Warranties work – depending on the loss that actually occurs

In a recent Commercial Court judgment on a complex dispute about the contamination of a fuel cargo, useful guidance was given on when insurers will be able to rely on breach of warranty to defeat a policy claim. While the Insurance Act 2015 seeks to reduce the traditionally draconian consequences of breach of warranty, Dias J robustly upheld insurers’ right to reject the claim – even on the basis of a merely technical breach.

MOK Petro Energy (the Insured), an oil trading company, was insured under an all-risks marine cargo cover, for shipments of petrochemical cargoes that were declared during the policy period.

Certain London market insurers (Reinsurers) reinsured the risk on back-to-back terms and, pursuant to a cut-through clause, could be held directly liable to the Insured in respect of any valid policy claim.

The Insured presented its policy claim on the basis that the relevant cargo of gasoline had originally, when it arrived at the load port, been on-specification. The Insured alleged that, during loading, the gasoline had accidentally been contaminated by a significant quantity of water.

The water contamination caused the gasoline cargo to be rendered off-specification. The Insured claimed a policy indemnity, representing the difference between the on-specification value of the gasoline cargo, and its actual (merely salvage) value following contamination.

Judgment

While the available factual evidence was of poor quality, following trial, the judge ultimately concluded that the cargo had probably never been on-specification in the first place.

Given that the cargo had “never existed in any other state” than defective, there was no “damage” capable of giving rising to an insurance policy claim.

While that outcome in itself disposed of the Insured’s claim on the policy, Dias J nonetheless went on to discuss breach of warranty, and held that the policy claim would have failed on the basis of the Insured’s breach of warranty in any event.

Warranty

Warranties are insurance policy terms – typically promises by the insured as to the circumstances of the risk – the breach of which may fully discharge the insurer from liability under the policy. But that outcome is now subject to the mitigating provisions of the Insurance Act 2015 (“the Act”).

The policy contained a warranty, in which the Insured promised:

“Quantitative/Qualitative survey carried out by internationally recognised marine surveyor at loading port […] at owner’s cost, including inspection/certification of the cleanliness of the vessel tanks at load port […]  and the connecting pipelines between the vessel and the shore tanks at [load port].”

It is important to note that this warranty refers both to the “inspection” and the “certification” of the cleanliness of the vessel tanks and the connecting pipelines at the load port.

Breach of warranty

As a matter of interpretation, the judge took the above warranty as only requiring “such steps to be taken as are usual in the industry to ascertain compatibility”, rather than the “cleanliness” of the tanks and the pipelines being taken to mean “clean in the sense that there are no residues at all,” which would be “wholly uncommercial and impractical”.

On the limited available evidence, the judge was prepared to hold that there had in fact been an adequate inspection of the vessel tanks and the connecting pipelines, to the above standard of commercial reasonableness.

However, on the evidence the judge held that there had been no certification of the cleanliness of the connecting pipelines, until a certificate was finally issued after the loss and the dispute had arisen - which the judge held was too late.

The judge held that the “certification is an independent and discrete part of the warranty”, in addition to the requirement for the inspection.

As no certificate of the inspection of the connecting pipelines was issued within a reasonable time, notwithstanding that the inspection was held to have taken place, the Insured was found to have breached the warranty.

Insurance Act 2015 – Risk of loss of a particular kind

The Act was intended to make it harder for insurers to reject claims on the basis of breach of warranty. In particular, section 11 of the Act provides that insurers’ liability under a policy is only extinguished if the relevant warranty related to the risk of the loss that had then actually gone on to occur. This is intended to avoid an insured losing cover when its breach of warranty (say, failure to maintain a fire alarm) is incidental to the cause of the loss (say, a burglary).

The Insured argued that the lack of certification – in itself – could not have affected the risk of the gasoline cargo becoming contaminated by water.

The judge rejected that argument. She held that, when considering whether the warranty related to the risk that had in fact occurred, it was necessary to take the warranty as a whole (i.e. inspection and certification) and not in part (i.e. just certification). Dias J found:

“There was no serious dispute that compliance with the warranty as a whole was capable of minimizing the risk of water contamination from either the shorelines or the Vessel’s tanks and that therefore non-compliance could have increased the risk of the loss which actually occurred.”

Therefore, the Insured could not rely on section 11 of the Act to redeem its breach of warranty, and Reinsurers’ liability under the policy would be fully discharged by that breach.

Finally, section 10 of the Act could have assisted the Insured if it had remediated the relevant breach of warranty (by issuing the certificate of the inspection) before the loss (the contamination of the gasoline cargo) had occurred. But that would not have assisted the Insured on the facts of this case.

Comment

When noting that the warranty in this case required both inspection and certification, and that there had been an inspection of the connecting pipelines but not certification of that inspection, Dias J commented:

“The alleged unmeritorious nature of the [Reinsurers’] case is neither here nor there. If there is a breach of warranty, the [Reinsurers] are entitled to rely on it, no matter how technical the argument might be.”

The argument that a merely “technical” breach - of failing to obtain certification of an inspection, but which had in fact been carried out – did not increase the risk of the contamination of the gasoline cargo that subsequently came to pass, can be comprehended. But the judge rejected it firmly.

Insurers should be strongly encouraged by this robust judgment. Warranties remain an important weapon in underwriters’ armoury for limiting the scope of the risk that is to be insured. While the traditional rigour of insurance warranties has undoubtedly been mitigated by the Act, insureds ought still take care to comply fully with them. Particularly where - with the benefit of hindsight - compliance with the warranty as a whole would have reduced the risk of a loss that then went on to occur.