Property Damage Insurance “Loss to Parts” Coverage: When is the Complete Replacement of Property Composed of Parts Covered?

On December 17, 2021, the Court of Appeal of Quebec released a decision relating to the scope of coverage of damage to equipment comprised of several parts under a commercial property insurance policy in Intact compagnie d’assurance c. 9004-9693 Québec inc., 2021 QCCA 1901.

The appeal gave the Court another opportunity to deal with the proper standard of review of a trial court’s interpretation and application of policy provisions. The key issue before the Court was whether coverage under a commercial property insurance policy should be limited to covering the cost of replacing only a part of a system, given the Insurer’s allegation that other components were not damaged, or whether the cost of replacing the entire system was covered.

Background

The Insured was a bowling alley which had suffered a breakdown of its scoring system (système de gestion du salon de quilles) composed of a server, client computer, 14 consoles and 14 screens installed in each alley [System]. The Insured’s policy with Intact provided that when insured property was composed of several parts, only the value of the part that has been lost or damaged was covered [Loss to Parts Provision]. Specifically, the General Provisions section of the Policy contained the following clause:

Intact accepted coverage of the loss in part, asserting that only the server had suffered damage and offering to pay the Insured an indemnity of $36,000 minus the deductible. The Insured filed an action against the Insurer before the Superior Court of Quebec, claiming $126,256 for the cost of replacing the entire System.

The trial judge allowed the Insured’s demand by finding that various components of the System were damaged. The Insurer filed an appeal arguing that the trial judge had erred in treating the system as a whole and in failing to apply the Loss to Parts Provision. The Court of Appeal dismissed the appeal for several reasons.

The Court of Appeal’s Decision

Standard of Review

Firstly, the Court of Appeal dismissed the Insurer’s argument that the trial judge’s decision consisted of a question of law which could be reviewed on the standard of mere error. The Court distinguished this matter from the circumstances in Ledcor Construction Ltd. v. Northbridge Indemnity Insurance Co, 2016 SCC 37, in which the Supreme Court of Canada had determined that the interpretation of a clause contained in a standard form contract was a question of law. The Court of Appeal stated that the interpretation of the contract in this case was essentially a question of mixed fact and law, and underlined that this was not one of the “rare” or “exceptional” cases in which the standard of correctness would apply to the trial judge’s findings on coverage.

Evidence of Damage to Each Component of System and Deference to Trial Judge’s Findings

Secondly, the Court of Appeal determined that the Insurer had failed to establish any overriding and palpable error in the trial judge’s finding that the cost of replacing the entire System was covered. The Court of Appeal underlined that the policy was clear in providing coverage for physical damage to equipment caused by a sudden and accidental disruption, but that a system did not constitute such equipment if each component could be qualified as a separate piece of electronic equipment. The Court of Appeal found that the trial judge had not ignored these provisions, but rather found that each component had been damaged and therefore benefited from coverage.

The Court examined the testimonial evidence introduced at trial and confirmed that it established that the server was damaged, that various consoles were not functional, although they had been prior to the occurrence and that scoring errors requiring manual correction occurred more frequently than prior to the event (The decision is silent as to the specific cause of the breakdown. The lower court decision seems unreported). The Insured’s expert’s report confirmed that the issue stemmed from the server, but affected the entire System, preventing it from working properly, and recommended that the entire System be replaced to allow the Insured’s business to operate. The Court underlined that the evidence of damage was to be assessed on a balance of probabilities and that scientific certainty was not required.

Application of Loss to Parts Provision did not Serve to Reduce Coverage

Finally, the Court of Appeal rejected the argument that the trial judgment should be reversed since the judge had failed to apply the Loss to Parts Provision even though there was no conflicting provision in the Equipment Breakdown form that applied. It considered that if there was any error by the judge on this point, it was not determinative since he had found, based on the evidence presented, that each component of the System had suffered damages or was not properly functional.

Takeaways

The decision serves as a reminder to parties and counsel of the importance of the role that evidence may play at the stage of determining whether indemnity is owed under an insurance policy. Findings of the trial judge, particularly in assessing credibility of both ordinary and expert witnesses, will be particularly resistant to review. In the case of equipment or property composed of several components, the insurer may be required to pay for the cost of replacing such equipment or property where the insured is able to demonstrate that each component has been lost or damaged following an occurrence. By contrast, it could be expected that an insurer who succeeds in establishing that the property is composed of distinct parts may succeed in contesting coverage for the repair or replacement of components that are unscathed.