What is “Damage” in Contract Works Claims?

This was a talk given to the Society of Construction Law on 28 September 2005.

Introduction

The purpose of this presentation is to comment on what is meant by damage for Contract Works Insurance claims. Although it sounds a straightforward concept, arguments over what constitutes damage have created a significant amount of litigation, both within the field of construction law and outside it. I will attempt to extract an appropriate test from that litigation to provide a working definition of damage. Of most interest to practitioners will be the important distinction between what is damage and what is a defect; damage being covered by insurance, and defects (and the effects of defects) being excluded to varying degrees. I will also review some of the cases on defect exclusions and introduce the standard defect exclusion wordings produced by the London Market.

Ordinary Rules of Construction

There is no doubt that the insurance industry has developed its only body of law and as a result there are aspects of insurance law which are particular to it. The best known example is the concept of utmost good faith. However it should be remembered that an insurance contract is just that, a contract, and it is generally subject to the normal rules of construction.1

The Ordinary Meaning of Damage – Promet Engineering v Sturge

It seems settled law that when construing an insurance policy, the term ‘damage’ should be given its ordinary meaning. This approach was adopted in the English Court of Appeal in Promet Engineering v Sturge.2 That case concerned a claim on an insurance policy relating to damage to an off-shore accommodation platform, which was built in Singapore.

The platform had three legs which were designed to extend and retract, so that the platform could be floated and towed into position. At their base, the legs passed through a steel box, which was designed to sit on the sea floor when the platform was in position. The steel box was called the ‘spud can’, which was strengthened by internal bulkheads and brackets and was designed to be watertight. The spud can was attached to the legs by welds. Fatigue cracking was discovered. The cracks were caused by the normal action of the waves. The cracks had started within the welds but had spread to the top plate and internal structure of the spud can. The cracks were such that the platform was in danger of collapsing. The cracks were repaired and the owners claimed on the insurance policy. It was found that the welds were not properly profiled and were therefore defective.

The Owners of the platform claimed on their insurance policy. The policy provided for an indemnity for damage to the platform. It also provided for an extension of the insurance cover for:

“any defective part which has caused loss or damage to the [platform].”

Insurers rejected the claim on the basis that there was no damage to the platform and succeeded at first instance. Tuckey J decided that the manifestation of the cracks was the result of a latent defect becoming patent and no damage had been suffered.

The Owners appealed and the Court of Appeal decided that there was damage within the meaning of the extension of the insurance cover. Hobhouse LJ said:

“It would be an abuse of language to describe the legs and spud cans as merely defective; on any ordinary use of language they were damaged. They were damaged by being subjected to stresses which they were unable to resist due to the latent defects, that is to say the wrongly profiled welds.”3

In most cases, whether there has been damage will be sufficiently obvious and therefore a general test of adopting an ordinary meaning of the word is appropriate. However this test does not assist in understanding what is meant by damage. We need to delve deeper into the concept.

The starting point for the ordinary meaning of any word is of course its dictionary definition. The Oxford English Dictionary definition of damage is as follows:

Harm or injury impairing the value or usefulness of something, or the health or normal function of a person

This Oxford dictionary definition was applied to define damage in two cases unrelated to insurance, which are the criminal case of R v Henderson & Batley4 and by Mance J in The Orjula.5

Ranicar v Frigmobile 6

A very similar definition, from a different edition of the Oxford dictionary, was also considered in the Australian case of Ranicar v Frigmobile. The court though in that case thought that this definition was not helpful on the basis that the use of the word ‘injury’ begs the question (that needs to be determined). In other words, by defining damage as an injury, the debate is not being taken much further.

Although not a construction case, the Ranicar decision does provide a useful analysis of the elements that constitute the definition of damage. The case concerns the transportation of scallops. The scallops were being shipped to a wharf in Melbourne and were destined for overseas export. However during a routine inspection in Melbourne, the scallops were found to have been stored at a higher temperature than prescribed by the relevant export regulations. In fact, the scallops could still be eaten, but under Australian regulations, they could not be exported. The owners of the scallops argued that they were damaged by the fact they could not be exported and claimed on their insurance.

