Insurance focus

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Maria Ross - Partner

maria.ross@nortonrose.com Susan Dingwall - Partner

susan.dingwall@nortonrose.com Laura Hodgson - Know how lawyer

laura.hodgson@nortonrose.com Our analysis of key legal developments in the insurance industry over recent months

In this edition of Insurance focus, marine insurance experts, Ian Teare, David McKie and Professor Robert Merkin consider the recent Supreme Court decision in The Cendor MOPU which has confirmed the limitation of the inherent vice defence to losses proximately caused by something internal to the insurance risk.

From our Paris office, Franck Poindessault focuses on the recent campaign to remove gender discriminatory pricing from the insurance sector and Salvatore Iannitti considers the implications of marketing and transparency regulations, which have had a profound effect on both insurers and intermediaries in the Italian market.

We also publish the first in a series of articles which consider the growing market for micro-insurance. In the first article Jonathan Teacher and Isabella Jones discuss the challenges facing the global micro-insurance market and the role of regulation in facilitating its development.

In our case notes section we examine several recent cases of interest to insurers including Re Digital Satellite Warranty Cover class="abbr" title="Limited">Ltd in which the High Court considered whether the provision of extended warranties in relation to satellite television dishes constituted a contract of insurance.

We also include updates on regulation and insurance related developments from across our international practice.

The true scope of inherent vice – 'The Cendor MOPU'

The marine insurance market will welcome the important decision of the Supreme Court in The Cendor MOPU1, which has unanimously confirmed that the inherent vice defence is limited to situations where the loss has been proximately caused by something internal to the insured subject matter and not as a consequence of the operation of some external fortuity. Ian Teare, David McKie and Professor Robert Merkin consider the implications of the decision.

The Court very helpfully clarified the complex and at times difficult relationship between the insured risk of perils of the seas and the excluded peril of inherent vice, when it comes to establishing the proximate cause of a loss. As a result, the market should now see fewer coverage disputes on inherent vice issues; and although some difficulties may still remain those disputes which do arise should now be easier to resolve.

The loss

In May 2005 the assured purchased a self-elevating mat-supported jack-up rig, laid up in Galveston, Texas, for conversion to a mobile offshore production unit to be put into service off Malaysia. The rig had three tubular welded steel cylindrical legs, each 312 feet long. The rig's platform could be jacked up and down by engaging steel pins into holes in each leg.

For a dry towage voyage to Malaysia, the assured obtained insurance on the rig under a policy on the terms of the Institute Cargo Clauses (ICC) A (1982) subject to English law. The ICC A clauses insure against "all risks", subject to various exclusions, one of which (Clause 4.4) is for "loss, damage or expense caused by inherent vice or nature of the subject matter insured". This exclusion mirrors that found in section 55(2)(c) of the Marine Insurance Act 1906.

Despite some recommendations to the contrary, the assured decided to move the rig without cutting the legs, so that the legs remained attached to the jackhouse and extended some 300 feet into the air. The insurers required a warranty survey on the rig, which recommended the rig legs be inspected mid-voyage for expected signs of fatigue cracking. The rig left Texas on 23 August 2005. She was inspected at Saldanha Bay, north of Cape Town, on 10 October 2005. Approved repairs were made to the legs and on 19 October the voyage resumed. On 4 November 2005 the starboard leg fractured and was lost; the following day the remaining two legs broke in quick succession and also fell into the sea.

The fractures were the result of progressive stress fatigue cracking at the corners of the pinholes. Once the first leg had fractured and fallen off, the other legs were subjected to increased stress so that they also failed. The stresses were generated from the effect that the height and direction of the waves had on the pitching and rolling motion of the barge. The weather encountered was within the range reasonably contemplated for the voyage.

The insured claimed for the loss of the three rig legs. The insurers denied the claim on various grounds, including inherent vice.

The history of the claim The High Court found the loss was very probable but not inevitable. The development of stress fractures did not of itself cause the legs to come off; rather, on the basis of the insurers' expert's evidence, what was required was a "leg breaking wave" to cause the fatal fracture. Nevertheless, applying the test used by Moore-Bick J in the Mayban case,2 the proximate cause of the loss was inherent vice, specifically the inability of the legs to withstand the normal incidents of the insured voyage, including the weather reasonably to be expected.

