Canadian National Railway Co. v. Royal and Sun Alliance Insurance Co. of Canada

Canadian National Railway Co. v. Royal and Sun Alliance Insurance Co. of Canada
Collection
Supreme Court Judgments
Date
2008-11-21
Neutral citation
2008 SCC 66
Report
[2008] 3 SCR 453
Case number
32062
Judges
McLachlin, Beverley; Binnie, William Ian Corneil; LeBel, Louis; Deschamps, Marie; Abella, Rosalie Silberman; Charron, Louise; Rothstein, Marshall
On appeal from
Ontario
Subjects
Insurance
Notes
SCC Case Information: 32062
Decision Content
SUPREME COURT OF CANADA
Citation: Canadian National Railway Co. v. Royal and Sun Alliance Insurance Co. of Canada,
[2008] 3 S.C.R. 453, 2008 SCC 66
Date: 20081121
Docket: 32062
Between:
Canadian National Railway Company,
Grand Trunk Western Railroad Incorporated
and St. Clair Tunnel Company
Appellants
and
Royal and Sun Alliance Insurance Company of Canada,
Axa Assurances Inc., Continental Casualty Company of Canada,
Reliance Insurance Company, Aviva Canada Inc. and
St. Paul Fire and Marine Insurance Company
Respondents
Coram: McLachlin C.J. and Binnie, LeBel, Deschamps, Abella, Charron and Rothstein JJ.
Reasons for Judgment:
(paras. 1 to 68)
Dissenting Reasons:
(paras. 69 to 131)
Binnie J. (McLachlin C.J. and LeBel and Abella JJ. concurring)
Rothstein J. (Deschamps and Charron JJ. concurring)
______________________________
Canadian National Railway Co. v. Royal and Sun Alliance Insurance Co. of Canada, [2008] 3 S.C.R. 453, 2008 SCC 66
Canadian National Railway Company,
Grand Trunk Western Railroad Incorporated
and St. Clair Tunnel Company Appellants
v.
Royal and Sun Alliance Insurance Company of Canada,
Axa Assurances Inc., Continental Casualty Company of Canada,
Reliance Insurance Company, Aviva Canada Inc. and
St. Paul Fire and Marine Insurance Company Respondents
Indexed as: Canadian National Railway Co. v. Royal and Sun Alliance Insurance Co. of Canada
Neutral citation: 2008 SCC 66.
File No.: 32062.
2008: May 14; 2008: November 21.
Present: McLachlin C.J. and Binnie, LeBel, Deschamps, Abella, Charron and Rothstein JJ.
on appeal from the court of appeal for ontario
Insurance — “All risks” insurance — Exclusion clauses — Scope of “faulty or improper design” exclusion — Test applicable to exclusion — Construction of largest customized tunnel boring machine — Railway company subscribing builders’ risk policy — Policy excluding from coverage costs of making good “faulty or improper design” — Differential deflection foreseen, but design accommodated expected degree of differential deflection — Tunnel boring machine failed due to excess differential deflection between components of machine — Whether “faulty or improper design” exclusion to coverage applicable — Whether excess differential deflection was foreseeable.
In the early 1990s, CNR established an elaborate and sophisticated process to design and construct the largest customized tunnel boring machine (“TBM”) of its kind in the world for use in the construction of a tunnel under a river. CNR had insured the project under a builders’ risk policy covering 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, plus any consequent economic loss occasioned by delay in the opening of the tunnel. The cost of making good faulty or improper design was excluded.
The design of a suitable TBM was a major challenge, partly because structural steel deflects (bends) under pressure. While differential deflection (adjacent components moving towards or away from each other) is acceptable within stated tolerances, excess differential deflection (deflection beyond acceptable tolerances) could lead to failure. This TBM had to withstand 6,000 metric tonnes of pressure from the soil and water above as it progressed under the river. In addition, the main bearing had to be protected from contaminants. To cope with the design challenge, an experienced tunnel equipment manufacturer was selected to design, engineer, and construct the TBM. A technical committee composed of expert tunneling contractors and consultants was formed to advise on the conceptual design parameters, and the technical committee’s work was guided by a steering committee which provided general guidance. A technical review committee also monitored, reviewed and advised CNR on the project as a whole.