The court agreed with the owners. In doing so, Green CJ adopted what he described as ‘ordinary meaning of the word damage‘. He said that damage required:

“a physical alteration or change, not necessarily permanent or irreparable, which impairs the value or usefulness of the thing said to have been damaged.”7

The court said that the alteration in temperature had ‘undeniably involved a physical change to a substance and that change had the effect of removing one of the primary qualities which the scallops had – their exportability‘.8 A change in temperature in itself was ‘a physical change’9 and the scallops were less valuable in the sense that they could not be exported.10

Test for Damage

The Australian Ranicar decision provides some useful guidance as to what is damage. There are two parts to the definition of damage from Ranicar, which are as follows:

(a) A need for a physical alteration – In the Ranicar case, the change in temperature was sufficient to satisfy this part of the test.
(b) The second part of the test is that the damage must impair the value or usefulness of the property.

The English cases do not expressly apply this two-part test. However an analysis of those cases suggests that it is in fact generally applicable.

1. Need for Physical Alteration

There are two recent product liability cases that demonstrate what is meant by physical alteration.

Bacardi v Thomas Hardy Packaging 11

The first case is Bacardi v THP and concerns the manufacture and bottling of Bacardi Breezers. The facts are that Thomas Hardy Packaging (THP) agreed with Bacardi to bottle Bacardi Breezers. One of the ingredients is carbon dioxide, which THP bought from Messer. Unfortunately, a batch of carbon dioxide was contaminated with benzene. Benzene is a chemical which can cause cancer in sufficient quantities, although it was made clear in this case that the level of the contamination in the carbon dioxide did not represent a health hazard.

However, Bacardi did not wish to take any chances and organised a major product recall, which cost £2.125 million. Bacardi recovered those costs from THP who in turn sought recovery from Messer. The contract between THP and Messer included a limitation of liability clause which stated that:

the liability of Messer…in respect of…direct physical damage to property… whether through negligence or otherwise, shall be limited to £500,000 in respect of any one incident.

Messer sought to rely upon the limitation of liability clause. THP argued that the loss incurred did not amount to “direct physical damage” so that the limitation of liability did not apply. The issue, which is relevant to our discussion, is whether the contamination of the Bacardi Breezer by benzene constitutes “direct physical damage to property”.

The Court of Appeal decided that the addition of the contaminated carbon dioxide did not constitute damage. Mance LJ, with whom the other two judges agreed, said:

Although there were ingredients owned by Bacardi which were separate from the defective carbon dioxide and water supplied by THP, THP’s activity involved creating a new product by mixing all of these elements. The new product was not damaged, but merely defective at the moment of its creation.12

Applying a Ranicar analysis, the property cannot be considered to have gone through a physical alteration until it is complete. In this case, the defects occurred before the property was complete and consequently did not undergo damage. Specifically, there was no evidence that the introduction of the benzene had altered the characteristics or effected a physical change in the concentrate or the water.

The legal discussion in the Bacardi case is very interesting. In coming to his conclusions, Mance LJ considered at length the House of Lords decision in Murphy v Brentwood.13 The House of Lords decided in Murphy that the loss suffered by a purchaser of a defectively constructed building is economic rather than physical loss, in circumstances where the defect was discovered before any injury to person or damage to property had been done. This is because the purchaser simply has bought less than he had bargained for. Relevantly the House of Lords rejected the ‘complex structure’ theory.14 The complex structure theory seeks to argue that defects in one part of a building (which in the case of Murphy was the foundations) could be said to have damaged another part of it. Although not expressly stated, in coming to the conclusion that the Bacardi was not damaged, Mance LJ appeared to apply the reasoning of the House of Lords in Murphy. The loss suffered in Bacardi is not physical damage, but economic loss.

Commentators have criticised the Bacardi judgment. For instance, what if one of the defective ingredients in a drink was glass particles or alternatively what if a contaminant was deliberately added to the drink prior to its final creation? On a Bacardi analysis of ‘damage’, these sorts of claims may not fall within the insuring clause at all.

