On 12 June 2019, the Supreme Court handed down its judgment holding that:

  • Pre-Notice of Abandonment (NOA) costs do count towards the CTL calculation – dealing with an issue which had not been addressed by English courts for over fifty years; and
  • SCOPIC costs do not constitute “costs of repairing the damage” for the purposes of calculating a CTL.

Pre-NOA costs

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In relation to the pre-NOA costs Lord Sumption, referring to certain eminent text books and the background of the arguments, commented:

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

His overall reasoning on the issue of pre-NOA costs was later summarised as follows:

“In the present case, the “cost of repairing the damage” for the purpose of determining whether the vessel was a constructive total loss included all the reasonable costs of salving and safeguarding the “RENOS” from the time of the casualty onwards, together with the prospective cost of repairing her. The cost of repairing the damage was in no way “adeemed” [i.e. lessened] because part of it had already been incurred at the time when notice of abandonment was given…”

In this respect, more subtle aspects of the case include:

  • although some insurance clauses (e.g. ITCH) provide insurers with certain rights to influence the repair tender process and/or the choice of repair yard, depending on the circumstances, such actions may ultimately have the effect of increasing the time allowable for the service of a valid NOA; and
  • differences in repair quotations (relevant to the calculation of a CTL) may have more to do with the differences as to the scope of repairs required, rather than the costs of the repairs themselves.

SCOPIC costs

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In accordance with section 60(2)(ii) of the MIA 1906, one of the situations where there is a constructive total loss is where the damage to the vessel is such that the cost of repairing it would surpass its value after repair. In relation to the issue of whether SCOPIC costs form part of the “costs of repairing the damage” for calculating a CTL, the reasoning of the Supreme Court can be seen from the following words of Lord Sumption:

The common feature of…cost of steps preliminary to repairs…is that their objective purpose was to enable the ship to be repaired…The objective purpose of SCOPIC charges was different. It was not to enable the ship to be repaired, but to protect an entirely distinct interest of the shipowner, namely his potential liability for environmental pollution…It was no part of the measure of the damage to the ship, and had nothing to do with the possibility of repairing her. The point may be tested by asking what the position would have been if the shipowner, instead of making a single agreement with salvors to salve the ship and prevent or minimise environmental damage, had contracted with one enterprise to salve the ship and another to put floating booms around her with a view to preventing or minimising environmental damage. Mr Berry QC was inclined to accept and that in that case the cost of the booms would not have entered into the comparison required by section 60(2)(ii). I think that his instinct was right. The money paid to the boom contractor would in no sense have been preliminary to the repairs.”

Side letters – a side point

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Although not addressed in the decision, an interesting effect of the decision is that the use of side letters could potentially have the effect of reducing the allowable “costs of repair” and effectively pushing more of the salvage costs into the SCOPIC portion of cost payable (arguably payable by the P&I insurer), thereby possibly avoiding a CTL. This would then make the issue of the enforceability of a particular side letter of critical importance. If there is a possibility of a CTL, owners and underwriters should consider this possibility carefully before entering into side letters.

Facts

The “MV Renos” was on a laden voyage in the Red Sea when a fire broke out in the engine room and caused extensive damage. The ship was insured under a hull policy, her insured value was US$12 million and her increased value was US$3 million.

The incident took place on 23 August 2012 and after the necessary salvage operations were undertaken (under a Lloyd’s Open Form 2011 with the SCOPIC clause invoked), the ship was delivered in the Suez Canal on 31 August 2012. After some initial surveys, she was towed to the port of Adabiya in Egypt, for the purpose of discharging the cargo and, after her return to Suez, a new more powerful tug was engaged for standby services.

Following this, after additional surveys, Owners drafted their repair specification and forwarded it to several shipyards and also to their hull and machinery insurers. The quotations received ranged from around US$2.5 million (based on the insurers’ specification) up to US$8 million (based on Owners’ specification). There was one report from an expert on Owners’ side, two reports from experts on insurers’ side and one report from an independent surveyor, that significantly disagreed on:

  • the scope of the required repairs; and
  • the estimated costs of the repairs.

There was also significant correspondence between Owners and the insurers. Finally, after a meeting between the parties had taken place, on 1 February 2013 Owners tendered an NOA, which was rejected by the insurers on the basis of it being served too late.

