HISTORICAL MARITIME FRAUD
DRILLING OIL RIG CENDOR MOPU, MARINE INSURANCE – INHERENT VICE- A BOON OR LOSS
It is not uncommon for hull and cargo underwriters to reject claims by relying on excluded perils in their standard forms.
Causation is a very important part in marine insurance law. The general principle in English Law is that the insurer will only be liable for any loss, which is proximately caused by a peril insured against. (Marine Insurance Act, 1906, section 55). At the beginning of last century, the determination of the proximate cause in common law was considered to be the nearest in time. ‘Inherent vice’ excluded the ordinary wear and tear that could be expected to occur as a result of the ordinary action of wind and waves.
This case is concerned with a marine insurance policy on cargo dated 5 July 2005, which incorporated the Institute Cargo Clauses (A) of 1 January 1982. In 2005, Global Process Systems (the assured) purchased the oil rig, Cendor Mopu, and arranged for her to be transported from Texas to Malaysia on a barge with her three massive tubular legs in place above the platform so that they extended some 300 feet into the air. Global placed insurance with Syarikat Takaful Malaysia Berhad (‘the Insurer’), on terms which incorporated the Institute Cargo Clauses, and, in particular, clause 4.4 which excludes “loss, damage or expense caused by inherent vice or nature of the subject matter insured” Clause 4.4 excluded “loss, damage or expense caused by inherent vice or nature of the subject matter insured” from the cover provided by the policy.
The subject matter of the insurance was the DRILLING oil rig “Cendor MOPU.” This oil rig had been laid up in Galveston, Texas. In May 2005 it was purchased by the respondents (the assured under the policy) for conversion into a mobile offshore production (MOPU) unit for use in the Cendor Field off the coast of East Malaysia. The insurance covered the loading, carriage and discharge of the oil rig on the towed barge “Boabarge 8” from Galveston in the United States to Lumut in Malaysia. The total sum covered was Malaysian Ringgits 38m (US$10m) with a deductible of US$1m. The premium was US$378,000.
The oil rig, originally called the “Odin Liberty”, was built in Singapore in 1978. It is what is called a “self-elevating mat supported jack-up rig,” consisting of a watertight working platform called the jack house, which can be moved (jacked) up and down three legs extending to the seabed, according to the sea depth at the drilling location. There is a mat at the bottom of the legs that sits on the seabed when the rig is in operation. The legs are massive tubular structures, made of welded steel cylindrically shaped, with an outside diameter of 12 feet and a length of 312 feet. Each weighed 404 tons. The jacking system worked by engaging steel pins into what were called pinholes in the legs. These pinholes were apertures some 16 inches wide and 10 inches high. Each leg had 45 sets of pinholes at 6-foot intervals.
The voyage began on 23rd August, 2005. During the course of transportation, the three legs of the rig were some 300 feet in the air, with each leg weighing some 404 tonnes. On 10th October, 2005, the tug and barge arrived at Saldanha Bay, just north of Cape Town. There some repairs were made to the legs and the voyage was resumed on 28 October. North of Durban on the evening of 4 November 2005, the starboard leg broke off at the 30-foot level and fell into the sea. The following evening the forward leg broke off at the same level, and some 30 minutes later the port leg broke off at the 18-foot level. Both these legs also fell into the sea. It is the loss of the three legs that is the subject matter of the claim under the policy. The loss resulted from metal fatigue in the three legs.
‘Fatigue’ is a progressive cracking mechanism resulting from repeated or fluctuating (cyclic) stresses each at a level lower than that required to cause fracture of an uncracked component. Generally, there are three stages to the fatigue failure of any component, namely initial cracking, propagation of the cracking and finally complete fracture. The initial cracking occurs in regions of stress raising features, such as corners or notches, where stresses are concentrated.
In this case, the corners of the pinholes were stress raising features. The initial fatigue cracks occurred there and then propagated until they reached a point where they were subjected to what was described as a “leg breaking” stress that completely fractured the weakened leg. Once the first leg had failed, the stresses on the remaining legs increased. The stresses in the present case were generated from the effect that the height and direction of the waves had on the pitching and rolling motion of the barge and thus on the legs. It was common ground that what the barge experienced was within the range of weather that could reasonably have been contemplated for the voyage.
