Can A Service Contract Create A Duty To Defend?

A clause obliging the insurer to defend an insured, or pay for the insured’s defence, is a well know feature of liability insurance policies. Recently, some Canadian courts have held that the duty of one party to defend or pay for defence of another party to the contract may arise in contracts outside the field of insurance, for instance in building contracts.  This obligation has been found to arise from an indemnity clause or insurance clause in the contract. Such a duty has been held to exist in a service or building contract even though that contract contained no express duty to defend or pay for a defence.

However, a duty to defend or pay for a defence before a finding of liability seems to be an obligation of a different kind than a duty to indemnify or to obtain insurance.  Recently, the Ontario Court of Appeal has clarified this issue in Papapetrou v. 1054422 Ontario Limited. The court held that an insurance clause may create an obligation to pay damages equal to defence costs, but it does not create a duty to defend.


Ms Papapetrou brought a slip and fall claim after she fell on ice on the stairs of The Galleria.  That building was owned by the numbered company and managed by the Cora Group. The Cora Group hired Collingwood to provide winter maintenance and snow removal.

The service contract between Collingwood and the Cora Group contained the following indemnity clause:

The Contractor assumes sole responsibility for all persons engaged or employed in respect of the Work and shall take all reasonable and necessary precautions to protect persons and property from injury or damage. The Owner shall not be responsible in any way … resulting from any act or omission of the Contractor…The Contractor shall indemnify and save harmless the Owner …against all claims, losses, liabilities, demands, suits and expenses from whatever source, nature and kind in any manner based upon, incidental to or arising out of the performance or non-performance of the contract by the Contractor….[Emphasis added.]

The contract also contained an insurance clause. Collingwood agreed to obtain CGL insurance covering the liability of Collingwood and its employees and agents for bodily injury up to a minimum of $2,000,000 and to include the Owners as additional insureds on the policy. Instead, Collingwood obtained an insurance policy covering a maximum of $1,000,000 and the policy did not name The Cora Group as an additional insured.

The Cora Group brought a motion to compel Collingwood to indemnify, and assume the defence of the action on behalf of, The Cora Group. The motion judge granted the motion, finding that “the true nature of [Ms. Papapetrou’s] claim is that [Collingwood and The Cora Group] were negligent in failing to maintain an ice free pedestrian stairway” and that based on the service contract, a duty to defend and indemnify therefore arose. The motion judge stated that Collingwood “should not escape responsibility to defend/indemnify merely because [it] failed to meet [its] contractual responsibility” to name The Cora Group as an additional insured in its CGL policy.  She ordered that Collingwood indemnify The Cora Group and undertake the defence of the action against The Cora Group.

The Court of Appeal’s decision

In the Court of Appeal, The Cora Group acknowledged that an order that Collingwood indemnify it was premature.  No evidence about liability or damages had been led on the motion. The service contract did not require that Collingwood assume sole responsibility for damage to persons and property. Rather, it required Collingwood to assume “sole responsibility for all persons engaged or employed in respect of the Work” and “take all reasonable and necessary precautions to protect persons and property from injury and damage.”  Moreover, Collingwood’s contractual obligation to indemnify The Cora Group was limited to claims “based upon, incidental to or arising out of [Collingwood’s] performance or non-performance of the [service] contract”.

In these circumstances and at this juncture, the Court of Appeal held that there could be no finding that Collingwood’s duty to indemnify had been triggered. Accordingly, the motion judge’s order to indemnify was set aside.

The Court of Appeal also held that the order requiring Collingwood to assume the defence of The Cora Group must be set aside, for two reasons:

First, the service contract contained no duty to defend.

Second, any duty to defend could be no wider than claims arising from Collingwood’s performance or non-performance of its contract.

The Cora Group argued that Collingwood’s obligation to defend arose, not out of the indemnity clause, but rather out of the insurance clause.  It argued that Collingwood’s failure to name The Cora Group as an additional insured in its CGL policy was a breach of contract and that the appropriate remedy was an order requiring Collingwood to defend it. However, the court held that “Collingwood’s breach of this contractual obligation does not create a duty to defend; rather, it gives rise to a remedy in damages.” The court also held that the failure of The Cora Group to object to the form of the insurance was irrelevant.

The court held that the amount of damages suffered by The Cora Group was the amount the CGL insurer would have paid on behalf of The Cora Group.  That amount had to be determined from the service contract, not the CGL insurance policy that Collingwood obtained, since that policy did not contain the additional insured coverage for The Cora Group that it was supposed to contain. The scope of Collingwood’s contractual obligation to indemnify was limited to “claims … based upon, incidental to or arising out of the performance or non-performance of the contract by the Contractor”. Accordingly, the amount of damages was “the amount The Cora Group must pay to defend claims for bodily injury arising out of the manner in which Collingwood performed or failed to perform the service contract.”

The court held that “these costs will include all costs of The Cora Group’s defence of the Papapetrou action, save for any costs incurred exclusively to defend claims that do not arise from Collingwood’s performance or non-performance of the service contract.” The court arrived at this conclusion by analogy to the payment of defence costs under an insurance policy.

First, it applied the principle that an insurer’s obligation to defend is limited to claims that, if proven, would fall within the policy.

Second, it applied the apportionment principle applicable to defence costs under an insurance policy that “where an action includes both covered and uncovered claims, an insurer may nonetheless be obliged by the terms of the policy to pay all costs of defending the action save for those costs incurred exclusively to defend uncovered claims.”

In view of the allegations of Ms. Papapetrou, there was a conflict of interest between Collingwood and The Cora Group, and The Cora Group was entitled to retain separate counsel.

The Court of Appeal set aside the motion judge’s order and substituted an order requiring that Collingwood pay for The Cora Group’s defence of the action, save for any costs incurred exclusively to defend claims that did not arise from Collingwood’s performance or non-performance of the service contract.


There are a number of interesting aspects of this decision from the aspect of construction law and insurance law.

First, this decision has to some extent clarified the law with respect to whether a duty to defend can arise from an indemnity or insurance clause in a non-insurance contract, such as a building contract.  The Court of Appeal has certainly held that such a duty does not arise from the breach of an insurance clause, and that the proper remedy is damages. If this is so, it seems hard to imagine that another court could conclude that an indemnity clause gives rise to a duty to defend and not damages. As well, it appears that a number of recent lower court decisions, holding that a duty to defend may arise from an indemnity clause in a non-insurance contract, are no longer good law.

Second, if a future action arises from the breach of an indemnity clause, we cannot be certain what principles the court will apply to the calculation of damages.  In the present case, since the breach was of the insurance clause, the court had a convenient proxy or reference point in the cases dealing with the determination and apportionment of defence costs under a liability insurance policy.  No policy reasons come to mind for applying different principles to breach of an indemnity clause, but we will have to await such a case for a clear answer.

Third, it may be a little surprising that, on an interlocutory motion, the court made what appears to be a final order determining the principles upon which damages were to be paid. There may be an argument on a duty to defend motion under an insurance policy as to whether, and to what degree, the court should finally determine the principles upon which the defence costs are to be paid, and the degree to which the trial judge should be left with some discretion on that matter.  In the present case, the Court of Appeal appears to have finally decided the matter.

