In this article we look at the meaning of “corrosion”, as it appears in a standard “wear and tear” exclusion in CAR policies. What lies behind the efforts of underwriters to create a separate exception for “corrosion”?
Over the past few years, the London Engineering Group (LEG), a consultative body for insurers of engineering class risks, has been working on a new corrosion clause to address the issues and problems that have arisen when applying the corrosion exclusion. The new clause, unsurprisingly named the “LEG Corrosion Exclusion”, is due to be released around 11 October 2017.
Ahead of the new LEG Corrosion Exclusion release, in this article we look at the meaning of “corrosion”, as it appears in a standard “wear and tear” exclusion in construction all risk (CAR) policies, and what lies behind the efforts of the LEG and underwriters to create a separate exception for “corrosion”?
What does corrosion in a “wear and tear” exclusion mean?
If you have had cause to consider the “corrosion” exception in a “wear and tear” exclusion lately, you may have experienced something of a mismatch between the expectations of underwriters and the insured as to the proper construction of the term “corrosion”. The problem frequently encountered is, in a nutshell, that in a “wear and tear” exclusion, more likely than not, only “gradual corrosion” is excluded. As to whether corrosion is gradual or not in the circumstances is a grey area, and one that can give rise to considerable debate. Some insurers in the market say that corrosion, whatever form it takes, is never fortuitous as it arises from an inevitable degradation of the property after construction, but that does not accord with the construction of the term corrosion in a “wear and tear” exclusion.
In this article, we seek to highlight the issues most frequently encountered when interpreting the “corrosion” exception, and then consider a number of solutions to the problem, including the development of the wording of the “wear and tear” exclusion.
First, is the loss fortuitous?
In considering a “wear and tear” exclusion, you will have to grapple with the fundamental, but not always straightforward, question of fortuity. It is well established that in order for an insured to recover his loss, he must first show that the loss is “fortuitous”. Often the insuring clause in a CAR policy calls for “damage arising from sudden, accidental and unforeseen” loss and each element requires careful analysis.
If, after careful analysis, your conclusion is that the loss was, on the balance of probabilities, fortuitous, then you must consider whether any of the policy exceptions apply. It is in this context you are likely to be looking at a “wear and tear” exclusion in your policy.
What might your “wear and tear” exclusion say?
Set out below is a typical “wear and tear” exclusion found in CAR policies:
“Insurers shall not be liable for loss or damage due to or arising out of:
Inherent vice, latent defect, wear and tear, erosion, contamination, corrosion and gradual deterioration.”
What is “wear and tear”?
As the corrosion exception appears in a “wear and tear” exclusion, it is relevant to address briefly, what is meant by “wear and tear”.
“Wear and tear” has a singular meaning, it is the inevitable loss sustained by insured property by action of the ordinary environmental forces and pressure exerted on it during its use. The following definition from Arnould’s Law of Marine Insurance and Average has been frequently adopted by the Court (See Midland Mainline Ltd v Eagle Star Insurance Co Ltd  EWCA Civ 1042 and CCR Fishing Ltd v Tomenson Inc (The La Pointe)  1 Lloyd’s Rep 89):
“the result of ordinary service conditions operating upon the hull or machinery, as for example when the relevant part wears out, having reached the end of its expected working life, or when initially sound material have undergone some process of deterioration, such as corrosion, which was introduced in the ordinary course of trading and remains uncorrected.”
“Wear and tear” is something that therefore lacks fortuity and, while it is impliedly excluded from cover, an express exclusion is incorporated for the purpose of clarity - normally for the insured’s benefit.
What is “corrosion”?
We then move to consider what corrosion is, and how it is construed in the “wear and tear” exclusion set out above? An apt definition is offered in Paul Reed QC’s Construction All Risks Insurance. He says:
“[t]he essence of corrosion is … the physical alteration, removal or destruction of part of the structure by a chemical process, such that any chemical reaction which causes deterioration of a material can be construed as corrosion.”
The word “corrosion” must, however, be read in the context of the wider exclusion clause in which it appears. Where an exclusion clause refers to a sequential list of processes to be excluded from cover, which in the example above include a number of naturally occurring processes, the exclusion is to be construed in line with the surrounding collective language. The result of that contextual reading is that the corrosion exception is likely only to be engaged where the corrosion is of a gradual nature rather than any other form of violent sudden corrosive action.
If the above interpretation is accepted, then there are two different forms of corrosion that can lead to damage under an insurance policy. The first, consistent with the meaning of “wear and tear”, is non-fortuitous corrosion that arises gradually from the ordinary force of nature on an object or ordinary use of the property. The second is corrosion caused by an accidental or fortuitous event, say for example a negligent installation of steel tubes to transmit steam, which escape and mix with other acids and result in corrosion (Burts & Harvey Ltd v Vulcan Boiler and General Insurance Co Ltd  1 Lloyd's Rep. 161).