Parallels can be drawn between the Bacardi case and claims for damage in the construction industry. For instance, will the addition of an inappropriate admixture into concrete constitute damage or the production of defective concrete? On the Bacardi analysis, the addition of an inappropriate admixture would presumably result in the production of a defective product rather than damage.

On the brighter side for contractors, there could be arguments that the addition of an inappropriate admixture has caused loss or damage to the constituent elements of concrete, for instance the reinforcement. In Bacardi, the Court of Appeal considered a similar argument in respect of the ingredients of the Bacardi Breezer. It was rejected on the basis that the loss pleaded arose from the uselessness of the finished drinks and from the recall. As Mance LJ put it, “The real complaint relates to the finished product”15 not to the ingredients. However claims for constituent parts remain open if losses can be identified.

Pilkington v. CGU Insurance 16

The second case rose out of the installation of heat-soaked toughened glass panels manufactured by Pilkington and installed in the roof and vertical panelling of the Eurostar Station at Waterloo, London. The glass panels were defectively manufactured and fractured after they were installed. Luckily no one was hurt. To prevent further fractures, Eurostar elected to put into place safety features including the installation of transparent material. Eurostar sued the main contractor, Tarmac, who in turn sued Pilkington. Pilkington ultimately settled by paying in excess of £1 million in damages and costs.

Pilkington claimed against its product liability insurance provided by CGU. The CGU Insurance covered liability for:

Loss of or physical damage to physical property not belonging to the Insured…caused by any commodity, article or thing supplied by the Insured.

The Insurers rejected the claim and ultimately the insurance claim went to the Court of Appeal.

To succeed with the claim, Pilkington had to show that there was loss or physical damage within the meaning of the insuring clause. It was accepted by Pilkington that there was no physical damage to any part of the terminal apart from the failure of the glass itself. Pilkington’s claim was that:

  1. the terminal itself was physically damaged by the very installation of the glass panels, because the glass was defective and potentially dangerous;17 and
  2. damage in fact occurs before any breakage. The existence of the defect, it was submitted, which requires substantial work to extract and repair it, renders the building a damaged building.

The Court of Appeal rejected this argument. It held that the incorporation of the defective glass itself cannot be considered as damage to property. The insurance contract required physical damage to property of another. Potter LJ said:

Damage requires some altered state…it will not extend to a position where a commodity supplied is installed in or juxtaposed with the property of a third party in circumstances where it does no physical harm, and the harmful effect of any later defect or deterioration is contained within it.18

Temporary Damage

It will be recalled that the test in Ranicar was that the damage did not need to be permanent or irreparable for it to be actionable. In the case of The Orjula,19 a ship’s deck was found to have been damaged when Hydrochloric acid was spilt onto it.20 The acid was neutralised by the addition of soda and then washed off. In fact, it was not pleaded that there was an actual ‘alteration’ of the deck21and perhaps therefore this case sits on the borders of what can be considered ‘damage’. However the Court of Appeal had no hesitation in deciding that acid contamination in itself constituted damage.

2. Impairs the Value or Usefulness

The second part of the Ranicar test is that the physical alteration must impair the value or use of the property. This is a consistent theme in all the approaches to damage, including within the definition within the Oxford English Dictionary.

In Hunter v. Canary Wharf,22 the Court of Appeal considered whether the deposit of dust could constitute damage for the purposes of a nuisance claim. Pill LJ, with whom the other two judges agreed, said:

‘Damage is in the physical change which renders the article less useful or less valuable.23

In agreeing that the deposits of excessive dust can be considered damage, Pill LJ said:

‘Reasonable conduct and a reasonable amount of cleaning to limit the ill effects of dust can be expected of householders. Subject to that, if, for example, in the ordinary use the excessive deposit is trodden into the fabric of a carpet by householders in such a way as to lessen the value of the fabric, an action would lie. Similarly if it follows from the effects of excessive dust on the fabric that professional cleaning of the fabric is reasonably required, the cost is actionable.’

