On September 3, 2021, in MDS Inc v Factory Mutual Insurance Company, 2021 ONCA 594, the Ontario Court of Appeal overturned MDS Inc v Factory Mutual Insurance Company, 2020 ONSC 1924. The appellate court concluded that the loss of use of an apparatus by corrosion did not qualify as physical damage. As a result, the physical damage exception to the corrosion exclusion in the insurance policy did not apply, and coverage was appropriately denied.
On February 21, 2006, MDS agreed to buy radioisotopes from Atomic Energy of Canada Limited, to be produced at the Nuclear Research Universal Reactor. MDS planned to sell the radioisotopes worldwide for cardiac imaging, cancer treatments, and sterilizing medical products. Factory Mutual Insurance Company (FMI) issued an all-risks insurance policy to MDS, which covered all risks of physical loss or damage to property. In essence, the policy provided that if an excluded peril (such as corrosion) caused physical damage not excluded by the policy, then only that resulting damage would be insured.
On May 14, 2009, heavy water containing radioactive tritium was discovered leaking through the wall of the reactor. The reactor was subsequently shut down for 15 months to repair the leak. The shutdown caused MDS to lose both its supplier of radioisotopes and profit of approximately $121,248,000. It was discovered that the leak was caused by unanticipated corrosion. MDS submitted a claim for lost profits, which FMI denied on the basis that the claim was excluded under the policy.
Interpretation of "corrosion"
In interpreting whether coverage was available under the policy, the Ontario Superior Court of Justice concluded that the term "corrosion" in the policy was ambiguous and that the exclusion applied only to non-fortuitous anticipated corrosion. Given that the leak was caused by unanticipated corrosion, the court concluded that MDS' claim should be covered.
The Ontario Court of Appeal rejected the trial judge's interpretation of corrosion for a number of reasons including (1) defining corrosion to include both anticipated and unanticipated corrosion is consistent with commercial reality and (2) the clear terms of the policy dictated otherwise. Additionally, the appellate court reasoned that this interpretation is congruent with the need to interpret standard form policies consistently and objectively. As per the Supreme Court's decision in Ledcor Construction Ltd v Northbridge Indemnity Insurance Co., "the parties do not negotiate terms and the contract is put to the receiving party as a take-it-or-leave-it-proposition." Further, as a standard form contract, it is open to the court to look to other jurisdictions — such as the United States — for guidance in interpretation. Adopting a plain meaning approach to the term "corrosion" that includes both anticipated and unanticipated corrosion, as American courts have repeatedly done, would maintain consistency and stability of interpretation of this term in insurance policies.
Physical damage exception to corrosion exclusion
The Ontario Superior Court of Justice also examined the exception provisions in the event that another court were to conclude that the corrosion exclusion applies. The court concluded that if the corrosion exclusion applied, then the exception provisions of resulting damage would apply, thereby allowing coverage for the plaintiffs' losses. To reach this conclusion, the court considered the reasonable expectations of the parties as to the meaning of physical damage. The court held that the unanticipated leak that precipitated the shutdown of the reactor constituted physical damage.
The Ontario Court of Appeal disagreed with the trial judge and reasoned that the loss resulted from the need to repair the corrosion, not from property damage. Therefore, the exception did not apply. The appellate court held that the need to repair the corrosion could be considered damage resulting from the loss of use or an economic loss, neither of which constitute physical damage.
Although not directly related to COVID-19, the Ontario Court of Appeal's approach to interpreting "physical damage" will doubtless guide courts in determining whether elements of COVID-19 could be conceptualized as physical loss or damage to the property. Whether economic losses arising in connection with the COVID-19 pandemic will be seen to amount to physical loss or damage to property will depend on the language of the policy. For example, the Ontario Court of Appeal stated that "where a policy is intended to include not only physical but economic losses, insurance policies have specifically defined property damage to include loss of use." On the other hand, the appellate court also considered that "Canadian authorities, including those that pertain to all-risks policies, have long held that exclusions for physical damage do not include loss of use or pure economic loss, unless otherwise specifically provided for."
Note: The Ontario Court of Appeal held that if it had decided differently on the issue of coverage, it would not have interfered with the trial judge's exercise of discretion to award prejudgment interest. As such, the Gowling WLG Insights from this article still stand.
Should you have any specific questions about this article or would like to discuss it further, you can contact the authors or a member of our Insurance and Professional Liability Group .