What does this mean for construing corrosion in a claims context?
At a policy coverage level, the issues are frequently not straightforward. There is sometimes a mismatch in expectations between insureds and underwriters. This is particularly so where the corrosion exclusion is contained in a wider “wear and tear” exclusion, when arguments can arise about whether the context means that the narrower interpretation of corrosion was intended. Where “wear and tear” is one of various items listed, all of which are gradual processes, this can point to a narrower interpretation. Even where both contracting parties agree on the legal interpretation of the words, a dispute on the facts often arises, as to whether or not the corrosion is gradual.
The inclusion of the word “sudden” in the insuring clause can also be a cause of controversy and dispute.
See for example, the case of Burts & Harvey Ltd v Vulcan Boiler and General Insurance Co Ltd. This illustrates the potential mismatch in expectations on the corrosion exclusion. There, the insurance was in respect of a chemical plant which manufactured maleic anhydride, a substance used in the manufacture of plastics. As part of the manufacturing process the maleic anhydride was pumped through steel tubes which were cooled by water jackets. Some of the tubes and jackets were not airtight and steam escaped and mixed with the gas, forming a highly corrosive compound called maleic acid. The acid attacked the steel tubes and the plant was shut down for repairs.
The policy provided for cover for “sudden or accidental” damage but also contained an exclusion for “wear and tear, corrosion, erosion, failure of any part or parts the nature of which necessitate their regular replacement.”
The judge said that the corrosion exception only applied to corrosion, caused by normal operations, that would have been inevitable. This was not the same as the corrosion of the kind in the claim. As the insuring clause expressly provided an indemnity for “sudden and accidental” damage, an interpretation that excluded both corrosion that, in the view of the court, was gradual and sudden would not have given proper effect to the words used in the policy.
Whether corrosion is gradual or sudden has to be construed in the context of the factual matrix of the loss and also in the context of a project policy that is issued for a defined period of time. Obviously, the policy must be construed as a whole with specific regard to the words in the insuring clause, and therefore, the exclusion of corrosion, should not be construed so as to deprive one party or another a substantial benefit in the cover created by the insuring provision, unless clear words have been used.
How is this affecting wordings?
We turn then to the need for clear words in policies. It is of course open to underwriters to extend the exception to cover all types of corrosion. This can be achieved with relative ease by the inclusion of words such as “corrosion of any kind” or “corrosion howsoever caused” - in which case, the exclusion should be construed as extending to all forms of corrosion.
In order to avoid the risk that the meaning of “corrosion” might be affected by including it in a list of similar processes or exclusions, underwriters have now started to make a separate provision for corrosion. An example of this is the following clause that is being used with greater frequency by underwriters:
“Wear and Tear and Corrosion Exclusion (consequences clause)
The cost of replacing, repairing or rectifying that portion of the Insured Property rendered necessary by:
a. its own wear and tear or gradual deterioration provided always that this Exclusion shall not apply to other portions of the Insured Property lost destroyed or damaged as a result of such wear, tear and gradual deterioration;
b. loss destruction or damage consisting of or caused by any form of corrosion or the action of which accelerates or otherwise aggravates another condition or mechanism howsoever the same may arise provided always that this Exclusion shall not apply to other portions of the Insured Property lost destroyed or damaged in consequence of the above loss destruction or damage.”
As we can see from the above example, the corrosion exclusion is extended significantly in sub-paragraph (b) and sets out what underwriters consider is a foreseeable risk and one which is not intended to be indemnified under the policy. The language is interesting as it not only excludes damage proximately caused by corrosion of any kind but, also, the aggravation (by corrosion) of another condition is also excluded. Any resultant damage to other parts of the insured property is, however, to be indemnified.
Depending on the underwriters concern with exposure to corrosion, for example, such as with a chemical or waste plant facility that is undergoing an extension, refurbishment and/or a change of fuel, a total restriction might be suitable. An example of a total restriction used by underwriters is as follows:
“Damage resulting from any mechanism of corrosion, oxidation or erosion whether sudden or gradual and regardless of any other cause or event contributing concurrently or in any sequence to the loss.”
The “corrosion” exception remains a hotly debated topic and will be for some time as many policies continue to be written with the normal “wear and tear” exclusion. The development of a new LEG Corrosion Exclusion then will be welcome news, as it will hopefully remove the concern that the word “gradual” tends to create a grey area when claims arise.