In the Court Of Appeal of New Zealand
CA41/2009
[2010] NZCA 316

BETWEEN	LUMLEY GENERAL INSURANCE (NZ) LIMITED AND ACE INSURANCE LIMITED
Appellants

AND	BODY CORPORATE NO. 205963
First Respondent

AND	JULIET BECKER & ORS
Second Respondents

AND	LEUSCHKE GROUP ARCHITECTS LIMITED (IN LIQUIDATION)
Third Respondent

Hearing:	13 April 2010

Court:	Glazebrook, Ellen France and Randerson JJ

Counsel:	M G Ring QC and J N Bierre for Appellants
G D R Shand and D M Brown for Respondents

Judgment:	22 July 2010 at 10.30 am 

JUDGMENT OF THE COURT	

A	The appeal is allowed.  We declare that exclusion cl 2.04 of the insurance contract between the appellants and the third respondent applies to exclude the liability of the appellants arising out of damage to the first and second respondents’ property from water entry and moisture damage occurring via the four defects identified in the question of law before the High Court (as expressed at [5] of the reasons).
B	The respondents must pay the appellants costs for a standard appeal on a band A basis and usual disbursements.  We certify for second counsel.  Costs in the High Court are, in the absence of agreement, to be fixed by that Court in light of this judgment. 

REASONS OF THE COURT
(Given by Ellen France J)

Table of Contents
Para No.
Introduction	[1]
Questions on appeal	[8]
Factual background	[10]
	The insurance policy	[11]
	The premises at Morningside Drive	[12]
	The defects	[14]
The approach of the High Court	[19]
Contentions on appeal	[24]
The meaning of cl 2.04	[27]
Application of cl 2.04 to the defects	[54]
Disposition	[61]
Costs	[62]

