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A Boring Coverage Dispute

Published in the March 2007 issue of Litigation Notes - View Article

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In the early 1990s, the Canadian National Railway Company (“CN”) was building a new railway tunnel under the St. Clair River between Sarnia, Ontario and Port Huron, Michigan. A tunnel boring machine (the “TBM”) was custom-built for the project and the boring of the tunnel began in November of 1993. Two months into the project, the TBM broke down, resulting in damage to the machine itself and a 229-day delay in the opening of the new tunnel.

CN held a builders risk insurance policy (the “Policy”) which insured it against “…all risks of direct physical loss or damage…to all real and personal property of every kind and quality including but not limited to the [TBM]”.  CN’s claim under the Policy was denied by the insurers, who relied on exclusions in the Policy that excluded coverage for “the cost of making good…faulty or improper design” and “inherent vice”. CN sued the insurers for recovery under the Policy.

In the Ontario Superior court of Justice the trial judge found that the cause of the failure of the TBM was “…excess differential deflection between components of the TBM which the TBM could not accommodate and which resulted in damage to the sealing system permitting soil and other foreign material to enter the main bearing area of the TBM”.

The trial judge dismissed the insurers’ claim that the failure of the TBM was caused by “faulty or improper design”.  He held that under Ontario law a design would be found to be “faulty” or “improper” if it failed to “accommodate or provide for a condition or occurrence that was foreseeable, however unlikely or remote”. 

In analyzing the faulty design exclusion, the trial judge identified three different standards that have been applied by our courts: “(i) the “prima facie” standard, which contemplates that the fact of the failure of the property in question establishes that the design of the property was flawed; (ii) the “reasonable foreseeability” or tort standard, which mandates an inquiry into whether all reasonably foreseeable risks were taken into account in the preparation of the design; and (iii) the “foreseeability” standard, which requires that the design in question provide for all foreseeable risks”.  He chose to adopt the ‘foreseeability” standard, stating that “… the law of Ontario is that the standard to be applied to determine whether a design was faulty or improper is that insured property must be designed so that it accommodates all foreseeable risks, even though such risks may be unlikely and remote, and that the standard is not the prima facie standard…nor a standard of reasonable foreseeability or negligence”.

He found that the cause of the failure of the machine was not foreseeable and that it had been designed in a manner to accommodate all foreseeable risks. As such the faulty or improper design exclusion did not apply. Furthermore, he held that the insurers had failed to establish the applicability of the inherent vice exclusion, as it applies only to the peril of a vice inherent or incidental to the insured property itself, as opposed to a loss arising from an external cause. As a result, the insurers were found liable to CN for $20,966,947.00. They appealed.

The Ontario Court of Appeal disagreed with the trial judge’s findings that the cause the failure of the TBM was not foreseeable and that the design of the TBM was such as to accommodate all foreseeable risks.  While the trial judge had given due consideration to the opinions of the engineering experts as to the cause of the failure, he had failed to give sufficient consideration to the testimony of the representative of the engineering firm that designed the TBM.  This was an error, of the kind referred to in Keljanovic Estate v. Sanseverino, 2000 CanLII 5711(On.CA), as a “processing error”. As was stated in that case, a “processing error” “…is an error in processing the evidence that leads to a finding of fact.  This type of error arises when a trial judge fails to appreciate the evidence relevant to a factual issue, either by disregarding or misapprehending that evidence.  When the appellate court finds such an error it must first determine the effect of that error on the trial judge’s reasoning.  It may interfere with the trial judge’s finding if it concludes that the part of the trial judge’s reasoning process that was tainted by the error was essential to the challenged finding of fact”.

The Court of Appeal concluded that the risk of the failure that occurred in this case was foreseeable, that the design of the TBM was faulty and the “faulty or improper design exclusion” applied. In doing so, the court made an interesting observation on the nature of “all risks” insurance: “An ‘all risks’ policy of property insurance, like any other insurance policy, represents an agreed allocation between an insurer and an insured of those risks that the insurer is prepared to underwrite and those that are to be borne by the insured.  Insurance policies of this type provide broad coverage for losses and damage to property.  But they do not provide coverage against all conceivable perils.  Obviously, were it otherwise, there would be no role for coverage exclusions…the Policy here was neither a warranty that the insured property – the TBM – would fulfill its intended purpose, nor a warranty of entrepreneurial design risk.  With respect, the effect of the trial judge’s foreseeability analysis in this case is to convert the Policy into just such a warranty”.

The Court of Appeal agreed with the trial judge that the inherent vice exclusion did not apply, accepting the definition of “inherent vice” that he adopted: “The term ‘inherent vice’ as a cause of loss not covered by the policy, does not relate to an extraneous cause but to a loss entirely from internal decomposition or some quality which brings about its own injury or destruction. The vice must be inherent in the property for which recovery is sought”. The Court of Appeal pointed out that the exclusion has been interpreted narrowly by the courts and made reference to the case of C.C.R. Fishing Ltd. v. British Reserve Insurance Co., 1990 CanLII 145 (SCC), a marine insurance case, involving a ship which sank either because a valve had been left open or because of corroded cap screws.  Justice McLachlin held that even if the loss was due solely to the corroded cap screws, this was not inherent vice:”The concept of inherent vice in the context of marine insurance refers to loss stemming from qualities inherent in the thing lost. The failure of the cap screws in the case at bar cannot be said to result from purely inherent qualities of the ship. The unfortunate installation of these parts in the ship was a result of the negligence of the repairers, an external cause unrelated to those qualities. The loss was fortuitous, in the sense that it was not the inevitable product of a quality inherent in the vessel”.

Nevertheless, based on the courts finding on the “faulty or improper design exclusion” the insurers’ appeal was allowed. One of the three judges in the court of Appeal dissented. She pointed out that the trial had taken 19 days, that the trial judge had deliberated for more than five months and written 176 paragraphs of reasons. In her view, his factual findings were supported by the evidence and were entitled to deference.