As designed, the TBM was 32 feet (9.5 metres) in diameter and its body was 278 feet (83 metres) long. The cuttinghead rotates on roller bearings while the main bearing generates a hydraulic thrust which drives the cutting tool through the earth. To shield the main bearing from damage, a system of 26 independent seals lubricated by the constant injection of pressurized grease was designed to prevent excavated material from getting into the main bearing and to stop the grease from leaking out. To get to the main bearing, contaminants had to get through all 26 seals. The design tolerances for the seals were precise and demanding, requiring a gap of six millimetres, plus or minus three millimetres, between the rotating cuttinghead and the stationary bulkhead. The best engineering advice indicated that there would be no excess differential deflection and that the configuration of the seals provided a margin* of safety approaching redundancy.
After completion of 14 percent of the tunnel, contamination was detected. Inspection revealed that some seals had been worn and destroyed due to excess differential deflection of the cuttinghead. Operations were halted, the main bearing was cleaned, and modifications were made. The project was then completed without further entry of dirt, but the 229‑day delay greatly increased costs. The experts were unable to explain how dirt penetrated the 26 seals while leaving some seals intact.
The insurers denied coverage on the basis of the “faulty or improper design” exclusion. The trial judge held the insurers liable. He found that, despite its failure, the innovative design accommodated all foreseeable risks however unlikely or remote and was not faulty or improper according to the state of the art at the time the design was finalized. The majority of the Court of Appeal set aside that decision, finding that the TBM’s design had been faulty within the meaning of the exclusion provision since the foreseeability standard also mandated that the relevant design succeed in withstanding all foreseeable risks.
Held (Deschamps, Charron and Rothstein JJ. dissenting): The appeal should be allowed.
Per McLachlin C.J. and Binnie, LeBel and Abella JJ.: Where, as here, the risk is broadly defined (“metal deflects under stress”) and the design addresses that risk with state of the art diligence and expertise, an insurer is not entitled to rely on the “faulty or improper design” exclusion just because existing engineering knowledge and practice lacked a proper appreciation of the design problem. Failure is not the same thing as fault or impropriety. In the interpretation of insurance policies coverage provisions should be construed broadly and exclusion clauses narrowly. The result should not be an unrealistic interpretation that would not be contemplated in the commercial atmosphere in which the insurance was contracted. The narrower interpretation of the exclusion best accords with the intentions of the parties based on a plain meaning of the words used in the policy. [5] [30] [32] [56]
At the time of contracting, all parties realized that this was to be the largest earth‑balance TBM ever built. Leading experts were enlisted to provide a state of the art machine, but, despite all efforts, there was an inevitable residual risk with the innovative design. The CNR purchased the “all risks” policy in recognition of that risk. The policy did not exclude all costs attributable to “the design”, but only costs attributable to an “faulty or improper design”. Although the TBM failed, the insurers did not meet the onus of bringing the loss within the exclusion. [5]
The “faulty or improper design” exclusion relates to faulty design, not designer fault. It implies a comparative standard against which the impugned design falls short. Such a standard can require no more than that the design comply with the state of the art. Under that standard, the loss may have been caused by the design, but the exclusion does not apply unless the design is faulty or improper. As there is inevitably a gap between the current state of engineering art and omniscience, a standard of perfection in relation to all foreseeable risks is too high, but the industry standard is too low. A design will have fallen below the standard reasonably required in the circumstances where the materialized risk was both foreseeable and avoidable by use of a design that matched state of the art standards. [31] [35] [41] [51] [53‑54] [65]
While differential deflection was a known risk in the design of the TBM, it had been properly explored in the design phase, as found by the trial judge. Based on the existing state of the art, excess differential deflection was not foreseeable, even as a remote or unlikely risk, with this design in these circumstances. Contrary to the finding of the majority of the Court of Appeal, failure to withstand does not discharge the onus of establishing fault — the insurer cannot rely on the benefit of hindsight to discharge its onus of proof. The CNR was entitled to insure against the possibility that the design might fail even though not faulty or improper according to the state of the art. The design failed, but, because it exhausted the state of the art, the insurers did not meet the onus of bringing the loss within the exclusion. [5] [48] [58] [61]