Fourth, the court appears to have finessed the issue of whether the claim by Ms. Papapetrou was entirely covered under Collingwood’s CGL policy.  There is no mention in the decision of any coverage dispute under that policy, so perhaps coverage was not an issue. In addition, the Court of Appeal may be saying that, because Collingwood did not obtain the coverage for The Cora Group, it could not argue anything about the scope of coverage under the policy. But in another case, if coverage is an issue under the “policy that wasn’t obtained” then this may be raised as an issue by the defaulting party.  That party may argue that there should be an additional exception to its liability, namely, “to the extent that coverage was not available under the policy not obtained.”

Fifth, this decision shows how a breach of an insurance clause can be expensive. By failing to obtain the right insurance, Collingwood turned what would have been a claim for payment of costs against the insurer under the CGL policy into a claim for costs against it personally.

Finally, the insurance law junkies will take note that the Court of Appeal has once again applied the apportionment principle that requires the insurer (and by analogy in this case, the party in breach of contract) to pay defence costs except to the extent that those costs are due exclusively to uncovered claims.  This rule is favourable to the insured and is generally applied by Anglo-Canadian courts to apportionment disputes, but other rules less favourable to the insured may be applied in other jurisdictions and are advocated for by many insurers.

See Heintzman and Goldsmith on Canadian Building Contracts, 4th ed. Chapter 5, part 3

Papapetrou v. 1054422 Ontario Limited, 2012 ONCA 506

Building Contracts –  Insurance –  Indemnity and Insurance Clauses  –  Duty to Defend    –   Damages

 Thomas G. Heintzman O.C., Q.C., FCIArb                                                                                  September 23, 2012


Does An Insurer’s Duty To Defend Apply If The Insured Complies With An Environmental Investigation?

The scope of an insurer’s duty to defend is a crucial issue in relating to any liability insurance policy, particularly those applying to building projects.   One of the questions which may arise is:  what is the nature of a “claim” for the purpose of the duty to defend?  That question will almost always be determined by the particular wording in the policy.  In General Electric Canada Company v. Aviva Canada, Inc., the Ontario Court of Appeal has just held that the wording of the policy did not apply when the insured complied with a request by the Ontario Ministry of Environment for an environmental investigation.

The Background

GE owned the subject property from 1903 to 1980, during which time it manufactured a variety of products on the site. During some period of that time, it used trichloroethylene (“TCE”) as a degreasing agent. In February 2004, the Ontario Ministry of the Environment (MOE) wrote to GE and other former owners of the property advising that it was reviewing potential TCE contamination and requested the assistance and co-operation of GE and the other recipients of the letter, asking them to provide any environmental assessments that they had in their possession.

In April, 2004, the MOE sent a second letter to GE, requesting further information concerning about potential TCE contamination.  The letter said that:

 “the data appears to support a TCE plume migrating from/ through the former GE property…As discussed you will be required to take action in delineating the source area on your former property. The delineation investigations are to determine the current levels and the full vertical and horizontal extent of all contamination within the soil and groundwater which are on site location. The delineation report shall include at minimum the following….At this time the ministry is willing to enter into an agreement with GE to pursue the required action items voluntarily. If at any time the ministry determines there is unsatisfactory progress a Director’s Order will be issued to resolve the matter.”

GE agreed to cooperate with the MOE request. It asserted that, in responding to that MOE request, it had incurred out-of-pocket expenses of $2.1 million for investigation costs, $1.86 million for remedial costs and $750,000 for legal costs. GE made a clam against its CGL insurers for payment of those costs.

The Policies

The two CGL policies contained language which required the insurer:

“to pay on behalf of the Insured all sums which the Insured shall become obligated to pay [by] reason of the liability imposed upon the Insured by law… for damages because of damage to or destruction of property caused by an occurrence within the Policy Period…

To serve the Insured by the investigation of claims on account of such damage to or destruction of property and occurrence alleged as the cause thereof,

To defend in the name and on behalf of the Insured any suit against the Insured alleging such damage to or destruction of property and seeking damages on account thereof, even if such suit is groundless, false or fraudulent.”

The Decision

The trial judge held that GE’s claim did not fall within the policy because GE had complied with the MOE’s request, and had not defended against it.  He said:

“What GE calls “defence costs” were not costs of defending against the MOE’s claim but, in fact, the costs of complying with the MOE’s claim. GE complied with the MOE’s request and performed the work on the basis that it was thought to be in GE’s best interests to do so.

In coming to this conclusion, I make no finding on whether the matters alleged and requested in the MOE’s letter fall within the coverage language of the Aviva and Dominion policies from an indemnity perspective. I base my conclusion rejecting GE’s request for a declaration that Aviva and Dominion have a duty to investigate and to defend the MOE’s request solely on the fact that there was no investigation or defence of the MOE’s claim at all. What GE is seeking, in my view, is indemnification for its costs of complying with the MOE’s claim. This is not the time to make findings on the merits of GE’s indemnity claim in this regard. As the Ontario Court of Appeal said in Halifax Insurance, supra, the time to determine the insurer’s duty to indemnify is at the conclusion of the underlying litigation, not during the abbreviated application for defence costs. My conclusion, therefore, is without prejudice to the parties’ positions on whether the MOE letter is a “claim” or to GE’s right to seek these costs by way of an indemnity claim against Aviva, Dominion, or both, as well as the right of those insurers to argue against the existence of that obligation.” (emphasis added)

The Court of Appeal agreed with this conclusion.  It said:

[T]the only evidence of a “claim” by the MOE in the April letter is the request, or requirement if you will, that GE take action in delineating the source of the TCE contamination. GE did not oppose, defend or investigate that request. GE, as it was invited to do in the letter, voluntarily complied with the request of the MOE. It cannot be said that it has suffered any defence or investigation costs recoverable under its insurance policies. As the application judge concluded, the costs incurred were compliance costs – not defence costs. The fact that GE provided a list of costs, which it has characterized as potential defence costs does not, in my view, change the analysis of whether the April letter triggers a duty to defend.

In the result, these decisions undertook no analysis of the indemnity coverage under the policy.  The courts did not consider whether there was indemnity coverage for the damage to the land, or whether there was an environmental exclusion.  Nor did they consider whether the MOE’s request was a “suit” against GE.  All that the courts decided was that GE’s cost of cooperation did not amount to defence costs.  The Court of Appeal declined to consider American case law on the issue.

This is an interesting decision from a number of aspects:

First, while the court’s reading of the word “defend” as excluding cooperation may be based on sound grammar and literal meaning, there could be a debate about whether it is based upon sound policy. If cooperation is the best defence, should the costs of that cooperation be excluded from coverage for defence costs?  Is fighting better or different than cooperating so far as a defence is concerned?

Second, if the cost of “cooperating” doesn’t amount to defence, does the cost of settling an action or regulatory proceeding amount to defence? Normally, the costs of settling an action, and obtaining the best evidence and expert reports to do so advantageously, would be included within defence costs under a liability policy.

Third, if the cost of cooperating is not defence costs, then that cost may fall within the indemnity coverage arising from damage to the property.  The trial judge’s decision appears to allow GE to argue that it does.  If so, then this proceeding was much to do about nothing.  Except that, by cooperating, GE may have materially reduced the insurer’s potential exposure.

See Heintzman and Goldsmith on Canadian Building Contracts, 4th ed. Chapter 5, Part 3

General Electric Canada Company v. Aviva Canada, Inc., 2012 ONCA 525

Building Contracts   –   Insurance   –   Duty to Defend

Thomas G. Heintzman O.C., Q.C., FCIArb                                         August 14, 2012

Incorporation By Reference In Building Contracts

Incorporation by reference in building contracts

By Thomas G. Heintzman and Julie Parla1

A common clause in a building contract is one which incorporates the terms of another contract or document into the building contract in issue. The effect of such a clause is referred to as “Incorporation by Reference”. These clauses are common in building contracts because the various contracts necessary for a building project are often cross-referenced and their performance are inter-related.