Introduction
[1]	The first and second respondents are the homeowners of units in a residential complex at 3 Morningside Drive in Auckland.  The units were poorly built and designed in such a way that over $3 million must now be spent to make the complex weathertight and safe. 
[2]	The homeowners sought to pursue remedies against those they say are responsible for the problems, including the developer, the builder and the building certifier.  Each of these has been placed in liquidation.  The last possible defendant was Leuschke Group Architects Ltd (Leuschke) who prepared the building plans, drawings and specifications. But, after proceedings were commenced against Leuschke alleging negligence in the provision of architectural services, Leuschke also was placed in liquidation.  At that point, the respondents learned that Leuschke had professional indemnity insurance.
[3]	The homeowners applied to have the insurers, Lumley General Insurance (NZ) Ltd and Ace Insurance Ltd, (Lumley), the appellants, joined to the proceedings.  Lumley consented to joinder as defendants provided there was an order for a determination under r 418 of the High Court Rules 1985 (then in force) of the interpretation of cl 2.04 of the insurance policy.
[4]	Clause 2.04 of the policy provides that Lumley shall not indemnify Leushke against liability:
for loss or damage of whatsoever nature to any building or structure arising directly or indirectly from moisture or water ingress through any exterior cladding or roofing system (and any associated waterproofing treatment and flashings) designed, specified or approved by the Insured, including but not limited to monolithic claddings and face sealed systems, fibre cement sheets, expanded polystyrene sheets, cellulose fibre sheets, PVC sheets, stucco plaster and proprietary plaster systems.
This exclusion shall not apply to any exterior cladding system, the design of which allows or promotes the ready escape of moisture and moisture vapour.
[5]	The Court made an order for joinder of Lumley and an order for a separate trial of the question:
Whether exclusion 2.04 applies to exclude the liability of [Lumley] arising out of damage to the [homeowners’] property arising from water entry and moisture damage via:
(a)	Metal balustrades that are fixed through horizontal surfaces on the decks to Units 201 to 205, 208 to 210, 213, 214, 219 to 221, 301 to 305, 308 to 310, 313, 314 and 319 to 321 causing the puncturing of the butyl rubber membrane;
(b)	Metal cappings that are fixed through the top vertical surfaces of the balconies with timber framed balustrades;
(c)	Metal cappings on the tops of wing walls between units; 
(d)	The penetration by storm water downpipes at the top of the wing walls between the units.
[6]	The matter came before Stevens J who concluded that cl 2.04 did not exclude Lumley’s liability in relation to the identified defects. 
[7]	Lumley appeals against the decision of Stevens J.  Lumley says liability is excluded by cl 2.04 with the result that the respondents’ claims against Lumley would be struck out.  The respondents support the decision of the Judge.
Questions on appeal
[8]	The appeal raises two questions, namely:
(a)	Does cl 2.04 exclude liability for defects arising from:
(i)	“... moisture or water ingress through any exterior cladding ... system ... (and any associated water-proofing treatment and flashings)” or
(ii)	“... moisture or water ingress through any exterior cladding”?
(b)	Was the Judge correct that the exclusion, properly interpreted, did not apply to each pleaded defect? 
[9]	After setting out the factual background and the approach taken by Stevens J, we deal with each question in turn. 
Factual background
[10]	We need to deal with three aspects of the facts.  First, we discuss some material relating to the insurance policy; secondly, the main features of the complex; and finally, the nature of the defects in the building.  
The insurance policy
[11]	The matter proceeded on the basis of a number of agreed facts about the policy.  There is therefore no dispute that Lumley was the insurer of Leuschke when Leuschke went into liquidation on 23 July 2007.  Further, it is agreed that Leuschke was a member of New Zealand Architects Co-operative Society Ltd (NZACS).  NZACS members have cover with Lumley on the basis of a master policy.  The relevant policy was that in force for the year 1 December 2004 to 30 November 2005.  Subject to the policy’s terms, conditions and exclusions, Leuschke has $1 million of cover subject to an excess of $10,000.  The policy is a claims made or notified policy.  Finally, the parties agreed that Aon New Zealand Ltd operates a claims notification service as part of its service as a broker.  Leuschke notified Aon on 1 June 2005 that a claim had been served on it.  Aon notified Lumley General Insurance Ltd of the claim on 2 June 2005.  
The premises at Morningside Drive
[12]	The complex at Morningside Drive is described by James Morrison, an architect who gave evidence on behalf of the respondents.  Mr Morrison said the building was four storied.  Three of the levels of the building were residential units and the fourth was the basement carpark.  The building comprised “precast concrete panels, concrete blockwork and timber framed construction”.  
[13]	Mr Morrison said that the exterior and interior walls had “lightweight timber framing, with intermediate timber floors”.  Mr Morrison continued:
The exterior cladding is a solid plaster system (stucco).  ...