While the words of the exclusion may require interpretation, they are not ambiguous, and the policy was a manuscript policy negotiated between two sophisticated parties. The doctrine of contra proferentem did not apply. [33]
Per Deschamps, Charron and Rothstein JJ. (dissenting): The exclusion providing for faulty or improper design applies. The “faulty or improper design” exclusion attaches to the thing designed, not the work of the designers. Whatever standard their work meets or does not meet, a design is faulty or improper if it does not work for the purpose for which it was intended. While a design cannot be expected to withstand “rare and unforeseeable conditions”, it must provide for and withstand all foreseeable risks, including extreme examples of those foreseeable risks. In this case, the insurers proved there was a design problem: differential deflection was foreseeable, but the design was unable to cope with the degree of differential deflection that occurred under normal conditions. This type of risk was excluded from coverage under the “faulty or improper design” exclusion. As there is no coverage under Section I of the policy for faulty or improper design, there can be no coverage under Section II for resultant damage or economic loss. [86-87] [100] [103] [106] [108] [126-28] [130]
The term “faulty or improper design” does not imply the introduction of a “state of the art” standard against which an impugned design is to be compared. The relevant distinction is between a design that is defective and a design that is free from defect. Introducing a comparative 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. It shifts the focus from the adequacy of the design of the TBM for its intended purpose, having regard to all foreseeable risks, to the adequacy of the work done by the design engineers, a focus not suggested by the words of the exclusion. There is no foundation for the inference that a “state of the art” standard was the parties’ common intention. [70] [111-113] [115]
Since the term “faulty or improper design” is not ambiguous, it is unnecessary to apply the contra proferentem doctrine, which only applies when other rules of construction fail to enable a court to ascertain the meaning of the words in question. [74] [76]
Cases Cited
By Binnie J.
Not followed: Queensland Government Railways v. Manufacturers’ Mutual Insurance, Ltd., [1969] 1 Lloyd’s Rep. 214; considered: Foundation Co. of Canada Ltd. v. American Home Assurance Co. (1995), 25 O.R. (3d) 36, aff’d [1997] O.J. No. 2332 (QL); referred to: Consolidated‑Bathurst Export Ltd. v. Mutual Boiler and Machinery Insurance Co., [1980] 1 S.C.R. 888; Reid Crowther & Partners Ltd. v. Simcoe & Erie General Insurance Co., [1993] 1 S.C.R. 252; Zurich Insurance Co. v. 686234 Ontario Ltd. (2002), 62 O.R. (3d) 447; Parsons v. Standard Fire Insurance Co. (1880), 5 S.C.R. 233; Stevenson v. Reliance Petroleum Ltd., [1956] S.C.R. 936; Continental Insurance Co. v. Dalton Cartage Co., [1982] 1 S.C.R. 164; Poole‑Pritchard Canadian Ltd. v. Underwriting Members of Lloyds (1969), 71 W.W.R. 684; Homeco Investments Ltd. v. Canadian General Insurance Co., [1984] O.J. No. 920 (QL); Lakeland Development Co. v. Anglo Gibraltar Insurance Group (1993), 10 C.L.R. (2d) 17; Simcoe & Erie General Insurance Co. v. Willowbrook Homes (1964) Ltd., [1980] I.L.R. ¶ 1‑1236; Collavino Inc. v. Employers Mutual Liability Insurance Co. of Wisconsin (1984), 5 C.C.L.I. 94; B.C. Rail Ltd. v. American Home Assurance Co. (1991), 79 D.L.R. (4th) 729; Kier Construction Ltd. v. Royal Insurance (U.K.) Ltd. (1992), 30 Con. L.R. 45; Hitchens (Hatfield) Ltd. v. Prudential Assurance Co., [1991] 2 Lloyd’s Rep. 580; Algonquin Power (Long Sault) Partnership v. Chubb Insurance Co. of Canada (2003), 50 C.C.L.I. (3d) 107.
By Rothstein J. (dissenting)
Queensland Government Railways v. Manufacturers’ Mutual Insurance, Ltd., [1969] 1 Lloyd’s Rep. 214; Consolidated‑Bathurst Export Ltd. v. Mutual Boiler and Machinery Insurance Co., [1980] 1 S.C.R. 888; Pense v. Northern Life Assurance Co. (1907), 15 O.L.R. 131, aff’d (1908), 42 S.C.R. 242; Stevenson v. Reliance Petroleum Ltd., [1956] S.C.R. 936; Cornish v. Accident Insurance Co. (1889), 23 Q.B.D. 453; Non‑Marine Underwriters, Lloyd’s of London v. Scalera, [2000] 1 S.C.R. 551, 2000 SCC 24; British and Foreign Marine Insurance Co. v. Gaunt, [1921] 2 A.C. 41; Simcoe & Erie General Insurance Co. v. Willowbrook Homes (1964) Ltd., [1980] I.L.R. ¶ 1‑1236; Collavino Inc. v. Employers Mutual Liability Insurance Co. of Wisconsin (1984), 5 C.C.L.I. 94; B.C. Rail Ltd. v. American Home Assurance Co. (1991), 79 D.L.R. (4th) 729; Foundation Co. of Canada Ltd. v. American Home Assurance Co. (1995), 25 O.R. (3d) 36; Algonquin Power (Long Sault) Partnership v. Chubb Insurance Co. of Canada (2003), 50 C.C.L.I. (3d) 107; Triple Five Corp. v. Simcoe & Erie Group (1994), 159 A.R. 1; Mellon v. Federal Ins. Co., 14 F.2d 997 (1926).
