Canadian National Railway Co. v. Royal and Sun Alliance Insurance Co. of Canada is an important decision from the Supreme Court of Canada which grapples with defining the scope of the “faulty or improper design” exclusion within the context of an “all risks” insurance policy. An “all risks” policy was obtained by CNR from the respondent insurers in respect of the construction of a railway tunnel. A tunnel boring machine (TBM) was halted when dirt penetrated its cutting head and threatened the integrity of the main bearing that drove the machine forward.  The project was consequently delayed by 229 days and its costs thereby greatly increased. 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”. 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.  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 therefore held the insurers liable to the CNR for $29,582,638.91 including pre-judgment interest, plus $1,150,837.35 in costs.

The Ontario Court of Appeal, by majority, allowed the appeal. 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”  however unlikely or remote.  If, in these circumstances, there was a failure attributable to “design”, the exclusion applies.  In a 4:3 decision, a majority of the Supreme Court allowed the appeal and held that the Court of Appeal’s conclusion read the qualifying words “faulty or improper” out of the exclusion, and hence greatly expanded its scope. In the majority’s 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”.  The “all risk” 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 the majority’s view, the insurers did not meet the onus of bringing the loss within the exclusion.  A design is not “faulty or improper” simply because it falls short of perfection in relation to all foreseeable risk. The majority of the Supreme Court distinguished a decision by the High Court of Austrailia (Queensland Government Railways v. Manufacturers’ Mutual Insurance, Ltd.) which holds that that the fact of failure not only speaks for itself but, once it is attributed to the design, it discharges the insurers’ onus of proof. The majority did not agree that a design can be said to be “faulty” if it conforms to the state of the art, as was found by the trial judge.

The minority, however, stated that 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.  As explained in Queensland, the distinction that is relevant is between a design that is defective and design that is free from defect.  The question is whether or not the damage to the insured property was due to an inability of the design to fulfil its purpose in the foreseeable conditions of the property’s use. It was not appropriate to create a test akin to negligence when nothing in the term “faulty or improper design” in the insurance contract implied the introduction of the law of torts. 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.

The Supreme Court’s decision is important for insurers as it poses the risk of transforming an “all risks” policy into a warranty. An insurer will be left covering a loss arising from the limitations of science. This may not exactly be the kind of risk the insurer signed up for. However, the case turns on a singular set of circumstances involving a highly complex and cutting edge piece of machinery. The case does not allow the insured to escape the exclusion simply because the machine was not negligently designed. Although not a standard of perfection, the majority’s “state of art” standard is still quite formidable.

Jim Davidson

St. Jean (Litigation guardian of) v. Cheung, [2008] O.J. No. 4862 (ONCA) is a medical malpractice claim where the Plaintiff, after having become severely hypoglycaemic shortly after his birth, suffered severe brain damage allegedly as a result of a failure to properly treat the hypoglycaemia. Twenty years after his birth, a claim was commenced against the doctor and hospital who cared for the Plaintiff’s mother prior to his birth. The primary allegation was that as a result of the failure to diagnose and treat his mother’s gestational diabetes, the Plaintiff was born severely hypoglycaemic. Close to two years after the claim was commenced, Plaintiff’s counsel obtained a medical report indicating that the likely cause of the Plaintiff’s injury was the protracted hypoglycaemia that followed his birth which was inadequately treated. Further, the report stated that had the hypoglycaemia been treated more aggressively, the Plaintiff would not have suffered injury. Thus, a second action was commenced against the medical professionals who cared for the Plaintiff after his birth. The defendants in the second action successfully had the action struck on the basis that the limitation period had expired.

The Ontario Court of Appeal reversed the motion judge’s decision. The decision involved the application of s. 24(2) of the new Limitations Act. It was clear that the second action was based on acts or omissions which took place before the effective date of the new Act (Jan. 1, 2004). The dispute was over whether a proceeding had already been commenced prior to the effective date. If yes, then s. 24(2) applied to the second action. The Plaintiff argued that the first action counted as a proceeding. However, the Appeal Court rejected this since the first action did not concern any acts or omissions of the defendants in the second action. Thus, s. 24(2) was found to apply. The next issue was the correct application of s. 24(5) of the new Act. If the claim was discovered prior to the effective date, then the old limitation period applied. If it was not discovered before the effective date, then the new period applied and it would be assumed that the act or omission occurred on the effective date. The new defendants argued that the claim was not discovered prior to the effective date since the Plaintiff was mentally incompetent and could not have discovered the claim on his own. The Appeal Court disagreed and found that the Plaintiff’s litigation guardian had in fact discovered the claim before the effective date. The Court made a clear distinction between a litigation guardian’s ability to “discover” a claim vs. the triggering of the limitation period. It is settled law that even though the litigation guardian had discovered the claim, this did not trigger the limitation period in cases where the Plaintiff is incapacitated. The discovery of claims and the commencement of limitation periods are different, though related, notions and should not be conflated. Thus, the Court found the limitation period in the old Limitations Act applied. Since the old Act suspended the triggering of the limitation period due to mental incapacity, the second action was brought in time.

Jim Davidson

Sekhon v. RBC General Insurance Co., [2008] O.J. No. 4999, concerns an appeal by an insurer from a decision requiring it to pay to the Respondent $37,000 for collision damage under her automobile insurance policy. The Respondent’s vehicle was damaged when the vehicle, driven by the Respondent’s daughter, struck a tree after having crossed three lanes of traffic and gone through a fence. It was an agreed fact that, immediately following the incident, the Respondent’s daughter said that she had caused the collision “on purpose” “to test her mortality” or “to test her immortality”. The issue at trial was whether the Respondent’s loss fell within the confines of “direct and accidental loss” under s. 7.1.1 of the standard Ontario Automobile Policy that governed the parties’ rights. The trial judge found on the totality of the evidence that, “on a balance of probabilities [the Respondent's daughter] was suffering from an acute psychiatric disorder, such that she had no conscious or deliberate physical control of the operation of the motor vehicle due to the absence of a sane and deliberating mind”. He concluded that the loss sustained by the Respondent as a result of the damage to her vehicle fell within the meaning of “direct and accidental loss” under s. 7.1.1.

This judgment was affirmed by the Ontario Divisional Court. The Court found that there was evidence upon which the trial judge could conclude on a balance of probabilities that the Respondent’s daughter had no conscious or deliberate physical control of the Respondent’s vehicle, despite her comments immediately following the event that she intended to test her mortality or immortality. Interestingly, the Court also dealt with the Respondent’s cross-appeal.  If the Appellant’s appeal were successful, the Respondent, on the cross-appeal, submitted that the trial judge erred in law in finding that the Respondent, the innocent owner of the vehicle that was damaged, was disentitled to compensation for loss under her standard automobile insurance policy as a result of an intentional act (if so found) of her daughter to whom the Respondent had innocently and without any negligence lent her vehicle. The Divisional Court held that since the loss was not intentional from the perspective of the Respondent, she could recover notwithstanding an intentionally caused loss. It would be interesting to see if such an argument would apply in other coverage situations, for instance in home owners’ or CGL policies. Typically these policies contain an exclusion for intentional or criminal acts of an insured. Depending on the wording of the exclusion, insurers often make the argument that the intentional or criminal acts of one insured excludes coverage for an innocent insured. Applying the reasoning in Sekhon would shift the focus to the perspective of the innocent insured, and thus provide an addtional argument for insurance coverage.

Jim Davidson