The scope of cover under the policy was never in dispute. The assured argued that there had been a constructive total loss while the insurers claimed that there was only a partial loss.

Section 60(2)(ii) of the MIA 1906 defines constructive total loss as:

“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. (emphasis added)

The hull policies were on the Institute Time Clauses (Hulls) 1983 and the Increased Value Clauses 1983, which similarly to section 60(2)(ii), indicate that there can be a claim for a constructive total loss where the costs of recovery and/or repair exceed the insured value.

Constructive Total Loss – General principles

Under the legal fiction of constructive total loss (CTL), provided the relevant test has been met (e.g. Section 60(2)(ii)), then the assured is entitled to claim for a total loss of the subject matter insured, even in case where a total loss has not in fact occurred.

As a condition precedent to the insurer’s liability for a CTL claim the general rule is that a notice of abandonment must be served by the assured[1]. Section 60 of the MIA 1906 provides a total of five categories of constructive total loss:

  • where there is a reasonable abandonment of the ship because either its actual total loss seems inevitable, or
  • the cost of preserving it from its actual total loss would surpass its value after the cost has been incurred – section 60(1) MIA 1906;
  • where a peril insured against deprives the assured of the possession of its vessel and the recovery is unlikely, or
  • the cost of its recovery would exceed its value after recovery – section 60(2)(i) MIA 1906;
  • where the damage to the vessel is such that the cost of repairing it would surpass its value after repair – section 60(2)(ii) MIA 1906.

Both the High Court and the Court of Appeal decisions dealt with the latter two categories in relation to the issue of whether a CTL had occurred.

Salvage and SCOPIC clause – General principles

Under Article 13 of the Salvage Convention 1989, salvors are entitled to an award, subject to the “No Cure – No Pay” rule (i.e. salvors are only paid under Article 13 if they are successful). Some of the criteria, on which the assessment of the award is based, are: the value of the salved property; the skills of the salvors in minimizing the environmental damage; the nature and the extent of the danger; the promptness and length of the salvage service.

According to Article 14 of the Salvage Convention 1989, salvors are also entitled to special compensation for preventing environmental damage, which is payable only for the period in which the threat of environmental damage is present. This award would include the “out of pocket” expenses of the salvors as well as expenses for a “fair rate for equipment and personnel” used in the salvage operation.

The awkwardly drafted Article 14 of the Salvage Convention 1989 has been discussed by the House of Lords (now The Supreme Court) in The Nagasaki Spirit[2], where it was held, much to the dismay of salvors, that the “fair rate” did not include an element of profit. There was also uncertainty and concern around the meaning of “…threatened damage to the environment…”, so that salvors did not feel safe as to when and whether Article 14 would protect them and produce a positive payment if they had expended efforts which protected the environment but, ultimately, left no value in the vessel.

SCOPIC is the outcome of the market’s response to the issues created by Article 14 of the Salvage Convention 1989. Once incorporated in the LOF contract, whether invoked or not, this clause replaces the Article 14 Award and functions effectively as a motivation for the salvors to exercise their best endeavours to save the property in danger, even where there is a low or zero “salved value”, since the SCOPIC amount is payable notwithstanding the “No Cure – No Pay” rule. Furthermore, as Hamblen LJ noted in the Court of Appeal judgment, its purpose is also “to protect P&I Clubs from liability they might otherwise incur in relation to environmental damage caused by a casualty”.

In relation to the function of the SCOPIC, it should be noted:

  • SCOPIC is not a part of every LOF contract. If it is not incorporated, then Article 14 will apply;
  • The SCOPIC remuneration due is assessed by reference to an agreed tariff for day rates;
  • There is a mechanism which provides a discount to the Article 13 Award: if the traditional salvage award is higher than the assessed SCOPIC remuneration then SCOPIC is not payable and the Article 13 Award is reduced by 25% of the difference between it and the SCOPIC remuneration – this is designed to prevent salvors from invoking SCOPIC too easily;
  • The shipowner is granted the right to withdraw from SCOPIC at any time after giving five days’ notice, provided Government and local authorities permit it to do so; and
  • The shipowner must provide $3 million as security within two working days of the clause being invoked.

The RENOS – The various courts’ decisions on allowable CTL costs

  1. The pre-NOA costs issue

(a)  The decisions in the lower courts[3]

 Section 60(2) of the MIA 1906, states:

“ii) In the case of damage to the 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.

