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Coverage under builders’ risk policies for COVID-19 issues

Friday, July 03, 2020 @ 3:29 PM | By Samantha Ip, Satinder Sidhu and Rosalie Clark

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Rosalie Clark
In this two-part series, we consider coverage for COVID-19-related losses under a builders risk policy in the event of construction site shutdown or suspensions, resulting impact costs and delay of completion. In the first instalment of this series, we set out what is typically covered by a builders’ risk policy. In the second instalment, we will consider exclusions that may remove from coverage losses related to COVID-19.

Consider this scenario. COVID-19 has caused temporary total project suspension. Construction starts again, crews have been reduced to 60 per cent of total planned manpower to maintain social distancing and that will be the case until completion. The schedule has been heavily impacted and this will add another year to the original scheduled completion. Can an owner or a contractor make a coverage claim under a builders’ risk policy (also often referred to as a course of construction policy)?

Builders’ risk policies provide coverage for buildings under construction, including project property, extra fees for architects and engineers, cost of additional site structures and soft costs. This is important for coverage considerations in the context of COVID-19 issues because builders’ risk policies often provide coverage for delayed start up (which provides indemnity for loss of anticipated or potential income due to delayed project completion, and is akin to business interruption insurance for construction projects) and civil authority coverage (interruption by civil authority coverage provides certain indemnity when access to project premises is prohibited by order of civil authority).

To gain access to any of the coverages available under builders’ risk policies, there must be physical damage (often referred to as property damage) or physical loss. Physical damage is tangible damage to any property involving a change in the physical state, such as a bent beam or cracked concrete. Physical loss has been interpreted as loss of use of property.

Will COVID-19 related project suspensions and site shutdowns meet the prerequisite of coverage for physical damage or physical loss? As with most issues in construction coverage, the answer is not straightforward.

There is no case law in Canada dealing with whether the infiltration of a virus causing delay or cessation of work or otherwise restricting or preventing access to a construction site will be interpreted as physical damage or loss. However, there is one decision suggesting this may be a viable argument. In D.P. Murphy, Inc. v. Laurentian Casualty Co. of Canada [1992] P.E.I.J. No. 70 (PEISC), the Prince Edward Island Supreme Court found that when a fire inspector ordered the closure of a Tim Hortons restaurant due to the risk of explosion caused by gas fumes in an adjacent building, the closure constituted direct physical loss under a commercial property policy.

In a very recent decision, MDS Inc. v. Factory Mutual Insurance Company (FM Global) 2020 ONSC 1924, the Ontario Superior Court of Justice made the bold statement that loss of use of project premises can constitute physical damage under an all-risks property policy, notwithstanding the lack of tangible physical damage. Builders’ risk policies fall within this species of policies that are intended to provide broad coverage for “all risks” that may arise (and that are not otherwise excluded).

The premise at issue in MDS was a nuclear facility that underwent a shutdown to address safety concerns. A pipe burst and allowed leakage of water containing radioactive particles which then caused the shutdown of the facility for 10 months due to the required protocol for nuclear cleanup, leading to profit losses of $121,248,000.

The insurer denied coverage for MDS’ coverage claim for loss of profits during the shutdown period. The Ontario Superior Court of Justice disagreed, and found that the loss of profits was covered by the insuring language of the policy providing coverage for loss of profits to the MDS “flowing from physical damage to a supplier directly resulting from physical loss or damage of the type insured by this Policy,” which coverage was extended “to situations, such as losses incurred when a civil authority has prohibited access to property, service interruption loss under certain conditions, and losses incurred for reasonable delays to the start-up of business operations.”  

The court did not stop there. The court also found that the corrosion exclusion did not apply, but if it did, then the court found that the exception to the corrosion exclusion, which required a finding of resultant physical damage, applied to bring the loss back into coverage. It was in the context of interpreting the exception to the corrosion exclusion that the court made the bold statement equating physical loss to physical damage.

In making its finding, the Superior Court of Justice acknowledged the conflicting case law on the interpretation of physical damage. One line of cases interprets “physical damage” as requiring actual physical damage; the other interprets physical damage more broadly to include damage other than actual physical damage to property, such as loss of use. In this case, physical damage was not a defined term in the policy.

Considering the conflicting common law definitions, the court found the relevant portion of the policy to be ambiguous. The court considered the Canadian case in which the court found that the presence of fumes from an oil spill constituted property damage (Jessy’s Pizza v. Economical Mutual Insurance Co. 2008 NSSM 38), and a United States decision in which the presence of gasoline vapours was found to constitute physical loss (Western Fire Ins. Co. v. First Presbyterian Church, 437 P.2d 705 (E.D. Mich.2010), aff’d 475 Fed Appx. 569 (6th Cir. 2012)).

Relying heavily on the reasoning from those decisions, and noting the general intent of all-risks insurance to provide broad coverage, the Superior Court of Justice broadly interpreted the exception to the corrosion exclusion and ultimately found MDS’ loss of profits claim to be covered.

Many have touted the MDS decision as a broadening of the law in Canada of what is required for a finding of property damage, which is often required to gain access to coverage in a property policy. But have they jumped the gun? Probably. 

The application of MDS to COVID-19-related insurance coverage claims is uncertain. MDS is extremely fact specific. Indeed, the judge in MDS makes that comment several times in the reasons for judgment. The all-risk policy in question in MDS did not contain a definition of physical damage. Many policies do.

The bold statement by the court equating physical loss to physical damage was done in the interpretation of a very specific exception to a corrosion exclusion. In addition, the insuring language for the loss of profits coverage clearly contemplated coverage for “physical loss or damage.” That insuring language was fundamental to the court’s interpretation of the corrosion exclusion in MDS.

MDS is nonetheless a seminal decision that expands on what may be considered physical or property damage in the context of property insurance coverage in Canada. MDS is currently under appeal, but for now, this decision will likely facilitate parties claiming business interruption or delayed start up coverage, even though the decision does not specifically deal with COVID-19.

Owners and contractors experiencing COVID-19 related project impact can make a coverage claim under a builders’ risk policy, but they must remember that coverage always depends on the specific wording of the policy. As we will discuss in our second instalment, losses incurred because of a suspected case or expenses incurred to implement prophylactic measures intended to prevent the spread of COVID-19 are likely not covered.

This is part one of a two-part series. Part two: Coverage under builders’ risk policies for COVID-19 issues: Exclusions.

Samantha Ip is a partner and chair of Clark Wilson LLP’s insurance practice. Ip particularly enjoys insurance coverage and has specialized in construction and insurance in her several years of practice. Satinder Sidhu is a partner and co-chair of Clark Wilson’s infrastructure, construction and procurement practice in addition to her insurance law practice. Sidhu ensures clients can execute their projects and resolve their claims in a timely manner. Rosalie Clark is an associate in Clark Wilson’s insurance, infrastructure, construction and procurement, and business litigation groups. Her practice focuses on infrastructure and construction matters and related disputes.

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