Thus, the main contract between the owner and the general contractor is inter-related with the subcontract between the contractor and the sub-contractor. The tender or other pre-contractual documents are inter-related to the contracts later entered into. The payment or performance bonds are related to the contracts for which they provide financial guarantees. The contracts between the consultants are related to the building contracts themselves. To a great extent, all of these contracts are part of the same package. Whether the object is to save drafting time or to ensure absolute consistency, or laziness, one of these contracts may state that the terms of another document or contract are incorporated into it.

While an Incorporation by Reference clause may provide a useful correlation of one contract to a second contract, they also open up dangers when the clauses are arguably unsuitable for inclusion in the second contract. This paper will examine the circumstances in which Incorporation by Reference clauses have been used and the potential problems they raise.

Uses of Incorporation by Reference Clauses

Incorporation by Reference clauses have been used in a wide variety of circumstances in building contracts. Here are some of the circumstances in which they have been used and applied:

  • (a)  Specifications:  A specification list prepared by the owner was incorporated by reference into the contract ultimately entered into with the contractor, rather than attaching a specification list physically to the actual contract.2
  • (b)  Specific work and Best Practices:  A term in the main contract specifying the work to be carried out and stating the obligation to use “best trace practices” was incorporated by reference into the subcontract.3 In another case, the measurement and price to be paid for concrete work in the main contract was incorporated into the subcontract.4
  • (c)  Force Majeure and Claim period:  A force majeure clause and a clause stating the period in which a claim must be made, contained in the main contract, was incorporated by reference into the sub-contract.5
  • (d)  Profit Sharing:  A contractor’s obligation in the main contract to pay the owner 75% of savings from the contract price was enforceable against the bonding company. While there was no Incorporation by Reference clause in the bond, the Ontario Court of Appeal applied principles that related both to Incorporation by Reference and to contractual interpretation.6
  • (e)  Tender Conditions – GST:  The term of a tender, requiring the tender price to include GST, was incorporated into the contract ultimately entered into.7
  • (f)  Performance Bond:  A provision in the main contract requiring the contractor to post a performance and materials bond for 50% of the contract price was incorporated into the subcontract and precluded the contractor from requiring the subcontractor to post a 100% bond.8
  • (g)  Letter of Intent:  A letter of intent was incorporated by reference into the subsequent contract, thereby creating contractual representations.9

On the other hand, Incorporation by Reference clauses have not been applied in many cases to incorporate the provisions of another contract or document. Thus,

  • (a)  Liquidated Damages: A liquidated damages clause in the main contract was not incorporated by reference into the sub-contract.10 A bond which contained a clause incorporating the building contract between the owner and the contractor was held not to impose on the surety the obligation to pay the liquidated damages referred to in the building contract between the owner and the contractor.11
  • (b)  Lien Security:  The obligation to post security for lien claims contained in the main contract was held not to be incorporated into the subcontract.12
  • (c)  Guarantee Period:  A two-year guarantee given by the contractor to the owner in the main contract was not incorporated by reference into the subcontract.13
  • (d)  Insurance:  An obligation to obtain insurance was not incorporated into the subcontract because, although there was an Incorporation by Reference clause in that subcontract, there had been no main contract in fact entered into.14
  • (e)  Inconsistency:  A Term in a building contract was not incorporated into a bond because it was inconsistent with the limited liability of the surety stated in the Bond.15
  • (f)  Additional Terms:  The subcontractor understood that the main contract between the owner and contractor was the standard CCDC 2 contract. In fact the owner and contractor negotiated additional terms which were unknown to the subcontractor. It was held that those additional terms were not incorporated by reference into the subcontract.16
  • (g)  Dispute Resolution:  In Canada, courts have generally held that an arbitration clause in the main contract is not incorporated by reference into the subcontract without specific incorporation.17

The courts in other common law jurisdictions have also considered the incorporation of arbitration clauses from one contract to another. Their decisions illustrate the nuances of this practice, especially when those clauses affect rights and obligations outside of the project work per se. The incorporation by reference of arbitration clauses from one contract to another has been the subject of a number of cases in the United Kingdom and Australia.18 The general trend is that an arbitration clause in one contract is only incorporated into the other contract if the arbitration clause in the first contract is specifically referred to in the second agreement. This rule is sometimes referred to as the “rule in Aughton” after the decision in Aughton Ltd. v. M.F. Kent Services Ltd.19 The rule was effectively applied 100 years ago by the House of Lords in TW Thomas & Co. Ltd v. Portsea Steamship Co Ltd (The Portsmouth).20 While the rule is more or less settled in the UK, there are cases in which the rule was not applied on the particular facts.21

Two commentators have recently reviewed the law in the UK and Australia. Their view is that, in Australia, the pendulum is swinging from requiring express reference to an arbitration clause in order to validly uphold an incorporation by reference, to more flexibility allowing arbitration clauses to be incorporated by general reference to a contract which contains an arbitration clause, provided doing so can be supported on a proper construction of the contract. This shift is generally credited to a more pro-arbitration policy of the courts, and may provide insight as to the direction other common law jurisdictions will ultimately take.22

Incorporation by reference of arbitration clauses may also be subject to the governing arbitration statute. Thus, the UNCITRAL Model Law, which is incorporated into the various provincial and federal statutes applicable to international commercial arbitrations23, states as follows:

“The reference in a contract to any document containing an arbitration clause constitutes an arbitration agreement in writing, provided that the reference is such as to make that clause part of the contract.” (underlining added)

It is arguable that the proviso to this provision was intended to require specific reference to the arbitration clause in the other contract before incorporation of it into the second contract occurs. But the opinions of commentators and the decided cases do not necessarily demonstrate this point of view.24

In light of these apparently inconsistent decisions, one might wonder why any subcontractor would agree to an Incorporation by Reference clause in the subcontract. Since the provisions of the main contract are drafted to suit the circumstances of the owner and the contractor, there is every reason for the subcontractor not to agree, holus bolus, to the terms of the main contract being incorporated into the subcontract. This is especially so where the main contract may contain provisions such as liquidated damages, an arbitration clause and other specific provisions with respect to security, insurance and removal of liens which may be wholly suitable to the owner and contractor, but totally unsuitable to the subcontractor.

Some examples from the cases referred to above make this point clear. For example, in Q.Q.R. Mechanical Contracting Ltd. v. Panther Controls Ltd., the contractor had given the owner a specific two-year guarantee. There does not seem to be much reason why the subcontractor should be bound by that guarantee. In Litchfield Bulldozing Ltd. v. PCL Construction Ltd., the owner was a municipality. While a municipality may need a specific force majeure clause, it is not evident that the same force majeure clause is suitable to the subcontract.

Similarly, in Niagara Structural Steel v. LaFlamme, the liquidated damages clause stated a specific per diem amount which was based upon the owner’s particular circumstances and was set to cover the owner’s supervisory cost. Those costs would have no bearing upon the costs incurred by the contractor or subcontractor. In the result, that liquidated damages clause had no relationship to the subcontract. Similarly, in Lac La Ronge Indian Band v. Dallas Contracting Ltd., a bond was interpreted as not including on obligation upon the surety to pay the liquidated damages due by the contractor under its contract with the owner, because that obligation was contrary to the specific terms of the bond.

