Canada: On-Risk E-Bulletin @ Gowlings: March 27, 2009

Last Updated: April 3 2009

Edited by Paul Stein and Allison Thomas


  • Message from the Executive Editors
  • A tale of twenty-six lubricated seals - Canadian National Railway Company v. Royal Sun and Alliance Insurance Company of Canada and others - The Supreme Court of Canada weighs in on the exclusion for "faulty or improper design"
  • Insurer Precluded from Denying Coverage Under "Settlement" Exclusion in an All-Risks Policy
  • Case Comment: McDougall v. Black and Decker Inc. et al.

Message from the Executive Editors
By: Allison Thomas, Toronto

In this issue of Gowlings' On-Risk E-Bulletin, Adam I. Zasada from our Waterloo office comments on the recent Supreme Court of Canada decision in Canadian National Railway Company v. Royal Sun and Alliance Insurance Company of Canada, where the Court overturned the decision of the Ontario Court of Appeal. The SCC held that when insuring something that has never been built before, it will be covered despite any exclusion for "faulty or improper design", as long as it was built to the state of the art at the time.

Tim Ryan from our Calgary office provides a case comment on the recent decision in Engel Estate v. Aviva Insurance Company of Canada, where the Alberta Court of Queen's Bench distinguished Canadian cases and followed U.S. case law regarding settlement exclusions in "All Risks" policies.

David C. Hendricks from our Vancouver office comments on the recent Alberta Court of Appeal decision in McDougall v. Black and Decker Inc. et al., where the court reviews the law on spoliation of evidence in Canada.

As always, please feel free to contact the authors of any of the articles in this issue of On-Risk or the Executive Editors if you have any questions.

A tale of twenty-six lubricated seals - Canadian National Railway Company v. Royal Sun and Alliance Insurance Company of Canada and others - The Supreme Court of Canada weighs in on the exclusion for "faulty or improper design"
By: Adam I. Zasada, Waterloo

The Essential Facts

This is not a story of slippery or drunken marine mammals. It is an insurance story.

In the early 1990s, the Canadian National Railway Company ("CNR") embarked on a project to have a tunnel boring machine ("TBM") designed and constructed to run under the St. Clair River to connect Sarnia, Ontario and Port Huron, Michigan. The TBM was a massive machine. One of the key design considerations was keeping dirt and debris out of the bearing housings of the TBM. Apparently, dirt in the bearing chamber is a very bad thing. To this end, the TBM design team integrated twenty-six specially lubricated seals into the TBM to act as a "gauntlet" to protect the main bearing from dirt.

CNR purchased an "all risks" policy of insurance (the "Policy") from a number of insurers (the "Insurers") and paid a hefty premium for same. The Policy insured against "All risks of direct physical loss or real and personal property of every kind and quality including but not limited to the TBM" but excluded "the cost of making good...faulty or improper design" "and inherit vice".

As the tunnel was being excavated by the TBM, engineers discovered that some amount of dirt had gotten into the main bearing chamber. Construction was halted, the TBM was repaired, modifications to the seals made, and the tunnel completed. The delay in completing the tunnel was a costly one; CNR claimed on the Policy, the Insurers denied coverage, and CNR sued.

The evidence at trial established that the probable cause of dirt making its way to the sacred bearing chamber was the deflection (movement/bending under stress) of metals in the TBM beyond what the engineers had anticipated in the design. The engineers had anticipated and accounted for some deflection of metals in the design but the degree of deflection that actually occurred was much greater.

The Trial Decision

The trial judgment can be read at Ontario&path=/en/on/onsc/doc/2004/2004canlii33029/2004canlii33029.html.

At trial, Justice Ground awarded CNR more than $30,000,000, including costs. The trial judge found that the design and construction of the TBM had taken all foreseeable risks into account and that the design of the TBM was not "faulty" or "improper", disentitling the Insurers from relying on the exclusion in the Policy. The judge accepted that deflection of metals will occur under stress but found that the degree of deflection that actually occurred was beyond what was foreseeable when the TBM was designed. As the designers had considered foreseeable risks, designing the TBM to a very high level, the trial judge held that the design was neither "faulty" nor "improper". The loss was covered and the Insurers had not discharged their burden of establishing that the exclusion applied.

