January 22, 2018
Bluebon Ltd (in liquidation) – v – (1) Ageas (UK) Ltd (2) Aviva Insurance Ltd (3) Towergate Underwriting Group Ltd (2017)
What was the proper construction of an electrical installation inspection warranty?
Bluebon Limited (‘Bluebon’) brought proceedings against their insurers, Ageas and Aviva (‘the Insurers’), and their broker, Towergate, following a fire at their premises at the Star Garter Hotel, West Lothian (‘the Hotel’) on 15 October 2010.
Bluebon had purchased the Hotel in December 2007, and the relevant insurance policy (‘the Policy’) incepted on 3 December 2009, for a period of 12 months.
The Policy contained the following Electrical Installation Inspection Warranty (‘the Warranty’):
“It is warranted that the electrical installation be inspected and tested every five years by a contractor approved by the National Inspection Council for Electrical Installation (NICEIC) and that any defects be remedied forthwith in accordance with the Regulations of the Institute of Electrical Engineers.”
The last electrical inspection at the Hotel had taken place in September 2003.
The insurers asserted that there had been a breach of the Warranty since no inspection had been carried out in the 5-year period immediately prior to inception, with the result that the Policy was either voided or suspended from inception.
At a hearing of preliminary issues, the Judge, Mr Justice Bryan, was required to determine the following:
- The proper construction of the Warranty – was the five-year period to be calculated from the date of the last electrical inspection, or from Policy inception?
- Was the Warranty a True Warranty, a Suspensive Warranty, or a Risk Specific Condition Precedent, and what was the consequence of a breach?
The First Issue
The Insurers argued that the natural meaning of the Warranty was that the 5-year period had to be calculated from the date of the last inspection, and, if no inspection had been carried out in the last 5 years, the inspection would have to be undertaken prior to or immediately upon inception (with there being no cover until such inspection had taken place). In support of that analysis, they said that the Warranty did not require the inspection to occur within 5 years of inception, and that a reasonable person, having all the background knowledge available to the parties, would know that inspections needed to be undertaken regularly.
Bluebon argued, perhaps optimistically, that the proper construction of the words “be inspected and tested every five years” meant “every five years starting with the date of imposition of the stipulation” i.e. from Policy inception. In support, Bluebon said that the language of the Warranty was “forward-looking”, and that if the Insurers had intended otherwise, the Policy could have stated “has been inspected and tested” or “is inspected and tested.”
The Judge found that Bluebon’s construction made no commercial sense in the context of a 12-month policy, and rendered the Warranty meaningless, since there would be no requirement for an electrical inspection until (at least) after the fourth annual renewal. This provided no protection from the risk of fire and, unsurprisingly, Bluebon’s construction was rejected. It followed that Bluebon had not complied with the Warranty.
The Second Issue
The Insurers’ primary case was that the Warranty was a True Warranty i.e. a term which took effect as a condition precedent to the existence of any cover, such that the breach rendered the Policy void from inception. Alternatively, they said the warranty was a Suspensive Warranty, which had the effect of suspending cover during the period of the breach. Neither construction required a causal link between the breach and the fire, and, accordingly, the Insurers asserted that they had no liability to Bluebon.
Bluebon, by contrast, argued that the Warranty was a ‘Risk-Specific Condition Precedent’ i.e. a term which required compliance as a condition precedent to the Insurers’ liability to provide cover in respect of risks relating to the electrical installation. Put another way, Bluebon said that unless the fire was caused by the electrical installation, their breach was irrelevant.
The Judge again rejected Bluebon’s argument, finding that it would be entirely unbusinesslike for the Warranty to suspend cover in respect of losses arising from defects in the electrical installation (pending inspection of the installation), but not for losses arising out of the fire generally. The Judge’s interpretation was that, while the Warranty was breached, there could be no cover for any losses arising out of fire.
Having regard to his findings on the proper meaning of the Warranty, the Judge found that the Warranty was a Suspensive Condition.
Insurance Act 2015 implications
Although the outcome in Bluebon may not be particularly surprising, it is interesting to consider whether it would have been decided differently under the Insurance Act (‘the Act’).
The Act does not change what an insurance warranty is, but does change the effect if breached. Under Section 11 of the Act, an insured will be protected in the event of a breach of warranty. Providing that it can show that the term was ‘totally irrelevant to the loss’ i.e. the breach “could not have increased the risk of the loss which actually occurred in the circumstances in which it occurred.”
There are two interpretations of how Section 11 might have applied in Bluebon (or for that matter generally), both of which have been postulated by the Law Commission.
Under the ‘non-causation’ interpretation, the Insurers would have been entitled to rely upon the breach of the Warranty, because the absence of an electrical inspection might have made a difference, given the type of loss that occurred i.e. a fire. It would not have been open to Bluebon to argue that the fire would have started even if the electrical inspection had taken place.
Under the ‘causation’ interpretation, it would have been open to Bluebon to establish that the fire was due to some other cause, so that the Insurers would be liable under the Policy. That is because, in that scenario, the ‘circumstances’ of the loss were such that compliance with the Warranty would not have made any difference.
Of course, unless and until the true meaning of Section 11 is determined by the Courts (and, given its importance, the point is likely eventually to end up at the Supreme Court), the interpretation will doubtless remain a matter for debate.
Alexander Rosenfield is an associate at Fenchurch Law
Business Interruption Claims – Improving Outcomes for Policyholders
Insurers are set to pay out a record $135 billion to cover losses from natural catastrophes in 2017, driven by the costliest hurricane season ever in the United States and widespread flooding in South Asia. Extreme weather events such as recent mudslides and wildfires, as well as industrial disasters and acts of terrorism, often cause damage affecting many businesses, bringing into focus the issue of policy response for BI claims involving wide area damage.
