FOREMAST

The newsletter of the Elborne Mitchell Marine, Aviation and Energy Group ED I T I O N 2 0 1 0 23 Latent defect a hidden problem
Claims presented to insurers arising from latent defects within insured property are rarely straightforward. When hidden defects within the structure of insured property reveal themselves, the effect often renders the property unfit for the intended purpose. This article will discuss one of the most difficult coverage issues arising in such circumstances. The problem is that even if the insured property has been damaged by the development of a hidden defect, if the defect existed at the time of the commencement of cover, and the only change is that the defect has revealed itself, can it be said that the physical state of the insured property has altered? Even though the insured property might appear to have been physically altered, particularly in circumstances where the resulting damage is obviously serious, such as where cracks in a hull might lead to water ingress and severe damage to cargo or the vessel, insurers will want to be satisfied that they are not effectively indemnifying the insured for a manufacturers faulty design, or a surveyors negligence etc. The standard marine and energy insurance market wordings, such as the Institute Time Clauses Hulls (1/10/95) (ITCH) and WELCAR (2001) for example, require loss or damage to have been suffered by the insured property. This emphasises that for a claim to succeed for loss or damage resulting from the manifestation of a latent defect (where latent defect is covered), loss or damage will need to have occurred. In a situation where cracks lead to a leaking hull, it might seem obvious to an insured that the vessel has been damaged, but what if previously undetected cracks suddenly appear, but have not yet caused loss or damage? The insurance law principles on this issue can be traced back to early English court cases, such as the 1911 marine insurance case, Hutchins Brothers v Royal Exchange Assurance Corporation. In that case the relevant policy wording provided cover for damage caused by latent defects, but the Court held that the development of a latent defect is not the same as damagethrough a latent defect. The Court went on to say that in a situation where a latent defect has simply developed, the damage is not damage caused by a latent defect, but is the latent defect itself and nothing more. The Court of Appeal had the opportunity to review the earlier case law on this point (amongst other issues) in a case called Nukila (1997). The Nukila was a mobile off-shore work platform, which had been in service for four years, without experiencing any operational problems. During the policy period, minute fatigue cracks, which had been unidentifiable on inception, were discovered on the legs and spud cans and extensive fractures developed. The policy incorporated the ITCH, which provided cover for damage caused by latent defects. One issue for the court to consider was whether and when, the defects developed from uninsured latent defects into insured damage caused by those defects. Hobhouse LJ discussed the problem of distinguishing between a fatigue crack as a latent defect and a system of cracking of such magnitude and severity that it significantly weakens the integrity or shear strength of the structure of the vessel. The court upheld the established legal principles, and said that for the claim to succeed it was necessary to show a physical change in the state of the vessel, which was in part a question of degree. In that case, the court held that the physical impact was not simply a latent defect becoming patent. It was well beyond that. Metal had fractured. That was damage to the hull. In conclusion, the question of whether a latent defect has caused damage will be fact dependant. The English courts have provided little guidance for insureds and claims handlers when dealing with this problem. The dilemma for the insured is to determine the position where a latent defect manifests itself and requires attention, but has not yet caused damage to the insured property. We will consider this question in our next edition. Laura Britten, Solicitor britten@elbornes.com

Inside:
Latent defect a hidden problem Piracy one question answered, another one raised Certificate Final? 1 2&3

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Piracy one question answered, another one raised

Over the past five years nearly 200 vessels have been seized by Somali pirates. Forty vessels have been taken this year, with the average period of detention exceeding three months. Whilst the attention of ship operators, their insurers and lawyers has tended to focus upon the issue of ransom payments made to secure the release of the ship, crew and cargo, there are other, no less serious, financial consequences of detention which have received rather less publicity. This article considers two of these. Many of the vessels transiting the Gulf, or trading via the Cape will be under charter. Conflict between owners and charterers has arisen on several occasions over the question of whether or not a vessel detained by pirates should remain on hire throughout the detention, or should go off hire. Unsurprisingly charterers are reluctant to pay for hire whilst the vessel is detained and unable to provide the intended service. Equally owners, having let the vessel to charterers in the expectation that they would receive periodic income, will not readily surrender that income in circumstances where they will not see themselves as being at fault. The likelihood of dispute has been increased in consequence of the fact that, perhaps unsurprisingly, most forms of charter which have been in use in present years do not expressly consider piracy amongst the recognised off hire events. There has been much speculation as to how the various forms of charters, and specifically the off hire clauses, might be made to cater for this situation, and there has been substantial debate as to how existing wordings might be interpreted so as to determine where the hire burden lies when a vessel is detained as a result of an attack by pirates. There has, however, until now been very little agreement. We now have some guidance from the Courts in terms of the better known standard charter wordings. In the SALDANHA decision in June 2010, the High Court gave its verdict in relation at least to some of the arguments that have been debated over the last two years or so. The Court was asked to consider the NYPE charter terms and, in particular, clause 15 of that charter wording. Clause 15 is an off hire clause. It says: That in the event of the loss of time from default and/or deficiency of men including strike of officers and/or crew or deficiency of stores, fire, breakdown or damages to hull, machinery or equipment, grounding, detention by average accidents to ship or cargo, drydocking for the purpose of examination or painting bottom, or by any other cause preventing the full working of the vessel, the payment of hire shall cease from a time thereby lost (emphasis added) There is nothing in clause 15 that refers to piracy specifically. The charterers, however, said that they ought to be allowed to rely on one or more of three provisions in that clause, namely: meaning of the term average accidents had been said, in the earlier case of THE MAREVA [1977] to be an accident which causes damage. The SALDANHA had not suffered any physical damage during the pirates attack or the subsequent detention. The Court also accepted owners argument that the deliberate and violent attack by the pirates could not properly be described as an accident. Accident required an absence of intent.

