The Ontario Court of Appeal recently issued its decision in the much-discussed case of MDS Inc. v. Factory Mutual Insurance Company, 2021 ONCA 594. The lower court decision from the Superior Court of Justice was of considerable interest to insureds advancing COVID-19 business interruption claims, given its holding that loss of use could constitute “physical damage.” The Court of Appeal overturned the lower court decision and denied coverage to the insured thus arguably affirming the requirement for physical damage in order to trigger coverage for business interruption loss.
Factual Background and Superior Court of Justice
The insurer, Factory Mutual Insurance Company (“FM”), contracted with MDS Inc. (“MDS”) for a standard policy which provided coverage for “all risks of physical loss or damage to the property and contingent time element coverage resulting from a supplier’s business interruption.”
The policy excluded losses resulting from corrosion, which was not a defined term. The policy included an exception to this exclusion for “resulting ‘physical damage not excluded by this Policy’ at specified locations.” Both parties agreed that the exception covered MDS’s supplier Atomic Energy of Canada Limited and their Nuclear Research Universal (“NRU”) reactor.
Corrosion damage caused a shutdown of the NRU for fifteen months. As a result, MDS suffered substantial financial losses and submitted a claim for lost profits which was denied by FM. The policy also excluded loss of market or loss of use, except to the extent provided by the policy, and stipulated that “if physical damage not excluded by this Policy results, then only that resulting damage is insured.”
The Superior Court of Justice held that:
- The term corrosion was ambiguous and should be interpreted in light of the dictionary definition but be modified by the reasonable expectation of the parties;
- The policy’s corrosion exclusion should only be applied to “non-fortuitous anticipated corrosion” not unanticipated “fortuitous corrosion” ; and
- The policy’s exception to the corrosion exclusion for “physical damage not excluded by this Policy” should include economic loss resulting from the loss of use.
Court of Appeal
The Court of Appeal’s decision focused on the interpretation of insurance contracts and, in particular, addressed the proper interpretation of corrosion and whether an exception for “physical damage” should be interpreted to include loss of use.
In addressing the issue of contract interpretation generally the Court of Appeal relied on the Supreme Court of Canada decisions in Sattva Capital Corp. v. Creston Moly Corp., 2014 SCC53, and Eli Lilly & Co. v. Novopharm Ltd., 1998 2 S.C.R. 129, for the proposition that contract interpretation is an objective exercise and a “party’s subjective intention has no independent place” in the interpretation.
When dealing with standard form insurance contracts specifically, the Court of Appeal noted the importance of consistent interpretations and that ambiguity should be examined in light of the surrounding circumstances, through the lens of a reasonable person at the time the parties came to an agreement. Further, the words of the contract are given their ordinary meaning, not the meaning they might be given by persons versed in insurance law. However, the interpretation must reach a “sensible commercial result that reflects the intention of the parties at the time the agreement was entered into.”
When considering the term “corrosion”, the Court of Appeal found that the term was not ambiguous. The parties’ subjective intent should not have been considered and the trial judge erred by modifying the plain language use of the term.
Next, and more importantly, the Court of Appeal addressed whether “physical damage” includes “loss of use” damage. The policy provided that if physical damage not excluded by the policy occurs, then only that resulting damage is insured. Physical damage was not defined.
The losses suffered by MDS were a result of shutdown due to the need to repair the corrosion, not from other property damage. The Court of Appeal found that Canadian, British and American authorities have all held that exclusions for physical damage do not include loss of use or pure economic loss unless otherwise specifically provided for.
Ultimately, the Court of Appeal determined that, although the leak caused by the corrosion resulted in the shutdown, the shutdown itself is not resulting physical damage. The exclusion for corrosion damage was restricted to resulting physical damage to MDS’s insured property or that of its suppliers. A contextual analysis of the policy did not merit a broader interpretation, particularly when considering the policy generally excluded loss of market and loss of use damages.
Although the Court of Appeal noted that its decision turned on the specific wording of the particular policy in issue (as is always the case with the interpretation of any insurance policy), the decision is significant because it reaffirms the requirement for actual physical damage to trigger coverage for loss resulting from “physical damage.” Loss of use or pure economic loss does not constitute “physical damage.”