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May a Contractor Sue a Subcontractor When It Agreed With The Owner To Obtain Project Insurance?

One of the most difficult issues in Canadian construction law is the impact of insurance on claims between owners, contractors and subcontractors.

There are two levels to the issue:

What is the impact of a clause in the building contract by which one party agrees to obtain insurance?

And what is the impact of the terms of the insurance itself?

Decisions of the Supreme Court of Canada and provincial appellate courts make it clear that insurance clauses and insurance policies can bar claims between the parties engaged in a building project.  Those decisions adopt two principles:

 First, the insurance regime relating to a building project should benefit all the parties to the project, so that each party does not have to go through the duplicative and expensive process of obtaining insurance for the same risk.

Second, the fundamental insurance law rule is that an insurer cannot pay a claim under a policy, say by the owner, and then bring a subrogated claim against a party that is a named or unnamed insured under the policy, say against the contractor.  But while the principles seem clear, the effect of a specific clause or policy remains unclear.

In Castonguay Construction (2000) Ltd. v. Commonwealth Plywood Co. Ltd, the Ontario Superior Court of Justice applied these principles to a new situation.  In this case, a subcontractor (or consultant to the contractor) sought to rely upon the insurance clause in the main contract between the owner and the contractor.  It did so in a motion to dismiss an action against it by the contractor.  While the court dismissed the motion, there are a number of fascinating issues raised by the subcontractor’s reliance upon the insurance clause in the main contract to which it was not a party.

The Background Facts

As the general contractor, Castonguay entered into a contract with Commonwealth for the expansion of a warehouse owned by Commonwealth.  At the end of the project, Castonguay sued for the holdback and Commonwealth counterclaimed for alleged deficiencies. Castonguay then issued a third party claim against Zenix which had provided engineering consulting services to Castonguay on the project, alleging that any fault with the construction was due to Zenix’s faulty design.

In the main contract between Commonwealth and Castonguay, Castonguay had agreed to obtain “wrap-up” liability insurance which was expressly to cover the “Contractor’s Consultant” as an unnamed insured and was to “preclude subrogation claims by the insurer against anyone insured thereunder.”

The main contract also required Castonguay to obtain comprehensive general liability insurance, which was to include coverage for damages to property, including blanket contractual and cross liability coverage. The CGL policy contained exclusions for improper material, workmanship and design.

In fact, Castonguay didn’t read the main contract and didn’t obtain this insurance.  But it did have a CGL policy of its own, and that policy had “Contractor’s Edge” coverage which provided coverage, subject to exceptions relating to defective materials and workmanship.  Castonguay’s insurer was defending it under this insurance policy.

Zenix brought a motion to dismiss Castonguay’s third party claim against it.  It made two submissions:

First, Zenix submitted that, in light of the total circumstances it was entitled to the benefit of Castonguay’s CGL and Contractor’s Edge policy even though Zenix was not named as an insured in those policies.

Second, Zenix said that it was entitled to the benefit of Castonguay’s obligation in the main contract with Commonwealth to obtain insurance.  Because of that obligation in the main contract, Zenix said that Castonguay was prohibited from asserting any claim against it.

The Decision

The motion judge dismissed Zenix’s motion.  What is not entirely clear is why he did so.  On the one hand, he could have said that the action had some apparent merit and that the insurance issues were too complicated to be dealt with by way of motion.  At some points in his reasons, the motion judge appears to be saying that.  But he went on to deliver sixteen pages of reasons which contain some very pointed comments about the insurance clause and policy issues.

The motion judge dismissed the motion for two reasons:

First, he was not satisfied that the “wrap-up” or CGL insurance which Castonguay should have obtained under the main contract would have applied to Castonguay’s claim against Zenix in the present case.  He referred to various exclusions in that sort of insurance which might well apply to the claim against Zenix.  He noted that there was no evidence that the provision of insurance, and the terms in the main contract relating to insurance, had been discussed in the negotiations leading up to the Castonguay-Zenix contract. In the result, he was not prepared to find that there was an implied term, in the contract between Castonguay and Zenix, that Zenix was entitled to the benefit of the insurance that Castonguay actually obtained or ought to have obtained.