In The Orduja, clearly the ship could not be used until it was decontaminated. The Court of Appeal considered that the fact that the property in question required the expenditure of money to restore the property to its former usable condition was material.24

Financial Loss as a Result of Damage

In order to claim under an insurance policy, the damage must eventuate in financial loss,25 usually in the form of expenditure to repair, reinstate or replace the damaged property. Financial loss will normally be self evident from the fact that the damage has impaired the value or use of the property. However this will not always be so and where the damage does not cause financial loss, the insurance claim will not succeed. This is neatly demonstrated by the recent decision of AMEC Civil Engineering Limited v Norwich Union Insurance Society Limited.26

In July 1993, AMEC was appointed as the contractors to carry out reclamation works in Jersey. As part of these works, AMEC was required to construct a sea wall from reinforced concrete blocks. The specification required the concrete to cover the reinforcement by 75mm. The blocks were cast in a mould at a pre-cast yard and progressively incorporated into the sea wall. During the course of the progress of the construction of the sea wall, random checks were carried out at the pre-cast yard, which showed that the concrete cover over the reinforcement in some of the blocks was less than 75mm. Further by May 1994, six of the installed blocks showed signs of rusting.

By May 1994, 617 blocks had been manufactured and 348 blocks had been installed. The 348 installed blocks were tested and a large number had concrete cover of less than the specified 75mm. Of this total, 104 blocks were identified as having less than 50mm of cover and Jersey required AMEC to replace these 104 blocks. These included three of the blocks, which showed signs of rusting. It was not in dispute that the cause of the lack of the specified concrete cover was that the reinforcement cage had moved during the casting process.

AMEC sought to claim on its insurance policy for the cost of replacing the 104 blocks. The insurance policy covered:

‘loss of or damage to the Insured Property arising from any cause whatsoever except as hereinafter provided.’

Exclusion 3 excluded:

Loss of or damage to and the costs necessary to replace, repair or rectify that part of the permanent works which is in a defective condition due to a negligent design, plan, specification, materials or workmanship.

Not surprisingly the Insurers relied upon exclusion 3. The Insurer’s argument was that the blocks were not damaged or lost, they were simply badly built.

AMEC had three arguments:

  1. that the blocks sustained loss as a result of negligent manufacture, but this argument was abandoned by the time of written closing submissions;
  2. rust marks on the blocks constituted loss or damage and further that, on the balance of probabilities, corrosion had already commenced within the reinforcement of the other blocks, albeit that rust marks had not yet become visible; and
  3. that blocks that were broken out and replaced became lost and/or damaged.

The second argument was obviously not causative of the need to replace the blocks given that only three of the six blocks with rusting were replaced. It was therefore rejected by the court.

AMEC’s third argument became its primary case by the time of the written closing submissions. AMEC’s argument was that:

  1. The blocks were broken out and replaced pursuant to a contractual obligation to Jersey.
  2. AMEC did not act maliciously in damaging the blocks;
  3. Although AMEC’s claim would be excluded if the need to replace the blocks resulted from negligent design, plan, specification, materials or workmanship, in this case the need to replace the blocks stemmed from defective manufacture which was not excluded.

Seymour J found against AMEC. He said that:

In my judgment, it is quite plain on proper construction of the principal insuring clause in the Policy that it did not extend to providing to AMEC an indemnity in respect of the cost of replacing items manufactured by AMEC which are defective.

Interestingly, Seymour J held that even if it could be said that the blocks were damaged as a result of being broken out, it was not that damage which caused any financial loss to AMEC. AMEC’s financial loss stemmed from installing defective blocks in the first place ie the damage caused no financial loss.

Seymour J’s view was as follows:

However, on the assumption that there was in fact damage caused [during the removal of the blocks], any financial loss was clearly caused at the point at which the need to remove the Block subsequently arose, namely when it was incorporated in the Wall. The damage which [the Plaintiff’s Counsel] ultimately put forward as AMEC’s main case was quite simply not damage in respect of which there can be any liability to indemnify under the Policy because that damage itself caused no financial loss.

