The Interpretation of Standard Form Insurance Policies: $56 Million Award Overturned
The recent Court of Appeal decision in MDS Inc. v Factory Mutual Insurance Company discusses the interpretation of standard form insurance contracts and coverage in all-risk policies.[1]
Background
In MDS, the insurer appellant, Factory Mutual Insurance Company (“FM Global”), issued an all-risk insurance policy (“the Policy”) to MDS Inc., a global health science company. The policy was a standard form policy and, as a result, there was no negotiation of the terms of insurance in the Policy. The Policy excluded coverage for losses caused by “corrosion” and did not define the term in the insurance contract.
MDS purchased radioisotopes for production at a reactor located in Chalk River, Ontario. In May 2009, the reactor shut down for (15) months as a result of water damage from a leak. It was determined that the leak was caused by corrosion and because of the shutdown, MDS lost its supplier for radioisotopes and profits of approximately $121,248,000. MDS submitted a claim for lost profits. FM Global denied the claim on the basis that it was excluded under the corrosion exclusion in the Policy.
Trial Decision
The central issues at the trial level were: (i) the interpretation of the corrosion exclusion in the Policy, and (ii) whether MDS’ business losses arising from the shutdown of the reactor were payable pursuant to the exception to the exclusion for physical damage caused by corrosion.
The trial judge held the following:
- the term “corrosion” was ambiguous and should be interpreted in light of the dictionary definition of the term and modified by the “reasonable expectations of the parties”;
- the exclusion does not apply to unanticipated and “fortuitous corrosion”, it only applies to “non-fortuitous anticipated corrosion”; and
- the exception to the “corrosion” exclusion for “physical damage” should be interpreted broadly and include economic loss caused by the inability to use the insured property during the shutdown.
MDS was awarded the policy limits of $25,000,000 (USD), plus prejudgment interest of $14,821,338 (USD), which amounted to $56,406,911 (CAD).
Appeal Decision
Corrosion Exclusion
On appeal, the Court of Appeal found that the trial judge erred in finding that the term “corrosion” is ambiguous and in deciding that losses other than physical damage are covered in the Policy.
Thorburn J.A. in her analysis considered the interpretation of standard form contracts of insurance. Courts have held that standard form contracts of insurance should be interpreted consistently. As a result, the words of the contract are given their ordinary meaning, not the meaning that they may have been given by persons versed in insurance law.
Thorburn J.A. also considered the general rules of construction where a provision is ambiguous. A contractual provision has been held to be ambiguous if it is reasonably susceptible to more than one meaning. In these circumstances, the goal is to reach a sensible result that reflects the intentions of the parties at the time the agreement was entered into.
The appellant, FM Global, took the position that the exclusion for corrosion was unambiguous. Thorburn J.A. agreed with the appellant and held that the term “corrosion” was not ambiguous, and should have been interpreted in a manner that was consistent with the Policy as a whole.
In the Court of Appeal’s analysis, Thorburn J.A. noted that although the contract is an all-risk policy that covers all claims, save for those that are specifically excluded, this does not mean that the interpretation of clear terms should be changed. All-risk policies in their nature are limited to cover only fortuitous or unanticipated losses.
The Court further referred to the case of British and Foreign Marine Insurance Co. v. Gaunt, which found that the words “all-risk” cannot be held to cover all damage. The Court in Gaunt stated that “Damage, in other words, if it is to be covered by [all-risk] policies such as these, must be due to some fortuitous circumstance or casualty”.[2]
The Court of Appeal found that the term “corrosion” in this case is unambiguous for three reasons. First, contrary to the trial judge’s assertion, the fact that two employees of the insurer stated that there might be circumstances in which losses involving corrosion may be covered, does not mean the term is ambiguous.
Second, even if the employees believed that there was coverage for damages caused by corrosion (there was no evidence they did believe this), the subjective belief of a party long after the standard form policy was entered into, absent other circumstances, is not evidence of the reasonable intention of the parties at the time the contract was entered into.
Third, the term “corrosion”, while undefined in the Policy, has a plain and ordinary meaning.
For these reasons, Thorburn J.A. concluded that the term “corrosion” was not ambiguous and should have been interpreted in a manner consistent with the Policy as a whole and the surrounding circumstances, including the purpose of the coverage, the nature of the relationship it creates, and the industry in which it operates.
Instead, the trial judge erred by modifying the term based on her interpretation of remarks made by two representatives of the insurer as to the possibility of coverage for corrosion. These comments were made long after the Policy had been signed and, as a result, were misconstrued by the trial judge.
Therefore, the Court of Appeal held that the corrosion exclusion applies.
Exception for Physical Damage
The Court of Appeal further found that the exception to the corrosion exclusion for “physical damage” did not apply. The exception provides that “[t]his Policy excludes [corrosion], but, if physical damage not excluded by this Policy results, then only that resulting damage is insured”.
The Court of Appeal stated that the exception does not include coverage for economic loss. While economic loss may result from physical damage, it is not physical damage.
Prejudgment Interest
Lastly, the Court of Appeal addressed the trial judge’s decision to award compound interest, with the rate of interest determined by MDS’ cost of borrowing money.
The Court of Appeal stated that courts of equity have always exercised the power to award compound interest whenever there is wrongful detention of money that ought to have been paid and which the company uses in its business.
The Court of Appeal would not have interfered with the trial judge’s exercise of discretion with respect to prejudgment interest.
Conclusion
This case illustrates two key take-away points. First, although all-risk policies cover all claims save for those that are specifically excluded, this does not mean that the interpretation of clear terms should be changed. Moreover, one party’s after-the-fact interpretation of a policy term has no independent place in determining the parties’ contractual intent at the time of entering into a standard form contract.
Second, all-risk policies, by their nature, are limited to cover only fortuitous or unanticipated losses. As stated by the Court of Appeal, “[i]f the corrosion exclusion were interpreted to apply only to non-fortuitous or anticipated corrosion (as the trial judge held), the exclusion would be meaningless as non-fortuitous or anticipated corrosion is not covered in the first place”.
[1] MDS Inc. v Factory Mutual Insurance Company, 2021 ONCA 594.
[2] British and Foreign Marine Insurance Co. v. Gaunt, [1921] 2 A.C. 41 (H.L.), [1921] All E.R. Rep. 447, at pp. 46-47.