Canadian National Railway Company et al v. Royal
and Sun Alliance Insurance Company of Canada et al.
Ontario Court of Appeal, Docket C42591, March 26, 2007
When can an insurer rely on an exclusion for faulty or improper
design? In Canadian National Railway Company et al v. Royal and
Sun Alliance Insurance Company of Canada et al. the Ontario
Court of Appeal considered the effect of a faulty design exclusion
under an all risks policy.
In the above noted case, C.N. was claiming against
its insurers the sum of roughly 30 million dollars. The claim was
damages due to delayed construction of a new railway tunnel. In
order to dig the tunnel, C.N. had hired a design firm to build a
tunnel boring machine ("TBM"). During the course of building
the tunnel, the machine broke down which caused damage to the machine
and delayed construction.
C.N.'s insurer denied coverage. Insurers claimed that
a policy exclusion for the "cost of making good . . . faulty
or improper design" was engaged. The court of appeal agreed.
The TBM was a unique and specially designed piece
of machinery designed by a large team of individuals. One of the
concerns in the creation of the machine was preventing soil from
entering the bearing chamber. As luck would have it, although the
designers believed that they had adequately dealt with the risk
to the bearings, the cause of the machine failure was that it did
not "operate as intended to prevent soil or other foreign materials
from passing through the seal gap and entering into the bearing
chamber thereby creating a risk of damage to the bearing".
C.N.'s insurance policy covered "all risks of
direct physical loss or damage, including general average and salvage
charges to: (a) all real and personal property of every kind and
quality including but not limited to the [TBM]". This coverage
excluded "the cost of making good . . . faulty or improper
design provided, however, to the extent otherwise insured and not
otherwise excluded under this Policy, resultant loss or damage under
any Section of this Policy shall be insured".
The main issue in this case was the standard of proof.
When is a design deemed faulty or improper so as to exclude coverage?
The court rejected the submission that the test should be one of
negligence, where a design would be faulty if it failed to account
for reasonably foreseeable risks. Rather, "property must be
designed so that it accommodates all foreseeable risks, even though
such risks may be unlikely and remote". It is not enough to
account for a foreseeable risk, risks must further be identified
and allowed for in the design.
It was clear that the TBM did not withstand the conditions.
However, the court had to consider technical evidence to determine
if the conditions were foreseeable. In this case, the evidence showed
that the designers were concerned about foreign materials compromising
the bearings. The designers knew of the potential danger and investigated
the extent of the risk. This was not a case where the problem was
not known to the industry. Rather the type of problem was a concern
to the designers. After the failure, the TBM was modified to prevent
future similar failures. The designers simply believed that the
risk had been accommodated, when in fact, it was not.
Further, the appellate court found that the a design
will still be faulty if the magnitude of the risk was not foreseen.
It was sufficient that the "design of the TBM was inadequate
to meet a known risk of possible failure of the TBM . . .".
As such, the TBM "was faulty and, consequently. . .the faulty
or improper design exclusion applies".
In coming to this conclusion, the court had to consider
the interpretation of all risks policies. These policies provide
broad coverage for losses and damage to property, but not against
all perils. The policy was not meant to be a warranty.
By rejecting the tort test of reasonable foreseeability,
the court was requiring a higher standard of designers. Under the
negligence test, a design would only be faulty if the designers
neglected risks that were reasonably foreseeable. If a risk was
determined to be foreseeable, but remote, then a design would not
be faulty for failing to account for the risk. In effect, insurers
would have greatly increased exposure for design defects, and in
effect, would be providing design warranties.
It can be argued that an all risks policy is ill-designed
to deal with design defects. When could it be said that a risk is
reasonably foreseeable rather than remote? This is a subjective
test. An all risks policy is not designed to compensate for shoddy
products, or to regulate technical areas such as the design of heavy
C.N. also argued that its losses were coverable under
the exception to the exclusion, in that, a portion of the loss was
for delay beyond the scheduled start-up date, and delay was a peril
insured against under another section. The faulty design exclusion
stated "to the extent otherwise insured and not otherwise excluded
under this Policy, resultant loss or damage under any Section of
this Policy shall be insured". However, the court found that
the section that covered delay was also subject to the faulty design
exclusion, and that C.N. was covered "for consequential economic
loss only to the extent that the economic loss results from insured
loss or damage to insured property".
Does this interpretation render the exception to the
exclusion nugatory? The court found that there are still situations
when this exception would apply. For example, if "the faulty
design of the TBM had caused a fire that damaged the TBM and part
of the tunnel constructed behind it, the damage to the TBM would
be excluded, as would any economic loss from delayed opening due
to the damage to the TBM. However, the physical damage to the tunnel
itself, which was insured property, would be covered, as would any
economic loss from delayed opening attributable to the damage to
This decision affirmed the reasonable expectations
of both parties to an all risks insurance contract. Insured's do
not expect that they will have coverage for design decisions on
complicated machinery. If the test for triggering a design exclusion
is that of reasonableness, the issues of cost and strategy would
come into play. Would it be sufficient to not plan for a risk that
had a low chance of occurring, if the expense to do so was very
great? This is a risky game, and not one that insurers want to play
under an all-risks policy.
Finally, C.N. argued that it had mitigated its damage
and that the sue and labour clause under the policy would oblige
the insurer to contribute to reasonable and proper expenses incurred
to prevent further damage. The court found that this does not "apply
to indemnify the insured for expenses incurred to minimize or mitigate
an uninsured loss". Sue and labour clauses simply require insured's
to ensure that insured losses are minimized.
Effectively, the court reinforced the expectations
of insurers under all-risks policies. Although exclusions must be
interpreted strictly, the court must be careful not to extend all-risk
policies to technical areas that are beyond the scope of this type
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