Defects

Normally, to some extent loss caused by defective workmanship or design is expressly excluded. The wordings of the defect exclusions however do vary remarkably and subtle differences in drafting can have a dramatic effect. The following exclusion is taken from a contractor floater policy.

Insurers shall not be liable for:

(i) in respect of Building contracts …

(a) the cost necessary to replace, repair or rectify any Subject Matter Insured which is defective in design, plan, specification, materials or workmanship.

The London Insurance Market has issued standard wording for defect exclusions. This standard wording is numbered from 1 – 5 and the extent of the exclusions ranges from an outright defect exclusion (DE1) above to what is called a design improvement exclusion (DE5). This excludes purely the cost of improving the design and all costs of loss or damage caused by a defect are covered. The full wording of all five of these exclusion clauses is attached as an appendix to this paper.

The London Market Defect Exclusion 1 (“DE 1″) states:

This policy excludes loss of or damage to the Property Insured due to defective design, plan, specification, materials or workmanship.

Note neither exclusion refers to defective manufacture, leaving open a possible variant on the AMEC argument.

These two exclusions have slightly different approaches. The first one excludes the cost of defects, whereas DE 1 excludes loss or damage due to defects. It is questionable, given the current state of the case law, whether the first exclusion acts to exclude anything at all. It can only do so if a ‘defect’ can fall within the Insuring clause wording of ‘loss of or damage to property’. If a part of the works is inherently defective then it does not go through a physical alteration required to come within the definition of damage.

The distinction between damage and defects was considered at length in the Bacardi decision. A defective product is something which is defective from the moment of creation, whereas a damaged product suffers an alteration in state. The distinction was confirmed in a construction context (but without any lengthy analysis) by the English Court of Appeal in Skanska v Egger.27 However I suspect that we will continue to see a general defect exclusion included in any ‘belt and braces approach’.

Defect Exclusions

Often, exclusions will seek to exclude defects but not consequential damage caused by them. It is these exclusions that have generated some interesting cases, particularly in Australia. One of the issues facing insurance claims is that the insurance policies are examined in minute detail despite the fact that there is often a lack of precision in the drafting and almost invariably a failure to tailor policy wordings to specific construction projects. In the Insurance industry, the intent behind the policy may have more significance than the language used within it.

Despite this however the courts’ approach is to examine the effect of every word and further interpret each provision within the context of the contract as a whole.28 The leading English case on the interpretation of defect exclusions is an example of this. This case is the Court of Appeal decision of Cementation Piling v Aegon,29 which concerns an insurance claim relating to the construction of a dock at Barrow-in-Furness.

Cementation was the subcontractor responsible for the construction of a diaphragm wall. The wall was constructed to protect a land area called a berm. Unfortunately, there were voids and gaps in the wall which meant that the sand escaped from the land area into the newly built dock. It was also discovered that there were gaps and voids between adjacent panels which had permitted the sand to escape.

Cementation claimed on its CAR policy. It alleged that it suffered the following losses:

  1. rectification of the gaps and all voids in the diaphragm wall;
  2. the removal of sand fill from the dock bed;
  3. grouting and filling behind the diaphragm wall of the voids caused by the escaping sand.

The insurance contract included the following insurance clause:

Insurers will indemnify the insured for any amount not exceeding the limit of indemnity in respect of physical loss of or damage to the property insured howsoever caused occurring during the period of insurance and arising from any cause whatsoever except as hereinafter mentioned.

The CAR insurance also included the following exception:

The Insurer shall not be liable in respect of…

(2) the cost of replacing or rectifying the defects in design, materials or workmanship unless the property insured suffers actual loss, destruction or damage as a result of such defect. However, additional costs of introducing improvements, betterments or corrections in the rectification of the design, material or workmanship causing such loss or damage shall always be excluded.

The insurer agreed to pay for the costs of removing the sand and the backfilling of voids caused by the escaping sand, but refused to pay for the rectification costs for the diaphragm wall repairs. The insurers had two arguments, which were:

  1. The walls were not damaged but were defective in their original state. Therefore, they did not fall within the insuring clause.
  2. Where the walls were defective, the indemnity does not cover the defective rectification costs. This was clear from the last sentence of the defect exclusion.