The Court of Appeal

The decision of the Ontario Court of Appeal can be read at Ontario&path=/en/on/onca/doc/2007/2007onca209/2007onca209.html

The Ontario Court of Appeal, in a 2-1 split, allowed the Insurer's appeal. The essential reasoning of the majority was that the very fact that the TBM failed is de facto proof that there was a faulty or improper design, triggering the exclusion in the Policy.

The Supreme Court of Canada

The decision of the Supreme Court of Canada can be read at

In a narrow majority (4-3), the Supreme Court of Canada allowed CNR's appeal and restored the award of the trial judge.

The Insurers' argument was that where the failure occurs under conditions that were foreseeable, the combination of that failure and the foreseeability of the element that lead to the damage should be sufficient to trigger the exclusion.

CNR's argument was that the TBM need not be designed to a standard of perfection. Further, because the TBM was designed and constructed to the state of the art (essentially to the best knowledge and practices of the day), the design was neither "faulty" nor "improper" so as to trigger the exclusion.

In finding for CNR, the majority made the following observations:

  • When considering whether a design is "faulty", the court must focus on the design itself - not the designer's fault or lack thereof [para 41];
  • To rely on an exclusion containing the words "faulty or improper" in relation to the design, an insurer must establish that the design fell below a "realistic" standard [para 53];
  • A design is not faulty or improper simply because it does not meet a standard of perfection in relation to all foreseeable risks [para 51];
  • While designing and constructing the TBM to the state of the art was sufficient to maintain coverage and not trigger the exclusion, the outcome may have been different had the TBM been designed and constructed to the lower "industry standard" [para 54]; and
  • It was open to the insurers to write the exclusion to exclude coverage for losses arising from "design failure" or "design failure in conditions of foreseeable risk" - suggesting that had the exclusion been so cast, the outcome of the case may well have been different [para 56].

The distilled message conveyed by the majority decision is that when insuring something that has never been built before (a novel design), it will be covered if a failure occurs despite the exclusion for "faulty or improper design" if it was designed and built to the state of the art at the time.

The essence of the minority decision is if the item insured fails as a result of an inability to withstand or cope with risks that were foreseeable, its design is "faulty" and the exclusion should apply. The minority decision makes the interesting observation that the majority decision effectively turns the Policy into a warranty.

A full scale discussion of the significance of the decision is beyond the scope of this article. Given the close divide in both the Court of Appeal and the Supreme Court of Canada, this case will almost certainly not be the final word on this particular exclusion clause. A very different outcome may well be possible on only modestly different facts.

Insurer Precluded from Denying Coverage Under "Settlement" Exclusion in an All-Risks Policy
By: Tim Ryan, Calgary

The 2008 decision of the Alberta Court of Queen's Bench in Engel Estate v. Aviva Insurance Company of Canada, 2008 ABQB 645 ("Engel Estate") is an interesting discussion of both U.S. and Canadian case law on "All Risks" property coverage. Perhaps most interesting is the fact that the Alberta Court of Queen's Bench distinguished Canadian cases and elected to follow U.S. case law in determining that a settlement exclusion in an all risks policy did not exclude non-natural causes of settlement.

The decision can be found at


The plaintiff owned commercial property located in Calgary. It sought a declaration that it was entitled to coverage and indemnity from Aviva Insurance Company of Canada ("Aviva") under an all risks policy for damages to its commercial property. The damage to the property occurred during construction work on an adjacent property.

The construction included excavation, pile driving and shoring work. Prior to this construction, the plaintiff had received an indemnity from the developer of the adjacent property. However, as a result of the construction work, significant damage to the building occurred. Eventually the structural stability, safety and physical integrity of the plaintiff's building was threatened by this damage. The plaintiff sought coverage from Aviva under an all risks policy.

Aviva denied coverage based on an exclusion that dealt with earth movement and settlement. The exclusion specifically excluded "settling, expansion, contraction, moving, shifting or cracking unless concurrently and directly caused by a peril not otherwise excluded..." (the "Settlement Exclusion").

Justice Hawco noted that there was general agreement that the property damage to the plaintiff's building occurred as a result of settlement. There was also general agreement that the settlement occurred due to the adjacent construction. The issue was whether or not this "non-natural" settlement qualified as "settling" under the Settlement Exclusion.

