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Supreme Court excludes SCOPIC charges from costs of repair when calculating constructive total loss

18.07.2019 Maritime

Carrie Radford

Carrie Radford Partner

Sveriges Angfartygs Assurans Forening (The Swedish Club) and others v. Connect Shipping Inc and another (MV Renos) [2019] UKSC 29

Insurers have succeeded before the Supreme Court in overturning the lower courts’ decision to include the salvors’ SCOPIC remuneration as part of the “cost of repair” for the purpose of the constructive total loss calculation. The Supreme Court held that SCOPIC charges are not aimed at repairing the vessel and are separable from the rest of an LOF salvage award.

The Supreme Court also rejected the other issue on appeal, ruling that costs incurred before the service of a Notice of Abandonment (including traditional salvage charges) can be included in the CTL calculation.

Introduction 

The Marine Insurance Act 1906 (“MIA 1906”) provides that in the case of damage to a ship, there is a constructive total loss (“CTL”) where “she is so damaged by a peril insured against that the cost of repairing the damage would exceed the value of the ship when repaired”: (s. 60(2)(ii)). 

The Supreme Court has now clarified two questions of how the cost of repairs should be calculated for the purpose of determining whether a vessel is a CTL. Those two questions related to the treatment of: a) costs incurred prior to the service of a Notice of Abandonment (“NOA”); and b) SCOPIC remuneration under the Lloyd’s Open Form 2011 (“LOF 2011”). 

The background facts 

The MV Renos was insured by her Owners for US$12 million under a hull and machinery policy that incorporated the Institute Time Clauses – Hulls (1/10/83) and for a further US$3 million under an Increased Value policy on the Institute Time Clauses – Hulls Disbursement and Increased Value (Total Loss Only) Clauses (1/10/83). Both sets of clauses had the effect of modifying the provisions of MIA 1906 so that the reference figure for a CTL was the insured value of the vessel, not the vessel’s sound market value. 

On 23 August 2012, while the vessel was on a laden voyage in the Red Sea, a serious fire broke out in the vessel’s engine room. Salvors were appointed under a LOF 2011 and they invoked the Special Compensation Protection and Indemnity Clause (“SCOPIC”). Having dealt with the fire, salvors towed the vessel back to the Egyptian loadport to discharge the cargo, and then on to Suez to be surveyed. 

Coverage under the H&M policy was not disputed, but quantum was. In December 2012 and January 2013, Owners and Insurers obtained quotations for repairs from a number of shipyards, ranging from under US$3 million to around US$9 million. It was common ground that in order to constitute a CTL, the shipyard repair costs had to exceed US$8 million. 

The Owners contended that the vessel was a CTL because the cost of repairs would exceed her insured value. However, the Insurers viewed the claim as a particular average claim (that is, a partial loss), to be quantified as an unrepaired damage claim, which they said came to approximately US$1.4m. As can be seen, the financial implications of the dispute were thus very significant. 

On 1 February 2013, the Owners served a NOA on the Insurers. The High Court and the Court of Appeal dismissed the Insurers’ argument that this was given too late and this issue was not pursued before the Supreme Court. 

The Supreme Court decision 

Issue 1: Costs incurred before the NOA 

In assessing whether the CTL threshold is met, the costs of repairing a damaged vessel include the costs of recovering the vessel so that she may be repaired. These will include, for example, the costs of salvage. 

Section 60(2) MIA 1906 provides that: 

“In estimating the cost of repairs… account is to be taken of the expense of future salvage operations …” 

It was submitted by the Insurers that the inclusion of the expense of future salvage operations implied the exclusion of the costs of past salvage operations. In this construction, the Insurers also relied on two old cases in which costs incurred before NOA were not counted towards the CTL calculation. 

Further, the Insurers argued that, as a matter of principle, whether there had been a CTL fell to be decided at the point in time when NOA was given, as the parties’ rights crystallised at that point, and because it was at that point that the Owners made their choice between incurring further costs of repairing the vessel or abandoning it to the Insurers. In making that decision, costs incurred to date were “sunk costs” and, therefore, not relevant to the choice faced. 

Lord Sumption, giving the judgment in the Supreme Court, was mindful that the effect of this would be to exclude salvage remuneration from the cost of repairs for CTL purposes in many cases, as in practice it is often necessary to professionally assess damage, having first salved the vessel and brought her to a place of safety. 

The Supreme Court found little assistance in the wording of the MIA 1906, agreeing with the Court of Appeal that the MIA 1906 did not indicate the point in time from which the costs must be “future” and did not make any reference to tendering NOA in this regard. The Court also found that the two authorities to which the Insurers referred were not particularly helpful. Rather, the question should be resolved according to the following two fundamental principles of insurance law: 

  1. A claim on an insurance policy is a claim for unliquidated damages, where the obligation of the insurer is to hold the assured harmless against an insured loss. Therefore where, as in an H&M policy, the insurance is against physical damage to property, the insurer is in breach of its obligation to hold harmless as soon as physical damage occurs. The assured’s cause of action against the insurer is thus complete at the time of the casualty, not only once the loss caused by the casualty has fully developed and the measure of indemnity can be ascertained. 
  2. A CTL is not a special type of loss, but simply a partial loss which is financially equivalent to a total loss. Whether or not the cost of repairs exceeds the insured value of the ship is a fact that has to be determined objectively, and is not determined by the subjective opinion or prediction of the owner at the time that the CTL election is made. Therefore, for the purpose of determining whether the vessel is a CTL, the damage to the vessel is the entire damage ultimately arising from the casualty, from the moment of the casualty. The measure of indemnity is the ordinary measure, being the depreciation of the vessel caused by the damage, represented by the entire cost of recovering and repairing it. As Lord Sumption reasoned: “It cannot make any difference when the cost was incurred.” 

