Posted: 30/09/2020
Following the landmark decision of the Supreme Court in The Renos[1] (in which Penningtons Manches Cooper represented the H&M underwriters) and the Commercial Court decision in The Brillante Virtuoso[2], the law surrounding the constructive total loss (CTL) of vessels has undergone close scrutiny.
The cases cited above involved engine room fires and substantial consequential damage to both the internal structure of the respective vessels and their electrical systems, resulting in the need for extensive repairs for the vessels to be restored. Disputes then arose as to whether such repair costs exceeded the monetary CTL threshold limit agreed in the H&M policy and, when assessing this issue, what costs should be included in the CTL calculation in light of the wording of s.60(2) of the Marine Insurance Act 1906.
In The Renos, the underwriters’ appeal was allowed and the question of whether the vessel was a CTL - based on the figures put forward - was remitted back to the court of first instance by the Supreme Court which determined that SCOPIC payments could not count towards the CTL figure and that costs counting towards the casualty should be looked at from the date of the casualty.
In The Brillante Virtuoso, Mr Justice Flaux at first instance held that the vessel was a CTL on the figures put forward. However, in a subsequent landmark ruling handed down in October 2019[3], it was found that the vessel had in fact been scuttled and that there could therefore be no recovery from the H&M underwriters. Mr Justice Teare stated that the owner was the “instigator of the conspiracy”[4] and that the CTL “was caused by the wilful misconduct of the Owner”.[5]
Nevertheless, in the initial decision of Mr Justice Flaux, consideration had been given to many key principles surrounding the law relating to CTL. These included the “prudent uninsured test”, in relation to which it was held that the best option for repairs need not necessarily be the cheapest; the level of contingency that should be factored into the CTL calculation; and guidance was provided on how sue and labour costs should be treated. These are discussed further below.
Following the COVID-19 outbreak, the shipping market has faced a difficult period. With the future remaining uncertain, where casualties occur, CTL payments in the H&M policy agreed amount, as opposed to repairs, may become a preferred option for owners, particularly when market demand is low.
In light of the above, the question arises: what items are the courts now likely to consider to form part of the CTL computation?
General principles
Following the Supreme Court judgment in The Renos, it would seem that the following principles now apply to the assessment of whether a vessel is a CTL:
The Supreme Court further went on to shed some light on what costs can be included in repair costs and stated that - depending on the facts - these could include the following as they are reasonable preliminaries to the vessel being repaired:[6]
In addition, as foreshadowed above, it was held in The Brillante Virtuoso that the most reasonable costs of repairs are not necessarily the cheapest. It was accepted that, in relation to the location for the repairs, that cost is only one of a number of factors a prudent uninsured will take into consideration when deciding where to have the vessel repaired.
Other considerations include:
On this basis, for example, Mr Justice Flaux held that a prudent uninsured owner would have wanted their vessel to be repaired in Dubai as opposed to China, notwithstanding the fact that the costs in Dubai were 17.5% more expensive [8] (which translated to millions of US dollars more).
Cargo costs
It will often be the case that a vessel involved in a casualty is laden with cargo. A question that commonly arises is whether the costs of discharging, storing and reloading the cargo can rank towards the cost of repairs.
In The Renos, Lord Sumption at the Supreme Court stated that the test for assessing whether a cost should rank is whether it is an expense incurred for the objective purpose of the vessel being repaired and this extends to expenses which are an essential preliminary to repairs [9].
Accordingly, it would seem that if, on an objective assessment, cargo is to be unloaded from a vessel in order to effect repairs, these costs can be included in the CTL calculation if the assured is the party liable to pay for these costs. The assured will also have to demonstrate that a prudent uninsured owner would have discharged the cargo in the same way and at the same cost, in order to be covered.
In relation to the costs incurred for storage and reloading the cargo, on the basis of the above principles, it is unlikely that these should be taken into account as these costs are not incurred for the objective purpose of repairing the vessel.
Costs incurred for the storage of the cargo are incurred by the assured in order to comply with any contractual or bailment obligations to care for the cargo. Furthermore, in the event that the vessel is a CTL, there would in any event be no onward carriage as the cargo voyage and underlying contract of carriage are likely to have been frustrated.
Similarly, in respect of the costs of reloading the cargo, any reloading would take place purely to fulfil a contractual obligation to carry the cargo to destination and, as such, this is not a cost incurred in order to repair the vessel. The vessel will already have had to be repaired in order for any reloading operation to commence and so these costs do not fall within Lord Sumption’s test.
General Average (GA)
If there is cargo on board the vessel at the time of the casualty, it is likely that cargo interests would be liable to contribute in GA and this would include a contribution to the cost of repairs.
Section 60(2)(ii) of the Marine Insurance Act 1906 provides that:
“In estimating the cost of repairs, no deduction is to be made in respect of general average contributions to those repairs payable by other interests, but account is to be taken of the expense of future salvage operations and of any future general average contributions to which the ship would be liable if repaired”.
Accordingly, it is an established positon that part of the cost of repairs which also benefits the common maritime adventure is not to be excluded from the CTL calculation merely because it is recoverable from cargo interests by way of a GA contribution.