The apartments have external decks.  These have timber framing.  These decks are outside the main building envelope.  There are no living spaces encapsulated within the deck footprint.  Some of these decks have walls with timber framing.  Other decks have steel balustrades.
The defects
[14]	We come back later to some of the detail of the defects themselves.  For these purposes we can adopt the Judge’s description of the defects.
[15]	The first defect relates to the metal balustrades on some of the decks.  Over the timber framing of the decks there is a butyl waterproofing membrane and stucco.  The base of the metal balustrade sits on top of the stucco.  As Stevens J said: 
The base plates of the posts of the balustrades have been screwed in vertically through the stucco, the hardibacker and the butyl.  Water ingress has occurred under the plates of the metal balustrades through the holes made by the screws through the cladding and then through the waterproofing membrane.  The water has damaged the framing and other elements of the building.
[16]	The next defect relates to the metal cappings on the timber-framed balustrades of other balconies.  Those cappings have been fixed through the top vertical surfaces.  Water has gained entry through the cappings leading to cracking of the plaster and decay in the timber. 
[17]	The third area of defects relates to the wing walls.  As Stevens J observed, the units on the top level of the complex have wing walls between them.  The wing walls are topped with flat metal flashings.  These are intended to stop water entering into the wing walls.  However, the defects associated with the metal flashings have led to water ingress into the building envelope leading to cracking of the external plaster cladding and damage to the timber framing.  
[18]	The final area of defects relates to downpipes.  Stormwater downpipes penetrate the top surfaces of the cappings on the wing walls.  Water has entered the wing walls through the penetration made by the downpipes and has damaged the timber framing underneath.  
The approach of the High Court
[19]	Stevens J proceeded on the basis that the words in cl 2.04 were not clear.  In particular, the Judge considered there was a genuine ambiguity as to whether or not the word “and” where it first appears in the bracketed words of the definition was used in a conjunctive or disjunctive sense.  His Honour said that the ambiguity should be construed in favour of the insured.  Stevens J placed some weight on the fact that it would have been easy for the insurers to add the words “system” after the words “exterior cladding” but they did not do so.  
[20]	Stevens J considered that the approach favoured by the respondents was consistent with the natural and ordinary meaning, was reasonably available, and consistent with industry practice.  On the meaning of “exterior cladding”, the Judge noted that in the building/architectural industry those words had the meaning described by Phillip Hartley, a chartered building surveyor, who gave evidence on behalf of the respondents.  Mr Hartley described exterior cladding by reference to the “assembly” of materials which provided “a system of enclosure” to an external wall.  
[21]	Stevens J did not find support for Lumley’s argument in the broader context of the clause.  The Judge considered that the words “roofing system” sit “comfortably” together and are used “in juxtaposition in the industry”.   Stevens J rejected the argument that the examples, like “monolithic claddings”, in cl 2.04 did not apply to the words exterior cladding.  He took the view that each of the examples was appropriate to the words “exterior cladding”.  Nor did the Judge consider that the proviso assisted Lumley.  Rather, Stevens J said that this describes a system which allows or promotes ready escape of moisture and moisture vapour.  The policy had to be clear about what the relevant design concerned and that was thereby written back. 
[22]	As to the bracketed words, “(and any associated waterproofing treatment and flashings)”, the Judge decided that in their natural and ordinary context they applied only to the words immediately preceding them.  That made “perfectly good sense”.   Again, the Judge said the insurer could easily have clarified the matter but had chosen not to do so.  
[23]	Stevens J then addressed each of the defects and concluded that they were not excluded by cl 2.04 as interpreted.  
Contentions on appeal
[24]	Lumley says cl 2.04 excludes damage from moisture ingress through the entire exterior cladding system and associated flashings and so the policy does not provide cover for the damage to the building.   In developing this submission, Lumley says the Judge’s approach is contrary to the ordinary and natural meaning of the words used and does not sit well with cl 2.04 when the clause is read as a whole.  Lumley also submits that Stevens J’s analysis is inconsistent with other contextual matters including the approach in industry documents.
[25]	The respondents say cl 2.04 excludes only damage caused by moisture ingress through the exterior cladding.  They say the damage to the building occurred because of moisture ingress through cappings and flashings and through the horizontal surface of the decks, and so it is covered by the insurance policy. 
