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Co-insurance clauses as complete codes - the surprising effects of the UK Supreme Court decision in The Ocean Victory

19.10.2017 Energy & infrastructure

Sophia Hendrie

Sophia Hendrie Associate

Why might anyone not involved in the shipping industry want to think about Gard Marine and Energy Limited v China National Chartering Company Limited and others (The Ocean Victory) [2017] UKSC 35? We included a short note on the case in our last Smart Contracting Bulletin in June. As the case involves the total loss of a Capesize bulker and a claim against the vessel’s (third party) time charterer, it might be thought to be of limited application to the energy industry. However, a more detailed consideration of the insurance issues shows that the decision does give rise to matters of more general relevance.

In The Ocean Victory, the party pursuing the recovery was the vessel’s insurer.  There are implications from the decision for insurers generally, although the subrogated rights available to them in the energy sector are often substantially limited as a result of indemnity and exclusion schemes. However, of most interest to those drafting and negotiating contracts in the energy industry are the comments made by the Supreme Court about the proper interpretation of the underlying contract and the interaction of the insuring provisions and those covering the parties’ other obligations.

The head contract in that case was a bareboat charter between related companies. It contained two particularly relevant clauses. 

The first was a rider clause by which the parties agreed that the vessel would be traded “only between good and safe berths, ports or areas”.  Whether or not it in fact was so traded was the main issue in the case. However, for the purposes of the insurance discussion it was assumed that the promise had been broken by the bareboat charterer and the port was unsafe. It is important to note that the promise had been expressly included in a standard form bareboat charter where it would not otherwise have appeared. 

The second was a clause which required the bareboat charterer to take out marine, war and P&I risks insurance in the name of both the owner and the bareboat charterer. An alternative clause provided for the owners to maintain insurance by which the bareboat charterers would be covered. That alternative clause also expressly provided that the owners and insurers would have no right of recovery against the bareboat charterers for insured losses. The alternative clause was struck through by the parties.  The clause which did apply contained no equivalent waiver of subrogation provision. 

So how should the two clauses be read together? Could the owners claim against the bareboat charterers for the loss of the vessel if the latter were in breach, which would then in turn allow the bareboat charterers to claim down the contractual chain against the (third party) time charterers? On the face of the bareboat charterparty, there was no express clause preventing the owners (who were the party which suffered the loss) from bringing that claim. Surely there would need to be – clear words and all that?

In a standard energy contract, of course, the question would likely not have arisen. Any property loss would probably be the subject of an additional knock-for-knock provision, designed to fit with insurance obligations. The contracting parties would not expect to recover those losses for that reason and each party (and their respective insurers) would know what to expect. But these days (often fault-based) carve-outs to knock-for-knock are still being sought by some. So let’s assume that a knock-for-knock does not apply (or that it is limited in some significant respect) and assume the parties have agreed a joint insurance arrangement whereby one party is to include the other as an additional insured. What might that mean for the allocation of liability and does The Ocean Victory have anything new to tell us?

The mechanism that prevents two jointly assured parties suing each other has been the subject of long-running debate. Earlier cases suggested it was because of circuity of action. If a claim for a jointly insured loss was permitted then one party would claim the loss from its insurers, there would be no point in then permitting a subrogated right of action against the other party since they would simply reclaim from the joint insurer. In The Ocean Victory the Supreme Court was unanimous in its view that the question was not one of circuity but of the proper interpretation of the underlying contract. The correct question in each case is “whether the parties are to be taken to have intended to create an insurance fund which would be the sole avenue for making good the relevant loss or damage, or whether the existence of the fund co-exists with an independent right of action for breach of a term of the contract which has caused that loss”.     

How clear does the wording of the requirement to insure need to be to lead to the former interpretation? The answer would appear to be “not very”. Both Lord Clarke and Lord Sumption (in the minority) felt that there was no express exclusion of the right to bring a claim under the safe port warranty, that it was not necessary to imply one and, furthermore, that since the insuring clause referred to marine, war and P&I risks, it would effectively render the safe port clause nugatory if there was one. However, the majority in the Supreme Court did not agree.

The idea that co-assureds cannot claim against each other for an insured loss is not new. But why they cannot, what that means in circumstances where insurers do not pay and how any third parties are affected are interesting points. On those The Ocean Victory does offer insight, albeit obiter.  It suggests that:

>  The proper interpretation of the contract is key but, according to the majority, “under a co-assurance scheme like the present, it is understood implicitly that there will be no such claim.”  That presumption is clearly capable of being displaced but it appears parties need to include specific wording to preserve their rights against each other.

>  It is not that the parties have agreed that their claims will be satisfied by the payment of insurance proceeds (Lord Sumption’s analysis in this case), but that they have agreed not to look to each other at all. 

>  As a result even if the insurance does not pay out for some reason, the claim will still fail. 

>  Similarly, if the claim never exists (as opposed to simply being satisfied), it follows that the party who would otherwise have been the paying party has no liability to pass to third parties. This is the strange result of The Ocean Victory case. The time charterers, who were strangers to the insurance arrangements in the bareboat charter, effectively nevertheless took the benefit of that insurance. This was despite the time charterers having sent the vessel to the port in question and being in breach of their back to back safe port promise to the bareboat charterers. The point was argued on the basis of a total loss (rather than a situation where the vessel was merely damaged), but the Supreme Court’s majority view was that the bareboat charterers could never have been sued for the loss of the vessel.

In drilling contracts, EPC contracts and other common energy industry forms, it is easy to see how the approach taken here could cause some surprising results. Parties who enter into joint insurance arrangements within a group will need to be particularly alive to the issue and should ensure that rights against third parties are not overridden by arrangements higher up the contractual chain.  It is worth risk and contract teams sitting down and looking at whether they have “created insurance funded solutions” and whether there are rights against third parties that they would like expressly to preserve.

Article authors:

Sophia Hendrie