Recently, in Canadian National Railway Company v. Royal and Sun Alliance Insurance Company of Canada, 2007 ONCA 209, the Ontario Court of Appeal held that failed efforts to prevent a foreseeable risk triggered the "faulty or improper design" exclusion clause in an all-risk builder's risk policy (the "Policy").

The Policy was issued to Canadian National Railway Company ("CNR") for construction of a rail tunnel beneath the St. Clair River to be mined by a Tunnel Boring Machine ("TBM"). During the construction phase, the TBM cuttinghead seals that were designed and intended to prevent the ingress of soils and contaminants from contacting the main bearing became damaged. Initially, the TBM property was the only property to sustain physical damage. To remove, inspect and repair the seals and the TBM, an extrication shaft had to be mined in front of the TBM for the TBM to mine into in order to provide access to the cuttinghead. When the TBM attempted to mine into the extrication shaft, it encountered unexpected difficulties resulting in it tunnelling into the shaft at an elevation below the design trajectory for the tunnel. To correct the misalignment and raise the TBM, blasting had to be conducted, which was done negligently and resulted in additional damage to the TBM.

The Policy insured 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]". CNR submitted a claim under the Policy in excess of $20 million and was denied coverage on the basis of the following exclusions: 1) "the cost of making good… faulty or improper design"; and 2) "inherent vice". CNR sued the insurers for recovery under the Policy.

At trial, causation and the foreseeability of the failure of the TBM were the key issues. Both sides called engineering experts who disagreed on the nature, cause and foreseeability of the failure of the TBM. The trial judge accepted the opinion of CNR's expert who opined that anticipating the cause of the failure would have been akin to identifying a "needle in a haystack". On this basis, the trial judge held that the occurrence of such excess differential deflection was not foreseeable and, therefore, the insurers were not able to rely upon the exclusion. The trial judge further found that there was no evidence to support the application of the inherent vice exclusion. In the end, the trial judge held that the TBM was designed to accommodate all foreseeable risks and, as such, the TBM's design was neither "faulty nor improper" within the meaning of the exclusion. The insurers were found liable. On appeal, the issue was whether the trial judge erred in his findings concerning foreseeability and the applicability of the faulty or improper design.

The majority of the Ontario Court of Appeal allowed the insurers' appeal and found that the trial judge erred by holding that the faulty or improper design exclusion did not apply. The Court of Appeal accepted the trial judge's formulation of the foreseeability standard as requiring proof that all foreseeable risks have been identified and addressed in the design in question:

[62] In our view, …"Accounting" for a foreseeable risk contemplates both that the risk is identified and that provision or allowance is made in the impugned design to meet the identified risk. On the foreseeability standard, anything less will not establish a fault-free and proper design. Nor, in our opinion, does designing against a foreseeable risk convert the risk into an unforeseeable one. It simply means that the applicable design provided for the risk, that is, the risk was identified and addressed in the design with a view to forestalling its occurrence, thus meeting the foreseeability standard. In this context, we agree that the foreseeability standard mandates that the relevant design "take into account", "accommodate", "provide for" and "withstand" all foreseeable risks

The majority of the Ontario Court of Appeal held, however, that the trial judge's application of the foreseeability test to the facts was reversible error. In particular, the Court of Appeal held that the trial judge failed to consider the evidence of Lovat's lead representative, whose evidence unequivocally confirmed Lovat's knowledge of the risk of failure of the TBM due to excess differential deflection, which was the type of risk that materialized in this case. As such, the Court of Appeal held that the type of risk at issue here was both foreseeable and foreseen. The Court of Appeal did not, however, disturb the trial judge's finding that there was no evidence to support a finding of inherent vice.

Finally, with respect to the nature of the Policy at issue, the Court of Appeal noted that an all risks policy provides broad coverage for losses and damage to property. However, this type of policy does not provide coverage against all conceivable perils. An all risks policy is not a warranty that the insured property "would fulfill its intended purpose, nor a warranty of entrepreneurial design risk." In that regard, the Court of Appeal held that the trial judge's application of the foreseeability test in this case had the effect of converting the Policy into just such a warranty