Supreme Court considers the costs to be taken into account in assessing whether a vessel is a CTL

In Sveriges Angfartygs Assurans Forening (The Swedish Club) and Ors v Connect Shipping Inc and Anor [2019] WLUK 126, the Supreme Court considered what expenditure should be taken into account when determining whether a ship is a constructive total loss (CTL) under the Marine Insurance Act 1906.  The Court upheld the decisions of the lower courts in part, confirming that expenditure incurred prior to service of the notice of abandonment was to be taken into account. However, overturning the decision of the courts below, the Supreme Court held that the CTL calculation should not include sums payable to salvors for measures taken while performing the salvage services to prevent or minimise damage to the environment.

Background

The M V Renos (the Vessel) sustained serious damage during an engine room fire on 23 August 2012 while off the coast of the Red Sea. The ship's owners, Connect Shipping, appointed salvors on the same day under the Lloyd's Open Form, a standard form salvage agreement which incorporated a Special Compensation, Protection and Indemnity Clause (SCOPIC). The Vessel was towed by the salvors to Adabiya, where her cargo was discharged, and then to Suez for either scrapping or repair.

Connect Supping had insured the Vessel for $12 million under a hull and machinery policy with The Swedish Club, amongst others. The policy incorporated the Institute Time Clauses (Hull) 1/10/83 (ITC). ITC Clause 19.2 provided that "no claim for constructive total loss based upon the cost of recovery and/or repair of [the Vessel] shall be recoverable hereunder unless such cost would exceed the insured value…". In addition, The Swedish Club on its own issued further insurance covering the same risks under an increased value policy, up to a maximum of $3 million.

Both parties engaged surveyors to provide estimates as to the scope of the damage and cost of repair, in order to determine whether the Vessel was a CTL. The owners also designed a repair specification and obtained quotations from shipyards for carrying out these hypothetical repairs. Connect Shipping concluded that the cost of repairing the damage exceeded the insured value of the vessel and that it was therefore a CTL.  On 1 February 2013 Connect Shipping gave a Notice of Abandonment (NOA) of the Vessel to insurers and claimed limits under the policies.

The Swedish Club contested the claim on a number of grounds.  In particular, it denied that the Vessel was a CTL, and argued the owners were only entitled to be indemnified on a partial loss basis.

The Marine Insurance Act 1906

The rules on assessment of CTLs are set out in Section 60 of the Marine Insurance Act 1906 (the Act).  Section 60(2)(ii) of the Act provides that there will be a CTL "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".

Section 60 further provides that "In estimating the cost of repairs, no deduction is to be made in respect of general average contributions to those repairs payable by other interests, but account is to be taken of the expense of future salvage operations and of any future general average contributions to which the ship would be liable if repaired…"

Where a vessel is a CTL, the insured party can elect either to treat its loss as a partial loss or to abandon the damaged property to insurers, and treat the loss as an actual loss. An insured can therefore recover for a total loss even if the insured property is not wholly destroyed or lost.

Where the insured elects to abandon the property, section 62(1) of the Act requires a NOA to be served on the insurers, save in certain circumstances.

Decision of the lower courts

The judge at first instance, Mr Justice Knowles, held that the Vessel was a CTL.  The Court of Appeal agreed.

Although a number of issues were dealt with by the lower courts, only two were addressed on appeal to the Supreme Court: namely, in calculating whether a vessel is a CTL, should one take into account:

• sums already incurred by the insured before the service of the NOA; and
• remuneration payable to the salvors under the SCOPIC clause for measures taken while performing salvage services in order to prevent or minimise environmental damage?

The Supreme Court Decision

Pre-notice of abandonment costs

Connect Shipping argued that "damage to a ship" under section 60(2)(ii) of the Act referred to all damage resulting from the casualty. The cost of repair and recovery was the entire cost, regardless of when the expenditure was incurred. The Swedish Club, in contrast, submitted that only the costs incurred before service of the NOA were to be included. Whether or not a ship was a CTL had to be assessed at the date of the NOA, on the facts as then existed. Since the parties' rights regarding the treatment of the ship crystallised when the NOA was served, so too did the costs of repair.

On a linguistic evaluation of section 60 of the Act, Lord Sumption found little to assist in answering this question. Section 60 does not refer to the NOA and the words "would" in section 60 and "future" in subsection (2)(ii) did not suggest a point in time beyond which expenditure should be excluded from consideration.

Lord Sumption helpfully summarised the key principles of CTL as follows:

• Under a hull and machinery policy, the general rule is that loss occurs at the time of the casualty. However, if the policy expires before the loss has developed this will not affect the insured's right to recover under the policy in full.
• CTL is a "legal device" to determine the measure of indemnity payable under such a policy. Where the reasonable cost of repairs exceeds the insured value of the ship, the ship is a financial total loss.
• The damage referred to in section 60(2)(ii) of the Act is, as the owners submitted, the entire damage arising from the casualty, from the moment it occurs. The measure of that damage is therefore the entire cost of repair and recovery, regardless of when that cost is incurred.

An insured is entitled to be indemnified for its actual loss, albeit the indemnity will be reduced by any events after the damage which reduce the extent of the loss. This could include positive developments (such as the return of a captured vessel) which render the vessel no longer a CTL before the insured sues on the policy. Lord Sumption found that it necessarily follows that an owner's expenditure on repairs or salvage does not reduce the cost of repair. Instead, that expenditure is part of the measure of loss for which the owner is entitled to be indemnified.

Costs incurred by the owners before the NOA had been served were therefore to be included when calculating the cost of repair under section 60(2)(ii) of the Act.

SCOPIC charges

Contrary to the conclusion reached by the lower courts, Lord Sumption was not prepared to accept that SCOPIC charges were either part of the cost of repair under the Act or the cost of recovery and/or repair under clause 19.2 of ITC.

Although it is well established that the cost of repair includes some costs which are preliminary to repair, these costs are objectively connected to the repair. Salvage charges, temporary repair costs and towage charges often fall into this category: salvage charges because a ship may need to be salvaged before it can be repaired, and temporary repair costs and towage charges because they may be required in order to bring a ship to the point where it is capable of being put right (The "MEDINA PRINCESS" [1965] 1 Lloyd's Rep 361).

SCOPIC charges are, however, a different sort of cost. They are payable by shipowners to remunerate salvors for their efforts in minimising environmental damage when salvaging the vessel. They are connected with the owners' potential environmental liabilities, which are insured separately under the shipowner's protection and indemnity policy.  They are not connected with damage to insured property or its potential reinstatement. Lord Sumption therefore overturned the decision of the courts below on this point, concluding that SCOPIC charges were not part of the cost of repair.

Comment

The Supreme Court's judgment provides a useful summary of the key principles relating to CTLs and the cost of repair under the Marine Insurance Act 1906 and clarity on the types of costs which may be taken into account in calculating a CTL. It is now clear that there is no difference in the application of section 60 of the Act as between costs incurred by shipowners prior to and following the service of a NOA. These costs must, however, have some objective connection to the damage suffered by the ship or to its hypothetical reinstatement if they are to be included in the CTL calculations.

As a consequence of the Supreme Court's decision, the case was remitted to the trial judge, Knowles J, to determine whether on the facts the Vessel was a CTL.