There may be a total disconnect between the necessity and rationale for terms in the main contract as opposed to the necessity or rationale for the same terms in the subcontract.

Nevertheless, standard form contracts in the Canadian building industry continue to contain Incorporation by Reference clauses. General condition 3.7.1 of the CCDC 2 Stipulated Price Contract between the owner and the contractor requires the contractor to “incorporate the terms and conditions of the Contract Documents into all contracts or written agreements with subcontractors and suppliers.” The wisdom of this requirement is questionable particularly when, as noted above, courts have found that the Incorporation by Reference will not necessarily occur even in the presence of such a clause.25

In these circumstances, it seems more advisable for the Incorporation by Reference clause to state that “the following provisions of the Contract Documents are to be incorporated into the subcontracts”, and then list them specifically, rather than incorporating each and every portion of the Contract Documents into the subcontract. This is particularly so in circumstances where the owner and the contractor have negotiated provisions which are peculiar to their relationship and which may have no place in the subcontract document.

Application of Contract Interpretation Principles

It should be kept in mind that the determination by the Courts of when a term will be found to have been incorporated by reference, will be subject to the general principles of contract interpretation as applicable to any contract.

First and foremost the court will look to the words of the contract, understood with reference to the “factual matrix”, that is, the circumstances and context surrounding contract formation.26 The factual matrix will include the purpose of the second contract to the overall project, in informing how to interpret the agreement.

Second, determining the intention of the parties is an objective exercise; the court does not look to the subjective intent of the parties, but rather presumes that the parties intended the legal consequences of their words.27

Third, the contract must be interpreted as a whole, such that meaning is given to all of the terms agreed to between the parties, without conflict.28

Finally, the contract is to be interpreted consistent with “sound commercial principles and good business sense” and in a way that is commercially reasonable.29

These principles guide how a court may treat terms incorporated into a contract by reference. So, for example, the court will look first to the words that the parties have used, and the subjective intent of one party to incorporate all terms of the incorporated contract (or to not do so) will not be determinative in interpreting what was intended to be incorporated. As discussed below, if a term makes little sense in governing the relationship between the parties who incorporate another contract, it may be inapplicable for failing to result in being commercially reasonable – for example an onerous liquidated damages term as applied to a relatively discrete subcontract, the value of which is far less than the purported liability, may be found to be inapplicable. Where the express terms of the contract appear to be in conflict with the terms of the contract purported to be incorporated, the incorporated terms may also fail to apply.

An Attempt to Draw General Principles

So long as Incorporation by Reference clauses are included in building contracts, can we derive any principles from the case law? To the extent that it is possible to do so, the following are general principles which, in our view, should be applied by the courts, based upon the decided cases, and the principles of contract interpretation:

1.   Incorporation by Reference will only occur if the objective intention of the parties was to incorporate one document into another. While this principle is sometimes stated to be based on the subjective intention of the parties, that approach is contrary to the fundamental principle of contract law that intention is to be objectively determined.30 The mere existence of Incorporation by Reference clause in a subcontract will not demonstrate such an objective intention in relation to matters which do not concern the coordination and undertaking of the physical work.

2.   Some of objective circumstances which may arguably demonstrate an objective intention not to include terms of one contract into another were discussed in the Dynatec Mining deicison, being: lengthy negotiation of the latter contract during which the terms proposed to be incorporated were never discussed; an entire agreement clause in the latter contract; and a comprehensive scheme (such as a dispute resolution procedure) in the latter contract which does not mention or is inconsistent with the term in the other contract (such as an agreement to arbitrate).

3.   Conflict between the provisions in the latter contract and the term sought to be imported from the other contract will in all likelihood preclude incorporation. In fact, the latter contract may directly address this conflict issue. Thus, the subcontract may well state, and should state, that if there is any conflict between the subcontract and the main contract, then the provisions of the subcontract apply.

4.   A conflict does not require an absolute conflict in wording. Indeed, the failure to provide for the matter in, say, the subcontract may itself preclude the importation of a term from the main contract, because to do so would be in conflict with the subcontract.

5.   If the parties are in a direct relationship with each other, then Incorporation by Reference will be more sustainable. Hence, if it is a question of incorporating a letter of intent or the terms of a tender into the contract which is ultimately made by the same parties who exchanged the letter of intent or participated in the tender, or incorporating the terms of a contract into a performance or payment bond relating to that contract, then a court will be much more likely to hold that the Incorporation by Reference clause is effective to bring all of the material portion of the other document into the contract.31

6.  The obligation in the main contract in respect of the actual physical work to be undertaken will likely be incorporated into the subcontract by virtue of the Incorporation by Reference clause.32 The courts view the purpose of an Incorporation by Reference clause in a subcontract to be for co-ordinating the prosecution of the actual physical project, and not for the purposes of subjecting the subcontractor to the same insurance, dispute resolution and similar regimes adopted by the owner and the contractor, absent the clear intention by the contractor and subcontractor to import into their contract the terms of the main contract.

For this reason, terms relating to liquidated damages, the obligation to obtain insurance, the provision for security for lien in the main contract will not likely be incorporated into the subcontract in the absence of a specifically articulated intention to do so.

7.   Similarly, arbitration clauses and other clauses relating to dispute resolution will not usually be imported from the main contract into the subcontract by virtue of a general Incorporation by Reference clause in the latter contract. However, the general principles of interpretation and the facts of the particular case may result in a general incorporation clause having that effect. Consideration must also be given to the specific arbitral statute governing the contract because it may favour or contradict such incorporation. In addition, the trend toward a more arbitration-friendly approach by courts may increase the likelihood of such general incorporation in the future.


Even though standard form building contracts contain Incorporation by Reference clauses, courts may not find that such incorporation has actually occurred. Incorporation by Reference will more likely be found to occur if the parties are in a direct relationship with each other or engaged in the preparation of, or exchanged, both documents, or if the document sought to be incorporated relates to the physical construction of the project. Otherwise, terms such as arbitration clauses, lien security, insurance and liquidated damages clauses will not likely be imported from one contractual regime into another. The interpretation of the contract as a whole, being the contract and the terms Incorporated by Reference, will be subject to the established principles of contract interpretation.

In these circumstances, the drafters of standard building contract might well revisit the Incorporation by Reference clauses contained in those contracts, and particularly in main contracts and subcontracts, and encourage the parties to direct their minds to which specific provisions of one contract they wish to be incorporated into the other contract.