The Court of Appeal in The Cendor MOPU rejected that test and decided that the proximate cause of the loss was perils of the seas in the form of the "leg-breaking wave" which resulted in the starboard leg breaking off leading to greater stresses on the remaining legs. The insurers appealed.

The Supreme Court decision The Supreme Court unanimously dismissed the insurers' appeal, all agreeing that the loss was proximately caused by a peril insured against, namely perils of the seas and not inherent vice (as properly interpreted). Four judges, Lords Saville, Mance, Collins and Clarke (with all of whom Lord Dyson agreed) gave concurring reasoned judgments, each perhaps slightly differing in emphasis.

The Court stressed that by virtue of section 55(1) of the Marine Insurance Act 1906 the key enquiry in any case is to establish the proximate cause of the loss, which is, applying the common sense of a business or seafaring man, that which is proximate in efficiency.3 To determine this it was necessary to establish the proper meaning of the phrase "inherent vice or nature of the subject matter insured". At the same time clarification was given as to what is meant by "perils of the seas".

In addition, the Court provided some comment on concurrent proximate causes and the true nature of the provisions of section 55(2) of the Marine Insurance Act 1906 and ICC A Clause 4.4 which will be of interest to practitioners.

Inherent vice The dispute as to the meaning of inherent vice arose from the decision in Soya v White.4 In the Court of Appeal, Donaldson LJ commented that "a loss is proximately caused by inherent vice if the natural behaviour of the goods is such that they suffer a loss in the circumstances in which they are expected to be carried." In the House of Lords, Lord Diplock referred to "the risk of deterioration of the goods shipped as a result of their natural behaviour in the ordinary course of the contemplated voyage without the intervention of any fortuitous external accident or casualty." On the face of things, these two statements appear to be consistent, and Donaldson LJ's formulation (with some reinterpretation) was that adopted by Moore-Bick J in Mayban, relied on by insurers and adopted by Blair J at first instance in The Cendor MOPU.

The Supreme Court rejected the insurers' interpretation of Donaldson LJ's analysis, not least because "such a definition pays scant regard as to how and in what circumstances the loss occurred", and held that Mayban was wrongly decided. The effect of the decision would be to reduce much of the purpose of cargo insurance, and effectively to imply a warranty that cargo would be seaworthy on shipment which section 40(1) of the Marine Insurance Act 1906 expressly excluded. There was no prior case in which inherent vice had been held to encompass anything other than an internal defect in the subject matter; it had never provided a defence where the loss was caused by an external fortuitous event.

The Court quoted with approval early case law to the effect that "the purpose of insurance is to afford protection against contingencies and dangers which may or may not occur; it cannot properly apply to a case where the loss or injury must inevitably take place in the ordinary course of things".5 A good example is Noten v Harding itself, where gloves containing moisture were damaged when the moisture was given off by the gloves in the form of vapour which then condensed and dripped back onto the gloves. There was nothing external to cause the loss. Lord Mance emphasised in The Cendor MOPU that the loss in Noten v Harding was entirely foreseeable but the reason that there was no recovery was because the gloves had effectively damaged themselves and had not sustained any fortuitous external accident. The Supreme Court approved the decision in Noten, and also cited with approval a Canadian decision6 where laminated truck flooring was damaged by moisture absorbed by the flooring in the course of manufacture, which on the voyage had evaporated and condensed. Once again, there was no external fortuity intervening in the loss.

Consequently, the Court decided that a loss is caused by inherent vice where the sole reason for that loss is the nature of the cargo, in that it would suffer loss irrespective of external fortuitous events.

In discussing section 55(2) of the Marine Insurance Act 1906, Lord Mance, while denying that he was laying down any exact definition, felt able to suggest that "ordinary wear and tear and ordinary leakage and breakage would thus cover loss or damage resulting from the normal vicissitudes of use in the case of a vessel, or of handling and carriage in the case of cargo, while inherent vice would cover...