Policies such as an Offshore Package Policy typically will provide cover for “All risks of physical loss of or damage to” platforms and pipelines etc., but difficult questions can arise as to what exactly constitutes “damage”.

In many cases there will be no argument as to whether physical damage has occurred, but the issue can be less straightforward where, for example, a pipeline suffers from a blockage, or where it is established that there was a latent defect in that property.

Defective condition versus damage

Unless expressly covered by the policy wording as in the Inchmaree Clause of the Institute Time Clauses Hulls (ITCH), marine insurance does not provide cover for inherent vice or wear and tear; ‘it covers a risk, not a certainty’.1 So where, for example, a latent defect develops and becomes patent in the ordinary course of operations, such defect will not, without more, be covered. However, insured damage may occur where loss is caused by a fortuitous event combining with a latent defect. What starts out as a latent defect, may, due to the exercise of some external, accidental force, become damage, which is insured under the policy. But the point at which that transition occurs can be very difficult to determine and will depend on the particular facts.

In the Cendor Mopu 2 case, it was determined that the loss could not have occurred but for the defective condition of the property, but nonetheless the policy responded and the loss was covered because the sequence of events which lead to the loss was
initiated by a fortuitous external event.

The question of when a defect may become damage was considered further in The Nukila.3 In this case, defective accommodation platform was being towed when fatigue cracks appeared in the welds joining the spud cans to the legs. Because the welding had been inadequately carried out there was a latent defect and the question was whether this latent defect had simply become patent or whether the defect had caused “damage”. The policy incorporated the ITCH standard form and by the Inchmaree Clause covered damage caused by latent defect. It was held that the platform legs had in fact suffered insured damage when they were subjected to stresses that they could not withstand due to the latent defects. Where do the boundaries of ‘physical damage’ lie? Are pipeline blockages covered?

Another scenario in which the definition of ‘physical damage’ becomes important is where equipment is affected in such a way that it becomes unusable even though its physical state or integrity appears unchanged, for example where a pipeline becomes blocked. In such a scenario, can it be said that the pipeline has suffered physical damage to enable a claim to be made under the policy?

There is no definitive case law on this point, however a number of cases provide indications of how this point may be interpreted were it ever to reach the courts.

The Orjula 4, the deck of a vessel was contaminated with acid. In deciding whether the acid had caused damage the court
considered some criminal law authorities on damage on the basis that the guidance provided was also relevant to civil cases. A relevant consideration was whether there had been ‘injury impairing value and usefulness’ and whether money would need to be spent to restore the property to its former useful condition. In this case it was deemed that there had been damage where acid had been spilt on deck and had to be washed off in order to return the deck to a useful condition, even though there had not been any apparent physical damage to the deck.

This outcome appears at odds with the Australian insurance case of Transfield v GIO 5 which related to an insurance policy covering physical loss or damage to a grain silo. The design of the silo was defective with the result that the fumigation pipes became blocked with grain, making the silo useless until the grain was removed. It was held that, in this context, loss of usefulness did not amount to physical damage. The judges agreed that loss of usefulness might in some context amount to damage, but held that it could not amount to physical damage.

Further guidance was provided in Pilkington v CGU Insurance 6. In this case it was held that under English law, damage usually refers to a changed or altered physical state.

So there would appear to be a difference between “damage” and “physical damage”, with the latter requiring some physical change of state of the property in question; loss of function or usefulness on its own appears not to be enough to amount to physical damage.

Whilst these cases are instructive, there is no definitive decision and each case will be decided on its facts. In the Transfield case for example, the grain which caused the blockage did not cause any physical damage in that it did not change or alter the physical state of the fumigation pipes. However, in certain circumstances an oil pipeline blocked with waxy crude may well result in a change to the physical state of the inside of the pipeline if the blockage results in aggressive corrosion to the inside of the pipeline. Even sub-molecular change has been held to qualify as physical damage (although in relation to time out rather than a sub-sea pipeline).

Often marine policies will not provide cover ‘in respect of…wear and tear, gradual deterioration,…corrosion, rusting, electrolytic action’. However, it has been held that this corrosion exclusion applies only where corrosion occurs in the ordinary course of production, not where corrosion is consequential on some fortuitous cause.8

So whether a particular loss is covered will depend very much on the policy wording and the particular facts.

Conclusion

What amounts to damage or physical damage in the insurance context may in certain cases be very difficult to determine and will depend heavily on the particular facts of each case and the particular wording of the policy. The examples discussed of inherent defect or pipeline blockage are prime examples of where the difficulties can lie. The case law provides guidance but in many cases it will not provide a definitive answer