High Court holds subcontractor liable for settlement monies paid out by contractor despite arguments on causation and remoteness - Siemens Building Technologies FE Ltd v Supershield Ltd [1.5.09]

On 9 October 2001, a nut and bolt connection on a float arm failed and water from a storage tank overflowed into the tank room of a new office building. The water then escaped from the tank room, leading to a flood, which caused extensive damage to electrical equipment in the building.

The owner and occupier of the building brought a claim against the contractor, who in turn issued a claim against the mechanical and electrical subcontractor. Siemens was then joined to the proceedings, as it had contracted with the mechanical and electrical subcontractor to install the sprinkler system. Likewise, Siemens then joined Supershield to the proceedings, as it had contracted with Siemens to install part of the sprinkler system.

Siemens alleged that, in the context of the sub-contract, “the sprinkler system” included the ball valve float arm that operated inside the fire sprinkler water tank (which was installed by a separate company) to regulate the water level. Supershield disputed that the scope of its works included the float arm and denied having installed it. In any event, Supershield maintained that the cause of the damage was not the escape of water from the tank but rather the escape of water from the tank room, which it attributed to the blocking of drains and failure to monitor alarms, which it argued was too remote to be recoverable under the sub-contract.

Siemens settled the Claimants’ claims and other claims for contractual indemnity up the contractual chain. It then pursued Supershield to recover those settlement monies.

Decision
The High Court found that, notwithstanding some probable confusion in the description of the scope of works in the sub-contract, Supershield was obliged to fit the ball valve.

The Judge dismissed the evidence of Supershield’s foreman that Supershield had not fitted the float arm.

Finally, Supershield argued that it had clear defences on remoteness of damage and causation and that the value of those defences (which had also been available to Siemens) was insufficiently reflected in the settlements agreed by Siemens up the contractual chain. The room from which the water escaped was equipped with three drains, all of which were blocked at the time of the flood. Furthermore, an alarm system designed to indicate any water escape from the tank was either ignored or not monitored at the time of the incident. Finally, there was a 600mm waterproof bunding above floor level in the tank room that was only exceeded because of a lack of response to the flood.

To be recoverable at law, the relevant damages had to be within the contemplation of the parties within the first rule of Hadley v Baxendale [1854].

The tank room where the flood occurred had been designed to prevent any damage occurring due to water escape from the tanks and a similar set of circumstances conspiring to cause such damage had never been encountered by either of the expert witnesses.

In Koufos v Czarnikow Ltd (The Heron II) [1967], Lord Reid stated that, “… a result which, though foreseeable as a substantial possibility, would only happen in a small minority of cases should not be regarded as having been in their contemplation.”

However, the Judge observed that, “Drains block or drain pumps malfunction, building management systems do not operate or warnings are not acted upon and maintenance is not always effective.” He then concluded that, “… the probable result of a breach of contract [by Supershield] in failing properly to install the nut and bolt would be that there would be an escape of water through the overflow which would, according to the usual course of things, cause a flood and lead to water damage.”

Supershield was, therefore, found liable to Siemens for breach of contract and the Court considered that, as a matter of causation and remoteness, Siemens could recover from Supershield the sums paid to settle the claim.

Comment
Having found that Supershield had contracted to fit and had fitted the float arm, the Judge took a wide view of what damage would be considered to be within the contemplation of contracting parties. The High Court was of the view that the subject damage was the “probable result” of the breach of contract and the damage that ensued occurred in “the ordinary course of things”.

A party claiming indemnity or damages for settlements it has paid “up the chain”, must establish a) that it would have been liable to the party claiming from it and b) that the measure of settlement was reasonable.

Courts are reluctant to examine closely or criticise a settlement achieved with the benefit of professional advice. This is understandable given that:

• When it finds a settlement was unreasonable, it appears to have no power to award damages based on its assessment of what would have been a reasonable settlement - instead the claim fails altogether.
• To interfere with bona fide settlements would discourage parties from settling up the chain for fear of finding the sums they paid out irrecoverable “down the line”.

An application for permission to appeal has been made to the Court of Appeal.

For further information contact William Evans, Kennedys, 020 7667 9366.

Kennedys set precedent with first court decision on the construction of a drop down clause - Flexsys America LP v XL Insurance Co Ltd [20.5.09]

Flexsys manufactures, distributes and sells 6PPD, a chemical used in the manufacture of rubber car tyres. Allegations were made against it that, along with others, it engaged in an unlawful conspiracy to monopolise the US 6PPD market, hampering fair competition from a Korean company, KKPC.

Flexsys had an international master policy with XL, covering public and products liability insurance, and a local policy with XL Select in Ohio, having limits of indemnity “in the annual aggregate” of US$25 million and US$1 million respectively.

When KKPC sued, Flexsys demanded an indemnity from XL Select under US-style “personal and advertising injury” cover and, because of the onerous “duty to defend” laws, XL Select secured a settlement with Flexsys, which exhausted the local policy.

Although the master policy was narrower than the local policy, Flexsys then sought an indemnity of up to US$25 million from XL, basing its claim on a drop down clause in the master policy.