Perhaps somewhat surprisingly, the Court of Appeal decided for the insured. This case helps to demonstrates how closely the court examined the wording of the insurance contract. The court’s reasoning was as follows.

1.  The insurance clause was widely drafted. It included not only an indemnity of physical losses or damage but “in respect of physical loss or damage”. The use of the words “in respect of” normally implies a wide search for a connection. Sir Ralph Gibson who gave the leading judgement said that:

It is possible, I think, to regard the cost of rectifying a defect which caused the physical damage as cost incurred ‘in respect of physical damage.30

2. Importantly, the court decided that “it would be impossible to repair the damage which the insurers had agreed to pay without also repairing the diaphragm wall”.’
3. The exclusion clearly stated that it excluded the costs of defects unless the property insured suffers actual loss, destruction or damage as a result of the defect. Therefore defects are covered if actual damage is suffered as a result of those defects.
4. Finally the Court of Appeal used the wording of the exclusion clause to assist in interpreting the scope of the insuring clause. It decided that the actual wording used, which was that:

‘additional costs of introducing improvements, betterments or corrections in the rectification of the design, materials or workmanship causing such loss or damage should always be excluded’31

suggested that there might be costs other than the betterment costs incurred in connection with the rectification of the design, materials or workmanship which were not excluded. In this case, it was conceded by the insurers that rectification would not produce a better structure than originally designed or intended. Therefore, the costs involved in rectifying the diaphragm walls without any improvement or betterment, must be included. The drafting which helped to defeat the insurers was the drafting which they expected to help them.

I said that this decision is somewhat surprising. What is more surprising is that Sir Ralph Gibson acknowledged that it may be that the interpretation given by the court extends the indemnity beyond that which insurers intended to undertake.32 However on the construction of the policy wording in front of him, he had no doubt that the policy imposed liability on insurers.’

Applying Defect Exclusions

One feature common in the interpretation of defect exclusions is a need to identify a part of the insured property which is defective causing damage to another part of the insured property. Often the defect itself will be excluded but any consequential damage caused by the defect to other parts of the Works will be included.

However, as Hobhouse LJ pointed out in Promet Engineering, part is capable of being used in a whole variety of ways depending on the context33 and this is where the difficulty lies. For instance, in the Australian case of Graham Evans v Vanguard Insurance,34 coats of paint were held to be damaged after it was discovered that the primer was too thin and therefore defective. The cost of the damage to the top coats caused by the defective primer was held to be covered by the insurance contract.35 However in the case of Skanska v Egger, Mance LJ dismissed out of hand any attempt to claim that a defective sub-base to the flooring could be considered to have caused damage to the floor above. Mance LJ said:

That argument attempts to divide the indivisible. I see no prospect of any Court accepting that the sub-base damaged the rest of the slab above it 36

The approach which appears to have been adopted by the courts is a commonsense approach. In Promet Engineering, the court was requested to consider whether a defective part, in that case the weld, had caused damage. Hobhouse LJ said:

‘The submission based upon the use of the word “part” is in my judgement open to…objections. It leads to absurd results. It provides no criterion for distinguishing between what is and what is not damage. The suggested criteria – what can be physically separated, what performs a separate function – are not derived from anything contained in the clause.’

Instead, Hobhouse LJ was content to apply a test of ‘obviousness’. To some extent therefore we are back where we started. Although we have been able to dissect the ordinary meaning of the word “damage”, when we apply a defect exclusion we must rely upon the obviousness of what constitutes a part.

There are though some obvious remarks that could be made to assist in the application of a defect exclusion.

1.  Causative connection – generally there is a need to show a causal link between the defect and the consequent damage. In Promet Engineering, the latent defect in the weld caused the damage to the spud can.37

2.  Complex structure theory – Tests derived from complex structure theory could also have same relevance. These tests could include the following.

