Co-insurance is particularly relevant to the construction industry because of the multi-party nature of building projects and the many different insurable interests that co-exist in the same asset(s). As Lord Sumption pointed out in his judgment:
"The business context in which this has most commonly arisen is the co-insurance of employer, contractor and subcontractors under standard forms of building contract."
The judgment means that the courts are more likely to interpret insurance clauses as relieving a party of liability for matters within the scope of the policy, even if insurance is not effected or there is a shortfall in insurance proceeds.
The insurance arrangements
The owners of a vessel entered into a demise charterparty with a related company, Ocean Line Holdings (OLH) under which OLH was obliged to maintain hull insurance for the joint benefit of itself and the owners. There was no specific exclusion of subrogation rights.
The contract also contained an express warranty that OLH would only take the vessel to safe ports (safe port warranty). OLH time chartered the vessel to China National Chartering (Sinochart), who in turn entered into a further time charter with Daiichi. For analogy with the construction industry I’ll call them the sub-charterers. The sub-charterers’ contracts also included the safe port warranty. It was alleged that the breach of the safe port warranty by one of the sub-charterers caused the total loss of the vessel.
What was the issue?
The relevant issue for the construction industry concerns the insurance arrangements between the owner and OLH. In particular, did they preclude the insurer’s subrogation rights and the owner’s right to recover the insured losses against OLH for breach of an express contractual warranty?
The Court of Appeal, in applying Co-op v Taylor Young, found that:
[T]he prima facie position where a contract requires a party to that contract to insure should be that the parties have agreed to look to the insurers for indemnification rather than to each other. That will be all the more so if it is agreed that the insurance is to be in joint names for the parties’ joint interest or if there are other relevant circumstances.
The Court went on to say that one of the main reasons why parties take out insurance is that they need to be covered for the consequences of their own negligence. In other words, even where there is no provision for joint names insurance there will be no rights of subrogation if it is clear that the insurance was intended to be for the joint benefit of the parties.
The Supreme Court decision on this issue is obiter (the judges agreed there was no breach of the safe port warranty), but the court gave its conclusions anyway because, in its view, the issue was of general importance. By a narrow majority it upheld the decision of the Court of Appeal. Its reasoning for doing so however may have ramifications in a construction context.
The Court of Appeal concentrated on whether scheme of insurance, which was for the benefit of both parties, and the implied term that the parties would not subrogate against each other, overrode the safe port warranty. In other words, whether the parties intended there to be an insurance funded result in the event of loss or damage to the vessel by marine risks (and war risks), even if OLH was in breach of the safe port warranty. The Court of Appeal found (on the wording of the charterparty) that this was the parties’ intention. Additionally it confirmed that the absence of an express exclusion of subrogation rights did not mean that subrogation would therefore be allowed.
All five Supreme Court judges agreed that:
[W]here it is agreed that the insurance shall inure to the benefit of both parties to a venture, they cannot claim against each other in respect of an insured loss. Co-insurance is the paradigm case.
The Supreme Court judges also endorsed the juridical explanation from the House of Lords in Co-op v Taylor Young (and the Court of Appeal in this case) that it is an implied term of the contract of insurance and/or the underlying contract that underpins this principle. At first sight this seems to be the beginning and the end of it but unfortunately, it’s not that simple. The judges did not agree how this principle should apply in this case. The majority view was that the implied term effectively ousted the safe port warranty.
Lord Sumption, in the minority, noted that “in all of the English cases before this one the question arose between co-insureds and their insurer”. In his view, a different issue arises as between a co-insured (or its insurer) and a third party wrong-doer. He looked at the relationship between the co-insureds and the consequences this has for claims against third parties. This was the key issue, as far as Lord Sumption was concerned. And it is here that the parallel with a multi-party construction dispute is most obvious.
Claims against third party wrong-doers
It is worth bearing in mind that Gard Marine brought a claim against Sinochart (which it passed on to Daiichi) as assignee of the rights of both the owner and OLH.
As Lord Sumption pointed out there were three possible bases on which OLH, as demise charterer, might be in a position to claim damages from the sub-charterer for the loss of a ship of which it is the bailee but not the owner:
- OLH is itself liable to the owner under the demise charter.
- OLH as bailee has a possessory title which entitles it to recover in its own name, accounting to the owner for any recovery exceeding its actual loss (Waters v Monarch Fire and Life Assurance Co (1856); the Winkfield ).
- Under the principle of “transferred loss” which may permit a contracting party to recover substantial damages for breach of contract where the loss is foreseeably suffered by a third party and the latter has no direct claim against the wrong-doer (to avoid the notorious “black hole”) (Linden Gardens Trust Ltd v Lenesta Sludge Disposals Limited, Alfred McAlpine Construction Ltd v Panatown Ltd). The recovery in this case is held on trust for the third party.
