In GE Canada Equipment Financing G.P. v. ING Insurance
Co. of Canada, [2009] O.J. No. 748 (ONCA), GE appealed from the dismissal of its application for a declaration that its security interests had priority over those of ING, the insurer, in respect of two highway tractor trucks , and a declaration that it was entitled to the return of the vehicles or the proceeds of sale thereof. GE financed the two vehicles for a leasing and rental company (Brampton), and it registered its security interests in the vehicles. Brampton then leased the vehicles to third parties who obtained insurance from ING, with the third parties named as lessees and Brampton as lessor, with no mention of GE. GE had taken all necessary steps under the Personal Property Security Act (PPSA) to perfect its purchase money security interests (PMSIs) in the trucks and their proceeds. The vehicles were stolen. Brampton submitted proof of loss forms to ING in respect of the stolen trucks. After the vehicles were recovered, ING took possession and sold one of the trucks. In granting the appeal, the Court of Appeal held that Statutory condition 6(7) conferred on ING only those rights to salvage possessed by Brampton prior to ING’s payment of the actual cash value of the trucks. Absent express statutory language to the contrary, Statutory condition 6(7) was not to be interpreted so as to confer on Brampton’s insurer greater rights to salvage in the trucks than were held by Brampton. Subrogation is a derivative right that rests on the principle of indemnification. It contemplates that on full indemnification of an insured by an insurer for an insured loss, the insurer becomes entitled to exercise a right belonging to the insured. Under the principle of subrogation, the insurer succeeds only to the exact right otherwise enjoyed by its insured. An insurer’s exercise of the right of subrogation under statutory condition 6(7) recognizes that prior to the insurer’s election to trigger statutory condition 6(7), the right to salvage in an insured vehicle is a property right of the insured. Where, however, the insurer pays the insured’s total loss claim in respect of the insured vehicle, it becomes entitled to all the salvage rights that the insured possessed in respect of the insured vehicle. Brampton’s interests in the Trucks were subject to GE’s perfected PMSIs. Statutory condition 6(7) conferred on ING only those rights to salvage possessed by Brampton prior to ING’s payment of the actual cash value of the Trucks. Absent express statutory language to the contrary, statutory condition 6(7) should not be interpreted so as to confer on Brampton’s insurer greater rights to salvage in the Trucks than were held by Brampton.

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

Unique Labeling Inc. v. Gerling Canada, [2008] O.J. No. 4090, deals with the unique issue of attempting to enforce a jury award pursuant to s. 132(1) of the Insurance Act. The Plaintiff obtained a judgment against the Defendants in Oregon for damages arising  from the negligent supply of bottled water. The Plaintiff was ultimately awarded $1.5 million in damages by a jury. It then sought to recover the judgment in Ontario, under s. 132(1), against the Defendants’ commerical liability insurers. The insurers denied liability on the basis that the Oregon judgment did not impose liability for damage to property, as required by s. 132(1). Instead, they argued that the jury simply awarded damages for pure economic loss. The Plaintiff argued that the requirement in s. 132(1) of “injury or damage to property” creates a much lower threshold than “physical injury to tangible property”, the latter being a term relevant to the CGL policies. It further argued that injury or damage to property includes both tangible and intangible property. The Plaintiff submitted that there could be no dispute that its property was damaged. Its bottled water, supplied by the Defendants, was contaminated and had to be destroyed. 

The parties were unable to find any caselaw in which an Ontario court had determined a judgment creditor’s right to successfully invoke the provisions of s. 132(1) where the underlying judgment follows upon a jury verdict on liability and damages issues. The Court observed that the Oregon jury had issued no reasons; it simply answered the questions put to it following the completion of the trial. The Court stated that any review of evidence, of arguments by counsel and/or of directions given the jury by the trial judge would pre-suppose that such matters influenced the jury. One might thereby come to a firm but entirely inaccurate understanding of the outcome of the trial below. Thus, the Court held that a better approach would be to consider the judgment and the jury questions and answers within it in the context of the claims, as framed by the pleadings in the Oregon action. The Court ultimately found that the Oregon jury had indeed only awarded damages for economic losses, and thus not for damage to property. Without more in the way of clarity in the jury questions, the Court was not satisified that liability had been imposed for property damage. Thus, inter alia, the Court dismissed the action.

The Court in Unique Labeling Inc. was clearly troubled by the exact nature of the damages awarded by the Oregon jury. The decision is instructive as clearer jury questions and pleadings in the underlying action would have given the Court much more assistance in its analysis under s. 132(1). In trying an action before a jury, and in contemplation of a potential s. 132(1) proceeding, Unique Labeling Inc. illustrates that it is vital that an eye is kept on creating a record, specifically by way of clear jury questions, that will satisfy the requirements of s. 132(1).   

Jim Davidson

Day v. Wood, [2008] O.J. No. 3296 is an interesting insurance coverage decision from the Superior Court. The insured was an owner of a property which was rented to a third party. The third party moved out after a month and complained of health problems due to the exposure to mould and yeast, as well as property damage due to a flood in the premises. The third party sued the insured for these damages. The insured sought coverage under a rental dwelling policy from his insurer, but the insurer denied coverage on the basis of a mould exclusion. The insured brought an application against the insurer and argued that since 3 out of the 4 theories of liability against him were covered under the policy, a duty to defend was owed. The mould exclusion specifically excluded claims arising from any losses or claims arising out of fungus “regardless of whether other causes acted concurrently or in any sequence with the fungus”.  Thus, since mould was a concurrent or contributing factor, under the wording of the policy, if another cause acted concurrently with the mould, there was no coverage. However, the motions judge rejected the insurer’s argument, and found that a duty to defend was indeed owed.

Key to the judge’s decision was the fact that it was possible that the damages arose solely from non-mould related circumstances (e.g. excessive moisture levels from flooding). Thus, though it may be that mould was a contributing factor, it was also possible that it was a non-factor. The continuing lesson from this line of cases is that the duty to defend will be interpreted more broadly than the duty to indemnify. Further, claimants would be wise to advance multiple theories of liability in order to negate the application of the mould exclusion. Insurers, in defending these insurance applications, may want to consider the availability of extrinsic evidence in determining the true nature of the allegations in the claim.

Jim Davidson

I have previoulsy commented on Leo Deluca v. Lombard, [2008] O.J. No. 1230, an insurance coverage case arising out of the hydro blackout in 2003. In that case, the motion judge denied indemnity under an All Risks policy on the basis of two exclusion clauses. However, in Caneast Foods v. Lombard, [2008] O.J. No. 1811, the Ontario Court of Appeal, interpreting the same two exclusions, came to the opposite conclusion. In Caneast, the hydro blackout caused the spoilage of a substantial quantity of the Plaintiff’s goods. The first exclusion clause excluded losses caused by changes in temperature. However, the clause contained an exception which stated that if the loss was caused directly by a peril insured and not otherwise excluded, then the exclusion did not apply. Since this was an All Risks policy, the blackout was a peril insured. As well, hydro blackouts were not expressly excluded in the policy. Hence, the Court of Appeal affirmed the motion judge’s decision that the exclusion did not apply. The motion judge’s decision in Leo Deluca only gives an excerpt of the change in temperature exclusion clause, but since both cases involved the same insurer, it would be surprising if the exclusion wordings were not similar. The second exclusion dealt with losses caused by mechanical or electrical breakdown or derangement. Unlike in Leo Deluca, the Court of Appeal held that this exclusion only applied to an internal problem in a machine, and not when the machine fails to operate due to an interruption in its power supply. In fact, the Court of Appeal remarked that the motion judge in Leo Deluca had erred in his interpretation.

Jim Davidson