More Open Interpretation?

Ubiquitous to virtually every commercial general liability (CGL) policy is the “sistership” exclusion, which gained its name from the airline industry practice of grounding all aircrafts of the same type when a defect was noted in that type of aircraft after an accident.

The resulting damages arising from the loss of use of these “sisterships” could potentially be enormous. As such, historically the clause was drafted so as to exclude coverage for those damages, other than the damages arising from the original aircraft involved in the accident (see the 1991 ruling by the Supreme Court of Washington, Olympic Steamship Co., Inc. v. Centennial Ins. Co.).

An argument can be made that the sistership exclusion represents one of the more vexing exclusions in the CGL policy, at least based on the inconsistent judicial treatment it has received, replete with heavy reliance on the intention and policy behind the exclusion, as opposed to a plain reading of the exclusion itself.

The very fact that it carries the moniker “sistership” exclusion is evidence its historical baggage exerts an influence that makes fresh judicial interpretation difficult.

A common version of the exclusion found in many modern CGL policies reads as follows:

This exclusion does not apply to:

1. Any loss, cost or expense incurred by you or others for the loss of use, withdrawal, recall, inspection, repair, replacement, adjustment, removal or disposal of:

1) “your product”;

2) “your work”; or

3) “impaired property”;

if such product, work or property is withdrawn or recalled from the market or from use by any person or organization because of a known or suspected defect, deficiency, inadequacy or dangerous condition in it.

CANADIAN CASE LAW

Gulf Plastics Ltd. v. Cornhill Insurance Co. Ltd.

While Canadian case law is limited, in one significant case, British Columbia’s Court of Appeal looked at a slightly older wording of the exclusion in the 1990 case, Gulf Plastics Ltd. v. Cornhill Insurance Co. Ltd. In that case, the exclusion applied to damages caused by the “withdrawal, inspection, replacement or loss of use of the Named Insured’s products or work completed by or for the Named Insured, or of any property of which such work or products form a part, if such products, work or property are withdrawn from the market or from use because of any known or suspected defect or deficiency therein.”

The insured had manufactured “masterbatch,” which was used by its customers in the manufacture of white opaque film for later use by others in the manufacture of plastic bags for the frozen food industry. One of the ingredients used by the insured was defective and, therefore, the masterbatch was defective in that the film could not be properly sealed.

Ultimately, the insured’s customer sued as a result of the failure of its product.

The court found that the film was rendered useless for the purpose for which it was intended through a fault in the manufacture of the masterbatch, caused by one of the masterbatch ingredients. In assessing the sistership exclusion, the court adopted a description of the intent of the exclusion from a United States text on liability insurance and, ultimately, concluded that the exclusion did not apply as there had been no “withdrawal” from the market since the insured’s customer did not withdraw the film from its own customers.

Further, for the exclusion to apply, there needed to be a withdrawal of other products because a similar fault may possibly occur in the bags.

In other words, there was no “sister” product that was being recalled. Rather, the court found the product was removed from use because the customer’s film had suffered “property damage” caused by the insured’s defective ingredient.

The court arguably erred in failing to properly consider the plain reading of the exclusion as, on its face, the exclusion fit squarely with the facts of the case. By applying a restrictive view of the term “withdrawal” that does not appear to be based on a plain reading of the word or its common understanding, the court limited the application of the exclusion.

In addition, a plain reading of the exclusion disclosed no requirement that there be a “sister” product. Rather, this restriction appears to be based largely on historic interpretation of the clause.

In another seminal case released in 1986, Foodpro National Inc. v. General Accident Assurance Co. of Canada, the insured’s defective food ingredient (a pre-mix agent) was incorporated into a peanut butter product manufactured and packaged by E.D. Smith. The pre-mix effectively ruined the end-product, rendering E.D. Smith’s peanut butter unusable because of the off-taste it had caused.

The product was recalled by E.D. Smith from its customers, resulting in lost profits and the cost of replacing the product. The product was, ultimately, able to be salvaged after “re-conditioning,” although there was a cost associated with that process as well.

The Court of Appeal for Ontario, in concluding that the sistership exclusion did not apply, referred exclusively to the description of the clause as set out in a liability text. There was no reference to the words of the exclusion itself.

