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Supreme Court Considers “Faulty or Improper Design” Exclusion
Published in the May 2008 issue of Litigation Notes - View Article
Synopsis: The Supreme Court of Canada has reversed a decision of the Ontario Court of Appeal, which found that there was no coverage for the failure of a tunnel boring machine, by reason of the “faulty or improper design” exclusion in an insurance policy
We have previously commented on an interesting coverage dispute involving a Builder’s Risk insurance policy (“A Boring Coverage Dispute”, Litigation Notes, March, 2007). In the 1990’s, the Canadian National Railway Company (“CNR”) purchased a tunnel boring machine (“TBM”) for the purpose of digging a railway tunnel beneath the St. Clair River in Ontario. The machine was manufactured by Lovat Tunnel Equipment Inc., which had manufactured many such machines in the past. However, each TBM is specifically designed for the job for which it is intended and at the time, this machine was the largest tunnel boring machine in the world.
The TBM began digging in November of 1993, but after two months operations were halted, because dirt had managed to penetrate into the inner workings of the machine. The TBM was out of service for 229 days. Modifications were made by the manufacturer and thereafter the machine continued to perform until the completion of the tunnel.
CNR had a Builder’s Risk insurance policy with Royal and Sun Alliance Insurance Company of Canada, which covered damage to the machine but excluded the cost of “making good… faulty or improper design”. At trial, the judge concluded that the damage to the TBMe had not been caused by faulty or improper design and awarded CNR over $20 million in damages. This decision was reversed by the Ontario Court of Appeal, in a two-to-one decision.
In a decision released on November 21, the Supreme Court of Canada has restored the decision of the trial judge on a for-to-three ruling. Writing for the majority, Justice Binnie rejected the notion that the fact that a machine fails, or does not perform as intended, means that the design was invariably faulty or improper. This would be to apply the benefit of hindsight. For a design to be faulty or improper, it has to have failed to take into account foreseeable risks. In doing so, one must apply a standard. An “industry standard” is not adequate, because an entire industry may be applying an inadequate standard. Rather, it is necessary to determine if the knowledge brought to the design was “state of the art”. As Justice Binnie states: “… at any given time risks may be foreseeable but… in addressing those risks in an innovative project there is inevitably a gap between the then current state of the engineering art and omniscience, i.e. a state of perfect knowledge and technique. This gap conceals risks within risks that are not foreseeable on ‘the basis of information that was available at the time… in the real world’… a design is not ‘faulty or improper’ simply because it falls short of perfection in relation to all foreseeable risks”
Justice Binnie went on to conclude that in the circumstances of this case the design had taken into account all available information at the time that it was made and was therefore “state of the art”. Consequently, it was not “faulty or improper” and the exclusion did not apply.
Writing for the minority, Justice Rothstein saw the case in much simpler terms. In his view the term “faulty or improper design” attaches to the thing that was designed, not to the work of the design engineers. “Whatever standard their work meets or does not meet, the thing designed either works for its intended purpose or it does not”. He went on to say that in some instances, everything is foreseeable in that it is imaginable, but that foreseeability must be considered in practical terms. He gives the example of a meteorite striking an aircraft. It could be argued that the design of an aircraft is faulty or improper if it does not contain a meteorite shield, because it is foreseeable that a meteorite may strike an aircraft but “such an event is so rare and unexpected in the context of a commercial airplanes expected use, that it would fall into the unforeseeable category”. However, this case was not at the “margins of foreseeability.” In this case, the TBM “…did not achieve its intended purpose because of an inability to cope with the expected, foreseeable conditions of its use. It could not, as originally designed, cope with the ground conditions it would foreseeably encounter. This type of risk was excluded from coverage under the ‘faulty or improper design’ exclusion”.
In Justice Rothstein’s opinion ,to apply a “state of the art” standard “…essentially turns a claim that must have its foundation in contractual terms into a claim in tort or something akin to a tort that is entirely foreign to the contract”. Furthermore it shifts the focus from the adequacy of the design of the machine for its intended purpose to the adequacy of the work done by the design engineers: “Did they design the TBMin accordance with the state of the art?”
Justice Rothstein felt that the approach of the majority had the effect of turning the insurance policy into a warranty. He said that “…if it was the intention of the parties that the property insurers would warrant that the design of an innovative TBM requiring such extensive technical input would not be faulty or improper, the policy would not have explicitly provided for such coverage. Instead, such coverage was expressly excluded. In view of the express exclusion, the intention of the parties must have been that the CNR was undertaking the risk involved in the development of the design of such an extraordinary piece of machinery”.
While this case has been finally decided, the divergence of opinions in both the Court of Appeal and the Supreme Court of Canada suggests that the debate over the interpretation of the “faulty and improper design” exclusion in Canada will continue.
Canadian National Railway Co. v. Royal and Sun alliance Innsurance Co. of Canada, 2008 SCC 6 (CanLII)