Authors Cited
Brown, Craig. Insurance Law in Canada. Scarborough, Ont.: Carswell, 2002 (loose‑leaf updated 2008, release 1).
Koughan, James. The Collapse of the Tacoma Narrows Bridge, Evaluation of Competing Theories of its Demise, and the Effects of the Disaster of Succeeding Bridge Designs (1996) (online: http://web.archive.org/web/20010813084722/%20http:/www.me.utexas.edu/~uer/papers/paper_jk.html).
Oxford English Dictionary Online, “faulty”, “improper”, “state of the art” (http://dictionary.oed.com).
Withey, P. A. “Fatigue Failure of the de Havilland Comet I”, Engineering Failure Analysis, vol. 4, No. 2, June 1997, p. 147.
APPEAL from a judgment of the Ontario Court of Appeal (Rosenberg, Cronk and Lang JJ.A.) (2007), 48 C.C.L.I. (4th) 161, 222 O.A.C. 129, 85 O.R. (3d) 186, 59 C.L.R. (3d) 169, [2007] I.L.R. ¶1‑4591, [2007] O.J. No. 1077 (QL), 2007 CarswellOnt 1706, 2007 ONCA 209, setting aside a judgment of Ground J. (2004), 15 C.C.L.I. (4th) 1, [2004] O.T.C. 851, [2004] O.J. No. 4086 (QL). Appeal allowed, Deschamps, Charron and Rothstein JJ. dissenting.
Guy Pratte, Richard H. Shaban and Sharon C. Vogel, for the appellants.
Earl A. Cherniak, Q.C., David Liblong and Kirk F. Stevens, for the respondents.
The judgment of McLachlin C.J. and Binnie, LeBel and Abella JJ. was delivered by
[1] Binnie J. — This appeal requires the Court to interpret an “all risks” policy of insurance negotiated by the appellants (collectively referred to as the “CNR”) with the respondent insurers in respect of the construction of a railway tunnel under the St. Clair River between Sarnia, Ontario, and Port Huron, Michigan, in the autumn of 1993. The CNR paid a premium of $890,000. The tunnel boring machine (“TBM”), a massive piece of machinery with a cuttinghead 32 feet (9.5 meters) in diameter and a body 278 feet (83 meters) long, was halted when dirt penetrated its cuttinghead and threatened the integrity of the main bearing that drove the machine forward. The project was delayed by 229 days and its costs thereby greatly increased. Repairs were done and eventually the tunnel boring was completed on December 8, 1994.
[2] The CNR had negotiated a builders’ risk policy with the insurers that insured them against “ALL RISKS of direct physical loss or damage . . . to . . . [a]ll real and personal property of every kind and quality including but not limited to the [TBM]” but excluding both “the cost of making good . . . faulty or improper design” and “inherent vice”.
[3] The design engineers anticipated that the TBM would have to withstand 6,000 metric tonnes of pressure from the weight of the soil and water above as it progressed under the river. The TBM was designed to accommodate those pressures. The trial judge found that despite its failure, the innovative design did “accommodate” within the then limits of the state of engineering knowledge all foreseeable risks encountered in the digging conditions in the tunnel ((2004), 15 C.C.L.I. (4th) 1, at para. 76). He acknowledged that the design proved in the result to be defective, but found that it was not “improper” or “faulty” according to the state of the art at the time the design was finalized. He concluded that the design not only addressed all reasonably foreseeable risks but all foreseeable risks however unlikely or remote. (He did not use the expression “state of the art” but that is how I interpret his reasons, as will be discussed.) He therefore held the insurers liable to the CNR for $29,582,638.90 including pre-judgment interest, plus $1,150,837.35 in costs.