However Gard Marine did not submit any arguments on the second and third bases. The only issue before the court was whether OLH had any liability to the owner and on this point the Supreme Court found that there was no liability.
Interestingly the judges suggested that if Gard Marine had raised a claim against the sub-charterers on one of the other bases, it may have been successful. However, in the absence of argument on these issues, they considered it was not appropriate to reach any conclusion on them.
Liability excluded or satisfied?
For me, the most interesting aspect of the Supreme Court’s judgment is the question whether liability exists between the two co-insured parties or whether the effect of the co-insurance arrangements is to exclude that liability.
The judges disagreed on this issue. Lord Sumption (in the minority) considered that the Court of Appeal had been wrong to hold that, because of the insurance arrangements, OLH had no liability to pass on to the sub-charterers. On his analysis, a liability existed between OLH and the owner but the insurance “makes good” the position. In other words, liability is not excluded, it is satisfied. This has two logical consequences:
- To the extent there is a shortfall in insurance proceeds, or even a delay in payment (and full liability is therefore not satisfied), OLH is responsible to make up that amount.
- The ability to claim against a third party wrong-doer (here the sub-charterers) survives.
Lord Mance (and the majority) disagreed. He found that:
[T]he reason why owners have no claim against [OLH]… is not that such a claim exists but is at some point discharged. It is that, under a co-insurance scheme… it is understood implicitly that there will be no such claim.
Consequently, the majority disagreed on the shortfall of insurance point. It was implausible that co-insureds, having agreed an insurance scheme, would have intended to reopen it by a breach of contract claim based on losses of an alleged different value to that which they had agreed. They must have accepted the value they agreed for insurance purposes as conclusive between themselves.
The principle is that hull insurance (like a construction all risks (CAR) policy) is a property damage policy and covers losses whether or not caused by one party’s fault. Lord Mance concluded that the safe port warranty was not intended to allow a claim for damages for breach of contract separate from and potentially counteracting the no-fault scheme of responsibility and insurance recovery under the contract. Lord Toulson agreed, pointing out that:
[T]he commercial purpose of maintaining joint insurance in such circumstances is not only to provide a fund to make good the loss but to avoid litigation between them, or the bringing of a subrogation claim in the name of one against the other.
In response to the argument that OLH must have some liability to the owner under the contract to allow a back-to-back claim against the sub-charterers for (alleged) breach of the equivalent safe port warranty in their contracts, Lord Mance considered that this issue was “entirely open” because it had not been tested. The only question before the court was as between OLH and the owner as co-insured and it wasn’t for the court to look beyond this in reaching its conclusion.
How does this apply to construction contracts?
On the terms of the demise charterparty in this case, the implied understanding from the co-insurance scheme was that there was no liability for the hull value in the event of total loss, whether or not:
- The total amount of the insured value had been or would be disbursed.
- The total loss was caused by a breach of the safe port warranty.
This raises two issues which are relevant in the construction context:
If there is no liability between co-insured parties, what happens if the loss is under-insured or in the (rare) event of an insurer’s insolvency?
The Supreme Court recognised that this issue raises different considerations of risk. Although it did not need to determine this issue, Lord Mance put forward two possibilities:
- The risk lies where it falls. This may have a different impact on the parties depending on whether there is a total loss of the property in question or repairable damage. In either case one party may find that it has suffered or incurred irrecoverable losses.
- The risk lies on the party responsible for effecting and maintaining the insurance during the relevant period.
What is the position if the contract expressly preserves liability despite the insurance arrangements?
Although the majority view was that the contractual scheme between the owner and OLH did preclude any claim by the owner (or its insurer) against OLH for the insured loss of the vessel, this was a matter of construction. Every case will turn on its own facts. An express contractual indemnity was upheld over the joint insurance arrangements in the Tyco Fire case. However, as the Court of Appeal expressed reservations about that case the position is unclear. Best practice for those drafting construction contracts remains to make express provision if it is intended that a warranty or indemnity should override or be unaffected by the insurance arrangements.
What about third party wrong-doers?
The issue regarding claims against “third party wrongdoers”, which Lord Sumption attempted to address was frustratingly not explored fully by the Supreme Court. I think this leaves confusion as to how insurers will look to recover from third party consultants or sub-contractors not protected by a joint insurance arrangement.
The opposing majority view that there is no liability to pass down the line to third party wrong-doers possibly raises even more questions than this case has settled and may make it more difficult for insurers to recover from negligent consultants or contractors. The basis for making a claim is now unclear.
It should be noted that this decision relates only to insurance for property damage (loss of the hull). It doesn’t cover other losses, such as salvage expenses or loss of hire, which were recoverable. While there are clearly important parallels with the construction industry and the judges helpfully had this in mind, there are of course differences in the way CAR insurance responds, and how different standard form contracts deal with subrogation, liability and consequential loss. This is a blog for another day.
A version of this blog post first appeared on PLC Construction on 31 May 2017.