Indemnity focus: meaning of corrosion and resultant physical damage

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 exclusion clauses to contain a write back for resultant property damage.  In this article, we look at both issues in light of a Canadian decision which held that a corrosion exclusion applied to “unanticipated” corrosion at a nuclear facility leading to a leak, which in turn led to a shutdown.  The Court held that the shutdown was not resultant physical damage, so that the loss of production was entirely excluded.  

Facts

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

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

For a period of 35 years, there was a light water leak from the reflector into the J-rod annulus. This was gradually corroding the calandria and reflector, but initially was not believed to be a concern.  However, in May 2009, as a result of corrosion, there was an unexpected leak of heavy water from the calandria.  The reactor was shut down to investigate the problem. 

AECL was unable to supply radioisotopes to MDS for around 15 months.  There was no alternative supplier.  MDS apparently suffered economic losses of around $121m Canadian dollars.  

MDS lodged a business interruption claim under its insurance policy.  The policy provided $25m USD of cover for economic loss sustained by MDS directly resulting from physical loss or damage to property of the type insured at the location of a supplier.   

Corrosion Exclusion

The insurer declined coverage due to a corrosion exclusion.  The exclusion applied to “deterioration, depletion, rust, corrosion or erosion, wear and tear, inherent vice or latent defect”.  However, the insured argued that this exclusion only applied to anticipated corrosion, such that the “unanticipated” event which happened in May 2009 was not excluded. 

The Ontario Court of Appeal disagreed with the insured and held that the exclusion applied to corrosion, regardless of whether or not it was anticipated.  The Court explained that the dictionary definition of corrosion includes “wear away, esp. by chemical action” and is not limited to anticipated wearing away.  This “clear and unambiguous” meaning had not been altered by the policy, and was “consistent with commercial reality”.  Also, the exclusion would be “meaningless” if it only applied to anticipated corrosion, which is non-fortuitous, and so not covered in the first place.

Resulting Damage Exception

The exclusion had an exception stating that “if physical damage not excluded by this Policy results, then only that resulting damage is insured”.  So, there was a further question of whether (or not) the exception saved the claim.  The trial judge took the view that the heavy water leak had caused loss of use of the reactor, and that this was resulting damage within the exception.  But the Ontario Court of Appeal disagreed.   

The Court stated that economic loss is not physical damage, and that loss of use is also not physical damage unless made clear in the policy.  In this case, the heavy water leak from the calandria into the J-rod annulus had caused a shutdown.  But, it had not caused “actual tangible damage” to the J-rod annulus.  Put another way, the inability to use equipment during a shutdown is not physical damage.

Comment (Andrew Durrant)

While this is a Canadian decision, and so does not apply directly in New Zealand, it provides helpful guidance on the scope of a corrosion exclusion and the resulting property damage write-back.  Specifically, the meaning of “corrosion” is not necessarily confined to anticipated corrosion.  The decision also shows that, in the absence of specific words to this effect, loss of use of property will not be “damage” to property.    

Andrew Durrant is a Senior Associate at Fee Langstone