Policy wording

The master policy provided that:

“In the event of partial exhaustion of a local policy this Policy will pay in excess of the reduced underlying Limit of Indemnity

“In the event of total exhaustion of a local policy this Policy will continue in force as the underlying insurance subject to the terms Exceptions and Conditions of the particular local Policy.”

Flexsys contended that the second sentence meant that, for any claim in excess of US$1 million, the master policy dropped down, providing up to US$25 million of cover, subject only to the terms of the local policy – except the US$1 million indemnity limit.

XL’s interpretation was that, in the event of partial or complete exhaustion of the underlying limit, the master policy would drop down to prevent a lacuna in cover for later claims, providing cover generally on its terms but reinstating the local policy subject to its terms - including limits - for claims following the one which exhausted the local indemnity limit.

Decision
The High Court held that XL’s construction was correct. To have succeeded, Flexsys would have needed to persuade it that the drop down clause was, effectively, a “reverse Difference In Conditions” provision, that is one requiring that cover be provided on the terms of the local policy if those were wider than those of the master, but it failed to do so.

XL’s construction was also preferred on the basis that it did not require an unnatural reading of the latter part of the second sentence, involving the exclusion of just the local policy indemnity limit. This meant the word “exhaustion” had a consistent meaning throughout.

Interestingly, the Judge also held that, notwithstanding any excess in the local policy, the master policy excess clause took effect before cover was provided. Accordingly, there is always a lacuna in cover at the point of attachment.

Comment
This is the first English decision on the construction and effect of a drop down clause, and emphasises the need for careful drafting to ensure that the terms of the master policy are not ousted.

Kennedys acted on behalf of XL in this matter. Leave to appeal has been sought by Flexsys.

For further information contact David Philip, Kennedys, 0207 667 9247.

“WD Fairway”, a mega-size trailer hopper dredger, became a constructive total loss (CTL) as a result of a collision off the coast of China. The vessel had hull and machinery cover written in two layers: primary hull and machinery cover was written by seven companies (primary underwriters), whilst excess cover was underwritten by the 15 Claimants.

Westminster International owned the vessel at the time of the loss and, subsequently, tendered notice of abandonment to the primary underwriters and the Claimants. They both initially declined the notice of abandonment but paid out for a CTL, plus salvage and wreck removal expenses, without expressly affirming or rejecting the assured’s interest in the wreck.

Insurers were entitled to the residual value of the wreck, which they put at €75 million. However, Westminster International valued the wreck at €25 million. To prevent insurers exercising an election to take over the wreck, they sold her to a related company.

The Claimants argued that an equitable lien arose automatically where insurers, having declined to accept a notice of abandonment, paid for a CTL but without either expressly affirming or rejecting the interest of the assured in the wreck. They claimed that those insurers who elected to take her over became, together with Westminster, co-owners of the vessel, as tenants in common.

Decision
In the Admiralty Court, it was held that, although the Claimants paid for a CTL, as well as salvage and wreck removal expenses, they did not acquire an equitable lien for two reasons. First, it was “unconscionable” to impose a security interest in favour of the insurers, as they could “easily” secure their position by virtue of ss.63(1) and 79(1) of the Marine Insurance Act 1906. Second, as insurers took additional time to determine whether they wanted to assume the burden of ownership, it did not seem equitable to recognise such a lien.

Comment
As a result of this decision, insurers must be aware that before payment of the claim:

• Accepting the notice of abandonment implies admitting liability.
• Accepting the notice of abandonment entitles the insurer to take over the assured’s interest.
• Declining the notice of abandonment deprives insurers of the right to take over the assured’s interest.
• By admitting liability and electing to take over the interest of the assured, a beneficial interest, in the form of an equitable lien, would arise.

Whereas, after payment of the claim:

• An equitable lien would arise if the insurer affirms the interest of the assured simultaneously with the payment.
• Payment entitles the insurer to take over the assured’s interest.
• Not exercising the right to affirm or reject the interest of the assured would not create a beneficial interest in the form of an equitable lien.

The Court highlighted the fact that an assured selling a wreck without the consent of the insurer that made the payment, was an “unprecedented” situation. Section 79 of the Marine Insurance Act 1906 establishes that, “Where the insurer pays for a total loss ... he thereupon becomes entitled to take over the interest of the assured in whatever may remain of the subject-matter so paid for...” However, it does not specify any period or limit for taking over the interest.

Accordingly, the Court tried to fill this gap, by saying that the right to take over the interest is not unlimited in cases where, “… the existence of a lien could of itself hinder the assured’s ability to take steps to protect its own interests.”

Therefore, the limit on taking over the interest is defined by the interest of the assured. This means that if the wreck is causing trouble to the insured (i.e. in the Judge’s words, “… in order to rid themselves of any further or potential liability for wreck removal, pollution etc.”), it is entitled to protect itself by selling the wreck without the consent of the insurer, who then loses the opportunity to take over the interest in the vessel.

For further information, contact Jonathan Evans, Kennedys, 020 7667 9334.

