July 13, 2018

The Court of Appeal weighs in on the obligation to adequately test equipment

In Arrangement relatif à Orbite Technologies Inc., the Court of Appeal recently confirmed that it is not sufficient for an insured to fulfil the conditions set out in its insurance policy to obtain coverage; rather, it must fulfil them adequately.

In addition to having proceeded remarkably fast, the case is also noteworthy for the extensive evidence heard regarding the commercial context in which the insurance policy was issued

Orbite Technologies Inc. operated in the fields of clean technology mineral processing and resource development. In 2012, it converted one of its plants to implement a processing method that was unique in the world and unparalleled in the field.

For the start of production, Orbite took out an insurance policy covering machinery and equipment breakdown and loss due to interruptions from Royal & Sun Alliance Insurance Company of Canada. The policy excluded loss of an object that had not been completely installed, tested and contractually accepted by the insured.

Before putting the plant into operation, Orbite tested its machines with a product having a chemical composition that was significantly different from the product that was supposed to be used for production. On the basis of Orbite’s representations that testing was fully completed for major equipment, RSA issued the machinery breakdown insurance policy for “operations”. 

Two and a half months after the start of operations, a first incident occurred, followed by two others shortly thereafter, each resulting in the breakdown of machinery and the interruption of operations. Orbite reported the losses to RSA only one and a half months after the first incident occurred.

Because RSA denied coverage for the incidents, Orbite brought an action against it under the Companies' Creditors Arrangement Act (CCAA) claiming $23.3 million, the maximum amount of coverage available under the insurance policy. Orbite submitted that the exclusion in the RSA policy was not applicable because all the required tests had been completed before the first incident.

Orbite sought protection under the CCAA in April 2017, and the action against RSA was therefore presented before the Commercial Division of the Superior Court, where time periods may be shortened significantly. In fact, the trial on the merits of the action, instituted on November 15, 2017, proceeded between January 29 and February 5, 2018, before the Honourable Louis Gouin J.S.C. The Court of Appeal then heard Orbite’s appeal on May 11, 2018, and rendered its judgment dismissing the appeal on June 28, 2018.

In addition to having proceeded remarkably fast, the case is also noteworthy for the extensive evidence heard by Gouin J.C.S. regarding the commercial context in which the insurance policy was issued. Among the 12 witnesses heard were Orbite’s head of insurance, two insurance brokers, RSA’s underwriter and its claim manager

The principles of interpretation applicable to exclusion clauses in insurance policies

The decision of the Superior Court is based on the principles of interpretation applicable in such cases:

  • It is up to the insurer to establish that a policy exclusion applies;
  • The insurer must establish the exclusion in a strict manner;
  • Exclusion clauses must be interpreted restrictively;
  • In the event of ambiguity, a document must be interpreted against the party who drafted it (contra proferentem).  

The Superior Court also reiterated the rules of interpretation set out in Ledcor:

  • Where the language of the insurance policy is unambiguous, the Court should give effect to that clear language, reading the contract as a whole;
  • Where the policy’s language is ambiguous, the interpretation should be consistent with the reasonable expectations of the parties and not give rise to results that are unrealistic;
  • Only if ambiguity remains should the contra proferentem rule be employed.

Orbite’s situation

The evidence revealed that Orbite had not “adequately” tested its equipment before the start of operations, contrary to what the insurance policy required. Orbite was under the obligation to complete adequate testing, and the Superior Court [translation] “had the clear impression that Orbite passed the buck to RSA by asking it to satisfy itself”. The Court therefore found in favour of RSA and dismissed the action, relying in particular on the testimony of metallurgy expert Dr. Nicolas Geoffroy with respect to the technical aspects of the case.

On June 28, 2018, the Quebec Court of Appeal, which had to determine whether the trial judge had committed an error by concluding that the exclusion clause was unambiguous and should be applied, upheld the judgment and dismissed the appeal. It found that the trial judge’s use of the adverb “adequately” in the phrase [translation] “adequately performed testing” added nothing new to the terms of the exclusion clause. In fact, the Court noted that there could be no valid testing of the insured equipment unless they were tested in accordance with the purpose for which they would be used by the insured. In this case, Orbite did not test the machines because it did not conduct such tests with the products that would be used for operations in its plant.

→ The Court of Appeal added that it goes without saying that the purpose of the exclusion clause was to absolve the insurer of liability for risks related to objects that had not been tested, that is, tested in accordance with their intended use.

→ In sum, the Court of Appeal concluded that the text of the policy, and more specifically the text of the exclusion, was unambiguous. The tests conducted by Orbite were inadequate and therefore, the exclusion applied, such that RSA was not required to cover the $23.3 million claimed by Orbite under the insurance policy.