[26]	The respondents accordingly maintain that the Judge was correct, that is, “system” is associated with “roofing” only and the bracketed words also refer only to roofing systems.  As an alternative argument, the respondents submit that even if system “attaches” to both cladding and roofing, the bracketed words do not.  At best, the respondents say, the clause is ambiguous.  Any ambiguity should be interpreted in favour of the insured especially where it was easy for the insurer to have made the position clear.  The respondents argue that the industry material on which Lumley relies does not assist and, to the extent that it is relevant, it supports the Judge’s views. 
The meaning of cl 2.04
[27]	There is no dispute between the parties that the insurance policy is to be interpreted applying the principles applicable to ordinary contracts.  We do, however, need to deal with a further submission made by Mr Shand for the respondents.  Namely, that cl 2.04 should be construed narrowly and the Judge’s interpretation upheld on the basis that it is reasonable.  We agree that, as an exclusion clause, cl 2.04 should be construed narrowly.  But that does not mean a strained interpretation is to be adopted.  The overall objective is to ascertain the presumed mutual intention of the parties. 
[28]	Applying these principles, we consider it was not correct to treat “or” in the phrase “any exterior cladding or roofing system” as involving two disjunctive concepts.  Rather, cl 2.04 means that “system” is associated with both “exterior cladding” and “roofing”.  Similarly, the bracketed words “(and any associated waterproofing treatment and flashings)” are also associated with both the exterior cladding and roofing systems.  Accordingly, subject to the proviso, cl 2.04 excludes liability for damage arising through any water ingress through any “exterior cladding system” or any associated waterproofing treatment or flashings designed by Leuschke.  
[29]	There are a number of reasons for that conclusion.  First, we consider this is the natural and ordinary meaning of the language used, particularly when the clause is considered as a whole.  Contrary to the findings of the Judge, we consider two aspects of the balance of the clause are important.  The first part of the clause we emphasise is the phrase, “including but not limited to monolithic claddings and face sealed systems, fibre cement sheets, expanded polystyrene sheets, cellulose fibre sheets, PVC sheets, stucco plaster and proprietary plaster systems”.  Some of those things, like stucco plaster, must relate back to exterior cladding and cannot only relate to roofing systems. 
[30]	Further, the proviso makes no sense if the reference to exterior cladding in the body of the clause does not mean an exterior cladding system.  Otherwise, the proviso is writing back in coverage when the clause has not in fact excluded such cover.  We agree with Mr Ring QC’s submission for Lumley that the necessary inference is that the parties must have intended that the main clause and the proviso be complementary.  
[31]	When the clause is read as a whole, we agree with Lumley that there is no genuine ambiguity.  There is no basis to bring into play the contra proferentem rule and therefore interpret the clause in favour of the insured.
[32]	Secondly, there was evidence supporting Lumley’s interpretation of the clause.  
[33]	The key proposition from Mr Morrison, the respondents’ expert, was that exterior cladding related solely to the main building envelope.  On his approach, the decks were not part of the exterior cladding.  Consistently with this, he initially maintained that capped flashings were a critical part of the building but not a part of the cladding system.  Subsequently, the proposition was put to him that the capping on the timber-framed balustrades was the only thing preventing water getting into the timber framing.  Mr Morrison accepted that.  The following exchange then occurred:
Q:	In that sense it really is the cladding for this particular exterior part of the building?
A:	It’s an element of the cladding. 
[34]	Mr Morrison also accepted that the same would apply to the cappings over the wing walls.  If this is the position, it suggests the words in brackets which refer to “associated” waterproofing treatment and flashings, must be associated with “cladding”.
[35]	We add that Mr Morrison’s exact position is not entirely clear because, in re-examination, he was asked if he maintained the view expressed in his brief that the “metal balustrade capping is not a part of the exterior cladding system or roofing system”.  He said he did although he gave no explanation for his earlier comment in cross-examination. 
[36]	In this context, we need to say something about the evidence of the respondents’ other expert, Mr Hartley, because that was relied on by the Judge.  The thesis of Mr Hartley was that exterior cladding stopped at the exterior wall.  That does seem odd given that without other components like flashings, the purpose of enclosure, that is, to exclude weather ingress, could not be achieved.  He also said that exterior cladding was limited to the vertical faces.
[37]	As we have noted, Stevens J preferred the definition of “exterior cladding” advanced by Mr Hartley.  Mr Hartley said that exterior cladding refers to:
... the assembly of materials forming a system of enclosure to an external wall,  including essential jointing materials, constructed for the purpose of excluding weather ingress from the wall structure to which it is attached. 
