Third Party Losses – Article dealing with Third Party Property Losses. Should these be dealt with on a traditional “Indemnity” bases? Article was subsequently published in the “Journal of the Society of Fellows” (Chartered Insurance Institute)
Introduction
Traditionally, third party property claims have been dealt with on an “indemnity” basis, i.e. deductions are made for wear and tear or increased life span or equivalent benefit. The argument is whether this is the correct approach and we suggest there is merit in departing from this method of calculation and that the Courts are likely to impose this cost on the defendant rather than to force the plaintiff to invest his resources in an additional benefit he may not otherwise have chosen to receive.
Every Adjuster and Claims Handler has encountered a subrogated recovery at some time in their career. In the normal course the Insured submits a claim under the material damage policy which is dealt with by the Insurer providing such cover and the Insurer then exercises their right to recover the amount paid from the negligent third party. The third party Insurers appoint Adjusters or similar representatives and where the loss involves property damage, the third party Adjusters appear to automatically seek wear and tear deductions, the only argument to support such a stance is that these cases are dealt with on an “indemnity” basis which implies that deductions for wear and tear and betterment automatically apply. We suggest that this is not necessarily the case.
Position under Material Damage Policy:
The function of a Material Damage Policy is to provide an indemnity to the policyholder. This is usually understood to mean that a sum of money will be paid to the Insured so that he is placed in the same financial position after the loss, following the operation of an insured peril, as was enjoyed before the loss. A contractual agreement exists between the Insurer and the policyholder whereby the amount payable is measured by the extent of the Insured’s pecuniary loss. However, this is subject to the terms of the contract which means that conditions may apply which limit or alter the amount payable and its method of calculation/payment.
Domestic policies are predominantly on a “new for old” basis. This means the Insured will receive the replacement cost of the item without deductions for wear and tear or increased lifespan. Commercial policies can be on an indemnity or in the case of machinery and buildings, reinstatement memorandum basis. The latter is a departure from the traditional calculation of reinstatement less deductions for wear and tear on the basis that the policy establishes an indemnity calculation based on the cost of replacing the damaged machinery or building. The wording is that of a valued policy in that it defines the basis of valuation for indemnity and in this regard is no different from marine valued policies.
It is clear, therefore, that an insurance policy agrees to indemnify the policyholder but subject to the terms and conditions outlined in each particular policy. The essence of insurance is indemnity and essentially differs from the rule that damages in contract and tort are purely compensatory. In Reynolds –v- Phoenix Insurance Ltd., (1978) it was held that deduction for betterment was too well established a feature of the law of insurance to be displaced. The Court reduced an award for the cost of reinstatement of commercial premises to take into account the enhanced condition of the premises after reinstatement by the Insured. If an Insurer who had paid out a reduced amount under this principle seeks to exercise subrogation rights and recovers damages which are unreduced by betterment, the surplus is due to the policyholder. This then leads us to the original question, i.e. whether deductions are warranted in terms of third party damage, particularly in the case where the damage in question has been dealt with on a new for old or reinstatement basis under a material damage policy.
Negligence:
There is scant reference in Irish Legal textbooks to the issue of deductions for third party property damage. Dermot Latham – v – Hibernian Insurance and Others (1991) is a professional indemnity case and the plaintiff sued his Broker and Insurer due to lack of advice in the context of non-disclosure of a material fact. One of the issues dealt with was whether the loss of the building which was destroyed by fire should be calculated on the basis of an “indemnity or on the basis of reinstatement”. The Court stated that it depended on the nature of cover and the loss would have been limited to what the plaintiff would have recovered under the Policy. At the time of the fire the policy provided for “indemnity only” but in his judgement, Judge Blaney stated the correct approach would have been on the basis of an indemnity but it was difficult to follow this approach as the only evidence given was more relevant to reinstatement as the Bill of Quantities produced was “reinstatement”. The Judge held that the plaintiff was allowed to recover what would have been paid under his insurance policy which was on an indemnity basis. In other words he was not entitled to the cost of reinstatement. This decision is interesting as essentially the claim was a third party recovery and it was decided that the correct calculation of the plaintiff’s loss was what would have been recovered had his insurance policy been in force. The Court was no doubt influenced by the fact that the plaintiff had already recovered under a malicious injury claim against Dublin Corporation based on a Bill of Quantities which “had been prepared to support a claim for reinstatement”.
For full and proper guidance on this matter, it is necessary to refer to the position in the UK which, in the absence of Irish precedent, will be followed or at the very least will be of persuasive influence.
Subrogated recoveries can occur in contract or tort and the situation in the UK is that in granting damages for breach of contract or tort affecting property, the Courts will normally award the property owner the full cost of repair or replacement without deduction for betterment in the form of increased lifespan or equivalent benefits. The mere fact that the owner receives “new for old” does not itself warrant a reduction in damages. The Courts prefer to impose this cost on the wrongdoer than to force the owner to invest his resources in an additional benefit he may not otherwise have chosen to receive.