This accords with the differences between a CTL computation and GA in that a CTL computation is concerned with assessing the cost of repairs including the essential preliminaries to be incurred in order to effect those repairs, whereas GA is concerned with adjusting sacrifices and expenses incurred for the benefit of the common maritime adventure.
It is not the position that all allowable GA expenses should rank towards a CTL but only those associated with the costs of repair. However, GA contributions to be paid on behalf of the ship are to be deducted from the CTL computation.
The above position was confirmed in The Renos by Lord Sumption who stated obiter dicta that in relation to s.60(2)(ii) of the Marine insurance Act 1906: “Its effect is that in computing the owner's cost of repairs: (i) no account is to be taken of general average contributions receivable by him from other interests such as cargo or freight; whereas (ii) account is to be taken of future general average contributions payable by him to other interests”.[10]
Finally, it is important to note that, when comparing the figures for a partial loss and potential CTL to assess whether to serve a notice of abandonment, the partial loss figures should take into account GA contributions from other interests and so the latter must be factored in.
Crew wages
In order for crew wages to rank towards the CTL calculation, the role played by the crew during the period in which their wages are claimed must go over and above what is ordinarily required in the normal course of their day-to-day duties and be an essential preliminary to the repair of the vessel.
On that basis, it could be argued that, following a casualty, crew wages incurred during any salvage or towage operations, any shifting of the vessel to the relevant repair location and for assistance with discharge of the cargo from the damaged vessel could be included in the CTL computation. However, wages accrued during periods where the crew is idle or performing daily maintenance on the vessel while it is waiting to be repaired should be excluded.
Analogies can be drawn with the treatment of crew wages and provisions in respect of partial loss and the general rule on this is set out by Arnould at (27-25) [11]:
“First… there can be no recovery in respect of expenses which an assured is in any event under an obligation to incur. Secondly, that the allowance of ordinary running expenses would give a concealed indemnity for loss of the use of the ship. It is the ship which is the subject matter of the insurance, and it is damages to the ship which the hull and machinery underwriter promises to indemnify the owner...”
SCOPIC
Pursuant to s.60(2)(ii) of the Marine Insurance Act 1906, salvage costs are to be included in the CTL calculation. In 1999, the Special Compensation P&I Club (SCOPIC) clause was introduced into the Lloyd’s Open Form salvage contract to address certain issues faced by P&I clubs arising out of the application of Article 14 of the 1989 Salvage Convention in respect of large-scale casualties which posed a substantial threat to the environment.
Forming an intrinsic part of the salvage operation, the question that then arose was whether SCOPIC costs could be included in salvage costs for the purpose of s.60(2)(ii) of 1906 Act.
In The Renos, the position on SCOPIC costs was finally clarified with the Supreme Court holding that they should be excluded from the CTL calculation. This was on the basis that the objective purpose of SCOPIC expenditure is not to enable the ship to be repaired but to protect owners’ potential liability for environmental pollution. This is covered by P&I insurance and is unconnected with the damage to the hull or its hypothetical reinstatement12].
Sue and Labour
In The Renos, substantial costs were incurred by the assured for the stand-by tug employed to come alongside the vessel following the casualty. The insurers argued that it was not reasonable or necessary to engage a tug of the size and capabilities retained by the assured and so these costs should neither be recoverable as sue and labour expenses nor should they rank towards the CTL calculation.
Mr Justice Knowles at first instance[13] held that such a tug was required initially but, as time went on, a smaller and cheaper tug could have been used. He therefore reduced the costs by nearly half to US$ 1.2 million and held that these costs could be taken into account for the purpose of the CTL calculation notwithstanding the fact that the assured was entitled to an additional indemnity for sue and labour expenses under the policy of insurance.
He further held that the reduced costs were reasonably and properly incurred to avert or minimise loss.[14] This view was upheld by the Court of Appeal [15] and the Supreme Court [16].
In The Brillante Virtuoso, Mr Justice Flaux held that the employment of stand-by tugs should be included as sue and labour expenses under the H&M policy as they were for the benefit of the insurers as well as the assured. Furthermore, he explained that, although the vessel was technically redelivered by salvors on 7 October 2011, the vessel at that time was not in a place of safety which meant that it was still in the grip of the original peril and posed a danger to itself and other vessels. These costs could therefore still be classified as sue and labour.[17]
The insurers went on to further argue that the assured’s right to sue and labour costs ceased when the NOA was tendered. This was rejected by Flaux J, who held that the assured’s right to claim for sue and labour costs ceased when the claim form was issued.[18]
Similarly to the position in The Renos, Flaux J went on to conclude that the vessel was a CTL on the figures and that the claimants were entitled to an indemnity in respect of sue and labour expenses up to the date of issue of the claim form.[19]
Contingency
Due to the uncertainty surrounding estimates for costs of repairs in terms of both the extent of the damage and the time required for repairs to be completed, CTL calculations frequently include a percentage uplift for contingencies.