[38]	Mr Hartley did not, however, suggest this was the only definition.  In any event, the use of the word “assembly” connotes more than just the stucco cladding material.  The Judge placed some weight on the fact Mr Marshall accepted Mr Hartley’s definition was not unreasonable.  However, as Mr Ring submitted, that acceptance needs to be seen in context.  Mr Marshall was discussing stucco cladding and was clarifying that metal cappings and flashings, while not a stucco item in themselves, were so integral to exterior cladding as to form part of it.  On that approach, they would be part of a “system of enclosure to an external wall”.
[39]	There was contrary evidence.  Lumley called evidence from Leigh Marshall, an architect.  His evidence was that in the building industry, a cladding system included all of its components.  As we shall see, Mr Marshall relied on various industry documents to support his conclusion that cladding systems include items like flashings.
[40]	The Judge said that where the views of the experts differed, he preferred that of Mr Hartley and Mr Morrison.  There was no contest of credibility as such between the experts but, as we have indicated, Mr Hartley’s evidence was not so conclusive as to be determinative of the matter.  In any event, where there is a difference between the experts, we prefer the evidence of Mr Marshall.  As we have noted, it is not entirely clear how Mr Morrison’s evidence fits together but his approach in response to cross-examination is the more logical.  To the extent Mr Hartley would confine the exterior cladding to the stucco plaster, again, that does not make a great deal of sense. 
[41]	Our third reason for preferring Lumley’s approach is that it makes commercial sense.  On the interpretation adopted by the Judge, part of the system for keeping water out is excluded but not all.  There is no obvious reason to draft the policy to differentiate between the roof and the walls in this way.  The respondents were not able to come up with any reason why the parties would take that approach.
[42]	Finally, the interpretation advanced by Lumley fits in with how the industry was dealing with the matter at the time.  The proposition advanced by Mr Ring on this aspect is that the policy was being bargained for in the context of definitive industry documentation which dealt specifically with avoiding water ingress as a result of design defects by architects.  That documentation focused on the weathertightness for the building envelope and addressed that by identifying risk factors in design and cladding and roofing systems that would address those risk factors.  
[43]	Amongst other things, Mr Ring relied on a Building Industry Authority (BIA) Approved Document.  The Approved Document sets out various ways in which the weathertightness requirements of the New Zealand Building Code could be met, and comprises a Verification Method (E2/VM1) and an Acceptable Solution (E2/AS1). The Approved Document deals with, for example, roofs and then sets out the associated requirements for claddings, the joints of claddings, and the pitch of the roof.  Hence, Mr Ring maintained, if the question was asked, “What is the watertight envelope for the building”?, the answer given by the E2/AS1 section of the Approved Document would be “the cladding system and the roofing system”.  On this basis, it would make no sense to differentiate in cl 2.04 between the roof and the wall cladding.  Further, Mr Ring points out, all of the defects apparent in the Morningside Drive complex are dealt with in the E2/AS1 section of the Approved Document.
[44]	Mr Shand responds that not all of the documents relied on by Lumley were in evidence before the Judge.  Further, he says that to the extent these documents are relevant, in fact they distinguish between cladding and between cappings and flashings, for example in the various diagrams.  On this basis, Mr Shand submits that it is not unreasonable to limit the term “cladding” to material on the external wall or face of a building.  
[45]	It was open to the Judge to consider the relevant documents as part of the context against which the contract is to be interpreted.  But we agree with Mr Shand that all of the material on which Lumley now seeks to rely should have been before the Court as part of the evidence.   Importantly, although excerpts of both E2/AS1 and E2/VM1 were in evidence in the High Court, for some unknown reason, the definitions were not included. 
[46]	There is also an issue about what versions of the various documents were in force at the relevant time, that is, at the date of acceptance of the policy (22 November 2004).  The Judge took the view that the version of the Approved Document relied on by Mr Marshall was not of assistance because it post-dated the inception of the policy.   
[47]	Certainly, the later (third edition) of the Approved Document is the high point for Lumley’s argument.  In this edition, “cladding” is defined as the “exterior weather-resistant surface of a building” with the comment that it includes “any supporting substrate and, if applicable, surface treatment”.   “Cladding system” is relevantly defined as:
The weatherproof enclosure of a building, including building wraps, claddings and their fixings, windows, doors and all penetrations, flashings, seals, joints and junctions. ...
[48]	“Capping” is defined as a “flashing formed to cover the top of an enclosed balustrade or parapet”.  “Flashing” in turn is defined as a “component, formed from a rigid or flexible waterproof material, that drains or deflects water back outside the cladding system”.  Finally, “weathertightness” is defined as a “state where water is prevented from entering or accumulating behind the cladding in amounts that can cause undue dampness or damage to the building elements”.  