The fact, that the legs of the rig were at risk of fatigue cracks during the voyage was known from the outset, and the legs were inspected at Galveston by experts appointed by the assured and approved by the insurers. It was a condition of the policy that the appointed surveyors Noble Denton approved the arrangements for the tow. These surveyors issued a Certificate of Approval on 23rd August, 2005. In this certificate they required that the legs be reinspect when the barge reached Cape Town (roughly the halfway point) for crack initiation in way of the six levels of pinholes above the mat; so that remedial work could be undertaken should it be found necessary.
When the rig was examined at Saldanha Bay it was found that there had occurred a considerable degree of fatigue cracking around the pinholes; and some repairs were made in order to reduce the stress concentrations in these areas. However, the repairs did not prevent the collapsing of the final failure of the legs a few days later.
It was agreed between the claimant and the respondent that the loss of the three legs resulted from metal fatigue. A dispute arose however between the claimant and the respondent, as to whether the proximate cause of the loss was an external factor or the inherent vice of the rig itself. If inherent vice of the subject matter was the proximate cause, the insurer would not have to pay out under the policy of insurance as inherent vice is excluded from the Institute of Cargo Clauses (A). The insurers rejected the claim for the loss of the legs and the matter came for trial before the Commercial Court.
At the trial one of the arguments advanced by the insurers was that the loss was the inevitable consequence of the voyage, and that since insurance was against risks, not certainties, they were under no liability for the loss of the legs.
The judge, Blair J, [2009], rejected this argument, concluding at para 87 “that the failure of the legs as this rig was towed round the Cape was very probable, but it was not inevitable.” As he put it: “…a developed crack would not, on its own, have been sufficient to cause one of the legs to come off. That required in addition a ‘leg breaking’ or ‘final straw’ stress that finally fractured the weakened steel. As Mr Colman [one of the experts called at the trial] put it, ‘you’ve got to catch it just right, if you want to make it actually fail all the way round.’”
The insurers did not challenge the judge’s conclusion. What Blair J decided was that, the insurers had proved that “the proximate cause of the loss was the fact that the legs were not capable of withstanding the normal incidents of the insured voyage from Galveston to Lumut, including the weather reasonably to be expected.” In his judgment this meant that the cause of the loss was inherent vice within the meaning of the policy and that accordingly the insurers were not liable for the claim.
One of the arguments advanced by the assured at the trial was that the loss resulted from the failure to effect adequate repairs at Saldanha Bay. This argument too was rejected by the trial judge, on the grounds that the loss occurred despite the repairs and not because of them. The assured did not challenge this conclusion.
This judgment was overturned on appeal. Waller LJ, giving the leading judgment in the Court of Appeal, stated that the test to be applied was not whether the rig had been capable of withstanding the weather which was reasonably to be expected on the voyage but rather, whether she was capable of withstanding such weather as was bound to occur. As Blair J had found that the loss was not bound to occur, it followed that it did not fall within the exclusion.
On appeal to the Supreme Court, both parties disavowed the ‘bound to occur’ test. Insurers argued that the test was too narrow while Global argued that the exclusion should only apply where loss was caused by something internal to the cargo and that, accordingly, where external conditions were the effective cause of the loss, the exclusions should not apply, irrespective whether those external conditions were bound to occur. The Supreme Court on February 1, 2011, unanimously dismissed the appeal. The essential question in this case for the Supreme Court was one of causation: the loss was caused by an inherent vice in the legs, or as a consequence of peril of the seas, or the concurrent two competing causes.
In his conclusion, Lord Saville reminded the definition of inherent vice or nature of the subject matter insured by Lord Diplock in Soya Gmbh Mainz Kommanditgesellschaft v White [1983]. ‘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 of casualty.’
In support of this argument, Insurers cited various cargo cases. A particular significance was given to T M Noten BV v/s Harding [1990] Lloyd’s Rep 283 in which industrial leather gloves shipped from Calcutta to Rotterdam were found to be wet, stained, mouldy and discoloured as a result of moisture absorbed in humid conditions in Calcutta. Reversing the first instance decision in that case, the Court of Appeal had held that the gloves deteriorated because of their natural behaviour in the ordinary course of the contemplated voyage, without the intervention of any fortuitous external accident. In particular, Bingham LJ noted that the temperature in Calcutta and on the vessel’s arrival in Rotterdam had not been unusual.
Insurers argued that if the ordinary, but not inevitable temperatures in Calcutta and Rotterdam did not constitute a fortuitous external accident, it must follow that the ordinary but not inevitable wave conditions off South Africa were equally irrelevant.
