Corrosion Exclusion II - Resulting Physical Damage

Published date07 July 2020
Subject MatterInsurance, Litigation, Mediation & Arbitration, Insurance Laws and Products, Trials & Appeals & Compensation
Law FirmMcCague Borlack LLP
AuthorMr Hillel David

In an earlier paper, I commented on the interpretation and (non-) application of a corrosion exclusion in the decision in MDS Inc. v Factory Mutual Insurance Company.1

I said that my only comment regarding the court's interpretation and applicability of the exception contained within the exclusion was that it was questionable whether the exception would have saved and protected all or part of the claim under the policy even had the corrosion exclusion been found applicable because the exception was plainly directed to the preservation of coverage for resulting physical damage, whereas the vast bulk of the claim apparently consisted of resulting economic loss.

I turn now to a consideration of that exception to the exclusion.

General factual background

The general factual background of the case was summarized in the earlier paper. For convenience, I repeat that here (in grey), and I also reproduce the corrosion exclusion.

A leak of heavy water coolant containing a radioactive element (tritium) occurred at the Nuclear Research Universal Reactor (referred to in the reasons for judgment as the NRU) in Chalk River, Ontario. The leak was discovered during the course of a generalized power shutdown in Eastern Ontario and Quebec which automatically triggered a shutdown of the NRU. Although the leak was small, the NRU was shut down, ultimately for a period of 15 months, for defueling, drainage of the heavy water, identification investigation, and repair of the leak location and other pre-leak corroded areas, and to satisfy the regulator's protocols. The plaintiffs were insureds under an all-risk policy and claimed to have lost approximately $121 million, due to loss of sales of medical isotopes and other material that could not be produced during that period of shutdown. There was coverage under the policy for this type of claim in the amount of $25 million.

The leak consisted of a single, isolated, small penetration in the wall of the calandria, a vessel or tank which contained the heavy water, resulting in the water entering what was known as the J-rod annulus. The leak was localized, unexpected, and was the result of an accelerated process. There were a further nine sites of similar localized, unexpected, and accelerated corrosion which had not yet penetrated the calandria wall. A finding of fact was made that the leak, and the other nine corrosion sites which had not yet progressed to the stage where there was a leak, were due to corrosion, which in turn had been caused by the unknown and unanticipated presence of a contaminant/aggressive agent, probably chlorine.

Interestingly, there was generalized corrosion of the outside walls of the calandria, but that corrosion had been ongoing for several decades (1974 to 2009) and was the result of nitric acid in the J-rod annulus that was created by water leaking from the reflector. The operator of the NRU (AECL) had known about the presence of that generalized corrosion for many years, although it was not considered to be dangerous or yet to require remedial action.

The trial judge drew a clear distinction between the two types of corrosion:

  1. The localized corrosion which caused the penetration of the calandria wall (and the nine other pre-leak sites), had been quick-acting and was not known to be present. This was classified and treated as fortuitous corrosion. It was found to be unanticipated/unexpected, unpredictable, and accidental corrosion.2
  2. The generalized corrosion, on the other hand, was classified as non-fortuitous corrosion, because not only was it anticipated/expected and normal, it was actually known to be present and was monitored.

The insurer acknowledged that the corrosion which caused the leak was fortuitous, in that it was unique, unexplained unexpected, and unknown.

The corrosion exclusion

The corrosion exclusion provided as follows:

This Policy excludes the following, but, if physical damage not excluded by this Policy results, then only that resulting damage is insured:

3) deterioration, depletion, rust, corrosion...

Additional facts relevant to the exception to the exclusion

Any unexplained leak of heavy water containing tritium is significant and potentially dangerous.3 The tritium that was observed when the leak was discovered "was at actionable levels, in the sense that its presence triggered mandatory reporting...though not [at] dangerous levels".4

The leak was a "serious...and major event".5 "Once it was determined that the leak was through the wall of the calandria, and not merely located at a repairable mechanical fitting where leaking may be anticipated to occur, the NRU could not return to service until the protocol requirements of the CNSC [the governing regulatory agency] were satisfied."6 "After the discovery of the unanticipated through-wall leak, CNSC established a protocol on August 14, 2009...that was revised and enhanced in January 2010 that established conditions that must be met by AECL before the NRU could restart. The process to identify the cause of the leak, to conduct the repairs and to meet the CNSC protocol took 15 months...In total, ten sites were repaired."7

The coverage provision under which the claim was made

The insured made its claim for loss of profits under the Contingent Time Element...

The insured made its claim for loss of profits under the Contingent Time Element ("CTE") coverage provision in the policy.8 An adjuster for the insurer testified that "the CTE business interruption coverage was additional coverage purchased by MDS for the type of loss in this case, when a supplier experienced a physical loss affecting the supply of product and hence profits of [the insured]...The Policy treats the loss at the supplier location in the same way as a loss at the insured location. Hence, if a supplier has an interruption of production caused by physical loss or damage, the loss of profits of MDS flowing from that damage would be covered by the CTE [section] in the Policy, unless a Policy exclusion applies."9

The loss which was the subject matter of the claim under the policy

I am not privy to the evidence led at trial other than as summarized in the reasons for judgment. As best I can tell, the claim made by MDS under the policy consisted entirely of the loss of profit sustained by it as a result of the lengthy shutdown of the nuclear plant. There were, of course, expenses incurred for the repair of the single, small, corrosion-caused penetration of the calandria wall, and of the nine other sites where the unknown unanticipated, and accelerated corrosion had occurred. Those costs were most likely incurred by AECL, the owner and operator of the plant. It may be that repair costs were also incurred for the rectification of the generalized corrosion that was classified by the trial judge as non-fortuitous corrosion. In addition, expenses presumably were incurred for investigation, removal of heavy water and tritium in the J-rod annulus, and perhaps for other purposes although again by AECL, not MDS. Those expenses, however, probably represented no more than a fraction of the claim made under the policy by MDS for loss of profit.

To my knowledge, MDS made no claim under the policy for expenses incurred by it for the investigation or repair of any physical damage, or for...

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