Corbett v Vero Insurance New Zealand Ltd
Earlier this year, the High Court released an interesting decision concerning the interpretation of an exclusion clause in an insurance contract.1
The main issue in this case was whether there was a distinction between the terms ‘defective’ and ‘damaged’. This issue arose because if the property in question was damaged but not defective, the cost to repair or replace it would be covered by a construction works policy. However if the property was defective, an exclusion clause in the policy would apply.
The plaintiffs contracted with a building contractor for the construction of a new house. At the same time, the plaintiffs took out a Contract Works Insurance Policy with the defendant, Vero.
Upon practical completion, the builder, under the construction contract, engaged a subcontractor to clean the house. The cleaner did not remove dust and grit on the windows before the main clean, which scratched the windows. The windows were expensive as they were bespoke, high quality, triple-glazed joinery made in Germany.
The plaintiffs made a claim under the policy for the scratched windows. Vero declined cover on the basis that, as a result of being scratched, the windows were “defective in workmanship” and thus the exclusion clause contained in the policy applied.
The insuring clause and exclusion clause
The policy’s insuring clause was “If at any time during the period of insurance physical loss of or damage occurs to any item of the property insured, then subject to the terms, conditions and exclusions of this policy the Company will indemnify the insured for such loss or damage.”
The policy also contained an exclusion clause that excluded the costs of repairing, replacing or rectifying any part of the contract works which are defective in material or workmanship. The exclusion clause included a proviso that provided the exclusion clause shall only apply to that part of the machine or structure immediately affected, and not to loss or damage to other parts of the contract works resulting therefrom.
The plaintiffs’ argument
The plaintiffs argued that the scratched windows were not defective in material or workmanship but rather they were damaged, relying on the fact that prior to the cleaning the windows were not in any sense defective (either in material or workmanship), but were scratched during cleaning and thereby underwent physical damage.
The plaintiffs argued that the purpose of the exclusion clause was to ensure that where part of the contract works is defective, and the insured suffers loss or damage (thus triggering the insuring clause), Vero would not have to pay for the cost of repairing, replacing or rectifying that part – given it would have needed to be repaired, replaced or rectified in any event. In this context, the plaintiffs relied on the English Court of Appeal decision in CA Blackwell (Contractors) Ltd v Gerling 2.
The plaintiffs argued that the exclusion clause does not apply where property that is not defective is damaged, even if the cause of the damage is defective material or workmanship.
Relying on dictionary definitions of ‘defect’ and ‘defective’, Vero argued that the scratching of the windows constituted a defect and there was no proper distinction between part of the works being defective and being damaged. Vero argued that it is a natural and ordinary use of language to describe the windows as defective in workmanship due to the shortcoming in the work performed. Vero also argued that the commercial context to the policy favoured their interpretation, namely, that it is important there be normal business incentives on contractors to build high quality products and to discourage substandard workmanship. It was argued that liability policies are not intended to insure contractual performance, or the quality of contract works.
Interpretation of the clause
Fitzgerald J held that the phrase, “defective in material or workmanship”, seeks to convey that the exclusion applies to any part of the contract work which is defective due to the materials used in it, or workmanship carried out on it. Her Honour noted that the use of the word ‘in’ is used as a way of saying ‘due to’.
Fitzgerald J pointed out that it is important to understand the distinction between items being in a defective condition and being damaged because of defective workmanship. This distinction highlights the purpose of the exclusion and the differing coverage that results.
Before being scratched, the windows in this case had been installed correctly and there was no suggestion that they were not capable of performing and being operated as expected. Given this fact, Fitzgerald J held that the windows were not in a defective condition (due to either materials or workmanship) at the point in which they were then damaged, in the sense of having undergone a physical transformation. As a result of being damaged, (and even if due to defective workmanship), the windows did not become ‘defective’. The concept of something being defective conveys an ‘inherent’ issue or fault with the windows or the way that they have been built. For these reasons, the exclusion clause did not apply to the damage.
Fitzgerald J concluded that the purpose of the exclusion clause was to exclude the cost of repairing, replacing, or rectifying any part of the contract works which are defective (either as a result of materials or workmanship), irrespective of separate damage done to it, and the cause of that damage.
Fitzgerald J accepted that there are some risks that are rarely insured by a construction contract, notably defective workmanship. The reason being, as pointed out by Vero, that this would make the insurer the guarantor the proper performance of the construction works, removing any incentive for the contractor to complete the works to the contract standard. However, Her Honour rejected the argument that the plaintiffs’ interpretation would result in insurance of contractual performance.
In the Judge’s view, an outcome that the policy covers physical loss or damage to contract works caused by defective workmanship is not an unusual outcome in the circumstances. However, it was noted that Vero may have gained more traction had the plaintiffs sought cover for the cost of re-doing the defective workmanship itself, and not only the resulting physical damage or loss.
This case provides useful guidance on the meaning of the word ‘defective’. It also shows the role that business common sense can play in interpretation as a cross-check on meaning. Her Honour also highlights the importance of clear drafting in insurance contracts.
The plaintiffs made the argument that Vero could have, but did not, exclude damage caused by defective workmanship. The plaintiffs referred to a number of authorities to demonstrate that an exclusion clause for physical loss or damage caused by defective workmanship is not uncommon and to reinforce that this is not what the exclusion clause in the present case did. Fitzgerald J accepted that the exclusion clauses in the authorities referred to by the plaintiffs were in a form that was a much more natural and ordinary way of expressing the result Vero says should occur in this case.
An example of such a clause can be seen in Pentagon Construction Co Ltd (Pentagon). 3 In Pentagon the exclusion clause stated that the insurance does not cover loss or damage caused by: 4
(i) faulty or improper material; or
(ii) faulty or improper workmanship; or
(iii) faulty or improper design.
Similarly, in Walker Civil Engineering Pty Ltd v Sun Alliance 5 the exclusion clause excluded “loss or damage directly cause by defective workmanship, construction or design”.
- Corbett v Vero Insurance New Zealand Limited  NZHC 1823.
- CA Blackwell (Contractors) Ltd v Gerling Allegemeine Verischerungs  EWCA Civ 1450.
- Pentagon Construction (1969) Co Ltd v United States Fidelity & Guaranty Co  1 Lloyd’s Rep 93.
- At .
- Graham Evans & Co (Qld) Pty Ltd v Vanguard Insurance Co Ltd (1999) 10 ANZ Ins Cas 61-418.