The defendant will no doubt argue that as damages in contract and in tort are purely compensatory a payment which gives the plaintiff a benefit he would not have otherwise received should be reduced by the amount of that benefit. This argument has not found much favour in the UK and the general rule is that no allowance is made for increased lifespan or similar improvements resulting from reinstatement. The main authority in the context of contract is Harbutts Plasticine Ltd., – v – Wayne Tank & Pump Co. Ltd., (1970) and in relation to tort, Dominion Mosaics Co. Ltd., – v – Trafalgar Trucking Co. Ltd., (1990) takes precedence. A third case Bacon- v – Cooper (1982) is particularly relevant in the context of damage to plant or machinery.
(a) Contract – Harbutts Plasticine:
The plaintiffs sued in contract for loss of their factory following the defendant’s installation of a faulty central heating system. They claimed for the cost of reinstatement but the defendants argued that this gave the plaintiffs better premises than they had before the loss. The Court of Appeal refused to make betterment deductions and stated reinstatement was a reasonable course of action in that the factory was income earning and the plaintiffs needed to replace it not only to return to pre-loss levels of turnover but also to mitigate their loss. No extras were incorporated into the new premises and whilst the plaintiffs adopted a new design they spent no more than was necessary to replace the old structure. It was stated that it was impracticable to replace a structure simply by re-using old material. Betterment was, therefore, inevitable and it follows that no deduction for betterment will be made in cases where: –
a) The original property was income earning.
b) The decision to replace it was reasonable.
c) No more was spent on the replacement than was necessary and that betterment was inevitable in the circumstances.
Whilst this case applied to breach of contract for work and materials affecting property, it is suggested that it would equally apply to claims for breach of contract for sale of goods or claims in tort for negligence or nuisance.
(b) Tort – Dominion Mosaics:
A contractual relationship did not exist between the plaintiff and the defendant. The plaintiff suffered a serious fire which required the premises to be demolished. The defendants were liable in negligence for the diminution in value. The plaintiffs leased new premises and claimed for both the rental on the new building and the market cost of replacing the destroyed machinery. Again, both categories of property were income earning and the plaintiffs acted quickly to mitigate their loss of profit. The defendants tried to argue that the new lease gave the owners better premises than they had before the loss.
However, the Court of Appeal followed the Harbutts judgement in that betterment does not necessarily make an award excessive or subject to discount and it therefore did not sanction a reduction. The plaintiffs had not sought to enlarge or improve the old premises but had sought merely to find existing premises which matched their requirements. Whilst they gained in increased floor space, this had to be balanced against a saving in loss of profits and the cost of the new lease compared moderately with the annual loss of profits the plaintiffs would have sustained.
In the context of machinery, the defendants argued that the special reduced price paid by the owners for machinery prior to the loss should be taken as the measure of quantum of damages. However, the Court rejected this saying that the measure of recovery for second hand chattels was the cost of the replacement in an available market. Where second hand substitutes are not available the plaintiff can recover the cost of new ones. The machinery was only a few months old at the time and originally cost £13,000 but its replacement cost was £65,000. The latter figure was awarded as the correct measure of the cost of replacement.
(c) Machinery – Bacon – v – Cooper:
This case related to an action in contract for the cost of replacing a rotor of a fragmentiser following the defendant’s supply of incorrect metal for crushing. The fragmentiser broke during use and a new part was obtained but it had a life span of nearly 4 years more than the damaged part. The Court refused to make a reduction to reflect this on the basis that there was no second hand substitute of equivalent lifespan and it was stated that the plaintiff can recover the cost of a new item whenever this would not cause an “absurdity”. It was explained that this absurdity might arise where the destroyed plant had only a short outstanding life such as a few days.
It is important to note, therefore, that in relation to plant and machinery where a plaintiff can obtain a second hand item different considerations arise. This is a well-tried doctrine on the basis that the owner of a second hand car cannot replace it with a new one following damage. Of course, this principle is subject to the availability or existence of a second hand market. Some goods like the rotor are unobtainable and if the only possible replacement is to purchase new plant the full cost of buying it will be awarded. If the plaintiff can produce evidence that a second hand unit was unobtainable or indeed unacceptable or that a search for it failed or that the time spent in sourcing such a replacement would prove uneconomic then he will be awarded the full cost of replacement as new. Of course price is also relevant in that the cost of obtaining a second hand unit may exceed the cost of replacing it with a new unit.