[4] The Ontario Court of Appeal, by majority, allowed the appeal ((2007), 48 C.C.L.I. (4th) 161, 2007 ONCA 209). In its view, a design error may, but need not, depend upon designer negligence. A design must “‘take into account’, ‘accommodate’, ‘provide for’ and ‘withstand’ all foreseeable risks” (para. 62 (emphasis added)) however unlikely or remote. If, in these circumstances, there was a failure attributable to “design”, the exclusion applies. This conclusion, it seems to me, reads the qualifying words “faulty or improper” out of the exclusion, and greatly expands its scope.
[5] In my view, the “all risks” policy afforded the CNR greater protection than that which the majority in the Court of Appeal was prepared to allow. At the time of contracting, all parties realized that this was to be the largest earth-balance TBM ever built. Leading experts were enlisted to provide what was described as a “state of the art” machine (Exhibit 6, A.R., at p. 744). The “all risks” policy was written to cover physical damage to an innovative piece of equipment almost the length of a football field operating on a scale with which the state of the art had no previous experience. The policy did not exclude all loss attributable to “the design”, but only loss attributable to a “faulty or improper design”. The design exhausted the state of the art but left a residual risk. Failure is not the same thing as fault or impropriety. In my view, the insurers did not meet the onus of bringing the loss within the exclusion. I would allow the appeal.
I. Facts
[6] In the early 1990s, the CNR established an elaborate and sophisticated process to design and construct a customized TBM. A technical committee composed of expert tunnelling contractors and consultants was formed to advise on the conceptual design parameters. Its work was guided by a steering committee which provided general guidance. A technical review committee monitored, reviewed and advised the CNR on the project as a whole. The design of a suitable TBM was a major challenge.
A. The Tunnel Boring Machine
[7] The TBM is cylindrical in shape. At its forward end it cuts the hole in such a way as to prevent subsidence or heaving on the surface above while, at its rear end, it evacuates soil and other detritus from the tunnel and installs liner segments. The cuttinghead is of a “spider spoke” configuration. It houses a variety of cutting tools. When the TBM is in operation, the cuttinghead rotates while the forward shell remains stationary through the use of roller bearings.
[8] The main bearing generates a hydraulic thrust which drives the cutting tool through the earth. To shield it from damage from soil and other excavated material, the TBM employed an extensive and unique sealing system, the purpose of which was to prevent “contaminants” from getting into the main bearing and to stop the pressurized lubricants from leaking out. In the case of this TBM, the system consisted of 26 separate seals which were lubricated by the constant injection of pressurized grease. The 26 seals created a gauntlet: to get to the main bearing, dirt would have to get through all 26 seals. The best engineering advisors considered the configuration of the seals on this TBM to provide a margin of safety approaching redundancy. Each of the 26 seals operated independently of the others.
[9] The design tolerances were precise and demanding. To be effective, a gap of six (plus or minus three) millimetres had to be maintained between the rotating cuttinghead and the stationary bulkhead. If a larger gap (around 9 millimetres) opened up under operating conditions the opening would allow dirt to flow in and grease to flow out. Too small a gap (below 3 millimetres) could crush the seals. The deformed seals would be rendered ineffective as the gap fluctuated as the TBM continued to operate. The seal gap tolerance was minuscule in relation to the size of the cuttinghead (3 millimetres to 9,500 millimetres).
B. The TBM Builder
[10] Lovat Tunnel Equipment Inc., an experienced tunnel equipment manufacturer was selected by the CNR to construct the TBM. Lovat became responsible for the detailed design and engineering of the machine which was bigger by about 25 percent than the biggest TBM Lovat had constructed in the past. Indeed, at the time, it was the largest TBM of its kind in the world.
[11] Lovat retained Wardrop Engineering Inc. to conduct an analysis of the extent to which the steel components would deflect under the anticipated operating pressures, including the outer shell, the cuttinghead, the cuttinghead flange, the bearing assembly (including the seals) and the fixed bulkhead. The design presented unique problems because, although Lovat had designed and built 124 tunnel boring machines, each one was different and designed for a specific application.
[12] Wardrop’s computer analyses simulated and predicted how the elements of the TBM would react under anticipated load and stress conditions, including whether and to what extent critical components of the machine would deflect under assumed conditions and the impact any such deflection would have on its operating capacity.
