Purpose of compensation: significance of corrosion and resulting physical damage

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MDS Inc v Factory Mutual Insurance Co [2021] ONCA 594

A corrosion exclusion is a common feature of many policies. It is also common for disclaimers to contain rewrites for resulting property damage. In this article, we examine both issues in light of a Canadian decision that a corrosion exclusion applied to “unexpected“corrosion at a nuclear facility leading to a leak, which in turn led to a shutdown. The Court ruled that the stoppage was not a resultant physical damage, so loss of production was entirely ruled out.

Facts

Atomic Energy of Canada Ltd. (AECL) provided radioisotopes to MDS. The radioisotopes were produced in a nuclear research reactor. In May 2009, the nuclear reactor had to be shut down due to a leak, which interrupted the supply of radioisotopes for months. This shutdown caused significant losses to MDS.

The reactor core was housed in a shell or pressure vessel containing heavy water, which was surrounded by a light water reflector, all within a concrete structure. There was a pressurized carbon dioxide compartment, called the J-rod ring, separating the grille from the reflector.

Over a period of 35 years there was a slight water leak from the reflector into the J-rod annular space. This was gradually corroding the grille and reflector, but was initially not considered a problem. However, in May 2009, due to corrosion, there was an unexpected heavy water leak from the grille. The reactor was shut down to investigate the problem.

AECL was unable to provide radioisotopes to MDS for approximately 15 months. There was no alternative supplier. MDS apparently suffered economic losses of approximately C$121 million.

MDS filed a business interruption claim under its insurance policy. The policy provided coverage of US$25 million for economic losses suffered by MDS resulting directly from physical loss or property damage of the type insured at a supplier’s site.

Corrosion exclusion

The insurer declined coverage due to a corrosion exclusion. The exclusion applied to “deterioration, exhaustion, rust, corrosion or erosion, wear, inherent defect or latent defect”. However, the insured argued that this exclusion only applied to anticipated corrosion, so the “unexpected” event that occurred in May 2009 has not been ruled out.

The Ontario Court of Appeal disagreed with the insured and held that the exclusion applied to corrosion, whether anticipated or not. The Court explained that the dictionary definition of corrosion includes “wear out, esp. by chemical action” and is not limited to anticipated wear and tear. This “clear and unambiguousmeaning had not been changed by the policy, and was “in line with commercial reality”. Also, the exclusion would be “without meaningif it only applied to anticipated corrosion, which is not incidental, and therefore not covered in the first place.

Exception for consequential damages

The exclusion had an exception stating that “if it results in physical damage not excluded by this policy, only the resulting damage is insured”. So there was another question whether (or not) the exception saved the claim. The trial judge held that the heavy water leak had caused the loss of use of the reactor, and that damage within the meaning of the exception resulted. But the Ontario Court of Appeal disagreed.

The Court said economic loss is not physical damage and loss of use is also not physical damage unless clearly stated in the policy. In this case, the heavy water leak from the grille into the J-rod’s annular space had caused a shutdown. But, that hadn’t caused”actual tangible damage” at J-rod’s ring. In other words, the inability to use the equipment during a shutdown is not physical damage.

Commentary (Andrew Durrant)

Although this is a Canadian ruling, and therefore does not directly apply in New Zealand, it provides useful guidance on the scope of a corrosion exclusion and property damage recovery that results. Specifically, the meaning of “corrosion” is not necessarily limited to anticipated corrosion. The decision also shows that in the absence of specific words to that effect, loss of use of property will not be “damage” to property.

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