Justice Hawco undertook an examination of American decisions that dealt with similar settlement exclusions. The courts in those decisions concluded that the natural meaning of words such as "settling, expansion, contraction, moving, shifting or cracking" referred to a slow process resulting from the condition of the ground or building. It did not refer to a non-natural or third party cause of the settlement. American authorities generally held that when the settling occurred from an accidental cause and happened abruptly or unexpectedly, then that settlement the was not the sort of "settling" to which the policy language in an all risk policy referred. Based upon these American authorities, the damage to the plaintiff's case in this instance would not qualify as "settling" pursuant to the Settlement Exclusion.

Justice Hawco then reviewed Canadian decisions which considered settlement exclusions. Canadian cases, including two appeal decisions, were quite different and generally excluded property damage regardless of whether the cause was natural or non-natural.


Justice Hawco concluded that settlement by non-natural causes is not excluded by the Settlement Exclusion.

Justice Hawco stated explicitly that he preferred the reasoning in the American cases which limits "settlement" to "settlement which results from natural causes". He distinguished the Canadian cases reviewed on the basis that they considered different policy language. In particular, the policies under consideration in most of those Canadian decisions referred to a type of damage rather than a cause of damage. As a result, Justice Hawco found that the property damage in this case was covered by the Aviva policy.

Case Comment: McDougall v. Black and Decker Inc. et al.
By: David C. Hendricks, Vancouver

In the case of McDougall v. Black and Decker Inc. et al., 2008 ABCA 353 ("McDougall"), the Alberta Court of Appeal summarized and clarified the current state of the law of spoliation of evidence in Canada.

The decision can be found at

The loss of critical evidence, whether by plaintiffs or defendants, is an issue frequently faced by insurers and their insureds in litigation. Documents and equipment are disposed of before their significance is appreciated for later use in litigation. With advancements in technology and increased interest in new forms of electronic evidence comes the additional potential for loss (accidental or otherwise) of evidence prior to or during the course of litigation. Participants in insurance litigation, both defence and subrogated claims, are well advised to understand the current status of the law of spoliation.


The McDougall case concerned a house fire, which was alleged to have been caused by a malfunctioning cordless electrical drill, manufactured by the defendant, Black and Decker. An investigator hired by McDougall's property insurer (the subrogated insurer) inspected the fire scene and retained the suspect drill.

The fire scene itself was effectively wiped clean, due to the fact that the house was rebuilt prior to Black and Decker being put on notice of a possible claim. Black and Decker was, therefore, unable to inspect the fire scene in its unaltered state. Moreover, certain parts of the suspect drill went missing for reasons which were unclear.

Black and Decker brought a pre-trial application to have the case dismissed, on the grounds that due to the spoliation of the evidence, it was unable to properly defend itself. The chambers judge agreed with Black and Decker and dismissed the claim.

Law of Spoliation of Evidence

The Court of Appeal overturned the chambers judge's decision and restored the claim. In so doing, the Court of Appeal canvassed the noteworthy authorities in this area of law in Canada. The main points made clear by the Court of Appeal are as follows:

  1. Spoliation of evidence requires that a party intentionally destroy or dispose of evidence, where it can be reasonably be inferred that the evidence was destroyed to affect litigation. Negligent destruction of evidence does not amount to spoliation, but may still give rise to procedural remedies.
  2. The principal remedy for spoliation is the imposition of a rebuttable presumption of fact (an adverse inference) that the lost or destroyed evidence would not have assisted the spoliator's case. The presumption can be rebutted by evidence showing the spoliator did not intend, by destroying the evidence, to affect litigation, or by other evidence to prove or repel the case.
  3. A court should not strike an action unless it is beyond doubt that the destruction was a deliberate act done with the clear intention of gaining an advantage in litigation, and the prejudice is so obviously profound that it prevents the innocent party from mounting a defence. Any court striking an action should only do so at trial, and not on a pre-trial motion.
  4. The Rules of Court allow for a variety of procedural remedies which, short of dismissing the claim outright, allow for a balancing of the playing field. These include: excluding a party's expert evidence where the opposing party could not have its own expert review the lost evidence; an award of costs where a party had increased expenses in proving its case in the absence of the lost evidence; and allowing pre-trial discovery of an opposing party's expert. The list of remedies remains open, and is subject only to the Rules of Court and the court's inherent jurisdiction to control its process and ensure fairness.


In the end, the law appears to be that a court will only dismiss a claim for spoliation in the most egregious of circumstances. The court has a number of alternative remedies to choose from, the common purpose of which is to attempt to level the playing field for the parties to the litigation. Clearly, this would be quite fact specific to each case, and the type of evidence lost.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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