Rotating Equipment Services Inc. v. Continental Insurance Co. [2004] A.J. No. 1340 Alberta Court of Queen's Bench

A subcontractor in a power plant construction project, Rotating Equipment Services Inc. ("RES"), was successful in obtaining an order that Continental Insurance Co. ("Continental") was obliged, under a wrap-up policy, to provide a defence to RES to a counterclaim filed by the owner of the power plant, Canadian Gas & Electric Company Ltd. ("CG&E"). The court found that the allegations against RES included claims for damages relating to property that was not designed or installed by RES, and therefore, coverage was not excluded by the work/product exclusion clauses in the policy.

RES provided materials, services and labour for the construction of a gas power generating plant owned by CG&E. Subsequent to the completion of the plant, RES filed a Statement of Claim alleging that a total of $63,341.20 remained unpaid relating to RES’s provision of materials, services and labour. CG&E filed a defence and a counterclaim to the RES action. CG&E denied the existence of a contract between RES and CG&E, as RES was a subcontractor to another supplier, and further alleged that RES breached its duty of care to CG&E in, among other things, inadequately designing the stub shaft resulting in the failure of the main shafts of both generators. CG&E further alleged that the negligence of RES led to damages of various parts of the engine and other equipment.

Continental had issued a wrap-up liability policy in respect of construction of the power plant which extended to contractors and subcontractors. It was acknowledged that RES was an insured under the policy. Continental denied coverage to RES on the basis that the true nature of the claim against RES was that CG&E was alleging various design defects pertaining to the stub shafts that RES was contractually obligated to CG&E to design and install.

In reviewing the scope of an insurer’s duty to defend, the court noted that where the pleadings raise allegations of fault within the scope of the policy, the insurer is obligated to provide a defence, regardless of whether the allegations ultimately prove to be meritorious. This "pleadings rule" has been modified by recent decisions. In Non-Marine Underwriters, Lloyd’s of London v. Scalera, [2000] 1 S.C.R. 551, the court set out a methodology for determining whether claims, as pleaded, trigger a duty to defend. In considering the scope of the insurer’s duty to defend, the following test is applicable:

    1. A court should determine which of the plaintiff’s legal allegations are properly pleaded;
    2. Having determined what claims are properly pleaded, the court should determine if any claims are entirely derivative in nature; and
    3. The court must then decide whether any of the properly pleaded, non-derivative claims could potentially trigger the insurer’s duty to defend.

In the case at bar, Continental contended that the true nature of the claim against RES was one for breach of contract. The court did not agree and found that the allegations encompassed a negligence claim for damage to property and further damages arising out of the loss of use of the property.

Continental submitted that the work/product exclusions should apply to exclude coverage for RES as the damage claimed by CG&E related solely to the stub shafts designed and installed by RES. The court reviewed the allegations and noted that claims were being advanced for damages to the main shaft and other portions of the generating equipment. CG&E also advanced claims for loss of revenue arising out of the property damage, which included damage to property that was not installed or designed by RES. The court found that there was no evidence that the damages alleged in the counterclaim could have been remedied solely by repairing RES’s work.

In the result, the court held that the claim fell within the scope of Continental’s duty to defend. With respect to the apportionment of the defence costs, the court noted that such apportionment was difficult but indicated that it should be possible for RES to bill Continental based upon an analysis of how much counsel would have expended if only insured risks were raised by CG&E’s claim.

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