On 3 November 2010 the High Court handed down the decision of Selected Seeds Pty Ltd v QBEMM Pty Limited regarding the extent to which an insurance company could rely on the terms of an exclusion clause known as an “Efficacy Clause” in a product liability insurance policy to avoid liability to pay an insured’s claim.

On the facts recounted in the Court’s unanimous judgment, the appellant Selected Seeds is a seed and grain merchant which purchased seed from another merchant in the Northern Territory that was represented to be Jarra grass seed. The seed was in fact substantially Summer grass seed or substantially contaminated with Summer grass seed. Jarra grass seed is extremely palatable to all types of stock as green feed, dry feed or hay and is grown for these purposes. Summer grass is fit only as a low-quality stock feed and is viewed as a weed when present in commercial hay and seed crops.

Selected Seed was joined to a damages claim brought by one of the ultimate consumers of the seed, the Shrimps. The Shrimps claimed the cost of eradicating the Summer grass seed from their land and the loss of use of their land during that period. The Shrimps’ claim was settled and Selected Seeds contributed $150,000.00 to the settlement. There was no dispute about the reasonableness of the settlement. Selected Seeds’ insurer refused to indemnify Selected Seeds for the loss.

The relevant insuring clause provided that the insurer agreed to pay to Selected Seeds:

“a. all sums which You become legally liable to pay by way of compensation

b. all costs awarded against You in respect of…Property Damage happening during the Period of Insurance and caused by an Occurrence within the Territorial Limits in connection with Your Business.”

Selected Seeds’ policy also contained an Efficacy Clause which had the effect of excluding liability arising from particular defined events:

“This Policy does not cover any liability arising directly or indirectly from or caused by, contributed to by or arising from:

1. the failure of any Product to germinate or grow or meet the level of growth or germination warranted or represented by the Insured, or

2. the failure of any Product to correctly fulfil its intended use or function and/ or meet the level of performance, quality, fitness or durability warranted or represented by the Insured.”

The insurer contended that the second limb of the exclusion clause was engaged because Selected Seed’s liability arose from the failure of the seed planted by the Shrimps to “fulfil its intended use or function” namely to produce Jarra grass and Jarra seed.

The High Court rejected the insurer’s argument and found that Selected Seed’s liability was not caused by the failure of the seeds to produce Jarra seeds, it arose by reason of the direct effect of the seeds upon the land. The seeds were so contaminated that Summer grass only was produced. The High Court found that the Efficacy Clause did not apply.

In assessing whether the exclusion clause should apply the Court applied general rules of construction – that is that the clause had to be read in light of the contract of insurance as a whole, thereby giving due weight to the context in which the clause appears. The High Court noted that the concern of the Efficacy Clause in Selected Seed’s policy was to exclude warranties and representations about what their product might do or achieve.

The High Court concluded that the Trial Judge was correct to hold that Selective Seed’s liability was for damage to the Shrimps’ land by the introduction of the weed, Summer grass. The Court found that the policy responded to such a claim. It was not damage caused by the seed sown failing to fulfil its intended use or function. The liability to the Shrimps was for what the seed did, not what it failed to achieve. That was the literal construction to be given to the Efficacy Clause.

The decision is a reminder of the need to draft exclusion clauses with specific regard to the potential types of liability arising under the relevant contract.