Finally, the Supreme Court held that the fact that an assured may not recover for a CTL where the loss suffered had been ‘adeemed’ or reversed at the time that NOA is given (such as where a captured vessel is later released) did not affect the question of whether an assured’s post-casualty expenses should count towards the “cost of repairs”. That orthodoxy is based on the indemnity principle, which precludes an assured from making a recovery where it has not ultimately suffered a loss. However, the indemnity principle is not contravened by an assured recovering their actual loss in the form of expenditure from the time of a casualty. 

Affirming the decision of the Court of Appeal, the Supreme Court held that costs incurred before the NOA should be included in the cost of repairs for the purpose of determining whether a vessel is a CTL. 

 Issue 2: SCOPIC remuneration 

The SCOPIC clause, which supplements the LOF, gives salvors the right to additional remuneration in respect of steps taken by them to minimise environmental damage following a casualty. This can have the effect of entitling salvors to payment for their services where they would not otherwise be so entitled, owing to the ‘no cure, no pay’ rule, and it was introduced with a view to creating an incentive for salvors actively to protect the marine environment following a casualty. 

The SCOPIC clause clearly states that SCOPIC charges are payable solely by the shipowner and will not be shared with other parties with an interest in the marine adventure. In practice, SCOPIC remuneration is paid by the vessel’s P&I insurers, as it reduces owners’ exposure to liability in relation to environmental damage. 

In the Supreme Court, the Insurers relied on a single, simple argument on this issue: that whether a cost could be considered a cost of repair counting towards a CTL should depend on the nature of that expenditure. Only expenditure in the nature of repair (including the cost of recovering the vessel in order to carry out repairs) should be included. Even if the costs of salvage generally are properly considered costs of repair, SCOPIC charges specifically cannot be treated in the same way. 

In response, the Owners maintained their principal argument from the courts below, on which they had succeeded, namely that SCOPIC costs formed an integral part of the salvage costs. The ship first had to be salved to be repaired, and the SCOPIC charges had to be paid in order for the ship to be salved. Therefore, the SCOPIC charges were properly part of the cost of repair. 

The Owners were forced to concede that they could have contracted with salvors on terms that excluded the SCOPIC clause. However, relying on the test of the ‘prudent uninsured owner’, they argued that while in theory SCOPIC charges were separate from the costs of recovery of the vessel, in practice a prudent uninsured owner would contract with salvors on terms that would minimise their liability for environmental damage. 

The Supreme Court found in favour of the Insurers, holding that it was necessary to identify the objective purpose of an item of expenditure to determine whether it was incurred to permit the ship to be repaired. Accordingly, expenses such as temporary repairs, salvage, and towage were to be considered necessary preliminaries to repair, the costs of which were “relevant to the question of whether the vessel was financially worth saving”. SCOPIC costs, on the other hand, protected an entirely different interest of the shipowner; its potential liability for environmental pollution. The objective purpose of that expenditure was therefore not repair, and indeed had nothing to do with the subject matter insured. 

The Supreme Court noted the ‘prudent uninsured owner’ test, but limited its application. The purpose of that test is as an aide to determining whether there is a CTL when the relevant facts are hypothetical or unknown. It consists of asking the question whether the prudent uninsured owner would have repaired the vessel, and how. In answering that question, the settled case law predating the MIA 1906 is clear: the prudent uninsured owner is assumed only to be interested in the cost of repair. Other factors, such as the value of the wreck, are excluded. Therefore, liability for environmental pollution was also not a factor that could be taken into account in the prudent uninsured owner test. 

Having allowed the appeal on this point, the Supreme Court remitted the claim to the Commercial Court judge to decide whether, with the SCOPIC charges excluded from the calculation, the vessel was in fact a CTL. 

Comment 

It remains to be seen whether the Supreme Court’s decision to exclude SCOPIC charges from the “cost of repair” will mean the difference between an unrepaired damage claim for US$1.4 million or a CTL claim for the full insured value of the vessel. The numbers are close either way in this case but, in other cases, this judgment could be of more obvious significance. 

In the Supreme Court, the Insurers dropped their argument that by including SCOPIC charges as a cost of repair, the Owners were making an indirect claim for SCOPIC charges against their H&M insurers, contrary to Paragraph 15 of the SCOPIC clause which prohibits this directly or indirectly. Nevertheless, a concern to preserve the proper division of liability between P&I and H&M insurers provides an obvious backdrop to Lord Sumption’s typically principled judgment. 

The decision will be welcomed both by hull insurers and those commentators who were troubled by the impact that the lower courts’ decision might have had on the future support for the LOF and salvors’ obligations under it (even in the absence of the SCOPIC provision) to endeavour to preserve the environment.

This article was co-authored by Keith Rowbory, second year trainee solicitor at Ince

Article authors:

Carrie Radford