The charterers said, alternatively, that any

failure by crew or officers to take recognised anti-piracy precautions during the attack (which in any case owners denied) would constitute a default of men and would render the vessel off-hire. The Court decided, however, that in terms of clause 15 the words default of men had a very limited meaning and were confined to a situation where there was a refusal of officers or crew to perform their duties as owed to the shipowners: it did not extent to the inadequate or negligent performance of those duties.

detention by average accidents to ship or cargo

default and/or deficiency of men or by any other cause

The parties agreed that the full working of the vessel had been prevented by the actions of the pirates and that a loss of time had occurred. The question for the Court was solely whether charterers could bring themselves within one or other of the three selected causes contained in clause 15. It was accepted that only then would the vessel go off-hire. As the Court subsequently put it hire is payable continuously unless charterers can bring themselves within any exceptions, the onus being on charterers to do so. Doubt as to the meaning of exceptions is to be resolved in favour of owners. The Court therefore considered each of the exceptions which the charterers sought to rely on:

Lastly, the charterers argued that the attack

by the pirates should fall into the any other cause provision of clause 15. The Court did not accept this. The LACONIAN CONFIDENCE [1997] was considered. In that case the Judge had said that any other cause was restricted, as were the exceptions that preceded that term in clause 15, to circumstances involving the physical condition of the vessel. The Court in the SALDANHA case concluded that the attack by pirates was a wholly extraneous cause of loss of time, unconnected with the physical condition of the vessel and which was not therefore intended to be covered by clause 15, which excepted the charterers from paying for time lost due to causes arising out of the condition or efficiency of the vessel or crew, and could not therefore be covered by the any other cause provision. The Court did comment, picking up on an observation made in the LACONIAN CONFIDENCE case, that amendment of the any other cause provision by the addition of the word whatsoever might

Detention by average accidents to ship or

cargo The Court acknowledged that the

well have the effect of widening clause 15 sufficiently that a Court might be persuaded that it should include extraneous causes of loss such as piracy. However that did not assist the charterers in this instance. The SALDANHA decision undoubtedly clears up several of the questions that have been raised as to which wordings in a charter might have the effect of rendering the vessel off-hire when seized by pirates. The three elements of challenge did not have that result. It is, perhaps, slightly regrettable that the particular dispute required the Court to look only at three specific, and quite narrow, arguments involving clause 15. One other aspect of the dispute, in particular, was not brought before the Court. This, then, is the second financial consequence which this article considers. The charterers had claimed that the officers and crew had not been trained, and the vessel had not been prepared, to deal with an attack by pirates. The charterers said, therefore, that the vessel was unseaworthy and that owners were therefore in breach of charter. That allegation, if it were successful, would entitle charterers to damages, and those damages could include, in effect, the cancelling out of any obligation to pay hire. That particular allegation, denied by the owners, still remains to be tested. It is not the first occasion on which an allegation of unseaworthiness has been raised in connection with a seizure by pirates. After the seizure, and eventual release, of the Malaspina Castle in 2009, it was reported that the cargo owners resisted payment of General Avenue Contributions on grounds that the vessel and her crew were insufficiently equipped to respond to an attack by pirates and that, accordingly, the vessel was unseaworthy. The approach that an unhappy charterer or cargo owner might take is that be it under the charterparty or under the bill of lading, the shipowner is required to exercise due diligence to make the vessel seaworthy at and before the

beginning of the voyage. For a vessel to be seaworthy she must be fit in all respects to carry her cargo safely to its destination having regard to the ordinary perils to which such a cargo would be exposed on such a voyage "(the KRITI REX [1996]). Ten years ago, the prospect of an attack by pirates on a large cargo vessel in the Gulf of Aden or off the coast of East Africa would not have been considered an ordinary peril. Now, in the light of the frequency of those attacks, it almost certainly is. The real debate in such instances will almost certainly centre on the question of whether or not the particular vessel was fit for the voyage, taking into account the risks involved in that voyage. There is some judicial guidance available which might well indicate the approach which the Courts will likely be invited to take. In the 1926 case of F. C. Bradley & Sons Limited v Federal Steam Navigation Co. the Court, approving the test which would later be echoed in the KRITI REX, said that the approach to the test should be to ask oneself the question would a prudent owner have required that the defect be made good before sending the ship to sea. The same point, specifically in relation to crew training and knowledge, was made in the case of Hong Kong Fir Shipping Co Ltd v Kawasaki Kisen Kaisha Ltd [1961]. The Court said that the question was would a reasonably prudent owner, knowing the relevant facts, have allowed this vessel to put to sea with this master and crew with their state of knowledge, training and instruction. In 2002, in the case of the EURASIAN DREAM the Court had to consider an outbreak of fire on a vessel which, in the event, the crew were unable to put out and which resulted in the constructive total loss of the vessel and of the cargo. The Court, applying the tests set out in the earlier cases found that the loss arose as a consequence of the unseaworthiness of the vessel in that fire fighting equipment on board the vessel was inadequate or inoperative and in that the master and the crew lacked adequate