Kennedys successfully defend claim against manufacturer; High Court rules that warning of potential dangers would not have been heeded, even if given - Coal Pension Properties Ltd v Nu-Way Ltd [27.4.09]

Kennedys recently successfully defended Nu-Way in an action brought against them by Coal Pension Properties Ltd (CPP) for damages arising from a gas explosion. The explosion occurred in the boiler house of a BHS store in Oxford Street shortly before midnight on 15 August 2001. CPP held the reversionary freehold interest in the building.

The explosion occurred because of a gas leak, due to a fracture in a gas booster’s casing. The booster had been installed in the boiler room 15 years previously, its function being to boost the gas pressure from the mains into the boilers. This type of booster had been manufactured successfully since the mid-1970s and enjoyed many years of relatively trouble-free operation. There were a small number of failures in the 1990s, where the booster’s casing fractured in operation. The underlying reasons for these failures had not been established conclusively prior to this incident at the BHS store, although poor maintenance was thought to be a common theme. Modifications had been made to the design of the booster over time, including adding a strengthening rib around the casing.

Allegations
CPP argued that, from August 1998, Nu-Way knew there was a problem with unmodified booster casings. The problem had been identified by their staff after an incident at the Nynex Arena in Manchester involving a failed gas booster. Following the incident, Nu-Way held a meeting in July 1998 to decide on their response. CPP thought Nu-Way’s response was inadequate, in that it failed to address the problem of old boosters that were not reinforced out in the field, and that a warning should have been sent out advising of the potential dangers of such boosters. CPP contended that, if the warning had gone out, BHS would have acted on it by checking the boosters and replacing their casings.

Defence
Nu-Way defended the claim on the basis that they did not know the underlying cause of the incident at the Nynex Arena but were justified in their view that defective maintenance and/or damage in transit was involved. Furthermore, following the meeting in 1998, the steps taken by them to modify the design of the booster and issue various product information notes, giving further information about maintenance, were appropriate and reasonable.

In any event, the maintenance regime in the BHS boiler house was wholly inadequate. This was relevant for two reasons:

• If Nu-Way had given BHS the advice that CPP alleged they should have, it was likely it would have been ignored and the explosion would not have been avoided.
• The incompetence of the BHS maintenance regime was such as to have broken the chain of causation.

Decision
The Judge reviewed the current state of the law on the duty to warn of dangers appearing after manufacture, referring to a passage in Clerk and Lindsell on Torts (19th edition), which stated that if a clear indication of a serious danger is received, the manufacturer might be under a duty to take reasonable steps to bring it to the attention of those likely to be affected. He also bore in mind that the claimant still has to prove causation, i.e. that had there been a warning, it would have been heeded and the loss would not have been suffered. A heavy burden, making it difficult for many claimants to succeed on a failure to warn basis. The Judge made it clear that observations about warnings being disregarded were made in relation to the particular facts of smoking cases and he did not assume, in this case, that CPP faced a heavy burden, only the usual burden of proving a case.

The Judge concluded that, in August 1998, Nu-Way were under a duty to give a warning that specifically addressed the risk to the fan casing. He did not think it was necessary to specifically draw attention to the risk of catastrophic failure since this might have induced undue alarm for end users.

On the issue of whether the loss would have been avoided if Nu-Way had issued the warning, the Judge took into account evidence about the highly unsatisfactory, inexplicable and unrecorded modification of another booster at the premises and the unexplained running of the incident booster at midnight in August, when it was only supposed to run between November and March. The Judge found that BHS left both the need for and frequency of maintenance to its contractors and its supervision of the maintenance regime was poor. He also found that such evidence as was provided suggested a very low general standard of inspection and maintenance of the boosters by the maintenance contractors.

In all these circumstances, the Judge was not satisfied that if the warning had been given, in the terms which he found it should have been given (or even in the broader terms advanced by CPP), it would have been heeded and the loss avoided. Accordingly, he ruled in favour of Nu-Way.

Comment
Courts seek to strike a balance between imposing unfair and onerous duties on manufacturers and the legitimate rights and expectations of the end users of products. As was recognised long ago in Donoghue v Stevenson [1932], once a product leaves the manufacturer they have no control over its use and, generally, their responsibility for it ends. Whilst the law of tort has undergone continuous development, there is still a reluctance to impose too heavy a burden on manufacturers in circumstances where a long time has elapsed since the product has gone into use.

One of the tools available to the court to determine who bears responsibility for such losses is causation. Here, the High Court found that the failed booster had been poorly maintained. Accordingly, the Judge was reluctant to hold that, even if a warning had been given, it was likely to have been heeded.

The Judge is to be commended for taking such a robust approach. To have ruled otherwise would, in this case at least, have meant the manufacturer was effectively underwriting the poor maintenance practices of those responsible for the booster’s operation.

For further information contact Nick Rouse, Kennedys, 020 7667 9357.

Kennedys’ Birmingham office is on the move - 27 June 09

On 27 June 2009, Kennedys’ Birmingham office will be moving to:

35 Newhall Street
Birmingham
B3 3PU

Please note that our numbers will also change from this date to:
T: 0121 214 8000
F: 0121 214 8001

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