This argument was rejected by the Supreme Court. While four consistent reasoned judgments were given, the most instructive is that of Lord Mance. An inherent vice of the cargo was not considered to be a concurrent cause of the loss. The loss came from an external agent, the stress imposed to one leg by the sea -in a form of a breaking leg breaking wave, which produced the falling of the two remaining legs. It was also stated by Lord Mance that perils of the sea and inherent vice are exclusive perils, they may not appear together as proximate causes in a loss. A peril of the sea is to be considered a paramount provision, the only proximate cause of the loss.
Lord Mance also considered that the exclusion of inherent vice is to be considered as a limitation of cover and not as a concurrent cause of exclusion. In this case it was common ground that the immediate cause of the damage to the cargo was the violent movement of the vessel due to actions of the wind and sea, but that also the cargo (the transformer) was not able to withstand the ordinary conditions of the wind and sea. If the conditions encountered by the vessel were not more severe than could reasonably have been expected, the conclusion must be that the real cause of the loss was the inherent inability of the goods to withstand the ordinary incidents of the voyage. This was the test applied by Blair J in the Commercial Court decision for The Cendor MOPU.
Although at the hearing his Lordship appeared to recognise the difficulty of distinguishing, on the one hand, the effects on a cargo of temperature and atmosphere, and on the other, the effects of wind and waves, in his judgment; he analysed Noten vs. Harding in rather more simple terms.
He also held that the gloves essentially damaged themselves under such conditions through their own moisture content, and it was not sensible to describe them as having sustained any fortuitous external accident. By contrast, the loss of the Cendor Mopu’s legs was neither expected nor contemplated and occurred only under the influence of a leg-breaking wave of a particular direction and strength catching the first leg at just the right moment.
In a passage which will surely be cited in all future cases involving inherent vice, Lord Mance explained the distinction by reference to the definition provided by Lord Diplock. He held, at paragraphs 80 and 81, that (1) Lord Diplock’s reference to “the ordinary course of the contemplated voyage” was not intended to embrace the weather conditions foreseeable on such a voyage, but was rather used as a counterpoint to a voyage on which some fortuitous external accident or casualty occurred (2) there was no apparent limitation in Lord Diplock’s qualification “without the intervention of any fortuitous external accident or casualty” – in other words, on the face of it, anything that would otherwise count as a fortuitous external accident or casualty will suffice to prevent the loss being attributed to inherent vice.
The Supreme Court unanimously dismisses the appeal. The Court finds that the cause of the loss was an insured peril rather than inherent vice. The effect of this ruling is stark, irrespective of how fragile a cargo is, where the actions of waves and wind have played a part in causing loss, it will be almost impossible for insurers to deny liability based on the exclusion of inherent vice.
The practical effect of the judgment is that the exclusion of loss caused by inherent vice and nature of the thing insured has become of much less use to insurers. They will not be entitled to rely on the unsuitability of cargo for sea transit to exclude recovery unless loss occurs as a result of the inherent characteristics or defects of the goods causing loss or damage to themselves without any intervention from waves or wind (or other perils of the sea).
Unattractive and impractical though it might seem to insurers, it follows that – unless changes are made to the standard policies – they must take additional steps to understand quite how susceptible to damage the insured cargo is. If they do not, and loss is sustained as a result of the foreseeable but not inevitable actions of waves or wind, they will have to pay the claim under the policy. This will be the case equally where the probability of such loss occurring is 5% or 95%.
It can also be noted about the relevant provisions of the Marine Insurance Act 1906 read as follows: “55.
INCLUDED AND EXCLUDED LOSSES
1. Subject to the provisions of this Act, and unless the policy otherwise provides, the insurer is liable for any loss proximately caused by a peril insured against, but subject as aforesaid, he is not liable for any loss which is not proximately caused by a peril insured against.
2. In particular, unless the policy otherwise provides, the insurer is not liable for ordinary wear and tear, ordinary leakage and breakage, inherent vice or nature of the subject-matter insured…”
The ruling of the Supreme Court, in narrowing the test for inherent vice in matters of marine insurance, will likely be welcomed by policyholders. The Supreme Court held that a fortuitous external accident would preclude the possibility of inherent vice operating as the proximate cause of any loss suffered.
Causation is a crucial issue in ascertaining whether certain loss or damage is covered in an insurance policy. Although marine insurance is well-known for investigating the “proximate” cause of loss in order to determine the insurers’ liability, decisions by English courts are far from reconcilable.