[13] For over 300 years engineers have known about Hooke’s Law which says that structural steel deflects (i.e. bends) under load or pressure. Differential deflection will occur when two adjacent components (i.e. the moving cuttinghead and the static bulkhead) move towards or away from each other. This too is expected and, within the stated tolerances, is quite acceptable. The term excess differential deflection describes the movement away or towards one another of different structures beyond acceptable tolerances, leading to failure. (This proved to be the cause of the TBM problem.)
[14] After thorough analysis Wardrop provided an opinion that the TBM as designed was “capable of resisting the loads provided”. The components of the TBM would “deflect” under various loads, but would not break or deform. Wardrop did not model the anticipated relative deflection of all components as assembled because Wardrop and Lovat both anticipated, based on the available expertise, that such an analysis would show increased rigidity and thus reduced deflection. Wardrop wrote:
We anticipate the results of the more detailed analysis would reflect a reduced deflection of the bearing plate area because of the increased stiffness from the thrust bearing, cutting head, and bearing plate interface.
(Wardrop Report, at p. 4)
[15] In addition, Lovat and Wardrop performed an “overlay exercise” (overlaying calculations rather than images), which combined the deflection calculations for the various components to see whether the components would deflect differentially to an unacceptable level. They were satisfied from the results of this further analysis that there would be no excess differential deflection. The trial judge concluded in substance (although he did not use the term) that the TBM had been designed in accordance with the state of the art.
C. The Breakdown of the TBM
[16] The TBM began boring the tunnel in November 1993. Approximately two months later, after digging about 14 percent of the route, but before reaching the river, the engineers discovered that dirt had entered the main bearing chambers. Operations were halted. A vertical shaft was dug from the surface down to the level of the TBM. The TBM was driven into the middle of the space thereby created. Repairs were done. In addition to cleaning out the main bearing, Lovat made modifications to strengthen the TBM, including changing the configuration of the seals and adding a bronze “wear ring” to the bulkhead. The cost of the modifications was $742,685.87. After that, the machine completed the project without further entry of dirt.
D. Battle of the Experts
[17] The CNR’s expert, Dr. Leslie G. Hampson, characterized the excess differential deflection in the seal area as unforeseeable, unanticipated, outside previous experience, and evident only with the benefit of hindsight. The precise mechanism of failure had not been established. The external conditions had not been proven to be more severe than anticipated. Although differential deflection was inevitable and foreseeable, the risk of excess differential deflection sufficient to crush some of the seals and permit entry of soil was not. Dr. Hampson offered a couple of examples of previous engineering failures to prove his point about the limits of the state of engineering expertise at any particular moment in time.
Well-known examples of failures when moving technology forward include: Comet 1 aircraft whose structure failed by fatigue cracks starting from windows and the Tacoma Narrows bridge which failed because of massive structural oscillations driven by wind forces. Aircraft and bridge design took steps forward with such insights gained — but the failures had first to be experienced.
(Hampson’s Second Report, at p. 6)
[18] The insurers’ expert, Dr. Norbert K. Becker, disagreed. In his view, Lovat’s engineers knew or ought to have known that the machine’s sealing system was vulnerable to failure because of the “enormous loads” to be transmitted through the cuttinghead. The risk of seal failure from excess differential deflection could have been avoided by modifications to the sealing system at the outset (as was done when the TBM was repaired). He concluded that the structural engineering of the machine failed to accommodate readily foreseeable risks. The TBM design was in his view faulty and improper.
[19] After hearing extensive and conflicting evidence, the trial judge accepted the opinion of Dr. Hampson, and provided extensive reasons for his preference, including Dr. Hampson’s greater expertise in the matters at issue.
[20] The CNR’s claim against Lovat under the warranty was resolved by arbitration and settlement (trial reasons, at para. 169).
II. Relevant Provisions of the Insurance Contract
[20a] SECTION I – BUILDER’S RISK INSURANCE
1. INSURING AGREEMENT:
This Policy, subject to the limitations, exclusions, terms and conditions hereinafter mentioned, insures, in respect to occurrences happening during the period of this Policy against 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] . . .;
. . .
3. EXCLUSIONS: This Policy does not insure:
. . .
(d) the cost of making good
(i) faulty or improper material;
(ii) faulty or improper construction or workmanship;
(iii) 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 . . .:
(e) wear, tear, inherent vice, normal upkeep and normal making good; but this exclusion shall not apply to resulting loss not otherwise excluded by this Policy;
. . .