The size of the contingency allowance will turn on the facts of each case and the level of uncertainty. A 10% contingency was permitted in The Renos and The Brillante Virtuoso. Both of these incidents were complex casualties and so it would arguably require a particularly challenging case for this level of contingency to be exceeded.
In The Renos [20], Knowles J stated that the location of the vessel and the range of estimates and quotations pointed to the fact that there were many matters which could not be determined with precision. In The Brillante Virtuoso [21], the nature and extent of the damage meant it was difficult to assess the costs of repairs with any certainty along with the risks inherent in a long tow to China such as collision, grounding and pollution.
Linked to the allowance for contingencies is the 'large margin' concept which can come into play alongside the prudent uninsured test in cases where it is particularly difficult to assess the extent of the damage.
Flaux J discussed this concept in detail in The Brillante Virtuoso [22] as in this case an explosion and fire resulted in the vessel’s engine room being totally consumed making it impossible to accurately determine the full extent of the damage.
He stated that: “… in relation to matters which cannot be determined with precision, such as the extent of damage to items of machinery and equipment which were not opened up and tested, the court has to apply to any repair estimate what Vaughan Williams LJ describes as a ‘large margin’. That is by no means the same thing as giving the assured the benefit of the doubt in a manner which reverses the burden of proof, which is always on the assured to prove that the vessel was a constructive total loss. It is simply recognising that a margin of error has to be applied in relation to the extent of the damage where, as in the present case, it was not possible to investigate fully and the assessment of the cost of repair has to take account of the fact that the items which were not opened up and tested might well have required replacement, so that a prudent uninsured owner would have replaced them.”
It transpired in The Brillante Virtuoso that the vessel was clearly a CTL without having to factor in a large margin. However, Flaux J confirmed that he would have applied a large margin to the CTL calculation had it been close to the insured value.[23]
Based on Flaux J’s reasoning, it would also seem that the 'large margin' concept, although connected to the level of contingency, may also be treated separately resulting in an overall higher contingency level being allowed. However, the interplay between these two principles is yet to be seen.
Finally, some policies such as the Nordic Plan enable a vessel to be condemned (and be deemed a CTL) when the damage is so extensive that the cost of repairing the vessel would amount to at least 80% of the insurable value [24]. This differs from the position under the Institute Time Hull Clauses which applied in The Renos case where the costs of repairs had to exceed 100% of the insured value of the vessel.
It could be argued that policies including such wording as the Nordic Plan already factor in a level of contingency and so a further percentage should not be allowed in the CTL calculation, although this point would be open to debate.
Prior to The Renos, the legal principles to be applied to the assessment of whether a vessel is a CTL remained unclear and piecemeal, being based on a historical statute enacted in 1906 and a string of legal authorities.
Following the legal analysis by the Supreme Court in The Renos on what costs can rank towards the CTL calculation, this area has received some clarity as many of the applicable legal principles have been drawn together in the judgment. This has been assisted further by the comments of Flaux J in The Brillante Virtuoso, particularly in respect of the appropriate level of contingency and sue and labour costs.
Notwithstanding the foregoing, much will turn on the specific facts of each casualty and, in case of any doubt, it is recommended to seek early legal advice.
Douglas, Lauren and the members of the Greek team can assist with all aspects of marine insurance law and would be happy to assist with any queries and matters arising.
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[1] Sveriges Angfartygs Assurans Forening (The Swedish Club) and others v Connect Shipping Inc and another [2019] UKSC 29
[2] Suez Fortune Investments Ltd and another v Talbot Underwriting Ltd and others [2015] EWHC 42 (Comm)
[3] Suez Fortune Investments Ltd and another v Talbot Underwriting Ltd and others [2019] EWHC 2599 (Comm)
[4] Ibid., at [476
[5] Ibid., at [596]
[6] [2019] UKSC 29, Lord Sumption at [24]
[7] [2015] EWHC 42 (Comm), Flaux J at [94]
[8] Ibid., at [126]
[9] [2019] UKSC 29, Lord Sumption at [25]
[10] Ibid., at [8]
[11] Arnould’s Law of Marine Insurance and Average 19th Edition
[12] [2019] UKSC 29, Lord Sumption at [25]
[13] Sveriges Angfartygs Assurans Forening (The Swedish Club) and others v Connect Shipping Inc and another [2016] EWHC 1589 (Comm), Knowles J at [57]-[60]
[14] Ibid., at [96]
[15] Sveriges Angfartygs Assurans Forening (The Swedish Club) and others v Connect Shipping Inc and another [2018] EWCA Civ 230, Lord Justice Hamblen at [103]
[16] [2019] UKSC 29, Lord Sumption at [19]
[17] [2015] EWHC 42 (Comm), Flaux J at [296]-[297]
[18] Ibid., at [304]
[19] Ibid., at [311]
[20] [2016] EWHC 1589 (Comm), Knowles J at [92]
[21] [2015] EWHC 42 (Comm), Flaux J at [253]
[22] [2015] EWHC 42 (Comm), Flaux J at [92]
[23] Ibid., at [253]
[24] See Clause 11-3 of the 2019 version of the Nordic Maritime Insurance Plan 2013
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