Second, he declined to find that Castonguay was a third party entitled to rely on the insurance provisions in the main contract. He was unwilling to analogize a subcontractor or consultant on a construction project to an employee or tenant entitled to the insurance protection of the employer or landlord. In the result, he concluded that the “law of privity does not provide for a principled exception that should extend to the circumstances of this case.”

The Implications of this Decision

On one level, this decision is simply a pleadings decision in which the motions judge has held that the claim should proceed further.  On this basis, it would demand little attention.

But the decision does reveal some fascinating tensions in two recently judge-made rules:

the Rule providing a defense based upon insurance clauses and policies;

and the Rule relating to third party beneficiaries.

The third party beneficiary rule requires that, before a party can gain the protection or benefit of a contract to which it is not a party, it must prove that:

1.  The parties to the contract intended to extend the contractual rights or protection in question to the third party; and

2. The activities performed by the third party are the very activities coming within the scope of       the contract.

In the present case, the motion judge held that it was not plain and obvious to him that these conditions were satisfied. He examined the terms of the main contract and the terms of “wrap-up” policies and held that it was not clear that either the terms of those sort of policies, or the third party beneficiary rule, applied to Castonguay’s claim against Zenix.  He concluded his decision by saying: “In the absence of any evidence of express terms in the subcontract between Castonguay and Zenix contemplating a waiver of liability, it is not plain and obvious that the Third Party Claim cannot succeed.”

So in this case, this issue will have to be finally decided at trial.  For the moment, the decision must be read that there is a possibility that the consultant/subcontractor may be able to rely on the insurance provisions in the main contract.

Clearly, there are some good policy reasons for the subcontractor or consultant to have the protection of the insurance regime put in place under the main contract.  Those policy reasons have been repeatedly stated by the courts as they have developed the rule precluding claims in the face of insurance clauses. Those rules have not depended upon the negotiations or dealings between the third party and a contracting party, but upon all of the circumstances.  Nor are those negotiations or dealings relevant to the two components of the third party beneficiary rule (the “intention to benefit” and the “very activities”). Thus, if Castonguay had taken out the insurance called for in the main contract, and if a claim had been made by either the owner or Castonguay against Zenix, then it is hard to see why Zenix would not fall within the third party beneficiary rule.

If this is so, then two very interesting issues emerge.

First, does the third party beneficiary rule apply at all if the party to the contract has failed to perform its contractual duty?  Can a third party rely on a breach of a contract to which it is not even a party?  In this case, was Zenix entitled to rely on a breach by Castonguay of its contractual obligation to Commonwealth to obtain insurance? It certainly seems to be a stretch of the third party beneficiary rule to allow a third party to rely upon a breach of a contract to which it is not a party.

Second, was it necessary to consider the terms of the policies to decide the motion?  Castongauy and Zenix apparently argued the motion on the basis that it was.  But wasn’t the real issue whether Zenix was entitled at all to the benefit of the insurance which Castonguay ought to have placed?  If Zenix was, then judgment to that effect might have been granted. If judgment to that effect was granted, then there would simply be a coverage dispute as to whether Castonguay’s claim fell with the coverage.  That dispute might be no different than Castonguay’s own claim for coverage.

A resolution of the motion in this fashion seems possible if Castonguay had taken out the required insurance, but difficult or impossible when it had not and the court was required to surmise or guess at what that insurance coverage might have been.  In the result, the Castonguay decision does not answer the question of whether a subcontractor or other third party may rely upon the insurance clause in the main contract if the insurance policies are in fact taken out in compliance with that clause.

Another interesting aspect of the Castonguay decision is that there is no reference to the main contract being incorporated into the subcontract or consultant’s contract.  If there had been such incorporation, then the insurance clauses in the main contract might have been directly relied upon by Zenix.

In the result, we will have to await the trial in this action, or further decisions, to resolve the degree to which those engaged in construction projects can rely upon insurance clauses in contracts to which they are not a party, or insurance policies taken out by the parties to those contracts.

Building Contract  –  Third Party Rights  –   Subcontractor   –   Consultant – Insurance

Castonguay Construction (2000) Ltd. v. Commonwealth Plywood Co. Ltd, 2012 ONSC 3487

Thomas G. Heintzman O.C., Q.C., FCIArb                                                                        June 24, 2012