The Ontario Court of Appeal recently released its decision in MDS Inc. v Factory Mutual Insurance Company (MDS) providing broadly awaited clarity on the scope of the term “physical damage”, which is the focus of this update. The Court’s decision could have widespread implication for several ongoing business loss coverage cases in which the physical damage trigger in the policy is a live issue.
In MDS, the insured made a claim for lost profits it says was caused by the shutdown of a reactor that resulted in the insured losing its supply of radioisotopes. The shutdown of the reactor was caused by a corrosive leak. Importantly, the cause of MDS’ lost profits was determined at trial to be corrosion. The trial judge also determined that the only physical damage that had occurred was the corrosion to the calandria wall of the reactor, and that the leak resulting from the corrosion did not cause physical damage.
At trial, a main issue of policy interpretation was whether business losses arising from shutdown of the reactor were payable pursuant to the exception to the exclusion for physical damage caused by corrosion. The exception to the exclusion provides that: “[t]his Policy excludes [corrosion], but, if physical damage not excluded by this Policy results, then only that resulting damage is insured”. Of note, the policy did not specifically define property damage to include “loss of use”.
The trial judge applied a broad interpretation to the exception and extended physical damage to also include economic loss from the loss of use of insured property arising from the shutdown.
One question raised on appeal was, if the corrosion exclusion applies, was the damage suffered by MDS resulting physical damage within the meaning of the exception to the exclusion for corrosion in the Policy?[1]
The Court of Appeal allowed the appeal and stated in respect of the physical damage issue:
Likewise, the term “physical damage” in the exception to the exclusion clause is clear. It does not apply to economic losses caused by the inability to use the equipment during the shutdown.[2]
The Court of Appeal found that “…where a policy is intended to include not only physical but economic losses, insurance policies have specifically defined property damage to include “loss of use”.[3] The Court further noted that both US and UK appellate courts have “…concluded that physical damage exceptions to exclusions do not include loss of use”.[4]
In critiquing the trial judge’s reliance on some US jurisprudence, and the accompanying analysis in support of the finding there was physical damage from loss of use required to trigger coverage, the Court stated:
[t]he trial judge relied on the American decision in MRI Healthcare to conclude that the resulting loss of use constituted resulting physical damage. That case, however, does not support the proposition that economic loss should be covered under an exception to an exclusion for resulting physical damage. On the contrary, the court concluded that there is no resulting physical damage to be covered where the detrimental impact is “unaccompanied by a distinct, demonstrable, physical alteration of the property”…. As such, although the leak resulted in the shutdown, the shutdown itself is not resulting physical damage. To read in coverage for “loss of use” distorts the plain language of the Policy and is out of step with the above case law.[5]
For these reasons, I find that the exception to the corrosion exclusion for resulting physical damage includes physical damage, but not damage resulting from loss of use. While economic loss may result from physical damage, it is not physical damage.[6] [Emphasis added]
It is expected that this decision will be strongly considered by lower courts in deciding business loss claims that involve a physical damage trigger, which is the case in several proceedings currently before the Courts including in respect of COVID-19-related business loss claims. While specific policy wording is important in each case, the principles espoused by the Court of Appeal that reign in the scope of the physical damage trigger from what the trial judge found in MDS, is expected to be highly impactful. It is unknown at this time whether the insured in MDS will seek leave to appeal to the Supreme Court of Canada.
[1] Para 80
[2] Para 12
[3] Para 89
[4] Para 90
[5] Para 96
[6] Para 97
