In July 2011, the vessel MV Brillante Virtuoso1 carrying a cargo of 141,000 mt of fuel oil from Kerch, Ukraine to Qingdao, China was boarded by pirates off the Gulf of Aden, who ordered the vessel to sail to Somalian waters. On the way, the main engine broke down and could not be restarted. The pirates then detonated an explosive device in the engine room before abandoning the vessel. As a result of the explosion, the ship was a dead ship without power. A day later, the US navy vessel USS Philippine Seas rescued the vessel and the shipowners engaged salvors to initiate salvage operations immediately, which included towing the vessel to Oman where the cargo was transshipped.
The vessel remained a dead ship even after redelivery of the vessel by the salvors in October 2011. As a result, the shipowners hired two tugs on stand-by until she was delivered to a buyer to whom she was sold for scrap in March 2012.
At all times, the vessel was insured against war risks, which included acts of piracy. During the salvage operations, the shipowners’ surveyor inspected the vessel and formed the opinion that the cost of repair would exceed the insured value2 of US$55 million.
On 7 December 2011, the shipowners tendered a notice of abandonment to the insurers declaring the vessel a constructive total loss (“CTL”).3
The shipowners claimed that in accordance with s 60(2) (ii) of the Marine Insurance Act 1906 (“MIA”),4 the vessel was a CTL since the damage caused by the act of piracy was so extensive that the cost of repair to put the ship right would exceed the value of the vessel when repaired (agreed between parties to be at US$10.2 million). The insurer rejected the notice of abandonment. In February 2012, a month before the vessel was sold, the shipowners issued a claim form to initiate legal proceedings against the insurers.
The primary contention was whether the vessel was a CTL. Other issues arose as to whether the shipowners:
- lost the right to claim for CTL, having sold the vessel after issuing the notice of abandonment; and
- were entitled to an indemnity for costs of salvage, tug hire and port expenses incurred as part of their “sue and labour” expenses under the marine insurance policy. If yes, what was the duration allowed for such claims?
Constructive total loss
In deciding whether the vessel was a CTL in accordance with s 60(2)(ii) of the MIA, the courts would first have to assess what the proper cost of repair would have been. In doing so, the court in MV Brillante Virtuoso adopted the long established “prudent uninsured shipowner” test:
“… what a prudent uninsured shipowner, in the position of the assured, would have done in deciding whether or not to repair the vessel and where and how the repair should be carried out, taking into account practical difficulties in assessing the extent of damage”.5
The MV Brillante Virtuoso is an example of the practical difficulties that the courts face where the shipowners are unable to determine with accuracy the actual extent of damage to the vessel. Because of the state of the vessel after the fire, a proper inspection could not be carried out by the surveyors and so no detailed and accurate repair specifications were drawn up.6
In such circumstances, the court would apply a large margin to any repair estimate.7
- Large margin
This is essentially a margin of error taken into account to reflect the extent of the damage that cannot be fully investigated,8 and is set based on the facts of a particular case.
In this case, the court allowed a 10% contingency to be added to the estimated cost of repair to account for machinery and equipment that could not be tested.
- Additional expenses
The court also took into account the additional costs that would have to be incurred by the shipowner to put the ship right.9
Some of the expenses that were recognised as additional costs were the costs of cleaning and gas-freeing the vessel, the costs of towage to the port of repair and insurance for that tow, bunkers supply, costs of salvage and also the cost for providing stand-by tugs.
The burden of proof is on the shipowner to demonstrate that the expenses were reasonably necessary to get the vessel repaired.
- Place of repair
Another issue concerns the place where a prudent uninsured owner would have carried out the repair works in the circumstances.10 The insurers argued that had the repair works been carried out in China rather than Dubai, the cost would not have exceeded the insured value and the vessel would not have been a CTL.
It was held that while the cost of repair is an important factor, it is not determinative given the presence of other factors. The loss of time and risks involved to proceed to the substituted port, the reputation of the rival yards, the risk of delay at those yards and difficulty with the repositioning of the vessel for gainful employment after the repairs were some of the factors that ought to be considered in determining the place of repair.
Flaux J held that, although it would have been some US$11 million cheaper to have repaired the vessel in China, a prudent uninsured owner would still, on balance, have favoured repair in Dubai. In any event, taking into account the additional costs of salvage, the judge concluded that the cost of repair (in both China and Dubai) would have exceeded the insured value of the vessel, and hence it was a CTL.
Sale of vessel after notice of abandonment
The insurers contended that the shipowners had lost the right to claim for CTL by selling the vessel after issuing the notice of abandonment as the shipowners had acted inconsistently with a continued intention to abandon the vessel to the insurers.
The court found that the shipowners had acted in the interests of both themselves and the insurers in mitigating losses by selling the vessel. In any event, the insurers were well aware of the proposed sale of the vessel but did nothing to object to the sale and, consequentially no question of loss of the right to claim for CTL arose.11
Sue and labour expenses
In a marine insurance policy, a sue and labour clause imposes on the insured a duty to take such measures as may be reasonable for the purpose of averting or minimising a loss.12
The insurers contended that after the redelivery of the vessel by the salvors to the shipowners:
- the insured peril of piracy ceased to operate as the vessel had been brought to safety and that, any expenses incurred thereafter would not fall within the ambit of sue and labour; or, alternatively,
- that the stand-by tugs were hired in compliance with international conventions13 and therefore were not expenses incurred to mitigate losses for the benefit of the insurers.
On the facts, the court found that the MV Brillante Virtuoso was a dead and disabled ship anchored in international waters and therefore posed an obvious danger not only to itself, but also to other shipping activities. Flaux J held that until the vessel was in a place of safety, the insured peril continued to operate.
Accordingly, the court recognised the costs of standby tugs and the associated agency fees as expenses incurred for the mutual benefit of the owners and insurers, and therefore claimable as sue and labour expenses.
This decision is a welcomed comfort as it enables shipowners to recover expenses reasonably incurred to safeguard the vessel from further danger even after it is salvaged or recovered from an insured peril.
In any case, the continued duty to mitigate loss will benefit insurers as the vessel will be protected from further structural damage which would diminish her residual value or could expose the insurers to a larger claim.
Time limit for sue and labour expenses
The question then arose as to when expenses ceased to be claimable as sue and labour expenses.
The shipowners contended that they should be entitled to claim for sue and labour until the vessel was sold since the need to protect the vessel did not cease, notwithstanding the issuance of a claim form.
Flaux J held that the duty to mitigate ended once a claim form is issued as the Civil Procedure Rules rather than the contract of insurance would govern the relations between the parties thereafter.
Insurers should take note that the mere rejection of a notice of abandonment will not end the duty to “avert or mitigate losses” under a marine policy. An insured may hold the insurer accountable for expenses incurred to protect the damaged property from further loss even after the issuance of a notice of abandonment. It is only upon the commencement of the proceedings that sue and labour will cease to operate.