[This article first appeared in Skylines – Newsletter of the CBA National Construction Law Section – July 2012]

  • 1 Thomas G. Heintzman OC, QC, FCIArb is counsel and Julie Parla is a partner in the Toronto office of McCarthy Tétrault LLP.
  • 2 Pozzebon v. Lamantea, 1988 Carswell Ont. 759 at para. 4
  • 3 Kor-Ban Inc. v. Pigott Construction Ltd. (1993), 11 C.L.R. (2d) 160 at para 529(Ont. S.C.J.)
  • 4 Online Constructors Ltd. v. Speers Construction Inc. 2011 CarswellAlta 104 at paras 17-20.
  • 5 Litchfield Bulldozing Ltd. v. PCL Construction Ltd. (1985) 14 C.L.R. 287(B.C. Co. Ct.)
  • 6 Whitby Landmark Developments Inc. v. Mollenhauer Construction Ltd., (2003) 26 C.L.R. (3d) 161 at para. 9-16 (Ont. C.A.)
  • 7 Ecozone Engineering Ltd. v. Grand Falls – Windsor (Town) (1995), 30 C.L.R. (2d) 277, (2000) 5 C.L.R. (3d) 55 (N.L.C.A.)
  • 8 Schaible Electric Ltd. v. Melloul – Blaney Construction Inc. (2005) 45 C.L.R. (3d) 41 (Ont. C.A.)
  • 9 Foundation Co. of Canada Ltd. v. United Green Growers Ltd. (1997), 33 C.L.R. (2d) 159 at para. 27 (B.C.C.A.)
  • 10 Niagara Structural Steel v. LaFlamme (1985), 14 C.L.R. 70 at para 28-32; aff’d (1987) 58 O.R. (2d) 773 (C.A.)
  • 11 Lac La Ronge Indian Band v. Dallas Contracting Ltd. (2004), 35 C.L.R. (3d) 236 at para 70, 82-95 (Sask. C.A.)
  • 12 1510610 Ontario Inc. v. Man-Shield (NOW) Construction Inc., 2010 Carswell Ont. 1395
  • 13 Q.Q.R. Mechanical Contracting Ltd. v. Panther Controls Ltd. (2005), 40 C.L.R. (3d) 154 at para 16-31 (Alta. Q.B.)
  • 14 529198 Alberta Ltd. v. Thibeault Masonry Ltd. (2001), 19 C.L.R. (3d) 63 (Alta. Q.B.)
  • 15 Lac La Rouge Indian Band v. Dallas Construction Ltd., (2004) 35 C.L.R. (3d) 236 (Sask. C.A.)
  • 16 Daiwood Construction Co. v. Wright Schuchart Construction Ltd. (1992), 3 C.L.R. (2d) 144.
  • 17 Dynatec Mining Ltd. v. PCL Civil Constructors (Canada) Inc. (1995), 25 C.L.R. (2d) 259 (Ont. Gen. Div.); Sunny Corner Enterprises Inc. v. Dustex Corp., (2011), 1 C.L.R. (4th) 281 (N.S.C.A.)
  • 18 Rebecca James and Michael Schoenberg, “Incorporating an Arbitration Clause “By Reference”: Reconciling Model Law Article VII and Australian Common Law in Light of Recent Developments”, (2011) 77 Arbitration, Issue I, 84. (“James and Schoenberg”)
  • 19 (1991), 57 B.L.R. 1; 31 Con. L.R. 60 CA.
  • 20 [1912] A.C. 1 HL.
  • 21 Modern Buildings (Waltes) Ltd. v. Limmer & Trinidad Co. Ltd. [ 1975], 1 W.L.R. 1281; [1975] 2 All E.R. 549 CA; Owners of the Annefield v. Owners of Cargo Lately Laden on Board the Annefieldl, [1971] P. 168; [1971] 2W.L.R. 320 CA
  • 22 James and Schoenberg, above.
  • 23 See, for instance, the Ontario International Commercial Arbitration Act, R.S.O. 1990, c. I.9, Article 7(2) of the Model Law attached to that Act The domestic Ontario Act, the Arbitration Act, 1991 ,S.O. 1991, c. 17 does not contain a provision that directly deals with incorporation by reference of an arbitration clause from one contract or document into a second contract. Section 5(1) does say that an arbitration agreement “may be an independent agreement or part of another agreement”.
  • 24 See James and Schoenberg, above, at footnotes 15 and 16.
  • 25 Dynatec Mining Ltd. v. PCL Civil Constructors (Canada) Inc., (1996), 25 C.L.R. (2d) 259; Daiwood Construction Co. v. Wright Schuchart Construction Ltd. (1992), 3 C.L.R. (2d) 144.
  • 26 SimEx Inc. v. IMAX Corp., [2005] O.J. No. 5389 (Ont. C.A.) at para. 23
  • 27 Eli Lilly & Co. v. Novopharm Ltd., [1998] 2 S.C.R. 129 at para. 56; SimEx, supra at para. 23; Drumbrell v. Regional Group of Cos. 2007 CarswellOn 407 (Ont. C.A.) at paras. 48-51.
  • 28 Ventas, Inc. v. Sunrise Senior Living Real Estate Investment Trust (2007), 85 O.R. (3d) 254 at para. 24; 3869130 Canada Inc. v. I.C.B. Distribution Inc. (2008) ONCA 396 (Canlii) at para. 31.
  • 29 Ibid.
  • 30 Heintzman and Goldsmith on Canadian Building Contracts, Chapter 1, Part 1(b)
  • 31 Foundation Co. of Canada v. United Green Growers Ltd. (1997), 33 C.L.R. (2d) 159 (B.C.C.A.); Pozzebon v. Lamantea, 1988 Carswell Ont. 759 at para. 4; Whitby Landmark Developments Inc. v. Mollenhauer Construction Ltd., (2003) 26 C.L.R. (3d) 161 (Ont. C.A.)
  • 32 Dynatec Mining Ltd. v. PCL Civil Constructors (Canada) Inc., (1996), 25 C.L.R. (2d) 259; Kor-ban Inc v. Pigott Construction Ltd, 1993 Carswell Ont. 825 at para 529.                                                                                                                               July 25, 2012

When Is A Mediation Agreement Enforceable?

One of the most difficult issues in the law of alternative dispute resolution is whether a mediation clause creates an enforceable obligation.  That issue has an impact on related issues and rights.  If a party gets the issue wrong, it may miss a limitation period or affect its right to rely upon an arbitration or exclusive jurisdiction clause.

In recent articles I have discussed two recent decisions of the Ontario Court of Appeal in which that court apparently arrived at conflicting decisions about whether a mediation clause created an enforceable obligation.  The English Court of Appeal considered this issue in its recent decision in Sulamerica CIA Nacional de Seugros S.A. v. Enesa Enenharia S.A..

The Sulamerica decision is more famous for its holding that the law applicable to an arbitration clause is the law of the place that the parties designate as the seat of the arbitration, not the law that they designate as the law of the contract.  But hidden in the back of the decision is another important conclusion, namely, that a mediation clause is not valid unless it contains sufficient minimum details to make it enforceable.

In Sulamerica, the enforceability of the mediation clause affected whether the insurer had properly commenced arbitration proceedings. The insurance contract provided that the law applicable to the contract was the law of Brazil and that the courts of Brazil were the exclusive jurisdiction for the proceedings relating to the contract. In addition, the contract contained an arbitration clause, condition 12 of General Conditions of the contract, which stated that the seat of the arbitration was London, U.K..

The insurers gave notice of arbitration, asserting that the insured’s claim was not covered by the contract. The insured commenced an action in Brazil for an order that the insurers were not entitled to submit the dispute to arbitration and obtained an injunction restraining the insurers from commencing an arbitration proceeding. The insurers then applied to the court in the U.K. for an order restraining the insured from continuing with the proceedings in Brazil.

The insured said that the law of Brazil governed the arbitration clause and that by the law of Brazil, its participation in the arbitration was voluntary, not mandatory. The insurers said that the law of England applied to the arbitration clause and that under English law, arbitration was the exclusive remedy to determine the dispute, that the jurisdiction of the arbitral tribunal was mandatory not voluntary, and that the insured would be bound by the decision of the arbitral tribunal.

The English judge of first instance held that English law applied to the arbitration clause and issued an injunction against the further prosecution of the Brazilian action by the insured, and the English Court of Appeal upheld that decision.  In doing so, the Court of Appeal may be seen as resolving a conflict of decisions in the English courts.  The result appears to be that, absent other evidence or factors, then in the face of a contest between the law of the contract and the law of the seat of the arbitration as to which law governs the arbitration clause , the latter will win out.