fire fighting training. A reasonably prudent owner would not have sent the vessel on that voyage in that condition. It is not difficult to see how a similar approach might be developed in considering the case of a vessel captured by pirates. Best Management Practices widely promulgated by the IMO amongst the ship owning community, identify measures that should be taken to avoid, deter or prevent seizure of a vessel by pirates. Training courses for masters, officers and crew are widely available and an imaginative array of anti-boarding devices is marketed to shipowners. Many owners have adopted such measures. Will they be taken to be the reasonably prudent owners by whom others will be judged? What will be the position of those owners who have not taken preventative measures? If ships continue to fall victim to pirates for the foreseeable future, unseaworthiness concerns are increasingly likely to be raised by charterers in disputes over hire, and, equally, many attract the attention of cargo insurers who have paid out for cargo loss claims following a vessels detention by pirates. Prospectively there may also be hull and machinery cover concerns. It must be only a matter of time before this question is brought before the Courts. Peter Tribe, Partner tribe@elbornes.com

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4 Certificate Final?
Last years Commercial Court decision1 in The Mercini Lady undermined the effectiveness of certificate final clauses in commodity contracts, and was widely regarded as anything but commercial. The recent judgment of the Court of Appeal2 has substantially restored their effectiveness, but there still remains a potential pitfall. The case concerned a sale of gasoil FOB Antwerp. The specifications clause in the contract, headed Quality, included a provision for total sediment. The contract also provided: Clause 12: Quality and quantity, basis shoretank, to be determined by a mutually agreed independent inspector at the loading installation.Such determination shall be final and binding for both parties, except in case of fraud or manifest error. Clause 18: There are no guarantees, warranties or representations, expressed or implied, or (sic) merchantability, fitness or suitability of the oil for any particular purpose or otherwise, which extend beyond the description of the oil set forth in this agreement. (1) under section 14(2) of the Sale of Goods Act 1979 and at common law, that the gasoil would be of satisfactory quality not only when it was delivered on to the vessel but also for a reasonable time thereafter; and (2) at common law, that the gasoil would remain in accordance with the contractual specification for a reasonable period after delivery on to the vessel. The judge held that clause 18 was ineffective to exclude these implied terms, because they were conditions of the contract, and a House of Lords decision, Wallis, Sons & Wells v Pratt & Haynes3 , made it clear that specific words have to be used in order to exclude a condition. Clause 18 did not mention conditions. Moreover, he did not consider it inconsistent with clause 12 to imply these terms. The decision caused considerable concern because it meant that a final certificate as to quality at the time of loading was not in fact final, as the seller could still be held liable for deterioration after shipment. The seller appealed against the judges conclusions on implied term (2) the effect of clause 18. Perhaps surprisingly, the seller did not (apart from its appeal on clause 18) also challenge implied term (1), which might be thought inconsistent with clause 12. In the Court of Appeal, Rix LJ, with whom the other judges agreed, firmly rejected the judges decision on implied term (2): the additional implied term was simply not part of the intention of the parties to this contract and would not have been understood by reasonable merchants to have been part of its meaning . If it had been otherwise, the whole point of a final and binding determination by an independent inspector on loading would be rendered pointless, for the buyer could always say that although the goods were within specification on loading, and had been conclusively determined so to be, they had nevertheless fallen out of specification during the contemplated voyage or within a reasonable time. All certainty in international sale of goods, which such inspection clauses are designed to providewould be utterly broken. On clause 18, the appeal failed because the Court of Appeal was bound by the Wallis decision. However Rix LJ indicated that but for that authority, it would have succeeded. It is unfortunate that the buyer did not also challenge implied term (1). On that point, the first instance judgment stands. Consequently there remains a risk for a seller that, despite a certificate final provision, he will remain under a duty to ensure that the goods remain of satisfactory quality for a reasonable time after shipment. This could mean, for example, that he would be liable for some latent defect not covered by the certificate. Careful contract drafting is therefore recommended if this potential pitfall is to be avoided. James Sleightholme, Partner sleightholme@elbornes.com 1 [2009] 2 Lloyds Rep 679 2 [2010] EWCA Civ 1145 3 [1911] AC 394

Analysis before loading showed that the cargo was on-spec, but when it arrived at its destination in Spain after an uneventful 4-day voyage, the buyer claimed that it was off-spec as regards sediment, and brought a claim for over US$3 million. The buyer accepted that the cargo was shipped on-spec but contended that it had changed by the time it arrived. The Commercial Court (Field J) held that the contract contained implied terms:

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