MDS Inc. v. Factory Mutual Insurance Company, 2021 ONCA 594
Last year, we commented on the Ontario Superior Court’s decision in MDS Inc. v Factory Mutual Insurance Company (FM Global), 2020 ONSC 1924, which held that the loss of use of premises without actual tangible damage could constitute physical damage under an all-risks property insurance policy. We indicated that it was possible for that decision to be relied on by insureds to claim that they had sustained physical damage to premises affected by closures due to the COVID-19 pandemic in our article here.
In the recent decision in MDS Inc. v Factory Mutual Insurance Company, 2021 ONCA 594, the Ontario Court of Appeal overturned the lower court’s decision and maintained a strict interpretation of physical loss, clarifying that it does not extend to economic loss. A summary of the decision is set out below. The decision signals that insureds will face an uphill battle when claiming coverage for economic losses caused by COVID-19.
Factory Mutual Insurance Company (“FM Global”) issued a standard form all-risks insurance policy (the “Policy”) to MDS Inc., a global health science company, and MDS (Canada) Inc., its Canadian subsidiary (collectively, “MDS”). The Policy covered all risks of physical loss or damage to property and a contingent time element coverage resulting from a supplier’s business interruption.
On February 21, 2006, MDS agreed to buy radioisotopes from Atomic Energy of Canada Limited (“AECL”) to be produced at the Nuclear Research Universal (the “NRU”) reactor located in Chalk River, Ontario. On May 14, 2009, heavy water containing radioactive tritium was discovered leaking through the calandria wall of the NRU reactor. This leak was caused by corrosion that was “not expected”. The reactor was shut down for 15 months to repair the leak. MDS ultimately lost its radioisotope supplier and profits of approximately CA$121,248,000.
On May 21, 2009, MDS submitted a claim to FM Global for these lost profits. On August 4, 2009, FM Global denied coverage on the basis that the loss was excluded under a corrosion exclusion. The Policy did not define “corrosion”. The Policy contained an exception to the corrosion exclusion for resulting “physical damage not excluded by this Policy”. Here, the NRU constituted property of the type insured under the Policy’s extended coverage (the Contingent Time Element Extended coverage) and that limit was US$25,000,000.
The Lower Court’s Decision
MDS succeeded in obtaining coverage under the Policy in the lower court decision and was awarded damages up to the Policy’s limit with prejudgment interest at the rate of the company’s actual cost of borrowing, including compound interest. In finding coverage, the lower court judge dealt with two main issues. First, the interpretation of the corrosion exclusion in the Policy and, second, whether MDS’ business losses arising from the shutdown of the NRU reactor were covered pursuant to the exception to the corrosion exclusion.
The lower court determined that the term “corrosion” was ambiguous and should be interpreted in light of the word’s dictionary definition, as modified by the “reasonable expectations of the parties”. The exclusion did not apply to unanticipated and “fortuitous corrosion” but only to “non-fortuitous anticipated corrosion”. Further, the term “physical damage” was ambiguous and the exception to the “corrosion” exclusion for “physical damage” should be interpreted broadly to include not only physical damage caused by corrosion but also economic loss caused by the inability to use the insured property during the shutdown. As a result, the lower court determined that there was coverage for MDS’ lost profits.
The Court of Appeal overturned the trial judge’s decision, denying coverage and maintaining that physical damage did not extend to economic loss.
- The term “corrosion” was clear and not ambiguous. The corrosion exclusion applied and MDS’ losses were not covered by the Policy.
The Court of Appeal identified that the goal of the court’s process of interpreting both standard form contracts and other contracts generally is to reach a sensible commercial result that reflects the parties’ intentions at the time the agreement was made.