Further considerations arise in the context of a replacement machine which is more efficient than the existing and produces what is referred to as “efficiency savings”. In British Westinghouse –v– Underground RY Co. (1912) the plaintiffs replaced defective turbines with ones different in make and design and which were more efficient than the original. The House of Lords held that the damages were to be reduced by the resultant savings. The difference between “efficiency” and increased life expectancy can probably be explained on the basis that in Westinghouse the savings take the form of greater efficiency reducing operating costs and thereby increasing profit. However, in Bacon the increased life expectancy translated to replacing the unit at a later date than which was originally anticipated and which is obviously more difficult to measure and which reinforces the principle of not forcing the plaintiff to invest additional resources.
A recent case of interest is Southampton Container Terminals Ltd., – v – Hansa Schittahrts (The Times 13th June 2001). The Claimants sought replacement of a crane destroyed by the negligence of the defendants and the amount sought was £2.3 million. At trial the Judge had awarded the re-sale value which was under £800,000 plus interest. The Claimant appealed and it was held that reinstatement of a working chattel should not be ordered where the benefit to the Claimant would be out of all proportion to his loss. The over-riding principle was that damages should be reasonable as between the parties and the original award i.e. the re-sale value of less than £800,000 stood. As ever this case demonstrates that each individual case will be considered on its own merits and that these issues are not always “black and white”.
The following is a “working” example where perhaps due to the negligence of the defendant fire or water damage is sustained to his neighbours, the plaintiffs property:-
EXTENT OF DAMAGE Structure / Buildings
Fixtures & Fittings
Contents Damage to roof timbers and slates.
Damage to decorative works, shelving and floor coverings.
Damage to normal household type of appliances including fridges, televisions, etc.
PROPOSALS Buildings
Landlords Fixtures & Fittings
Contents The structure may be over 50 years old and the slates and roof timbers are the original. Clearly it is not the intention of the owner to replace this aspect of the structure unless required. On the basis of the foregoing there is little merit for arguing wear and tear deductions.
Similar considerations would probably apply to fixtures and fittings such as shelving, fitted units, etc. The decorative work may have been reaching the end of its lifespan and in this respect measurable betterment could be argued but the issue is whether the owner should be forced to invest resources which he had not otherwise planned to invest.
The appliances may have been purchased recently in which no case for deductions can be made. Otherwise, they may have reached the end of their lifespan in which case deductions could be argued but again can the owner be forced to invest resources if prior to the loss the appliances were performing their function uninterrupted? Provided the damaged goods are replaced with the nearest equivalent in the market there can be no such argument.
Contract:
A subrogated action based on breach of contract should be viewed differently. The terms and conditions of the particular contract should be looked at as they may restrict or indeed extend the obligations of the parties to the contract and these conditions will be binding particularly in the
context of a commercial contract. Additionally, the implied conditions as outlined by the Sale of Goods Act 1893 – 1980 will be relevant. The property owner in which the cause or damage originated may have a right of recovery in contract against a contractor engaged on site and who caused the damage. Of course, there is no contractual nexus between the contractor and the owner of the adjoining property so that considerations will be in the context of tort only and perhaps statute. Otherwise damages in contract are intended to include losses which flow naturally from the breach of contract or are in contemplation of the parties (Hadley v Baxendale). Whereas in negligence damages are based on the test of reasonable foreseeability.
Summary:
It has occurred to us that the approach adopted in this country in relation to third party recoveries is out-moded and does not appear to have a legal basis. Claims handlers appear to adopt the wear and tear argument simply because this is the way it has always been. Whilst the details outlined by us are based entirely on our findings we have referred the matter for Counsels opinion and he stated that our findings are correct in principle and that whilst the situation in the U.K. may be persuasive it is not binding and it is for the Irish courts to determine the position in the event that a similar type case comes before the superior courts of Ireland.
In summary whilst the courts in this jurisdiction will deal with damages for injury to property on the basis of restitutio in integrum i.e. an attempt is made to place the plaintiff in as near as possible a position he enjoyed before the loss or damage, we feel the measurement in such cases is a matter for interpretation and discussion and the traditional approach should be challenged where appropriate.
It is hoped the foregoing is of interest and will generate some debate on the whole issue of third party recoveries. The views expressed are the opinion of the writer and we would welcome any contributions or conflicting arguments. As indicated we will issue further bulletins on related matters in due course.
References:
The Principal of Indemnity and its Application (R.M. Walmsley – CILA)
A Casebook of Irish Law (Michael Corrigan and John A. Campbell)
Legal Liabilities (with reference to Irish Law) (A.J. Peck & Michael MacNamee)
Insurance Law in Ireland (Austin J. Buckley)
Fire Insurance Law & Claims (Peverett – CILA)
Liability Insurance Claims (Kenneth Cannar)
Building Law Monthly (The Advisory Service For Specialists In Building and Construction Industries)
Public Liability Policies (J.P.P. Shaw)