The court noted that the exclusion was “designed” to limit coverage where, because of a failure of the insured’s products, similar products were withdrawn to prevent further failure.

On that basis, the court concluded the exclusion did not apply since the withdrawal was due to “property damage” to the customer’s entire product from the insured’s product and there was no withdrawal of “sister” products.

The court suggests that if the clause applied, it would render coverage nugatory for “the most obvious risks” for which such policies are issued. However, it is not clear that the court was provided with any evidence to support its conclusion that this would be the case; nor is it clear how the court finds the “acknowledged purpose” of the clause when the insurer was arguing against such an interpretation.

LACK OF ANALYSIS OF EXCLUSION

Because of the restrictive manner in which the clause has been interpreted, there is relatively little in-depth analysis of the sistership exclusion by the Canadian courts. A brief review of the case law shows fewer than 15 decisions considered the exclusion prior to the Supreme Court of Canada’s decision in Progressive Homes Ltd. v. Lombard General Insurance Co. of Canada, released in 2010.

While Progressive Homes does not address the sistership exclusion, it does revisit the general principles of policy interpretation and reminds courts that “the primary interpretive principle is that when the language of the policy is unambiguous, the court should give effect to clear language, reading the contract as a whole (Scalera, at para. 71).”

Based on the Progressive Homes decision, there should be a new approach taken to the sistership exclusion as well, which means relying only on a plain reading of the words as opposed to general principles behind the exclusion.

Since the Progressive Homes decision, the sistership exclusion has only been reviewed twice.

In California Kitchens & Bath Ltd. v. AXA Canada Inc., released by Ontario’s Superior Court of Justice roughly one month after Progressive Homes, the claim arose out of the negligent installation of kitchen cabinetry by California Kitchens. California Kitchens brought an application, seeking a declaration that its insurer had a duty to defend.

The court found there was “property damage” as the result of an “occurrence.” However, the insurer also argued that several exclusions, including the sistership exclusion, applied to exclude the claim from coverage. The court stated the burden was on the insurer to show that the exclusions apply.

It found that the insurer did not discharge its burden and its entire analysis in relation to the sistership exclusion is as follows:

Exclusion (l) is known as the “sistership” or “recall” clause as it addresses products withdrawn from the market as a result of defects discovered in other “sister” products (Tsubaki of Canada Ltd. v. Standard Tube Canada, [1993] O.J. NO. 1855, para. 13). It does not apply.

The decision in California Kitchens gives little hope that new life will be given to the sistership exclusion, in the form of a full consideration based on a plain reading of the exclusion’s words. However, a more recent case from B.C.’s Supreme Court indicates there may yet be some use for the sistership exclusion.

In the 2014 ruling, Westaqua Commodity Group Ltd. v. Sovereign General insurance Co., the insured supplied to its customer defective corn gluten meal (CGM), which the customer was going to use in its fish food. It was discovered that the CGM was contaminated prior to it ever being put to use by the customer. However, the customer incurred significant cost to dispose of the CGM.

Although the case was ultimately decided on the issue of whether or not there was an “occurrence,” the court also looked at the potential application of the sistership exclusion.

The court set out the words of the exclusion, and then applied those words to the facts of its case. It stated that the issue was the “disposal” of the contaminated CGM. The CGM was a “product” of the insured and it was “withdrawn” from the market by an “organization” (the customer) because of its known “defect.”

Essentially, the court applied a very simple plain reading application, without any tortuous definition of the term “withdrawal,” and concluded that the exclusion applied.

Importantly, the court makes no attempt to find a “sister” product, nor did it limit the exclusion on the basis that there was not one.

The decision is significant in that it represents the first plain reading review of the sistership exclusion and the result is a potential expansion of its use.

In particular, this is the “sistership” exclusion no more, as a plain reading of the exclusion discloses no reason to limit the exclusion in such a manner.

Therefore, it is time to retire the “sistership” nickname and give the exclusion back its true title, the “product loss of use, withdrawal, recall, inspection, repair, replacement, adjustment, removal or disposal exclusion.”

Perhaps, however, the name could use a little work.

Alexander Holburn Beaudin + Lang LLP is a member of The ARC Group of Canada, a network of independent insurance law firms across Canada.