The Court of Appeal went on to review how courts had interpreted the term “corrosion” and determined that, while there was little Canadian authority, American appellate courts consistently found that “corrosion” included corrosion, however brought about. Thus, “corrosion” was not ambiguous and should have been interpreted consistent with the Policy as a whole and the surrounding circumstances. The Court of Appeal’s summary of its decision is reproduced below:
- This was not a negotiated agreement and, in any event, no evidence was adduced as to the understanding of the parties at the time the Policy was entered into in 1985. There is therefore no evidence to assist in understanding the way in which the language of the Policy would have been understood by a reasonable person at the time the Policy was signed;
- The Policy should therefore be interpreted in accordance with the terms of the Policy read in context;
- The dictionary definition of corrosion includes “wear away, esp. by chemical action.” It is not limited to anticipated corrosion but includes any kind of wearing away;
- The clear and unambiguous meaning of the term “corrosion” is not altered by other provisions in the Policy;
- The fact that two FM Global employees believed there might be coverage for unanticipated corrosion at the time the corrosion was discovered does not render the term ambiguous. As noted above, there is no coverage where the loss was caused by corrosion, as it was in this case. By contrast, there may be coverage if the damage is caused by an insured peril such as a sprinkler leakage and that damage in turn results in corrosion, to use the example provided by one of FM Global’s witnesses. Moreover, opinions of employees many years after the agreement was signed, do not, of themselves, alter the reasonable expectations of the parties when the Policy agreement was entered into. (In any event, FM Global’s senior supervisor in Toronto simply said that “[s]ome causes can trigger coverage for some types of corrosion.” He was not cross-examined on the causes or “types of peril”. This statement is consistent with FM Global’s point that “the corrosion exclusion would not apply if the corrosion was itself precipitated by an insured peril”);
- Defining “corrosion” to include both anticipated and unanticipated corrosion is consistent with commercial reality, the clear terms of the Policy, and the need to interpret standard form policies consistently and objectively because “the parties do not negotiate terms and the contract is put to the receiving party as a take-it-or-leave-it proposition”: Ledcor, at para. 28, citing MacDonald, at para. 33. To allow one party’s subjective intention of the meaning to alter the plain meaning of the term would enable one party to define terms in a standard form contract for many other insurers and insured: Ledcor, at para. 40;
- Because the Policy is a standard form contract, used in many jurisdictions, consistency of interpretation is desirable;
- As noted above, Canadian courts have long looked to other jurisdictions for guidance, particularly where the same contracts are used in multiple jurisdictions. This is in keeping with the desire for consistency and stability. American courts have consistently adopted a plain meaning approach to the term “corrosion” that includes both anticipated and unanticipated corrosion;
- If the corrosion exclusion were interpreted to apply only to non-fortuitous or anticipated corrosion (as the trial judge held), the exclusion would be meaningless as non-fortuitous or anticipated corrosion is not covered in the first place. This is because all damage covered by all-risk policies must be fortuitous: Canadian National Railway Co., at para. 79; and
- The trial judge’s interpretation may also create an incentive to avoid detection of corrosion as, if only non-fortuitous or anticipated corrosion is excluded from coverage, there would be little incentive to maintain equipment to avoid the risk of unanticipated corrosion.
- The exception to the corrosion exclusion for “physical damage” caused by corrosion did not apply to economic losses caused by the inability to use the equipment during the shutdown.
The Court of Appeal acknowledged that Canadian authorities had long held that “physical damage” did not include loss of use or pure economic loss, unless specifically provided. Further, the appellate courts in the US and the UK had concluded that physical damage exceptions to exclusions did not include loss of use. Therefore, the exception to the corrosion exclusion for resulting physical damage included physical damage but not damage resulting from loss of use; that is, while economic loss might result from physical damage, it was not physical damage. The Court of Appeal’s summary of its reasons is reproduced below:
- The exception to the exclusion for corrosion is restricted to “resulting physical damage” to MDS’ insured property or that of its suppliers. The plain meaning of physical damage does not include economic loss.
- A contextual analysis of the Policy does not lead to a broader interpretation of “resulting physical damage” because:
- Damage for “loss of market or loss of use, except to the extent provided by this Policy” is specifically excluded from coverage;
- The Contingent Time Element provision that allows for loss of profits only applies to insured claims; and
- A reasonable interpretation of the exception to the corrosion exclusion in this all-risk Policy is that, while lost profits are not covered, the provision does cover all costs to repair physical damage.
- The preponderance of cases in Canada, the United States and the United Kingdom have not interpreted resulting physical damage to extend beyond physical repairs to include loss of use. On the contrary, they have held that where loss of use is to be included as resulting physical damage, this must be made clear in the policy.
- The lower court did not err in awarding compound prejudgment interest at the rate of actual borrowing costs.
Given that the Court of Appeal ultimately denied coverage, there was no need to address this issue. Had it found otherwise, the Court of Appeal would not have interfered with the lower court’s exercise of its discretion to award compound prejudgment interest.
Through its decision, the Ontario Court of Appeal has returned the interpretive focus back to the plain meaning of the policy’s terms. The potential for the lower court’s decision to be applied broadly in favour of insureds seeking coverage for business interruption claims caused by COVID-19 which do not involve any physical damage was uncertain given the unique facts of this case. The Ontario Court of Appeal as now closed the door on any such arguments. With very few exceptions, business interruption claims under property policies require “property damage” which will usually require physical damage to property.