That part of the Sulamerica decision has been well discussed by the commentators. But there is another part of the decision which could be equally important.

Condition 11 of the insurance contract – the one immediately prior to the arbitration clause- required the parties to mediate before proceeding to arbitration. The insurer had not sought to mediate prior to instituting arbitration. The insured submitted that the mediation and arbitration clauses were part of a single dispute resolution regime, that mediation was a condition precedent to arbitration under that regime and, accordingly, the arbitration proceeding was premature and should be dismissed on that ground alone.

Condition 11 of the contract contained five paragraphs and some 31 lines, so it was not a “bare-bones” provision. It did not prescribe any particular mediation process, but it did clearly state that “the parties undertake that, prior to a reference to arbitration, they will seek to have the dispute resolved amicably by arbitration.” The clause contained an elaborate provision relating to confidentiality, stated the means by which the mediation could be terminated and stipulated a 90 day period for the mediation to be conducted from the date that one party started the mediation. The clause dealt with the sharing of the costs of the mediation. All in all, not a bad mediation clause.

But not good enough to be enforceable, according to the Court of Appeal.  It dismissed the insured’s submission on the ground that the mediation clause was not sufficiently precise to be enforced. It held as follows:

“…condition 11 does not set out any defined mediation process, nor does it refer to the procedure of a specific mediation provider. The first paragraph contains merely an undertaking to seek to have the dispute resolved amicably by mediation. No provision is made for the process by which that is to be undertaken and none of the succeeding paragraphs touch that question.  I agree with the judge, therefore, that condition 11 is not apt to create an obligation to commence or participate in a mediation process. The most that might be said is that it imposes on any party who is contemplating referring a dispute to arbitration an obligation to invite the other to join in an ad hoc mediation, but the content of even such a limited obligation is so uncertain as to render it impossible of enforcement in the absence of some defined mediation process.”

The Court of Appeal also rejected the insured’s argument that, at the very least, the insurer was required to show that, as a matter of fact, it had satisfied condition 11.  The court held that if “mediation is not defined with sufficient certainty, the condition cannot constitute a legally effective precondition to arbitration.”

This conclusion raises a number of difficulties:

First, mediation is usually considered to be a consensual process requiring no agreement on process. If that is so, it is difficult to see why certainty of process is an essential element for its validity.  In Sulamerica, the English Court of Appeal has applied to the details of the mediation process the certainty requirements found in the law of contract which relate to the making of a contract. Is that necessary or appropriate? If the mediation process is voluntary, why is the agreement to mediate not sufficient?  If a party does not want to mediate, it can immediately state that position and the mediation may be at an end, but why should the parties not be obliged to at least take that step without further agreement on the process?

There is an ongoing debate, at least in North America, about the effort that a party to a mediation agreement must demonstrate before it has complied with a duty to mediate. Some say none; some say that there must be at least some good faith effort to mediate. But the Court of Appeal appears to pre-empt that debate by requiring that the details of the mediation process must be sufficiently clear from the beginning before any obligation to mediate can come into being.

Second, it seems unlikely that most mediation clauses satisfy the “sufficient certainty” requirement established by the Court of Appeal.  In order to do so, it is likely that the mediation agreement will have to refer the mediation to an arbitral or mediation institute. Agreements to engage in ad hoc mediation may, almost by definition, be unenforceable since those sorts of agreements usually leave the parties with the flexibility to choose the mediator and the “style” and procedures adopted by a particular mediator. Even mediation institutions will have to review their rules to ensure that they are “sufficiently certain”.

Third, different courts may have different views on this issue.  Those views may have a dramatic impact on limitation periods.  If an obligation to mediate arises, then the limitation period may well be extended.

As I noted in my article dated July 17, 2011 the Ontario Court of Appeal held in L-3 Communication Spar Aerospace Limited v. CAE Inc that an enforceable obligation to mediate had arisen in that case and accordingly the cause of action did not accrue and the limitation period did not start to run until the mediation was over.

In L-3 Communications, the agreement in question contained no details about the mediation process.  It simply stated that when the parties “had not agreed” then they could proceed to arbitration.  The Ontario Court of Appeal found that was sufficient to create a duty to mediate so that the cause of action did not accrue and the limitation period did not start to run until that occurred.  Had the Ontario Court of Appeal applied the logic of the English Court of Appeal in Sulamerica, presumably it would have concluded that there was no enforceable mediation clause, and the plaintiff’s cause of action accrued once the conditions for liability had occurred without any necessity for those conditions to include mediation.

As I noted in my article dated May 5, 2012, in another decision of the Ontario Court of Appeal, Federation Insurance Co. of Canada v. Markel Insurance Co of Canada, that court held in 2012 that wording similar to that considered in the L-3 Communications decision did not give rise to an enforceable obligation to mediate.  The result in Federation Insurance appears to be different than the decision in L-3 Communications and more consistent with the decision in Sulamerica

All of the above may leave those drafting agreements wondering about what exactly to put into a mediation agreement to make it binding.  It may leave those suing to enforce rights under those agreements wondering whether to first start an action or mediate.  The decision to sue or mediate first may, like in Sulamerica, simply affect or delay the determination of which tribunal – court or arbitrator – is the proper tribunal. But more troubling is the limitation problem.

Making the decision to mediate, and not to commence the action, may result in the limitation period being missed.  With this risk, a party may be well advised to “sue first and mediate later”, unless the opposing party agrees to extend the limitation period in the meantime.

See Heintzman and Goldsmith on Canadian Building Contracts, 4th edition, Chapter 10, part 6

Sulamerica CIA Nacional de Seugros S.A. v. Enesa Enenharia S.A., [2012]EWCA Civ. 648

Arbitration – Mediation – Enforceable Agreement – Choice of Law – Choice of Forum – Limitations – Insurance

Thomas G. Heintzman O.C., Q.C., FCIArb                                                                                                       July 5, 2012

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


An Insurance Clause Does Not Necessarily Bar A Claim By The Owner

When does an insurance clause in a construction contract bar a claim by the owner against the contractor?  Is it barred if the contract requires that the contractor obtain insurance and that the owner is to be named as an additional insured and that subrogation is waived against the owner?  That was the issue in the recent decision of the British Columbia Court of Appeal in Lafarge Canada Inc. v. JJM Construction Ltd.

The Background

The contract in question was for the charter of barges by the owner, JJM, to the charterer, Lafarge, but the principles in question appear to be no different than in a construction contract. The contract placed the sole responsibility on Lafarge for the barges’ good condition during the term of the contract.  The contract contained “insurance clauses” which required Lafarge to maintain insurance on the barges with loss payable to JJM and also required that the insurance name JJM as an additional insured and expressly waive subrogation against JJM as the owner.

When the barges were returned to JJM at the end of the contract they were damaged.  JJM repaired the barges, made a claim under the insurance and then claimed against Lafarge for the additional costs that it incurred over the insurance recovery. The parties agreed to arbitrate the claim.

In the arbitration, Lafarge argued that the “insurance clauses” barred any claim against it.  It relied upon a series of decisions of the Supreme court of Canada (Agnew Surpass v. Cummer-Yonge, Ross Southward v. Pyrotech Products, T. Eaton v. Smith and Commonwealth Construction v. Imperial Oil) and various lower court decisions which applied the principles in those decisions.

