An obiter of the Québec Court of Appeal makes its way up to the Supreme Court of Canada

November 3, 2016

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The facts

The client, Station Lands Ltd. (“Station”) retained the general contractor Ledcor Construction Ltd. (“Ledcor”) to build the Epcor tower in Edmonton. As is customary, Station and Ledcor purchased a builders’ risk all-risk property insurance to cover property damage which may occur in the course of the construction project. This insurance also covered all the subcontractors participating in the project.

At the end of the project, Bristol Cleaning (“Bristol”) was hired to clean the windows of the Epcor Tower. However, in doing so, Bristol damaged the windows. The replacement cost of the windows was $2.5 million.

The insureds, Station and Ledcor, filed claims with their insurers, Northbridge Indemnity Insurance Company, Royal & Sun Alliance Insurance Company of Canada and Chartis Insurance Company of Canada. The insurers denied coverage, relying on the faulty workmanship exclusion:

“4. (A) Exclusions

This policy section does not insure:

[…]

(b) the cost of making good faulty workmanship, construction materials or design unless physical damage not otherwise excluded by this policy results, in which event this policy shall insure such resulting damage.”

[emphasis added]

The decisions of the lower courts

The insureds were successful at trial² on the basis of the contra proferentem interpretation principle applied to Clause 4. (A), which was deemed to be ambiguous. However, the trial decision was reversed by the Alberta Court of Appeal³, which concluded that coverage denial was justified on the basis that the damage to the windows was related and closely connected to the object of Bristol’s contract.

The issue of the interpretation of Clause 4. (A), which seemed to exclude damages for faulty workmanship while seeming to cover damages resulting from it, ended up before the Supreme Court of Canada⁴.

The common law principles

To determine the scope of coverage and nature of the insured property, the common law jurisprudence of the Canadian provinces developed a three-step analytic approach for assessing whether the damages claimed by the insured were excluded from coverage or covered under the exception to the exclusion. Accordingly, the following had to be determined:

a) the nature of the damages claimed, making a distinction as to whether they consisted in the cost for making good defective workmanship, that is, re-do the faulty work or damages to property resulting from faulty workmanship;

b) the damages caused to property which was the very subject of the contract of the contractor or subcontractor at fault were invariably excluded, whether they were claimed for making good faulty workmanship or resulted from faulty workmanship;

c) the damages to property which were not part of the object of the contract of the contractor or subcontractor at fault were covered under the exception to the exclusion.

The above principles expressly or implicitly resulted from the following decisions:

Poole-Pritchard Canadian Ltd. and Armstrong Contracting Canada Ltd. v. Underwriting Members of Lloyds (Supreme Court of Alberta), (1969) (1970) I.L.R. 1-324;
Poole Construction Ltd. v. Guardian Assurance Co. (Supreme Court of Alberta), (1977) I.L.R. 1-879;
Sayers & Associates Ltd. v. The Insurance Corp. of Ireland et al. (Court of Appeal of Ontario), (1981) I.L.R. 1-1436);
Simcoe & Erie General Insurance Co. v. Royal Insurance Co. of Canada et al. (Alberta Queen’s Bench), (1982) (183) I.L.R. 1-1597;
Bird Construction Co. Ltd. et al. v. United States Fire Insurance Co. et al., (Court of Appeal of Saskatchewan), (1985) (1986) I.L.R. 1-2047;
Mr. Elegant Ltd. v. Canadian General Insurance Co. Ltd., (New Brunswick Queen’s Bench), (1987) 78 N.B.R. 225, reversed by the Court of Appeal of New Brunswick, 31 CCLI 243.

However, a discordant note was heard in 1989, in the decision of the Québec Court of Appeal in the matter of Commercial Union Compagnie d’assurance du Canada v. Pentagon Construction Canada inc., 1989 CanLII 657 (QCCA). In that case, the insured, Pentagon Construction Canada, was claiming an insurance indemnity from its insurer, Commercial Union Compagnie d’assurance du Canada, for damages caused to a stake-pile jacket while in the process of being rammed in the ground. Writing for the Court, the Honourable Marcel Nichols concluded, as had the trial judge, that no faulty workmanship was involved. Accordingly, the exclusion of the policy did not apply.

As an obiter, Mr. Justice Nichols stated that even if faulty work had been involved, the exclusion would not have applied to damages to the insured property resulting from the faulty performance of the construction contract. He analysed the subject of the exception to the exclusion as follows:

[TRANSLATION]

“The appellant maintains that the damage to the stake-pile in itself constitutes “faulty workmanship” irrespective of the fault or mishap of the contractor and thereby falls within the scope of the exclusion.

The appellant however forgets to consider the proviso which follows the exclusion.

