Damaged beyond repair? Supreme Court clarifies test for constructive total loss of a ship

UK

The Supreme Court has given welcome clarity on the types (and timing) of costs incurred in relation to a damaged ship which may be considered when assessing whether the vessel was a constructive total loss.

Section 60(2)(ii) of the Marine Insurance Act 1906 (MIA) provides that a damaged ship is a constructive total loss (as opposed to an actual or partial total loss) 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”

The Supreme Court held that, for the purposes of determining the ‘cost of repairing the damage’ for the purposes of the MIA:

  1. Costs already incurred before service of a notice of abandonment were to be taken into account; but 
  2. SCOPIC charges (i.e. additional charges paid to salvors for preventing or minimizing environmental damage) were not to be taken into account.

The matter has now been remitted back to the High Court, to determine the financial consequences of the Supreme Court’s decision on these issues of principle. On these facts, the exclusion of SCOPIC charges may make the difference between the vessel being a partial loss or a constructive total loss.

Background

The key facts of the matter were as follows.

On 23 August 2012, the “RENOS” was severely damaged by a fire in the engine room while on a voyage in the Red Sea.

On the same day, Connect Shipping Inc. as shipowners appointed salvors under Lloyds Open Form 2011. The vessel was towed to a port of refuge, where her cargo was discharged, and then on to Suez, where the salvage services ended.

Notice of abandonment was served on 1 February 2013, while the vessel was at Suez.

The vessel’s hull and machinery (H&M) were insured at an agreed value of US$12,000,000.

The owners made a claim against the H&M insurers for the constructive total loss of the vessel. The insurers admitted liability for a partial loss, but denied that there had been a constructive total loss.

The MIA provides where relevant as follows.

“60. Constructive total loss defined


(2) In particular, there is a constructive total loss …

(ii) In the case of damage to a ship, 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.


62. Notice of abandonment

(1) Subject to the provisions of this section, where the assured elects to abandon the subject-matter insured to the insurer, he must give notice of abandonment. If he fails to do so the loss can only be treated as a partial loss.”

The High Court (with whom the Court of Appeal agreed) found for the owners, deciding that there had been a constructive total loss.

In doing so, the High Court held that, when determining the “cost of repairing the damage” to the vessel under section 60(2)(ii) of the MIA, the owners were entitled to take into account both costs incurred before service of the notice of abandonment and SCOPIC charges aimed at reducing the risk of pollution.

The Supreme Court heard an appeal on both these points.

Decision

Issue 1 : Losses pre-notice of abandonment

The insurers argued that losses incurred prior to service of the notice of abandonment fell outside the calculation under section 60(2)(ii) and could not be counted.

Lord Sumption (delivering the only judgment) decided that the reference to costs which “would” be incurred did not impliedly exclude costs previously incurred. In doing so, he found little assistance from prior authority, noting that:

“In my opinion, the issue is better approached as a matter of principle than by trying to squeeze more juice from these rather dry lemons”.

The Supreme Court described as “the mainstay” of the insurers’ remaining argument the proposition that the assured may not recover on the basis of a constructive total loss unless the loss is still total at the time of notice of abandonment.

That proposition itself was not challenged by the Supreme Court. It was supported by long-standing authorities, many of which dealt with historical scenarios where ships that had been captured by hostile forces (and declared a constructive total loss) were later re-captured by friendly forces. However, the Supreme Court distinguished those scenarios, holding that:

“If the principle in these cases is that although a constructive total loss has occurred, the assured is limited to his actual loss so far as reduced by subsequent events, it must follow that no expenditure of the owner himself by way of salvage or repair can be regarded as reducing the “cost of repairing the damage”. It does not reduce his loss.”

It followed that the reasonable costs of safeguarding and salving the vessel from the time of the casualty onwards counted towards the costs of repair, and that these were: “in no way “adeemed” because part of it had already been incurred when notice of abandonment was given and action brought on the policy.”

Issue 2 : SCOPIC charges

The SCOPIC provisions are supplemental to the Lloyd’s Open Form salvage contract.

As set out in a helpful summary at paragraphs 21 and 22 of the judgment, SCOPIC remuneration is to reward salvors for preventing or minimizing environmental damage which would be a liability of the shipowner, in respect of which he will be insured not under the H&M policy but by the owner’s P&I insurer.

The insurers argued that SCOPIC charges by their nature fell outside the calculation under section 60(2)(ii) and could not be counted, because they were directed to safeguarding the environment and not the ship.

The owners argued that the SCOPIC charges are part of the “cost of repairing the damage” because they were an integral part of the salvors’ remuneration. The owners argued that the test is whether a prudent uninsured owner would have contracted on terms that included the SCOPIC clause. The High Court and Court of Appeal accepted that a prudent uninsured owner would have done so.

The Supreme Court sided with the insurers, noting that case authority showed that preliminary steps had been included only where their objective purpose was to enable the ship to be repaired. In that regard, the Court found (at paragraph 27 of the judgment) that:

“…it is necessary to identify the purpose of the expenditure which it is proposed to take into account, and to apply the prudent uninsured owner test only to expenditure for the purpose of repairing the ship ... The fact that a prudent uninsured owner might have contracted with the same contractors for both the protection of the property and the prevention of environmental pollution does not show that both are part of the cost of repairing the damage. Neither does the fact that the charges under both heads are secured on the ship. The two heads of expenditure have quite different purposes, only one of which is related to the reinstatement of the vessel. If they were truly indivisible, this might not matter. But the whole scheme of the SCOPIC clause depends on their being separately identifiable, and the very fact that one is for the hull underwriter’s account and the other for the P&I insurers shows that they cannot be indivisible. In my opinion, SCOPIC charges are not part of the “cost of repairing the damage” for the purpose of section 60(2)(ii) of the Act or the “cost of recovery and/or repair” for the purpose of clause 19.2 of the Institute Clauses, because their purpose is unconnected with the damage to the hull or its hypothetical reinstatement.”

Comment

This Supreme Court decision helpfully clarifies the position on costs to be counted under section 60 MIA when working out if there has been a constructive or partial loss of a ship. The financial consequences of this distinction can be significant.

It is also a matter of some importance: the Lloyd’s Open Form remains a world-standard for salvage contracts, and the SCOPIC clause is included by most parties as a matter of course.

The first issue before the Supreme Court, regarding costs incurred prior to the notice of abandonment appears to be uncontroversial. It was decided by all three Courts in the same way, and disfavours the highly technical argument of the insurers which it may be said favoured ‘form over substance’ in giving the timing of the notice of abandonment a weight it did not deserve.

The second issue was more controversial, concerning as it did the SCOPIC charges.

This decision overturned the lower Courts, and was contrary to the widely held view that SCOPIC charges were a (albeit ancillary) part of the salvage costs which counted towards the ‘repair of the damage’ and hence could be taken into account for the purposes of section 60(2)(ii) MIA. The distinction between the costs of recovery or repair of the hull and the cost of steps taken to reduce the shipowners’ separate risks as regards the environment is however logical and easy to apply in practice.

Further reading: Sveriges Angfartygs Assurans Forening (The Swedish Club) v Connect Shipping Inc [2019] UKSC 29.