[49]	As we understand the position, while the E2/AS1 part of the Approved Document was not in force at the relevant time, the E2/VM1 part was.  That would mean that these definitions reflected the industry view at the time of the inception of the policy.
[50]	There is some force in Mr Ring’s argument that it is not suggested that the tenor of any of these definitions has changed, although obviously the range of defined terms has been extended.  That would suggest the fact that the correct definitions were not before the Judge was not problematic.  However, even if E2/AS1 and E2/VM1 are put to one side, we consider it can be said on the basis of what was in evidence, and in force, that the industry documentation supported Lumley’s approach.  In particular, reference can be made to the BIA’s “New Zealand Building Code Handbook”.  This was one of the documents relied on by Mr Marshall.  The version of this Handbook in force at the time the policy was accepted and at the time cover commenced was the December 2000 edition.  The Handbook at that time contained a definition of “cladding” but not of “cladding system”.  “Cladding” meant the “exterior weather-resistant surface of a building”.  
[51]	In addition, the Building Research Association of New Zealand (BRANZ), which publishes bulletins providing the building industry with good practice guidelines concerning building performance, issued Bulletin Number 304 “Flashing Design” in February 1993.  This Bulletin says that the “function of a flashing is to block direct water leakage paths and divert water away from any point where it may enter the building structure”.  Mr Marshall referred to a second BRANZ bulletin (Number 305 “Domestic Flashing Installation”) issued in February 1993 which says that flashings are a “primary defence against water entry”.  Finally, Mr Marshall referred to the BRANZ “Weathertight Solutions Vol 2: Stucco” publication, issued in January 2004, which describes flashing systems as an “essential element of any cladding system”. 
[52]	Although, for obvious reasons, the various components are depicted separately in the various diagrams, the thrust of this documentation is that all of the components are seen as part of a system for ensuring weathertightness.  We agree that Lumley’s interpretation of cl 2.04 is consistent with relevant industry documentation. 
[53]	For these reasons, Lumley succeeds on this point.
Application of cl 2.04 to the defects
[54]	The respondents submit that even if cl 2.04 excludes cover for water ingress through “exterior cladding systems”, cl 2.04 does not apply to the defects.
[55]	In terms of the first defect, the respondents rely on the 2004 BRANZ “Good Practice Guide: Stucco” which is a recognised guide to the application of stucco plaster.  That publication makes no reference to butyl membranes on decks.  On this basis, the respondents submit that it is at least arguable that moisture ingress through that membrane is not through the exterior cladding system and so not caught by the exclusion.  The respondents add that common sense dictates that a waterproofing membrane on a deck is not part of any exterior cladding system.  The respondents also rely on Mr Morrison’s evidence that none of the defects resulted from moisture through the cladding system or the roofing system.
[56]	In terms of the metal cappings to the deck balustrades and wing walls, the respondents submit that any exterior cladding system was a stucco system and that metal cap flashings are not an essential part of that system.  Again, Mr Morrison’s evidence is relied on.
[57]	We consider it follows from our approach to cl 2.04 that all of the defects are within the exclusion.  They all occur because of water ingress through a part of the water-resistant surface.
[58]	In addition, we note that Mr Marshall’s evidence provides an answer to the respondents’ argument in relation to the metal balustrades.  He says that the butyl membrane is a water proofing treatment associated with the exterior cladding.  Further, Mr Marshall deposes:
The water has been allowed to ingress not only through the associated waterproofing treatment but also through the exterior cladding itself as the base plates to the metal balustrades are fixed directly through the exterior stucco cladding which has allowed water to ingress through that cladding into the building.  The first point of entry of water into the building is through the exterior cladding which is over the waterproofing membrane.
[59]	The other defects involve water ingress through cappings.  Mr Shand accepted that a capping could be treated as a subset of flashing.  There was evidence to support that.  While Mr Hartley maintained that cappings and flashings were different, Mr Morrison accepted they were the same thing.  
[60]	For these reasons, we consider the defects come within the exclusion.
Disposition
[61]	The appeal is accordingly allowed.  We declare that cl 2.04 applies to exclude Lumley’s liability arising out of damage to the first and second respondents’ property from water entry and moisture damage occurring via the four defects identified in the question of law before the High Court (as expressed at [5] above).  
Costs
[62]	There is no reason why costs should not follow the event.  The respondents must pay the appellants costs for a standard appeal on a band A basis and usual disbursements.  We certify for second counsel.  Costs in the High Court are, in the absence of agreement, to be fixed by that Court in light of this judgment. 

Solicitors: 
Morgan Coakle, Auckland for Appellants
Grimshaw & Co, Auckland for Respondents