The word “provided”, in the context of such an exclusion clause translates the idea that this particular exclusion does not apply to a case where faulty workmanship results in a damage being caused to the insured property.

In other words, the insurer will not pay to make good the faulty workmanship, but will pay the damage to the insured property even if it results from faulty or improper workmanship.

The word “provided” is nothing more than a condition to which the insurer intended to submit the exclusion it stipulated. The exclusion stipulated as to “faulty or improper workmanship” will not apply if such “faulty or improper workmanship” translates into a damage to the insured property.

(…)

In such a case, the insurer will not be required to pay “the cost of making good”, meaning that the cost which would represent ramming a new caisson in the correct location because the insured property would not be affected by a damage.

In short, the damage which is covered is not the cost of making good faulty workmanship but the “resultant damage to the insured property.”

These comments of Mr. Justice Nichols, although they do not affect the reasons for the Court’s decision in Pentagon Construction Canada, seem to have made their way to the Supreme Court⁵.

The appeal before the Supreme Court

The Supreme Court refused to follow the three-step analytic approach favoured by the common law, particularly the second condition related to damages caused to the insured property being the subject of the construction contract itself. As the Québec Court of Appeal⁶, the Supreme Court was of the view that the exclusion for faulty workmanship only applies to the costs of making good the faulty workmanship, while the exception necessarily has to cover all the damages to the insured property resulting from the faulty workmanship. Moreover, we note that the interpretation of an insurance clause, restrictive as to an exclusion and broad and liberal as to an exception, is reaffirmed and takes on its full meaning in the Ledcor case.

To arrive at such a conclusion, the Supreme Court⁷ used the principles of interpretation set out in Progressive Homes⁸. It is incumbent on the insured to demonstrate that the damages are covered either by the initial coverage⁹ or by the exception to the exclusion. To promote a broad interpretation of the insurance coverage, the Court considered the reasonable expectation of the parties to a standard form contract such as most of insurance contracts. The Court noted that the underlying purpose of a builder’s risk insurance is to promote the swift indemnification of the parties involved to avoid paralyzing a construction project¹⁰. It concluded that the parties could reasonably expect that the damages caused to the insured property by faulty workmanship of a subcontractor such as Bristol would be covered.

The Court then discussed the issue of the valid result from a commercial point of view, which is sought by an insured who pays significant premiums in consideration of builder’s risk coverage. If the exclusion was to receive a broad interpretation, the insurer would incur no risk because the property damaged by faulty workmanship would inevitably be excluded from coverage¹¹.

The Court dismissed the argument of the insurers whereby broadly interpreting the initial coverage and the exception to the exclusion would allow or encourage contractors to perform their work improperly or negligently¹².

As to the principles directing consistency in the interpretation of similar insurance contract clauses, the Court noted that each matter is unique. The object of the construction work which resulted in faulty workmanship must be reviewed to determine what, in fact, constitutes an excluded damage.

The Supreme Court agreed with the trial judge, who considered that Clause 4. (A) was ambiguous, without however relying on the contra proferentem principle since it is a principle of last resort, as the ambiguity of the clause could be resolved using other interpretation principles.

What is to be noted

From a procedural point of view, which is however not the purpose of this bulletin, we note that the Supreme Court considers the interpretation of insurance standard contracts as an issue of law respecting which the decision of a lower court may be appealed on the basis of the standard of correctness, as opposed to the patently unreasonable standard. This decision of the Supreme Court may result in applications for review of the decision of lower courts being more frequently made.

We especially note that the restrictive interpretation of an exclusion clause in a builder’s risk insurance contract, which originated from an obiter of the Québec Court of Appeal¹³, puts the brakes on the expansion of the common law jurisprudence whereby insured property damaged as a result of a badly performed construction contract was excluded. Exclusion from coverage, henceforth, only applies to the cost of making good faulty workmanship.

Although their wording is completely different from the exclusion clause in the Ledcor case, the exclusion clauses for faulty workmanship contained in standard CGL and Umbrella commercial insurance policies had also been restrictively interpreted by the Québec Court of Appeal in 2013¹⁴. While keeping in mind that the underlying purpose of a builder’s risk insurance policy is very particular and distinctive from that of a commercial insurance, it remains to be seen whether the Ledcor case will have repercussions in the interpretation of the exclusion clauses for faulty workmanship in commercial insurance contracts and on premiums.