In some of those cases, claims by owners against tenants and contractors were dismissed based upon insurance clauses in which the owner had agreed to obtain insurance covering the building or project.  In other cases, the owners’ claims were dismissed based upon clauses requiring the tenant or contractor to contribute to the insurance premiums incurred by the landlord.  In both cases, the courts held that these clauses effectively passed the risk of loss to the owner, even in the presence of a general duty placed on the tenant or contractor to repair and maintain the building or project.

The arbitrator agreed with JJM that the insurance clause in question did not protect Lafarge.  The arbitrator’s decision was upheld by the British Columbia Supreme Court and Court of Appeal.

The Court of Appeal held that the prior decisions relied upon by Lafarge did not apply to the present circumstances.  Those cases involved two situations.

The first situation is a claim by the party which undertook the obligation to insure the other party.  That was the situation in each of the Supreme Court of Canada cases in which the owner, expressly or impliedly, undertook to obtain insurance on the building or project, and then sued the tenant or contractor when there was damage to the building.  The obligation to insure was express if the lease or construction contract stated that the owner would insure the building or project.  The obligation to insure was implied if the lease stated that the tenant would contribute to the insurance maintained by the landlord.  In either situation, the courts held that the owner had assumed the risk of damage to the building and could not sue the tenant or contractor.

The second situation is a subrogated claim by an insurer of the owner.  The claim may be against a tenant or contractor which was a named or unnamed insured under the insurance policy taken out by the owner.  Or the claim may be against a tenant or contractor which the owner agreed to name as an insured party in the insurance policy to be taken out by the owner, but the owner failed to take out that insurance. In both cases, the courts have held that the insurer could not maintain such a claim.

Neither situation existed here.  In this case, the claim was by the owner but the owner had not contracted to take out insurance.  Rather, it was the charterer, Lafarge, which had contracted to take out the insurance, and insurance naming the owner as an insured party.  Here, the claim was not by the insurer but by JJM for its uninsured loss after giving full credit to Lafarge for all insurance proceeds it had received.

Lafarge argued that a wider principle applied.  Effectively Lafarge was seeking to broaden the first category, namely, the implied obligation to insure arising from a contribution made by a tenant or contractor to the owner’s insurance premiums.  Lafarge argued that this implied obligation is based upon the principle that any time a party pays for insurance under a contract relating to a project or building, all claims arising from that project or building must be made under the insurance policy, and that all other claims against that party are barred.

The Court of Appeal rejected that argument.  It pointed out that Lafarge had cited no cases that supported its argument.  It also noted that, in the first category of cases on which Lafarge relied, the party suing (usually the owner) was the party which had an express or implied obligation to obtain insurance for the benefit of the other party (usually the tenant or contractor) .  In the present case, the party suing (the owner, JJM) had not undertaken to obtain insurance.  To the contrary, the party suing was the beneficiary of the insurance to be obtained by the other party.  Effectively, Lafarge was arguing that JJM should be deprived of a remedy by the very insurance that Lafarge had agreed to obtain for JJM’s benefit.

The Court of Appeal concluded that the other cases cited by Lafarge were all based upon claims made by insurers and were based upon two principles of subrogation.

First, the insurer could not sue the other party (usually the tenant or contractor) because the other party was a named or unnamed beneficiary of the policy under which the insurer had paid.  Under well known principles of insurance law, an insurer cannot bring a subrogated claim against another party insured under the same policy.

Second, another well know principle of insurance law is that the insurer has no greater subrogation rights than its insured (usually the owner).  If the owner had contracted to obtain insurance for the building or project and to name the other party (usually the tenant or contractor) as an insured and had failed to do so, then the owner had accepted the risk of damage and the insurer could be in no better position than the owner when maintaining a subrogated claim.

The present case did not fall within those principles.  JJM had not contracted to obtain insurance and the claim was not a subrogated claim.

This decision by the British Columbia Court of Appeal is a good reminder that “insurance clauses” do not necessarily create a water-tight regime which precludes claims by one party  against the other under insurance contracts.  The water-tight regime may apply to, and exclude, claims by the party (or its insurer) which agrees, either expressly or by implication, to obtain insurance on the project for the benefit of the other party.  But, without more, it may not apply to and exclude claims against the party which agreed to put that insurance in place.

The business logic of this decision is also sound.  As the Court of Appeal pointed out, it was Lafarge which arranged for the insurance, together with the terms and the deductible that resulted in JJM’s insurance claim not being paid in full.  In this circumstance, it seems only fair that Lafarge bear the risk of any uninsured shortfall.

This conclusion may have several unsettling implications for a party taking out insurance for a construction project.

First, the party agreeing to take out insurance (Lafarge in this case) undoubtedly conferred a benefit on the owner (JJM).  Wasn’t the amount of rent paid by Lafarge for the barges likely reduced, in some measure, by the cost of that insurance and the benefit conferred on JJM?  If so, isn’t that benefit akin to the contribution made by a contractor or tenant to the owner’s insurance premiums?  And if that is so, should that fact not give rise to an implied duty on JJM to accept that insurance as its sole remedy?

Second, to the extent possible owners and contractors usually want to create a water-tight insurance regime in the construction contract.  Each of them wants to ensure that the insurance regime provides the only remedies available to the other party.  How can they accomplish that result?

Clearly, this case tells us that the insurance clause and the insurance itself is not sufficient, at least so far as claims against the party which agrees to take out the insurance.  What is sufficient?  Must the contract provide that the insurance is the sole remedy of either party?  Is there any other way to create that “water-tight” regime so far as claims against the party taking out the insurance?  This case will have owners and contractors scratching their heads to come up with an answer.

See Heintzman and Goldsmith on Canadian Building Contracts (4th ed.), Chapter 5, Part 3

Arbitration  –  Construction Contract   –   Insurance  –   Subrogation

Lafarge Canada Inc. v. JJM Construction Ltd., 2011 BCCA 453

Thomas G. Heintzman O.C., Q.C.                                                                                                     February 20, 2012

Does An Insurance Clause Preclude The Contractor From Being Sued?

An insurance clause in a building contract usually provides that one of the parties will obtain insurance for the project, and that some or all of the other parties engaged on the project will be covered under that insurance. The issue raised by such a clause is whether the party that agreed to take out that insurance, or that party’s insurer, may sue another party which was to be covered by that insurance.

In Greater Toronto Airport Authority Association v. Foster Wheeler, the Ontario Superior Court recently held that the insurance clause did preclude such an action against the contractor. In the course of its decision the Ontario court set out some useful principles.

There is always a tension between the liability or indemnity clauses, and the insurance clause, in a building contract. If the contract states that the contractor shall be liable for faulty workmanship, or warrants that the project will be free of defects for a certain period of time, or agrees to indemnify and hold the owner harmless from certain liabilities, how can the insurance clause over-ride those provisions? Yet, if the owner agrees to take out builders’ or other broad insurance policy that would normally cover the contractor in those circumstances, how can the owner’s insurer maintain a subrogated action in the owner’s name against the contractor?

Foster Wheeler entered into a contract with the GTAA to supply four boilers to the GTAA. One of the boilers exploded during installation, damaging the boiler and other property. The GTAA was compensated by its insurer which brought a subrogated claim against Foster Wheeler.

The contract between GTAA and Foster Wheeler contained a variety of apparently conflicting provisions:

1.      GTAA agreed to take out an All Risk Course of Construction insurance policy, and to include Foster Wheeler as an additional insured (“the insurance clause”);

2.      Foster Wheeler warranted the boilers to be free of defects for 12 months;

3.      Foster Wheeler was responsible for damage to GTAA’s property that occurred as a result of Foster Wheeler’s operations under the contract, except to the extent that the GTAA received proceeds of insurance under the All Risk Course of Construction insurance policy;

4.      Foster Wheeler agreed to place all risk insurance on its machinery and equipment and that such insurance was to contain a waiver of subrogation against the GTAA.