In estimating the costs 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;” (emphasis added)

In that regard, the insurers argued that the purpose of the wording in section 60(2)(ii) of the MIA 1906 (namely the inclusion of the term “future” expenses) was to include only future expenses, namely after the service of the NOA. Owners, on the other hand, contented that the word “future” referred to the period following the date of the casualty.

The Court of Appeal, upholding the first instance decision, held that the NOA was not given too late. This was based on the fact that the information available to the assured was of a contradicting nature, so that the six-month period between the date of the casualty and the service of the NOA was considered to be within the “reasonable time” margin and the assured had acted with “reasonable diligence” when assessing the information. Hamblen LJ held that the assured’s behaviour was in line with the relevant section of MIA 1906, namely section 62(3), which reads:

“Notice of abandonment must be given with reasonable diligence after the receipt of reliable information of the loss, but where the information is of doubtful character the assured is entitled to a reasonable time to make inquiry”.

The Court of Appeal also upheld the view expressed by Knowles J, namely that the costs incurred prior to the service of the notice of abandonment could, as a matter of law count towards the calculation of the CTL.

The court based its finding on the interpretation of s. 60(2)(ii), which makes no reference to the service of the NOA.

(b) The Supreme Court decision[4]

Lord Sumption delivered the unanimous decision of the Supreme Court, which upheld the Court of Appeal decision. His Lordship noted the following in his judgment:

(i) The inclusion of the word “would” in section 60 of the MIA 1906 in reference to the expenditure that “would” be incurred, “reflects the hypothetical character of the whole exercise not the chronology of the expenditure”;

(ii) In relation to the word “future” in section 60(2)(ii), Lord Sumption noted that it:

seems to me to be clear that the reference to future liabilities was not intended as an implicit exclusion of past expenditure even for the purpose of general average, let alone more generally for the purpose of determining whether the ship is a constructive total loss…the maxim expression unis, exclusio alterius [i.e. “the expression of one thing is the exclusion of the other”] is often perilous…”; (emphasis added)

(iii) As a general rule, “the loss under a hull and machinery policy occurs at the time of the casualty and not when the measure of indemnity is ascertained” and that CTL is a “legal device for determining the measure of indemnity”; and

(iv) The damage referred to in section 60(2)(ii) is the whole damage arising from the casualty from the moment it occurs.

As referred to above, the reasoning of the Supreme Court can be seen in the paragraph below:

“In the present case, the “cost of repairing the damage” for the purpose of determining whether the vessel was a constructive total loss included all the reasonable costs of salving and safeguarding the “RENOS” from the time of the casualty onwards, together with the prospective cost of repairing her. The cost of repairing the damage was in no way “adeemed” [i.e. lessened] because part of it had already been incurred at the time when notice of abandonment was given and action brought on the policy. These costs are therefore to be taken into account for the purposes of section 60(2)(ii) of the Act. On this point, I would affirm the decision of the courts below.” (emphasis added)

It is now clear that pre-NOA costs count towards the calculation of a CTL and that the concept of the NOA (which is aimed at allowing insurers to realise any value left in the vessel) is entirely separate from the question of whether a CTL has occurred.

2. The SCOPIC costs issue

(a) The decisions in the lower courts

The insurers argued that the SCOPIC element of the salvage costs could not count towards the CTL calculation for the following reasons:

(i) SCOPIC costs were not a “cost of repair” (whether under section 60(2)(ii) of the MIA 1906 and/or clauses 19.2 of the Institute Time Clauses – Hulls (1/10/83) or 9.2 of the Institute Time Clauses – Hulls Disbursement and Increased Value (Total Loss only) Clauses (1/10/83)); and/or

(ii) Owners were contractually precluded, by para 15 of the SCOPIC clause, from counting SCOPIC costs as part of the CTL calculation.

In relation to the first point, Knowles J at first instance held that the SCOPIC aspect of the salvage remuneration was “an indivisible part of an item the balance of which the insurers accept is a ‘cost of repair’”.

Hamblen LJ, delivering the judgment in the Court of Appeal, held that the first instance judge was correct and that “in order to recover the vessel the owners had to pay the entirety of the salvage remuneration to the salvors” and “the cost of recovery was the total amount paid and that the remuneration comprised two distinct elements does not alter that fact”.