Standard UK policy wordings provide BI cover for interference to revenues caused by loss or damage to the insured’s property (the “Incident”). The link to physical damage is maintained for purposes of the “Other Circumstances” clause, which provides that adjustments shall be made as appropriate to reflect trends in turnover affecting the business at the relevant time, so the level of indemnity represents so far as reasonably practicable the loss of profits that would have been achieved but for the Incident. This does not encompass interruption consequent upon damage within the surrounding area and is not synonymous with operation of the insured peril itself, which can give rise to anomalous results and severely limit policyholders’ recoveries.
In the aftermath of a catastrophic event causing wide area damage not all businesses will be affected in the same way. Despite a general downturn in the local economy, some businesses will experience increased demand (provided they are able to continue trading), for example builder’s merchants supplying materials for reconstruction or those catering for an influx of claims handlers, while similar operations shut down by the damage sustained may be deprived of the opportunity to enjoy such “windfall profits”. There is some reluctance by certain parts of the insurance market to agree to cover lost windfall profits, but in principle the Other Circumstances clause works both ways and policyholders should be able to invoke an upward trend in appropriate cases, subject to adequacy of the overall sum insured.
UK Legal Position
The issue of whether the Other Circumstances clause can or should be used to adjust the standard turnover to reflect trends resulting from an event causing damage not only to the insured’s property, but also to the wider geographical area, was considered by the English courts in Orient-Express Hotels v Generali . Prior to this some disputes over holiday resorts in the Far East, subject to UK policy wordings, had gone to arbitration and been variously decided both in favour of and against the respective insureds.
The Orient-Express case considered the impact of Hurricane Katrina on a luxury hotel in New Orleans, and the owner’s appeal on points of law following arbitration. In summary, the hotel suffered significant physical damage from wind and water resulting in its closure throughout September and October 2005, and partially reopened in November, albeit with limited amenities and ongoing repairs. A state of emergency had been declared and mandatory evacuation of the city ordered on 28 August, and lifted at the end of September. Insurers rejected the owner’s claim for BI losses during closure of the hotel by applying the trends clause, arguing that New Orleans was effectively closed throughout this period and the adjusted standard turnover should be zero.
The owner argued that: it was entitled to indemnity for losses caused by insured damage even if concurrently caused by damage in the vicinity (The Miss Jay Jay ); a reasonable interpretation should not permit adjustment of the consequences of the same insured peril which caused the insured damage; the trends clause was effectively being treated as an exclusion, which it was not; the precise reasons for cancellations and reduced revenue were likely to be a combination of factors, which could not sensibly be separated from each other evidentially; and insurers’ position had the remarkable result that the more widespread the impact of a natural peril, the less cover is afforded by the BI policy for the consequences of damage to insured property.
The Commercial Court disagreed with these submissions, upholding the tribunal’s conclusion that a “but for” causation test was appropriate in accordance with the policy wording, so that the BI loss was to be assessed on the hypothesis that the hotel was undamaged but the city was devastated, as in fact it was. Permission to appeal was granted, however, and it was subsequently rumoured in academic circles the Court of Appeal might have taken a different view, had the case not settled by then.
BI forms in the US generally refer to “Direct physical loss of or damage to property, including personal property in the open or within 100 feet, at premises described in the Declarations and for which a Business Income Limit of Insurance is shown in the Declarations. The loss or damage must be caused by or result from a Covered Cause of Loss”. The link to physical damage for claims involving wide area loss is not as strong as the standard UK wording.
Many US policies include a loss determination provision specifically excluding windfall profits caused by the impact of the insured peril. Nevertheless it is interesting to note the decision in Berkshire-Cohen LLC v Landmark Aon Insurance (2009), in which the claimant realty agents were successful in recovering windfall profits due to increased demand for rental properties following Hurricane Katrina, despite the exclusion clause. The reasoning was that both storm and flood damage had occurred with only the former being a covered cause of loss, and in the US (as in most of mainland Europe) flood is a contingency addressed by the government rather than by insurance. The US District Court therefore held that, whilst the exclusion applied to storm damage under which the property damage claim was presented, it did not apply to an upward trend based on flood damage.
The UK legal position reflected in Orient-Express has been criticised as unsatisfactory for both insurers and policyholders in applying a downward trend or “windfall loss” under the Other Circumstances clause in response to wide area damage during the period when the insureds themselves were affected by their own property damage. Most policyholders expect their loss to be measured in relation to the impact of the event that caused both damage at their premises and more widely, and consider arguments otherwise to be unjust and artificial.
Furthermore, this is in contrast to the approach adopted by the UK market following previous incidents including the City of London bombing in 1992, and severe Cumbrian flooding in 2009. In Cockermouth all businesses on Main Street were submerged to a depth of six feet or more and reconstruction works continued for around six months. A strict application of Orient-Express would have resulted in limited if any BI cover for individual insureds, who would have suffered a severe downturn irrespective of their own damage. Although the reduction might be offset in some cases by windfall profits and “non-damage” denial of access/loss of attraction extensions, subject to inner policy limits, such an outcome seems paradoxical at best and would have been reputationally damaging for insurers.
As firms become more exposed to major disasters and subsequent business interruptions as a result of increasingly complex global networks, improvements are required to ensure optimal coverage and effective risk management. It seems that insurers always intended to pay for losses that insureds would have suffered based on their own damage and challenges remain for the market to develop suitable wordings fully consistent with this approach, avoiding punitive application of the “but for” test in wide area damage scenarios that does not reflect well on the industry.
Amy Lacey is a Partner at Fenchurch Law