  1. Function – There could be some benefit in identifying a part of the works on the basis of its self standing function. In Walker Civil Engineering v Sun Alliance38 the Contractor claimed for water damage to machines within a tank, after the tank leaked. The court rejected the claim on the basis that a tank or a gasket could not be considered a separate part. This was because the machines in the tanks were useless unless the tanks were free of defects. However, a similar analysis was not accepted in Promet Engineering on the basis that it could not be supported by the wording of the policy.39
  2. Subcontractor – If different subcontractors were responsible for the defective works and the damaged works, then that is an obvious divide. This was one approach left open by Lords Keith and Jauncey in Murphy v Brentwood.40
  3. Contract Provisions – Similarly, if the defective and damaged parts of the Works are set out in separate parts of the specification or the Bill of Quantities, then again there is support for an argument that they should be considered separate parts.

It must be stressed however that any approach which adopts a complex structure theory approach could be open to criticism following the Promet Engineering and Skanska v. Egger decisions.

3.  Avoid artificiality – The final point that needs to be made is that any argument needs to avoid any artificial divide behind the defect and the consequential damage. This is inherent in any approach dependent upon the application of common sense. As Mance LJ said in Skanska, any attempt to divide the indivisible will not be accepted.

Appendix – London Market Design Clauses

DE 1 Outright Defect Exclusion

This policy excludes loss of or damage to the Property Insured due to defective design, plan, specification, materials, or workmanship.

DE 2 Extended Defective Condition Exclusion

This policy excludes loss of or damage to and the cost necessary to replace, repair or rectify

(a) Property Insured which is in a defective condition due to a defect in design, plan, specification, materials, or workmanship of such Property Insured or any part thereof
(b) Property Insured which relies for its support or stability on (a) above
(c) Property Insured lost or damaged to enable the replacement, repair or rectification of Property Insured excluded by (a) and (b) above

Exclusion (a) and (b) above shall not apply to other Property Insured which is free of the defective condition but is damaged in consequence thereof.

For the purpose of the Policy and not merely this Exclusion, the Property Insured shall not be regarded as lost or damaged solely by virtue of the existence of any defect in design, plan, specification, materials, or workmanship in the Property Insured or any part thereof.

DE 3 Limited Defective Condition Exclusion

This policy excludes loss of or damage to and the cost necessary to replace, repair or rectify

(a) Property Insured which is in a defective condition due to a defect in design, plan, specification, materials, or workmanship of such Property Insured or any part thereof
(b) Property Insured lost or damaged to enable the replacement, repair or rectification of Property Insured excluded by (a) above

Exclusion (a) above shall not apply to other Property Insured which is free of the defective condition but is damaged in consequence thereof.

For the purpose of the Policy and not merely this Exclusion, the Property Insured shall not be regarded as lost or damaged solely by virtue of the existence of any defect in design, plan, specification, materials, or workmanship in the Property Insured or any part thereof.

DE 4 Defective Part Exclusion

This policy excludes loss of or damage to and the cost necessary to replace, repair or rectify

(a) Any component part or individual item of the Property Insured which is defective in design, plan, specification, materials, or workmanship
(b) Property Insured lost or damaged to enable the replacement, repair or rectification of Property Insured excluded by (a) above

Exclusion (a) above shall not apply to other Property Insured which is free of the defective condition but is damaged in consequence thereof.

For the purpose of the Policy and not merely this Exclusion, the Property Insured shall not be regarded as lost or damaged solely by virtue of the existence of any defect in design, plan, specification, materials, or workmanship in the Property Insured or any part thereof.

DE 5 Design Improvement Exclusion

This policy excludes

(a) The cost necessary to replace, repair or rectify any Property Insured which is defective in design, plan, specification, materials, or workmanship.
(b) Loss or damage to the Property Insured caused to enable replacement, repair or rectification of such defective Property Insured.

But should damage to the Property Insured (other than damage as defined in (b) above) result from such a defect, this exclusion shall be limited to

  • the costs of additional work resulting from
  • the additional costs of improvements to the original design, plan, specification, materials, or workmanship.