As to the second point, paragraph 15 of the SCOPIC clause, reads:

…any liability to pay such SCOPIC remuneration shall be that of the Shipowner alone and no claim direct, indirect, by way of indemnity or recourse or otherwise relating to SCOPIC remuneration in excess of the article 14 Award shall be made in General Average or under the vessel’s Hull and Machinery Policy by the owners of the vessel”. (emphasis added)

Both Knowles J and the Court of Appeal held that the relevant claim was a claim for a total loss, and not in any way a claim for SCOPIC costs. The SCOPIC costs were only relevant as to the method of calculation used of the CTL and nothing more. This did not mean that there was a claim in relation to SCOPIC costs. Therefore, paragraph 15 did not prevent the SCOPIC costs from forming part of the costs of repair.

The first of these findings relating to SCOPIC was overturned in the Supreme Court.

(b) The Supreme Court decision

The Supreme Court reversed the decision of the Court of Appeal on the SCOPIC costs issue, by holding that SCOPIC costs do not constitute “costs of repairing the damage” for the purposes of the CTL calculation.

Lord Sumption stated that:

SCOPIC remuneration is intended to avoid environmental damage which would be a liability of the shipowner, in respect of which he will be insured not under the hull and machinery policy but by the owner’s Protection and Indemnity insurer.

His Lordship based his decision on the purpose that the SCOPIC clause serves. What was important was whether the expenditure “was for the purpose of repairing the ship”. In relation to the SCOPIC costs, the purpose was to provide salvors with an economic incentive to engage with salvage operations (i.e. when otherwise they would be deterred by the “No Cure – No Pay” rule and lack of confidence in the Article 14 award), since they will be compensated for their effort even if their salvage attempts were unsuccessful.

Lord Sumption also noted that only costs incurred for the purpose of repairing the ship would count towards the calculation of a CTL. As he stated, salvage charges, costs of temporary repairs, towage and other steps plainly preliminary to permanent repairs would count as “costs of repairing”. However, as mentioned above, the purpose of the SCOPIC costs is not to repair the vessel.

The reasoning of Lord Sumption can be seen in the following extract of his judgment:

The common feature of…cost of steps preliminary to repairs…is that their objective purpose was to enable the ship to be repaired…The objective purpose of SCOPIC charges was different. It was not to enable the ship to be repaired, but to protect an entirely distinct interest of the shipowner, namely his potential liability for environmental pollution…It was no part of the measure of the damage to the ship, and had nothing to do with the possibility of repairing her. The point may be tested by asking what the position would have been if the shipowner, instead of making a single agreement with salvors to salve the ship and prevent or minimise environmental damage, had contracted with one enterprise to salve the ship and another to put floating booms around her with a view to preventing or minimising environmental damage. Mr Berry QC was inclined to accept and that in that case the cost of the booms would not have entered into the comparison required by section 60(2)(ii). I think that his instinct was right. The money paid to the boom contractor would in no sense have been preliminary to the repairs.”

In conclusion, he stated:

“The result is 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…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…” (emphasis added)

Comments

It is now settled law that:

  • Pre-NOA costs count towards the calculation of a CTL; and
  • SCOPIC costs do not constitute costs of repairs under section 60(2)(ii) of the MIA 1906 and, thus, cannot count towards the CTL calculation.

The insurers’ interaction

In light of the issues that arose in relation to the NOA in The RENOS, the following points should be borne in mind:

  1. From the rationale of the Court of Appeal decision, it is clear that the questions that deal with the timing of the NOA, the “reliable information” of the assured and the exercise of “reasonable diligence” when assessing the information regarding a loss are questions of fact. The answer to this question is case-specific since the law only provides the guiding principles. In that regard, and by way of contrast and warning, in The Galatea[5], a yacht-case which is dealt with under the same legal regime, a 3-month period between the receipt of information and the service of the NOA was held to be too long. The judge found that the assured had reliable information in May and it would need a few days to seek legal advice and instruct its solicitors. However, the assured tendered an NOA in July, which the judge held to be invalid. Hence, it is advisable that the assured obtains solid legal advice on “reasonable time to make inquiry” according to section 62(3) of the Marine Insurance Act 1906;
  1. Engaging in negotiations will not automatically, and regardless of the facts, increase the time margin for a valid NOA to be tendered. There can be cases where the assured will have reliable information at an early stage – e.g. a case where the damage is clearly exceeding the value of the vessel, or the nature of the information, although from different sources, is enough to assess whether a CTL can be claimed;
  1. In relation to the insurers’ interaction, it is noteworthy that according to clauses 10.2 and 10.3 of the ITC-Hulls (1/10/83), on which the hull policy was concluded in the present case, the insurers have the right to decide the port to which the vessel should proceed for docking or repair and can also exercise a right of veto concerning the place of repair or the repairing firm. The insurers can also take tenders or require further tenders to be taken for the repair of the vessel. These powers and rights serve a useful and valuable purpose, but the use of these rights, can, in some circumstances, have the effect of lengthening the time for serving of a valid NOA; and
  1. There is a significant point to be made when assessing quotations for repairs: That is to understand that in some cases (particularly where the insurer also becomes involved in obtaining repair quotations that are shared with the assured), the quotations might refer to a different scope of repairs, so that the difference as to the quantum relates more to the correct scope of repairs than the accuracy and reliability of the quotes received. This distinction between scope and quotations should be borne in mind when assessing information originating from different sources, which may appear to be contradictory. If the scope of the repairs explains the difference in the quotations received then, in relation to the length of time for giving an NOA, the focus should be more on whether the scope included in the tenders is correct.

Side letters

Further to the Supreme Court decision, it would seem that side letters could become more attractive to hull underwriters. A side letter is sometimes agreed between owners and salvors to the effect that the compensation from the hull and machinery policy in relation to the Article 13 award will be capped at a certain limit. This may have a twofold result:

  • The costs that would count towards a CTL would decrease, making it potentially more difficult for owners to successfully claim for a CTL; and
  • The P&I insurer could potentially become liable to pay any “extra” costs as a result of the side letter.

Article 6(i) of the SCOPIC clause reads:

“The salvage services under the Main Agreement shall continue to be assessed in accordance with Article 13, even if the Contractor has invoked the SCOPIC clause. SCOPIC remuneration as assessed under sub-clause 5 above will be payable only by the owners of the vessel and only to the extent that it exceeds the total Article 13 Award (or, if none, any potential Article 13 Award) …” (emphasis added)

Article 6(i) of the SCOPIC clause is not clearly drafted. In relation to side letters, the main question is whether a side letter would effectively agree or settle the Article 13 Award at a lower amount, for the purpose of assessing the payable SCOPIC costs.

If the answer to this question is positive and the side letter does settle the Article 13 Award, this could have the effect that the P&I insurer would be liable to pay a higher amount of remuneration, which would consist of the SCOPIC costs exceeding the agreed or settled Article 13 Award.

If the answer to the question is negative – i.e. if the side letter does not have the effect of settling the Article 13 Award, there could be two possible solutions:

  • The Article 13 Award should still be calculated as if no side letter was ever agreed – this would result in a shortfall, which is likely to fall on the salvors themselves, since the latter would have entered the side letter and agreed to reduce their remuneration; or
  • There would be no Article 13 Award” – because the amount agreed on side letter has replaced any Article 13 Award and there could not be a “potential Article 13 Award” because it has been settled – however, this seems an unrealistic result because this is unlikely to have been the objective intention of the parties.

The answer is dependent on the interpretation of article 6(i) of the SCOPIC clause, which has not yet been addressed by English courts.

None of the three outcomes is ideal. The most likely outcome would appear to be that the salvors would suffer the shortfall, but the position is uncertain.

Given the uncertainty regarding the enforceability of side letters, as explained above, owners and underwriters will need to think carefully before entering into a side letter, in circumstances where a CTL is a possibility. That said, there are plenty of examples of well drafted side letters that avoid the above problems and work well. The devil is in the detail.

[1]However, there are instances where the service of the NOA is not needed.

[2][1997] 1 Lloyd’s Rep 323.

[3]Connect Shipping Inc and Another v Sveriges Anfgartygs Assurans Forening (The Swedish Club) and others (The Renos) [2016] EWHC 1580 (Comm); [2018] EWCA Civ 230.

[4][2019] UKSC 29.

[5][2015] 2 Lloyd’s Rep 289.