"A LIGHT AT THE END OF THE TUNNEL" -
CNR v. Royal and Sun Alliance [2007 ONCA 209]

In November 1993 the world’s largest tunnel boring machine (TBM) started excavating a new railway tunnel under the St. Clair River for the Canadian National Railway (CN). Two months later, it broke down resulting in damage to the TBM machine itself and a 229 day delay in the opening of the new tunnel. The CN companies held a builders risk insurance policy issued by the appellant insurers that insured them 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]". When the CN companies sought indemnity under the policy for their losses, the insurers denied coverage, relying on exclusions in the policy that exempted from coverage "the cost of making good... faulty or improper design" and "inherent vice". The CN companies sued the insurers for recovery under the policy.

Now some 130 years after Jules Verne’s Journey, the Ontario Courts have been called upon to determine not only where the error began, but whether it was foreseeable. The result is a very detailed analysis of the foreseeability element as a prerequisite to reliance upon the faulty or improper design exclusion.

TRIAL JUDGMENT

At trial, it was held that the cause of the failure of the TBM was "excess differential deflection between components of the TBM which the TBM was not capable of withstanding". This deflection allowed soil and other materials to enter and contaminate the TBM’s main bearing.

The trial judge held that in order to rely upon the faulty or improper design exclusion it must be shown that a design failed to "accommodate" or "provide" for a condition or occurrence that was foreseeable, however unlikely or remote.

Expert reports were tendered by both CN and Royal that the failure was or wasn't reasonably forseeable. The trial judge ultimately accepted the opinion of CN's expert that anticipating the cause of the failure would have been akin to identifying a "needle in a haystack". As such, the trial judge held that the occurrence of such excess differential deflection was not foreseeable thus insurers were not able to rely upon the exclusion. In addition, the trial judge found that there was no evidence to support the application of the inherent vice exclusion.

As a result there was coverage under the policy and judgement was issued against the insurers for damages in excess of $20 million dollars, pre-judgment interest of $8.1 million and costs to CN of over $1 million dollars.

APPEAL

The focus of the Appeal was directed towards errors in findings of fact made by the trial judge. The insurers argued that the trial judge’s foreseeability findings and, hence, his decision concerning the applicability of the faulty or improper design exclusion were unsustainable on the facts presented a trial. Specifically they argued that evidence had been led that the risk of the type of failure of the TBM that materialized was both foreseeable and foreseen by the designer of the TBM. Further the insurers argued that certain of the background facts relied upon by the trial judge to anchor his overall foreseeability findings were not supported by the record.

While the Court of Appeal’s decision was largely factually based, the court did comment on the foreseeability and inherent vice tests applied by the trial judge.

Application of the Standard of Foreseeability to the "faulty design" Exclusion:

The Court of Appeal upheld the trial judge’s application of the foreseeability test in respect of this exclusion. Importantly, they agreed that the standard of all foreseeable risks requires both that the risks be 1. identified and 2. accommodated for:

The Court of Appeal went onto hold that the trial judge’s application of the foreseeability test to the facts was reversible error. In particular they held that the trial judge had failed to consider evidence which showed that the designer of the TBM was aware of the risk posed by differential deflection and had actually commissioned studies to investigate this risk. They concluded that the design of the TBM was inadequate to accommodate for a known risk hence it’s design was faulty and, consequently, the exclusion applied.

Inherent Vice:

The Court of Appeal did not disturb the trial judge's finding that there was no evidence to support a finding of inherent vice. It noted this exclusion has been narrowly interpreted by the courts including the British Columbia Court of Appeal in Dawson Creek v. Zurich 20000 BCCA 158; the subject of a previous Clark Wilson e-mail bulletin.

The Court of Appeal noted that "inherent vice refers to some internal decomposition that made deterioration of the thing inevitable because of qualities inherent in the TBM". The insurers had argued an inference ought to be drawn from the very fact that the TBM failed under normal conditions there therefore must have been some inherent defect, if the failure was not the result of faulty or improper design. Given the narrow interpretation of "inherent vice", the Court of Appeal was not prepared to find that the trial judge erred in concluding that was insufficient evidence and therefore that the exclusion had not been proved.

DISSENT

Madam Justice Lang, in a strongly worded dissent agreed that the test for faulty or improper design is that of "all foreseeable risks". However she felt that the majority reasons had unacceptably altered the "all foreseeable risks" test in two ways:

Madam Justice Lang opined that by making those two alterations, the majority was adopting a standard of foreseeability which was essentially a results-focused standard which had been specifically rejected by the Court in Foundation.

CONCLUSION

In light of the majority decision, in order to rely upon a faulty design exclusion an insurer must prove that a designer neither identified nor accommodated all foreseeable risks, even though such risks might be unlikely or remote. The decision appears to significantly broaden the application of the faulty or improper design exclusion as it is difficult to imagine what type of failures would not be forseeable to design experts. In a report tendered at trial CN's expert opined that as failure models are based on previous experience, it is not always possible for designers to identify a forseeable risk when breaking new technical ground. He pointed to the historical example of the Tacoma Narrows Bridge of which some readers might be familiar. The Tacoma Narrows Bridge spectaularly collapsed mere months after it's completion as the result of "massive structural oscillations driven by wind forces". It may well be that in such techologically groundbreaking projects failures occur which are simply not forseeable.

We have been advised that counsel for CN is seeking leave to appeal this decision to the Supreme Court of Canada. We will keep readers posted as to the results of the leave to appeal application by way of a future e-mail bulletin.

The full text of the Ontario Court of Appeal judgment of CN v. Royal and Sun Alliance can be found on the CANLII website.

If you have any questions about the decision or any other insurance matter, please contact Krista Prockiw (telephone 604-643-3105 or e-mail kxp@cwilson.com) or any other member of the Clark Wilson LLP Insurance Practice Group.