SECTION II ‑ DELAYED OPENING
1. INSURING AGREEMENT:
This Section of this Policy insures against the loss directly resulting from delay beyond the scheduled start-up in the use and/or occupancy of the construction operations caused by loss or damage by a peril insured against under Section I of this Policy to any property used or to be used in, a part of or incidental to, the construction operations . . . .
(Emphasis added.)
III. Judicial History
A. Ontario Superior Court of Justice (2004), 15 C.C.L.I. (4th) 1
[21] After a careful review of the jurisprudence, Ground J. concluded 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” (para. 54). It was clear that the detailed design, engineering and structural integrity of the machine “were the sole responsibility of Lovat and that, with respect to deflection of components of the TBM, all detailed analyses and calculations were done by Wardrop on behalf of Lovat or by Lovat using the results of Wardrop’s finite element analyses” (para. 69). There was no evidence that the 124 tunnel boring machines previously built by Lovat had experienced similar failure, although many had used similar sealing systems.
[22] The trial judge did not agree with the insurers that, because the machine had failed in November 1993 and had then been modified successfully to preclude another such occurrence, the risk ought to have been foreseen and the problems solved at the outset. He found that,
[w]hen all of the evidence is consistent that none of the experts or other persons involved, who had substantial experience in the design and manufacture of TBMs and with tunneling projects, expressed no concern with respect to differential deflection adversely affecting the sealing system and when the design of the TBM and the analyses of the various components did not indicate the possibility of the failure which occurred, it seems to me to be making an unjustified logical leap to conclude that because a failure did occur and was remedied, it should have been foreseen initially. [para. 75]
B. Ontario Court of Appeal (2007), 48 C.C.L.I. (4th) 161, 2007 ONCA 209
(1) Majority (Rosenberg and Cronk JJ.A.)
[23] Rosenberg and Cronk JJ.A. allowed the appeal, finding that the design of the TBM had indeed been faulty within the meaning of the exclusion provision. They agreed that the onus was on the insurers to bring the loss within the policy exclusion. They substantially accepted the trial judge’s formulation of the legal test but not his application of it to the facts:
In our view, the trial judge’s formulation of the foreseeability standard properly recognized that satisfaction of this standard requires proof that all foreseeable risks have been identified and addressed in the design in question. Mere recognition of a foreseeable risk is insufficient. “Accounting” for a foreseeable risk contemplates both that the risk is identified and that provision or allowance is made in the impugned design to meet the identified risk. On the foreseeability standard, anything less will not establish a fault‑free and proper design. Nor, in our opinion, does designing against a foreseeable risk convert the risk into an unforeseeable one. It simply means that the applicable design provided for the risk, that is, the risk was identified and addressed in the design with a view to forestalling its occurrence, thus meeting the foreseeability standard. In this context, we agree that the foreseeability standard mandates that the relevant design “take into account”, “accommodate”, “provide for” and “withstand” all foreseeable risks. [Emphasis added; para. 62.]
(A crucial difference between their view and the trial judge’s formulation seems to be that whereas he held that “the TBM must be designed to withstand all foreseeable risks” (para. 174 (emphasis added)), the majority judgment of the Court of Appeal held that the design must in fact, with the benefit of hindsight, be shown to have succeeded in withstanding all foreseeable risks.) The Court of Appeal majority noted that the trial judge found little difference between the experts’ opinions on why the TBM failed. The controversial issue was whether or not the risk of excess differential deflection was foreseeable at the time the TBM was designed. The trial judge’s findings on foreseeability were tainted by reversible error in four respects, in their view. Firstly, in accepting Dr. Hampson’s expert opinion that excess differential deflection was not foreseeable, the trial judge failed to consider Lovat’s admission that he had known in advance that if the seal flanges of the TBM deflected at a different rate than the fixed bulkhead, differential deflection affecting the critical seal gap would occur. “[A]ccording to Rick Lovat, this type of risk was both known to and investigated by Lovat or its agents” (para. 89).
[24] Secondly, the trial judge relied upon the fact that the blue ribbon technical committee convened by the CNR had accepted Wardrop’s analyses and Lovat’s design. But the trial judge’s own findings showed that the design committee had asked very few questions about the sealing system or its potential for differential deflection.
