The ZouZou – Banks and their coverage (or lack thereof) under MII policies

Introduction

Executive Summary

The High Court decision in Piraeus Bank AE v Antares Underwriting Ltd (and others) will be of interest to mortgagees and the marine insurance market. The Court clarified the extent of coverage under mortgagee interest insurance policies (MII Policies), confirming that they are secondary and so will not necessarily be the backstop mortgagees have assumed. MII Policy terms are not to be constructed in isolation; they are dependent on the primary War Risks Policy and will be interpreted in light of the purpose of MII insurance and good commercial sense.

Decision Synopsis

The judgment concerned the detainment of a ship for approximately 14 months in Venezuela.  It was held that this had not been unlawful under Venezuelan law and so was not a Constructive Total Loss (CTL).  As such, the detainment was not covered under the War Risks Policy.

Second, the judgment clarified that it is unnecessary for a bank to tender its own notice of abandonment under the MII Policy to establish whether and when a ship becomes a CTL under the MII Policy. 

Third, the MII Policy did not cover losses which would not have given rise to a loss covered by the War Risks Policy, where, for example, there was no CTL under the War Risks Policy, or the loss was excluded. The latter example is confirmed by the wording at the end of Clause 1(v) of the MII Policy which requires the loss not to be: “otherwise excluded from payment by any exclusion or other provision therein”.

Facts

The Claimant, Piraeus Bank A.E. (the Bank), was the mortgagee of the ship ‘ZouZou’ (the Ship), as well as the assured under a MII Policy. The thirteen defendants were the underwriters of the MII policy (the Insurers). The owner of the Ship was Doran Navigation Inc (the Owner).

The Ship was insured against war risks by the Hellenic Mutual War Risks Association (the Club), on Club Rules terms (the War Risks Policy). The War Risks Policy stated that the Club Rules and all contracts of insurance were subject to the Marine Insurance Act 1906 (MIA). The Bank was the assignee of the War Risks Policy, and the Ship was insured for a total value of US$55,000,000.

The War Risks Policy contained a deeming provision under Rule 3.14.2, whereby if the Ship was detained for more than 12 months, the Owner would be deemed to have been deprived of possession without any likelihood of recovery. The War Risks Policy also excluded losses arising out of action taken by any state authority on the grounds of any alleged contravention of the laws of any state.

On 16 August 2015, the Ship, which was being sub-chartered by Petróleos de Venezuela S.A., called at Puerto La Cruz, Venezuela to load a cargo of high sulphur diesel oil (HSDO). During the loading process, HSDO entered the Ship’s No. 6 cargo tanks, even though only tanks Nos. 1 and 2 were intended to be used. During an inspection on 22 August 2015, this irregularity was spotted, and as a result, later that day, the Venezuelan authorities arrested seven individuals.

Following an arraignment hearing, the Venezuelan criminal court ordered, pursuant to the 2012 Law Against Organized Crime Act (LAOC), that the Ship be made subject to “preventive seizure” on 27 August 2015 (the Detention Order).  This was on the grounds that it was used as a means to carry out alleged criminal activity of smuggling HSDO.  Eventually, on 17 October 2016, the Venezuelan court ordered that the preventive seizure of the Ship be lifted.

While the dispute over the preventative seizure of the Ship was ongoing, on 30 June 2016, the Owner made a claim for indemnity under the War Risks Policy for the actual total loss (ATL) of the Ship. The Club refused the Owner’s claim on several grounds, including that:

(a) the Owner had failed to give notice to the Club of the fact that the Ship had entered an Additional Premium Area (Venezuela) with the result that the Owner was not entitled to any recovery of any claim arising out of events occurring whilst the Ship was in Venezuela (Rules 25.1 and 25.4 of the Club Rules);

(b) The loss was excluded by Rule 3.5 of the Club Rules, in that the loss arose “out of action taken … under the criminal law of any state; or… on the grounds of any alleged contravention of the laws of any state ...”

