BLACKOUTS SPARK DEBATE OF ALL RISKS POLICIES

July 4, 2008

A massive blackout hit Eastern Canada and parts of the United States in August 2003. For food processors the interruption in the supply of electricity to refrigeration and other equipment resulted in substantial spoiled product. Much litigation ensued including the case of Caneast Foods Limited v. Lombard General Insurance Company of Canada, [2008] O.J. No. 1811 (C.A.). Caneast sustained significant losses as a result of the blackout and sought indemnity from its insurer, Lombard, under an “all risks” policy.

Lombard denied coverage, relying on two exclusion clauses that precluded recovery for loss caused directly or indirectly by “changes of temperature” and “mechanical or electrical breakdown or derangement”. The “changes of temperature” clause contained an exception that if the loss was caused “directly by a peril insured and not otherwise excluded”, then the exclusion did not apply.

The motions judge held that the exclusion clauses were not engaged and Lombard appealed.

Counsel for Lombard conceded that the “changes of temperature” exclusion was not engaged as this issue had been dealt with in 94325 Ontario Inc. v. Commonwealth Insurance Co., (2006), 81 O.R. (3d) 399 (C.A.). The Ontario Court of Appeal in Commonwealth considered coverage under an all risks policy for loss sustained during the same blackout. The Court concluded that the loss was caused by a power outage and, although there may have been a “change of temperature”, the exception in this clause was engaged. In particular, the power outage was “a peril otherwise insured” in the policy, as this was an all risks policy, and it was not “otherwise excluded” in the policy.

With respect to the “mechanical or electrical breakdown” exclusion, the Court of Appeal affirmed the motion judge’s view that “breakdown” denotes a failure in the operation of a piece of equipment due to some mechanical or electrical defect in some part or parts of the equipment and there is no breakdown if there is an interruption in the machine’s power supply.

The main question on appeal was whether an interruption in power supply constitutes a “derangement”. The Court noted that the term derangement has received little or no judicial consideration. It observed it was an odd word to use in an exclusion clause as it is generally in reference to mental health and impaired bodily function. Caneast and Lombard relied on the definition of “derange” as follows: “to disturb the normal state, working operation or functioning of”. Lombard argued that there was a derangement because the power supply was not functioning properly. The court concluded, similar to the definition of breakdown, that derangement also refers to an internal problem or defect in a machine, and not to the machine’s failure to operate due to an external interruption to its power supply.

The Court expressly rejected the decision in Leo DeLuca Enterprises Inc. v. Lombard General Insurance Co. of Canada, [2008] O.J. No. 1230 (S.C.J.), released about three weeks before the subject appeal was argued. The plaintiff in Leo DeLuca also sustained damages when its refrigeration did not function because of the same blackout. In its action against Lombard, for indemnity under an all risks policy that contained the identical mechanical derangement and change of temperature exclusions as the policy in this case, the motion judge found that both the change of temperature and mechanical derangement exclusions applied. The Court of Appeal in Caneast did not agree with the motions judge’s decision in De Luca that “the derangement exclusion will apply regardless of the cause, internal or external”.

The ambiguity surrounding “derangement” was construed against the insurer and the exclusion was given a narrow interpretation, even in light of decisions that did not find ambiguity in the very same exclusion. Insurers have been forewarned by this case that if the intention of the policy is to exclude loss resulting from failures in external power supply, then this must be done in express terms.

If you have any questions about this case or any other insurance matter, please contact Satinder Sidhu (telephone: 604-643-3119 or e-mail: sks@cwilson.com) or any other member of the Clark Wilson LLP Insurance Practice Group.