[25] Thirdly, the trial judge failed to distinguish between the foreseeability of the risk of failure that occurred and the foreseeability of the precise mechanism by which that risk might manifest itself in physical damage to the machine. The trial judge conflated the foreseeability of the type of risk and the magnitude of that risk. The machine’s failure was not attributable to a cause external to the TBM but to the design itself.
[26] Fourthly, to allow recovery in a case where a known risk materialized would convert the insurance policy into a warranty. The insurance policy here was not intended to be a warranty that the machine would fulfill its purpose or a warranty to cover entrepreneurial design risk.
[27] As to the CNR’s alternate submission that even if the exclusion for faulty or improper design applied, the CNR could still recover for resultant loss or damage, the trial judge was correct that “the delayed opening insurance under Section II provides coverage for consequential economic loss only to the extent that the economic loss results from insured loss or damage to insured property” (para. 138). There being no recovery under Section I there could be no recovery under Section II for related losses. The trial judgment was set aside and the action was dismissed.
(2) Dissent (Lang J.A.)
[28] Lang J.A. held that even if she accepted that factual errors were made by the trial judge as asserted by her colleagues, the exception would still not apply in this case. The governing standard for foreseeability set out in Foundation Co. of Canada Ltd. v. American Home Assurance Co. (1995), 25 O.R. (3d) 36 (Gen. Div.), required the design to take all foreseeable risks into account. This was done. Unlike the Foundation test, however, the majority here required that the design succeed in accommodating all foreseeable risks. In her view, the majority’s test was objectionable because
if a design is required to succeed in accommodating all foreseeable risks, as my colleagues say it must, then the design is required to meet a standard of perfection with respect to those risks. [para. 194]
The insurers had called no evidence from an expert with credentials equal to the CNR’s expert, Dr. Hampson, to show that the key Wardrop analysis was based on faulty data or that a different overlay analysis would have revealed that the design was at risk of excess differential deflection (para. 200). There was no evidence accepted by the trial judge that any other designer would have undertaken more or different tests.
[29] Lang J.A. rejected any distinction between unforeseeable internal causes of loss and unforeseeable external causes. She would have dismissed the appeal and cross-appeal, apart from adjusting to March 31, 1995, the date upon which prejudgment interest was to commence, with costs to the CNR.
IV. Analysis
[30] Some general principles governing the interpretation of insurance policies were set out by Estey J. in Consolidated-Bathurst Export Ltd. v. Mutual Boiler and Machinery Insurance Co., [1980] 1 S.C.R. 888, at p. 901:
Even apart from the doctrine of contra proferentem as it may be applied in the construction of contracts, the normal rules of construction lead a court to search for an interpretation which, from the whole of the contract, would appear to promote or advance the true intent of the parties at the time of entry into the contract. Consequently, literal meaning should not be applied where to do so would bring about an unrealistic result or a result which would not be contemplated in the commercial atmosphere in which the insurance was contracted.
See also Reid Crowther & Partners Ltd. v. Simcoe & Erie General Insurance Co., [1993] 1 S.C.R. 252, at pp. 268-69, per McLachlin J., and Zurich Insurance Co. v. 686234 Ontario Ltd. (2002), 62 O.R. (3d) 447 (C.A.), at p. 458.
[31] What was insured here was “physical loss or damage” to property of “every kind and quality including but not limited to the [TBM]” plus any consequent economic loss occasioned by delay in the opening of the tunnel. The TBM suffered physical damage and the consequent delay occasioned substantial economic loss. The insurers are therefore liable under the policy unless they can show that the physical damage was caused by “faulty or improper design” or inherent vice. In other words, the loss may have been caused by the design, but unless the design is shown by the insurers to be “faulty or improper”, the exclusion does not apply to relieve the insurers of liability. Substantially the same difficulty confronted the insurers in establishing the “inherent vice” exception.
[32] The key question that divided the Court of Appeal majority and the trial judge was how to define the scope of the “faulty or improper design” exclusion within the context of an “all risks” insurance policy which must be read as a whole: Parsons v. Standard Fire Insurance Co. (1880), 5 S.C.R. 233, at p. 238; Consolidated-Bathurst, at p. 899. In Reid Crowther & Partners, McLachlin J. observed that “coverage provisions should be construed broadly and exclusion clauses narrowly” (p. 269).
[33] The CNR contends that the terms of the policy should also be read contra proferentem. However, while the language of the exception was fairly standard for an “all risks” policy, the entire policy had been negotiated between sophisticated parties. It was a “manuscript policy