On 3 October 2016, the Owner tendered its Notice of Abandonment to the Club, claiming an indemnity for a CTL of the Ship under the War Risks Policy, without prejudice to the validity of its contention that the Ship was already an ATL.

On 16 November 2016, the Owner served a further Notice of Abandonment to the Club (Second NOA), claiming an ATL or alternatively a CTL. 

On 23 November 2016, the Club rejected the Second NOA.

On 16 December 2016, it having become apparent that the War Risks Underwriters would deny liability for Owner's claim for ATL and/or CTL, the Bank brought a claim under the MII Policy.

The Judgment

Was the detention of the Ship excluded under the War Risks Policy?

Calver J accepted the Insurers’ submission that any loss caused by the detention of the Ship would have been excluded by Rule 3.5 of the Club Rules. The detention of the Ship was made under the LAOC, so under an ordinary and business-like interpretation of Rule 3.5.1 of the Club Rules, the Detention Order fell within Rule 3.5.1. 

The Bank had argued that, because the relevant articles under the LOAC did not legislate what constituted an offence, and permitted preventive seizure of assets owned by parties “without participation in [offences under the Act]”, the detention was not under but incidental to that criminal law. Calver J rejected this argument on the grounds that the preventative seizure occurred because it was alleged that the Ship had been involved in a conspiracy to smuggle fuel, a clear breach of Venezuelan criminal law. 

Calver J also rejected the Bank’s argument that Rules 3.5.1 and 3.5.2 presupposed that the owner of the insured ship had to be alleged to be guilty of an offence under the relevant criminal law. Not only was there nothing in the language of Rules 3.5.1 and 3.5.2 to indicate so, but The B Atlantic (No. 1) [2012] Lloyd's Rep IR 363 (The B Atlantic (No. 1)) had rejected a similar argument. The Bank failed to distinguish The B Atlantic (No. 1) on the grounds that the word “owner” appeared in the present clause (“An owner … is not insured for any loss”). Calver J held that the reference to the “owner” here was clearly a descriptive reference of the assured, rather than standing for the proposition that the owner is not insured for action taken against the owner (as opposed to, for example, the charterers or managers) under criminal law.

Calver J did acknowledge that if the Ship had been unlawfully detained under the laws of Venezuela, the detention would not fall within the scope of exclusion (even if there was a bona fide error in applying the law). However, Calver J found on the facts that the Ship was, at no point, unlawfully detained under the laws of Venezuela and that the actions of the Venezuelan authorities were unequivocally bona fide. 

Finally, Calver J also found that there was no CTL under section 60(2) of the Marine Insurance Act 1906.

Was there coverage under the MII Policy?

The Bank submitted that it could bring its claim within Clauses 1(i) and 1(ii) of the ‘Coverages’ section of the MII Policy.

The Clause 1(i) head

 Clause 1(i) provided cover if there was “prima facie” cover under the Owner’s Policies, but there was subsequent non-payment by the Underwriters of the Owner’s Policies, resulting from any act of the “Relevant Parties”, including any breach of warranty or condition or any misrepresentation or non-disclosure or alleged non-disclosure of any fact or circumstances.

The Bank submitted that Clause 1(i) was engaged as there was prima facie cover for the loss (a CTL) under the War Risks Policy, but the Club had not paid out due to the Relevant Parties’ alleged non-disclosure of the Ship’s entry into an Additional Premium Area (amongst other factors). The Bank argued that “prima facie” cover under the Owner’s Policies referred to the loss having been caused by an insured peril, without regard to any policy exclusions.

Calver J held that the term “prima facie” must be considered in its context. The term “prima facie” referred to loss, damage or liability which would have been covered by the Owner’s Policies – taking into account both the insured perils and the policy exclusions – but in respect of which there was no cover, or lost cover, because of the conduct of a Relevant Party (by reason of non-disclosure, misrepresentation, etc.). On the facts, he held that there was no prima facie cover since cover was excluded by Rule 3.5.1 and/or 3.5.2 of the Club Rules. Moreover, the Bank’s argument failed because there was no CTL of the Ship.