An obiter is an incidental remark that has no binding force, but is persuasive only.
Ledcor Construction Limited v. Northbridge Indemnity Insurance Company, 2013 ABQB 585.
Ledcor Construction Limited v. Northbridge Indemnity Insurance Company, 2015 ABCA 121.
Ledcor Construction Ltd. v. Northbridge Indemnity Insurance Company, 2016 SCC 37.
Id., para. 94.
Commercial Union Compagnie d’assurance du Canada v. Pentagon Construction Canada inc., 1989 CanLII 657 (QCCA).
Id., para. 49-51.
Progressive Homes Ltd. v. Lombard General Insurance Co. of Canada, 2010 SCC 33.
Supra, note 4, para 52.
Supra, note 4, para 72.
Supra, note 4, para 78 and 79.
Supra, note 4, para 80.
Supra, note 5.
Lombard General Insurance Company of Canada c. Factory Mutual Insurance Company, 2013 QCCA 446; leave for appeal denied: Lombard General Insurance Company of Canada v. Factory Mutual Insurance Company, 2013 CanLII 55903 (CSC).

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Marie-Claude Cantin
Partner, Lawyer

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October 19, 2023

Smart product liability: issues and challenges

Introduction In 2023, where do we stand in terms of liability where smart products are concerned? The rules governing product liability set out in the Civil Code of Québec were introduced early in the 20th century in response to the industrial revolution and the growing number of workplace accidents attributable to tool failures.1 Needless to say, the legislator at the time could not have anticipated that, a century later, the tools to which this legislation applied would be equipped with self-learning capabilities enabling them to perform specific tasks autonomously. These “smart products,” whether they are intangible or integrated into tangible products, are subject to the requirements of general law, at least for the time being. For the purposes of our analysis, the term “smart products” refers to products that have: Self-learning capabilities, meaning that they can perform specific tasks without being under a human being’s immediate control. Interconnectivity capabilities, meaning that they can collect and analyze data from their surroundings. Autonomy capabilities, meaning that they can adapt their behaviour to perform an assigned task more efficiently (optional criterion).2 These capabilities are specific to what is commonly referred to as artificial intelligence (hereinafter referred to as “AI”). Applying general law rules of liability to smart products Although Canada prides itself on being a “world leader in the field of artificial intelligence,”3 it has yet to enact its first AI law. The regulation of smart products in Quebec is still in its infancy. To this day, apart from the regulatory framework that applies to autonomous vehicles, there is no legislation in force that provides for distinct civil liability rules governing disputes relating to the marketing and use of smart products. There are two factors that have a major impact on the liability that applies to smart products, namely transparency and apportionment of liability, and both should be considered in developing a regulatory framework for AI.4 But where does human accountability come in? Lack of transparency in AI and product liability When an autonomous product performs a task, it is not always possible for either the consumer or the manufacturer to know how the algorithm processed the information behind that task. This is what researchers refer to as “lack of transparency” or the “black box” problem associated with AI.5 The legislative framework governing product liability is set out in the Civil Code of Québec6 and the Consumer Protection Act.7 The provisions therein require distributors, professional sellers and manufacturers to guarantee that the products sold are free from latent defects. Under the rules governing product liability, the burden of proof is reversed, as manufacturers are presumed to have knowledge of any defects.8 Manufacturers have two means to absolve themselves from liability:9 A manufacturer may claim that a given defect is the result of superior force or a fault on the part of the consumer or a third party; or A manufacturer may argue that, at the time that the product was brought to market, the existence of the defect could not have been known given the state of scientific knowledge. This last means is specifically aimed at the risks inherent to technological innovation.10 That being said, although certain risks only become apparent after a product is brought to market, manufacturers have an ongoing duty to inform, and how this is applied depends on the evolution of knowledge about the risks associated with the product.11 As such, the lack of transparency in AI can make it difficult to assign liability. Challenges in apportioning liability and human accountability There are cases where the “smart” component is integrated into a product by one of the manufacturer’s subcontractors.In Venmar Ventilation,12 the Court of Appeal ruled that the manufacturer of an air exchanger could not be exempted from liability even though the defect in its product was directly related to a defect in the motor manufactured by a subcontractor. In this context, it would be reasonable to expect that products’ smart component would be likely to result many similar calls in warranty, resulting in highly complex litigation cases, which could further complicate the apportionment of liability. Moreover, while determining the identity of the person who has physical custody of a smart product seems obvious, determining the identity of the person who exercises actual control over it can be much more difficult, as custody and control do not necessarily belong