OTTAWA—A Supreme Court of Canada ruling favoring policyholders likely will result in insurers rewriting language commonly used in exclusion clauses of policies covering specialized equipment for engineering and building projects, attorneys say.

Canada's highest court resolved a 14-year dispute between Canadian National Railway Co. and six insurers that included Royal Sun Alliance Insurance Group P.L.C.

In a 4-3 decision last month, the court ordered insurers to pay $30.8 million Canadian ($24 million) for costs associated with the 1994 failure of a tunnel-boring machine during a tunneling project under a river.

Montreal-based Canadian National insured the tunnel-boring project between Sarnia, Ontario, and Port Huron, Mich., under a builders' risk policy that covered "all risk of direct physical loss or damage to all real and personal property of every kind and quality including but not limited to the tunnel-boring machine, plus any consequent economic loss occasioned by delay in the opening of the tunnel," according to the decision.

Failure of the custom-made machine caused a 229-day delay, greatly increasing costs, according to the decision. Insurers denied coverage, though, citing the "faulty or improper design" exclusion in the policy, saying the innovative machine was unfit for the project in the first place and they should not be liable.

Kirk Stevens, who represented the insurers and a partner with Lerners L.L.P. in Toronto, said the case was more of a machine warranty issue, not a coverage issue.

"We said, 'If the machine fails to meet expected and ordinary conditions because the design doesn't work, then the exclusion applies,"' Mr. Stevens said.

Olivier Chouc, assistant vp-legal affairs for Canadian National, said the company never looked at this as a warranty issue, but as an insured loss. As a result, it sued.

A trial judge held the insurers liable, saying the design accommodated all foreseeable risks and was not faulty according to the state-of-the-art standard when the design was finalized. The Ontario Court of Appeal reversed that decision, finding the machine's design was faulty within the exclusion's meaning and did not withstand all foreseeable risks that the standard required.

The Supreme Court, however, determined that the insurers should be liable.

"The CNR was entitled to insure against the possibility that the design might fail even though not faulty or improper according to the state of the art," the ruling said. "The design failed, but, because it exhausted the state of the art, insurers did not meet the onus of bringing the loss within the exclusion."

Mr. Stevens said the ruling greatly affects insurers because they now essentially must prove whether a machine's design is state of the art, not just faulty or improper. He said proving a nearly one-of-a-kind machine is not state of the art, and therefore faulty and excluded, is difficult because there is little to compare it with and few experts on the subject.

Ultimately, he said insurers will have to redesign the policy language to say even if a design is state of the art, the exclusion will apply should the machine prove faulty. Even then, he said, such changes may not always protect insurers.

Mr. Chouc said insurers will have to decide whether to refine exclusion provisions or adapt the premium to the magnitude of the risk the court said insurers must assume.

"We're mindful of the fact this will lead to changes in the insurance world, but at the same time, to be honest with you, when we negotiated this policy way back when, we paid a fairly hefty premium to insure against that risk," Mr. Chouc said. "We paid to protect against that risk and we were of the view the risk had been transferred to insurers and they had to pay for the loss once it materialized."

Canadian National Railway Co. vs. Royal and Sun Alliance Insurance Co. of Canada; Supreme Court of Canada; 2008 SCC 66; Nov. 21, 2008.