On Nov. 21, 2008, in CNR v. Royal and Sun Alliance et al, the Supreme Court of Canada set the standard for determining the scope of a “faulty or improper design” exclusion under a builder’s “all risks” insurance policy. This case involved an action commenced by Canadian National Railway (CNR) under the policy to recover a loss arising out of the failure of a tunnel boring machine (TBM) used in a new tunnel project.
Richard Shaban and
On November 21, 2008, in CNR v. Royal and Sun Alliance et al, the Supreme Court of Canada set the standard for determining the scope of a “faulty or improper design” exclusion under a builder’s “all risks” insurance policy. This case involved an action commenced by Canadian National Railway (CNR) under the policy to recover a loss arising out of the failure of a tunnel boring machine (TBM) used in a new tunnel project.
The policy insured CNR 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 tunnel boring machine...and structures, temporary works and underground tunnels in the course of construction.”
The policy, like most standard industry forms, contained an exclusion for “the cost of making good...faulty or improper design.”
The decision of the Supreme Court is important to the construction industry and the insurance industry as it clarified the standard to be applied in interpreting such exclusions. The Supreme Court found in favour of CNR, restoring a trial judgment, which, together with interest and costs totals almost $40 million.
The TBM was at the time the largest of its kind in the world and was the key piece of equipment used for the project, the purpose of which was to dig a tunnel under the St. Clair River between Sarnia, Ont. and Port Huron, Mich.
The TBM was purchased at a cost of $14 million by CN. A significant number of the world’s leading experts participated in the design of the TBM.
Approximately two months into tunnelling, the TBM failed because of a failure of the sealing system caused by excess differential deflection (adjacent components moving towards or away from each other beyond acceptable tolerances). CNR’s loss to repair the TBM and for 229 days of delay was claimed under the policy.
The insurers relied on the faulty or improper design exclusion to deny coverage.
At trial, Ground J. concluded that the insurers failed to satisfy their onus of proving that there was fault in the design of the TBM and therefore could not rely on the exclusion.
In reaching this conclusion, Ground J. applied a foreseeability standard, i.e. the insurer had the onus to prove that all foreseeable risks had not been taken into account in the design of the subject property for the “faulty or improper design” exclusion to apply.
The Court of Appeal, in overturning the trial judgment, effectively applied a perfection standard to conclude that because the TBM failed, its design was therefore faulty. Mr. Justice Ian Binnie, for the SCC majority, noted the trial judge held that, “the TBM must be designed to withstand all foreseeable risks,” while the majority judgment of the Court of Appeal held that the design must, in fact, and with the benefit of hindsight, be shown to have succeeded in withstanding all foreseeable risks.
Judge Binnie further stated in the SCC Judgement, “at any given time risks may be foreseeable but that in addressing those risks in an innovative project there is inevitably a gap between the then-current state of the engineering art and omniscience — a state of perfect knowledge and technique. This gap conceals risks within risks that are not foreseeable on “the basis of information that was available at the time . . . in the real world.” As Lang J.A. in the dissent pointed out, a design is not “faulty or improper’ simply because it falls short of perfection in relation to all foreseeable risks.’ ”
Judge Binnie went on to state, “I do not believe that where, as here, the risk is broadly defined (‘metal deflects under stress’), and the design addresses that risk with state of the art diligence and expertise (as here), the insurers are entitled to the exclusion just because, with the benefit of hindsight, it turns out “that “engineering knowledge and practice lacked a proper appreciation...” of the design problem. A narrower interpretation of the exclusion, it seems to me, best accords with the intentions of the parties based on the plain meaning of the words used, namely ‘faulty or improper.”
“The risk had been properly explored in the design phase and, based on the existing state of the art, it was not foreseeable that excess differential deflection was even a remote or unlikely risk with this design and in these circumstances. None of the experts involved in the Project, who had substantial experience in the design and manufacture of TBMs and with tunnelling projects, expressed any concern with respect to differential deflection adversely affecting the sealing system.
Judge Binnie stated that, “the trial judge’s point, as I understand it, was reminiscent of Sherlock Holmes: The significance of the evidence was that the watchdogs did not bark.”
Richard Shaban is a partner and the regional leader of the Construction, Engineering, Surety and Fidelity Group in Borden Ladner Gervais LLP’s Toronto office. Sharon Vogel is a partner in the Toronto office of Borden Ladner Gervais LLP and practices surety and construction law, working on matters frequently involving construction disputes relating to mega-projects in various jurisdictions.