to the same “person.” There are two types of custodians of smart products: The person who has the power of control, direction and supervision over a product at the time of its use (frontend custody); The person who holds these powers over the algorithm that gives the product its autonomy (backend custody)13. Either one of these custodians could be held liable should it contribute to the harm through its own fault. As such, apportioning liability between the human user and the custodians of the AI algorithm could be difficult. In the case of a chatbot, for example, determining whether the human user or the AI algorithm is responsible for defamatory or discriminatory comments may prove complex. C-27: canadian bill on artificial intelligence Canada’s first AI bill (“Bill C-27”) was introduced in the House of Commons on June 16, 2022.14 At the time of publication, the Standing Committee on Industry and Technology was still reviewing Bill C-27. Part 3 of Bill C-27 enacts the Artificial Intelligence and Data Act. If adopted in its current form, the Act would apply to “high-impact AI systems” (“Systems”) used in the course of international and interprovincial trade.15 Although the government has not yet clearly defined the characteristics that distinguish high-impact AI from other forms of AI, for now, the Canadian government refers in particular to “Systems that can influence human behaviour at scale” and “Systems critical to health and safety.”16 We have reason to believe that this type of AI is what poses a high risk to users’ fundamental rights. In particular, Bill C-27 would make it possible to prohibit the conduct of a person who “makes available” a System that is likely to cause “serious harm” or “substantial damage.”17 Although the Bill does not specifically address civil liability, the broad principles it sets out reflect the best practices that apply to such technology. These best practices can provide manufacturers of AI technology with insight into how a prudent and diligent manufacturer would behave in similar circumstances. The Bill’s six main principles are set out in the list below.18 Transparency: Providing the public with information about mitigation measures, the intended use of the Systems and the “content that it is intended to generate”. Oversight: Providing Systems over which human oversight can be exercised. Fairness and equity: Bringing to market Systems that can limit the potential for discriminatory outcomes. Safety: Proactively assessing Systems to prevent “reasonably foreseeable” harm. Accountability: Putting governance measures in place to ensure compliance with legal obligations applicable to Systems. Robustness: Ensuring that Systems operate as intended. To this, we add the principle of risk mitigation, considering the legal obligation to “mitigate” the risks associated with the use of Systems.19 Conclusion Each year, the Tortoise Global AI Index ranks countries according to their breakthroughs in AI.20 This year, Canada ranked fifth, ahead of many European Union countries. That being said, current legislation clearly does not yet reflect the increasing prominence of this sector in our country. Although Bill C-27 does provide guidelines for best practices in developing smart products, it will be interesting to see how they will be applied when civil liability issues arise. Jean-Louis Baudouin, Patrice Deslauriers and Benoît Moore, La responsabilité civile, Volume 1: Principes généraux, 9th edition, 2020, 1-931. Tara Qian Sun, Rony Medaglia, “Mapping the challenges of Artificial Intelligence in the public sector: Evidence from public healthcare”, Government Information Quarterly, 2019, 36(2), pp. 368–383, online EUROPEAN PARLIAMENT, Civil Law Rules on Robotics, European Parliament resolution of 16 February 2017 with recommendations to the Commission on Civil Law Rules on Robotics (2015/2103(INL)), available online at TA (europa.eu). GOVERNMENT OF CANADA, The Artificial Intelligence and Data Act (AIDA) – Companion document, online. EUROPEAN COMMISSION, White Paper on Artificial Intelligence: a European approach to excellence and trust, COM. (2020), p. 3. Madalina Busuioc, “Accountable Artificial Intelligence: Holding Algorithms to Account”, Public Administration Review2020, online. Civil Code of Québec (CQLR, c. C-1991, art. 1726 et seq. Consumer Protection Act, CQLR c. P-40.1, s. 38. General Motors Products of Canada v. Kravitz, 1979 CanLII 22 (SCC), p. 801. See also: Brousseau c. Laboratoires Abbott limitée, 2019 QCCA 801, para. 89. Civil Code of Québec (CQLR, c. CCQ-1991, art. 1473; ABB Inc. v. Domtar Inc., 2007 SCC 50, para. 72. Brousseau, para. 100. Brousseau, para. 102. Desjardins Assurances générales inc. c. Venmar Ventilation inc., 2016 QCCA 1911, para. 19 et seq. Céline Mangematin, Droit de la responsabilité civile et l’intelligence artificielle, https://books.openedition.org/putc/15487?lang=fr#ftn24; See also Hélène Christodoulou, La responsabilité civile extracontractuelle à l’épreuve de l’intelligence artificielle, p. 4. Bill C-27, An Act to enact the Consumer Privacy Protection Act, the Personal Information and Data Protection Tribunal Act and the Artificial Intelligence and Data Act and to make consequential and related amendments to other Acts, Minister of Innovation, Science and Industry. Bill C-27, summary and s. 5(1). The Artificial Intelligence and Data Act (AIDA) – Companion document, Government of Canada, online. The Artificial Intelligence and Data Act (AIDA) – Companion document canada.ca. Bill C-27, s. 39(a). AIDA, Companion document Bill C-27, s. 8. TORTOISE MEDIA, The Global AI Index 2023, available at tortoisemedia.com.

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