5.      GTAA agreed to waive any claim for damages against Foster Wheeler in contract or tort “except to the extent that such damage might be recovered under insurance”.

During the negotiation of the contract, Foster Wheeler asked that the contact include a waiver of subrogation under the All Risk Course of Construction insurance policy taken out by the owner, but the GTAA refused to agree to such a waiver.

The Court reviewed a number of Canadian cases dealing with the effect of an insurance clause in contracts of this nature and arrived at what it called the “beneficial aspects” of typical course of construction insurance contracts:

(a)      on a construction site the possibility of damage by one contractor to the property of another and the construction as a whole is ever present:

(b)      there is a common interest in avoiding the necessity to debate issues of negligence and responsibility in court;

(c)      parties can focus on the common goal of completing construction instead of fighting amongst themselves;

(d)      given the obligation of the owner or general contractor to obtain comprehensive insurance it makes “no business sense for sub-contractors to pay premiums to duplicate that coverage”;

(e)      the insurer sets the premium recognizing there is no right of subrogation;

(f)      the owner purchasing comprehensive insurance on behalf of contractors and subcontractors is less expensive than each party obtaining its own insurance.

The Court then considered the contract and concluded as follows:

1.      The All Risk Course of Construction insurance that GTAA had agreed to obtain admittedly provided insurance for Foster Wheeler’s negligence in the present circumstances.  Accordingly, the insurance clause protected Foster Wheeler from GTAA’s claim even in respect of Foster Wheeler’s negligence, up to the limits of that policy.

2.      The provision in the contract that exempted Foster Wheeler’s liability for damages to the GTAA’s property up to the limits of the owner’s All Risk Course of Construction insurance policy confirmed that conclusion.

3.      The insurance that the contract required the owner to obtain was described as “course of construction insurance”, which is exactly the sort of insurance that had been held by the Supreme Court of Canada to describe insurance which barred an owner’s subrogated claims against contractors and subcontractors.

4.      The insurance clause commenced with the words “Without restricting any other responsibility of the Supplier….. However, those words did not over-rule the fundamental impact of the insurance clause.

5.      The insurance clause did over-ride the warranty obligations of Foster Wheeler, to the extent of the insurance coverage and that result was “necessarily incidental” to the customary interpretation and effect of an insurance clause.

6.      The fact that, during the negotiation of the contract, Foster Wheeler had asked for a waiver of subrogation clause and the GTAA had not agreed to such a clause did not change the meaning and effect of the insurance clause. Foster Wheeler was not relying on an implied waiver of subrogation but rather an express insurance clause and its accepted effect.

7.      There was an exception to the release of Foster Wheeler’s liability. That exception applied to the extent of damages recoverable under insurance. However, that exception did not over-ride the insurance clause to the extent that the GTAA’s claim was covered by and paid out of the All Risk Course of Construction insurance. Rather, it provided for the liability of Foster Wheeler over and above the insurance obtained by the owner.

The fact that these liability/insurance issues are still being debated is remarkable. In 1976, the Supreme Court of Canada established the general principle relating to the issue, and there have been many decisions applying the principle since then. Yet parties to building contracts continue to insert into those contracts provisions which are contradictory and do not clearly apply the principles set out in the decided cases.

In these circumstances this judgment, which has not been appealed, is a helpful guide to resolving the various clauses relating to liability, indemnity and insurance in a building contract.

The conclusion to be drawn is that, if there is an insurance clause in the contract by which one of the parties obligates itself to obtain builders’ risk or course of construction insurance for the project and another party is to be an insured under that insurance policy, that clause will likely preclude a claim by the owner (or by its insurer in a subrogated claim) against the contractor unless the contract clearly and expressly states that the contractor’s liability to the owner remains outstanding notwithstanding the insurance clause.

If a provision is included in the contract which expressly states that the contractor is liable to the owner notwithstanding the insurance clause, then the contractor will likely have to obtain its own insurance, particularly against claims by the owner.

Limited insurance of that nature may not be available and the net effect may be that the contractor may have to duplicate the owner’s entire insurance program for the project.

See Goldsmith and Heintzman, Canadian Building Contracts (4th ed.) at Chapter 1, part 3(d); Chapter 5, part 3 and Chapter 6, parts 2(b)(i)(D) and 2(b)(ii)(D).

Construction Law – Insurance – Contractors:
Greater Toronto Airport Authority Association v. Foster Wheeler, 2011 ONSC 1442 (CanLII)

Thomas G. Heintzman O.C.,Q.C                                                                        July 10, 2011

The Duty To Defend: What Are The Indemnity Obligations In Construction Contracts?

Construction Law –  Insurance – Duty to Defend

A recent Ontario decision regarding the duty to defend against claims may have wide reaching implications for construction law even though the action did not involve a building contract.

In Cadillac Fairview v. Jamesway Construction, 2011, the Ontario Superior Court recently held that an indemnity obligation in a maintenance contract gave rise to a duty to defend the landlord.  This conclusion may apply to indemnity obligations in a building contract.

Jamesway entered into a contract with Cadillac Fairview to shovel the sidewalks and parking lot of a shopping centre owned by Cadillac Fairview, and to keep those premises free of ice and snow.  The contract contained an indemnity by Jamesway in favour of Cadillac Fairview, and an agreement by Jamesway to maintain CGL insurance in which Cadillac Fairview would be an unnamed insured.  Jamesway did take out such a policy.  So far as the reasons of the court disclose, the contract did not contain an agreement by Jamesway to defend Cadillac Fairview from any claim.

When Cadillac Fairview was sued arising from a slip and fall on the ice on the shopping centre, it brought an application against Jamesway and the CGL insurer to require those parties to defend Cadillac Fairview in the slip and fall action.  The Superior Court granted the application against Jamesway.

In arriving at its conclusion, the court referred to a number of cases involving insurers and an insurer’s duty to defend.  Relying on the reasoning in those cases, the court held that Jamesway had a duty to defend Cadillac Fairview.  The court held that the indemnity and the obligation to insure combined to create an obligation to defend.

The court referred to no cases in which an obligation to defend had been ordered against a non-insurer, nor any case in which such an order had been made against a non-insurer when the contract contained no express obligation to defend.  Rather, the court reasoned from the cases against insurers, and then concluded that the indemnity plus the duty to obtain insurance amounted to an agreement to defend.

The court dismissed the application against the CGL insurer, holding that there was no privity of contract between Cadillac Fairview and that insurer.

The implications of this decision for the construction industry are obvious.  Many construction contracts contain indemnities.  For example, Article 12.1 of the standard CCDC 2 Stipulated Price Contract contains indemnities between the owner and the contractor.  However, construction contracts do not usually contain an express obligation on either party to defend the other party in the event of litigation by a third party.  Even in an insurance setting, an obligation to defend will not necessarily be inferred if it is not expressly contained in the insurance contract.  Implying such a duty to defend into a maintenance or construction contract may well exceed the intentions of the parties.

Construction Law- Insurance- Duty to Defend: 

Cadillac Fairview v. Jamesway Construction, 2011 ONSC 2633 (CanLII)

Thomas G. Heintzman O.C.,Q.C.                                                                                                                July 3, 2011