such clauses, even though they’re not really in standard form contracts,” he observed.

Counsel for the respondent insurers, Gregory Tucker of Vancouver’s Owen Bird Law Corporation, said the decision on standard of review is a positive legal development “for both insurers and insureds, and for the industry generally.

“Consistent interpretation, while important in many areas, is particularly important in insurance law,” he remarked. “Adopting a correctness standard of review will assist in bringing certainty, and in avoiding unnecessary litigation.”

The Supreme Court unanimously allowed the appeals of Ledcor Construction Ltd., the general contractor who built Edmonton’s EPCOR Tower, and the office building’s owner, Station Lands Ltd. As a result, the respondent insurers will have to cough up an estimated $2.5 million, interest and costs, to compensate the appellants for replacing all the windows in the new building.

The original windows were permanently scratched when the contractors hired to clean away construction debris — paint specks, dirt and concrete spatter — used the wrong tools and cleaning methods. The appellants claimed coverage under their standard form builders’ all risk policy — which covers physical damage caused by contractors and subcontractors on a construction site. But the insurers balked, relying on the standard form clause that denies coverage for “the cost of making good faulty workmanship” but, as an exception to that exclusion, nonetheless covers “physical damage” that “results” from the faulty workmanship.

According to the insurers, what is covered as resulting damage is only consequential damage to some other part of the insured property or project, not the repair of that part of the insured property or project that was itself the subject of the faulty work (i.e., the windows).

Justice Wagner held that, correctly interpreted, the exclusion clause excludes from coverage only the cost of redoing the faulty work (i.e. the cost of recleaning the windows), and therefore does not exclude the cost of replacing the windows damaged by the cleaners’ faulty workmanship —as claimed by the insurers. “This interpretation is dictated by the general rules of contractual interpretation,” he explained. “It best represents the parties’ reasonable expectations, as informed by the purpose of builders’ risk policies, aligns with commercial reality and is consistent with the jurisprudence on the matter.”

Tucker said, in his view, the way the court applied the faulty workmanship exclusion in Ledcor is “not a positive development.

“While largely upholding the existing case law, the decision makes application of the exclusion dependent on the scope of the contract of the individual party who carried out the defective work,” he explained by e-mail. “The ‘course of construction’ [builders’ all risk] policy should provide a uniform and predictable level of cover to the project owner or general contractor for cost of repair of damage to the project. Making application of the exclusion dependent, not on the nature of defective work itself, but on the scope of the contractual obligation of the party who carried out the defective work, potentially creates an arbitrary distinction which has little or nothing to do with the underwriting considerations that underlie the policy.”

However, Tucker predicted this aspect of the ruling will affect “a fairly narrow class” of faulty workmanship cases, on the “cost of making good” version of the exclusion. “For that class of faulty workmanship cases, involving contractors whose scope is restricted to work on project components installed by others, the exclusion, on the wording considered in the Ledcor case, will no longer apply. Those cases will generally involve contractors whose work involves cleaning, possibly painting or coating, or testing and commissioning, and who were not involved in earlier phases of the work (such as supply or installation).”

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