The Clause 1(ii) head

Clause 1(ii) provides for coverage to the Bank where the loss occurs “by virtue of any alleged deliberate, negligent or accidental act … of any Relevant Parties”.  The Bank argued that in contrast to Clause 1(i), this made no reference to coverage under “the Owners’ Policies” and was not expressed to be contingent on establishing prima facie cover thereunder. Thus, the alleged deliberate, negligent and/or accidental acts of Relevant Parties did not need to be the cause of a lack of cover under the War Risks Policy for Clause 1(ii) to be triggered. Clause 1(ii) looked not at the cause of the lack of cover for a loss which would otherwise be covered under the War Risks Policy, but at the cause of the Ship’s loss.

Calver J did not agree that Clause 1(ii) was so broad. He noted that the clause requires loss or damage “which occurs by virtue of any alleged deliberate, negligent or accidental act … of any of the Relevant Parties” (emphasis added). Calver J held that on any sensible commercial construction, the allegation referred to must have been an allegation which was made by the Owner’s insurers. This was because the purpose of the clause was to indemnify the Bank where the Owner’s insurers decline cover on the basis of their allegation that the loss of the Ship was caused by the Owner and/or other Relevant Parties. Therefore, the allegation of the prosecuting Venezuelan authorities of criminal conduct would not suffice. In the alternative, the Bank submitted that the cause of the detention was actual (not alleged) conduct on the part of the crew for negligently allowing HSDO into the No. 6 tanks. Calver J rejected this argument because first, it ignored the word “alleged” altogether, and second, if Clause 1(ii) did not require the making of an allegation, its scope would be extremely broad.

When considering how Clause 1(ii) operated, Calver J also held that it had to be read with Clauses 4(i) and (ii). Clause 4(i) provided that the indemnity payable under the MII Policy is limited to the amount not paid under the Owner’s Policies by reason of the “circumstances” specified in Clause 1. Clause 4(ii) provided that for the purposes of the MII Policy, there shall be deemed to be a non-payment by the Underwriters under the Owner's Policies after a reasonable period not exceeding 365 days from the date on which the Owner has demanded payment under the Owner’s Policies.

Whilst Clause 1(ii) did not expressly refer to non-payment by the Owner’s Underwriters, it described circumstances which were likely to result in a claim under the Owner’s Policies not being paid. If non-payment was not a pre-condition under Clause 1(ii), it would not have been a pre-condition in cases other than Clause 1(i) – which Calver J held was a decidedly uncommercial interpretation.

The Bank had argued that the wording of Clause 4(i)(a) meant that when there is cover under Clause 1(ii)), Clause 4(i)(a) does not apply. Calver J rejected this submission, noting that the clauses worked in tandem such that each of the sub-clauses 4(i)(a), (b) and (c) had to be applied to the claim in order to determine which is the least in amount. He held that if non-payment under the Owner’s Policies was not made due to any of the circumstances specified in Clause 1, there would not be any claim for an indemnity, thus it would be pointless to apply Clause 4(i). If Clause 4(i)(a) did not operate, any loss of or damage to the Ship would trigger an obligation to pay either the total indebtedness or the full sum insured, which would be uncommercial and contrary to the purpose of MII cover.

Since the Owner’s War Risks underwriters did not allege that the detention had occurred by virtue of any deliberate or accidental act or any knowledge of any of the Relevant Parties, Calver J held that Clause 1(ii) of the MII Policy was inapplicable.

Conclusion

The Court determined that the Bank was trying to expand the scope of the MII Policy, and to convert it from a secondary insurance contract into a primary insurance contract. In rejecting the Bank’s arguments, the common thread running through Calver J’s decision was that such arguments were “wholly uncommercial”. The judgment provides clarity as to the purpose and scope of MII policies. While this decision may not be welcomed by banks, it provides much-needed certainty as to the exact limits of coverage under MII policies.

This article was co-authored by Ernest Cheong, Trainee Solicitor - Ascendant Legal LLC.