For the purpose of the Policy and not merely this Exclusion, the Property Insured shall not be regarded as lost or damaged solely by virtue of the existence of any defect in design, plan, specification, materials, or workmanship in the Property Insured or any part thereof.

1.Smith v Accident Ins Co (1870) LR 5 Ex 302. See generally Clarke – The Law of Insurance Contracts at 15-1.
2.[1997] 2 Lloyds Rep 146.
3.ibid per Hobhouse LJ at page 156.
4.Unreported 29 November 1983.
5.[1995] Lloyds LR 395 at page 399.
6.[1983] 2 ANZ Ins Cas 60-525.
7.per Green CJ at page 78.
8.per Green CJ at page 78.
9.There were submissions made that the change in temperature caused enzymic activity and chemical oxidation. However the court found that these matters did not constitute damage in that they did not affect the marketability, edibility or other material qualities of the scallops.
10.See also Axa Global Risks (UK) v Haskins Contractors Pty Ltd [2004] NSWCA 138.
11.[2002] 2 Lloyd’s Rep 379.
12.ibid per Mance LJ at page 386.
13.[1991] 1 AC 398.
14.ibid – see for instance Lord Keith at page 470C-G.
15.per Mance LJ at page 386.
16.[2004] BLR 97.
17.Pilkington relied upon the US cases of Sturges Manufacturing Company v Utica Mutual Insurance Company 371 NYS 2d 444 (NY 1975) and Maryland Casualty Company v W R Grace & Company 23 F 3d 617 (CA2 1993).
18.[2004] BLR 97 at page 107. It should be noted that in Austral Plywoods v FAI General Insurance Co Ltd (1992) 7 ANZ Ins Cas 61-110 the suppliers of plywood that was installed into the hull of a boat, partly succeed with a similar argument. In that case, the Court of Appeal in Queensland decided that any affixation of plywood to a hull by means of screws and glue causes physical injury to the hull.
19.[1995] 2 Lloyd’s Rep 395.
20.See also King v Lees (1949) 65 T.L.R 21 where it was held that a passenger urinating in a taxi ‘injured’ it despite the fact that the taxi could be restored to its original condition with no residual effect.
21.although the survey report did attest to the corrosive nature of the Hydrochloric acid.
22.1996 1 ALL ER 482.
23.ibid at page 499.
24.[1995] 2 Lloyds Rep 395 per Mance L at page 399. A similar approach was taken in R v Henderson and Batley (1984), where the Defendants were found guilty of recklessly or intentionally damaging a development site by using it as a rubbish tip.
25.The Orjula: [1995] 2 Lloyds 395.
26.[2003] EWHC 1341
27.[2002] BLR 236.
28.Royal & SunAlliance v Dornoch [2005] 1 C.L.C. 466. Longmore, J said: “There are dangers in judges deciding what the parties must have meant when they have not said what they meant for themselves. This is particularly dangerous when the parties have selected from the shelf or the precedent book a clause which turns out to be unsuitable for its purpose. The danger is then intensified if it is only one part of such a clause which is to be construed in accordance with business commonsense.”
29.[1995] 1 Lloyd’s Rep 97.
30.1 Lloyd’s Rep 97 at page 102.
31.ibid at page 98.
32. Per Sir Ralph Gibson at page 102. A further example is the Hong Kong decision of Dragages v RJ Wallace [2004] HKEC 266 where the obvious intentions of the insurers in excluding liabilities to employees from a third party liability policy were similarly ignored.
33.[1997] 2 Lloyd’s Rep 146 at page 147.
34.(1986) 4 ANZ Ins Cas 60-689.
35.Although this case was considered to be the high-water mark for the division of the Works into parts, it was recently cited with approval by the New South Wales Court of Appeal in AXA Global Risks v Haskins [2004] NSWCA 138.
36.[2002] BLR 236 at page 243.
37.[1997] 2 Lloyd’s Rep 146.
38.[1999] 10 ANZ Ins Cas 61-418.
39.See above.
40.[1991] 1 AC 398.