10 May, 2016
On 18 April 2016, Clyde & Co Australia kicked off its inaugural property insurance seminar series in Sydney. On 19 April, and as part of our ongoing cyber series, we held a seminar focusing on business interruption and cyber risks.
Our Sydney panel members on 18 April were Toby Rogers (Partner, London), Gareth Horne (Partner, Sydney), Kon Nakousis (Partner, Sydney) and Nicholas Sykes (Senior Associate, Singapore). Dean Carrigan (Partner, Sydney) joined Toby, Gareth and Nicholas at the 19 April seminar.
These seminars focused on four key areas:
- Coverage and recovery issues associated with faulty design and workmanship;
- The art of successful subrogation;
- Contra proferentem – the misunderstood rule; and
- Business interruption and cyber risks.
Property insurance trends and coverage issues
Faulty design and workmanship
In considering the operation of exclusion clauses such as faulty design and workmanship, it is imperative that due regard is given to the "proximate cause" test. Amongst all jurisdictions, there is a general impression that exclusion clauses are commonly misunderstood which can often be as a result of a failure to give proper consideration to the proximate cause of the event which threatens to trigger an exclusion clause.
In Asian jurisdictions the proximate cause test is often referred to as the "effective cause" test. The High Court of Singapore in Pacific Chemicals Pte Ltd v MSIG Insurance (Singapore) Pte Ltd and another  SGHC 198 considered the issue in examining the operation of a change in temperature exclusion where it was argued that the cause of the loss was the malfunction of a gauge and not a change in temperature. Choo Han Teck J held that the evidence established that the proximate cause of the damage was the malfunction of the gauge. But for the malfunction of the gauge, the assured would not have instigated the shutdown of the heating system and as such the change in temperature exclusion clause was inapplicable.
In Australia, the cover offered by the write back to a faulty workmanship exclusion was considered in Prime Infrastructure (DBCT) Management Pty Ltd v Vero Insurance Ltd & Ors  QCA 369 where a majority of the Queensland Court of Appeal held that the words "not otherwise excluded" were a reference to other exclusions in the policy and not a reference to exclusions in the clause to which the qualification applied. This issue has not been ventilated in the UK to date but it is anticipated that the Australian authorities will be of assistance if the issue becomes contentious in the future.
In recent years and particularly in the UK, the soft market in the insurance industry has resulted in a move away from the traditional insurance model as pressure has been applied to ensure that policies absorb what would have been viewed previously as commercial risk between parties to a contract. For example, in the UK, common contract works clauses DE5 and LEG3 permit cover for the damage to the defective property, but exclude from the recoverable cost of repair any additional costs incurred relating to improvement to ensure that the damage does not occur again.
Parties to large construction projects will often look to transfer and mitigate risks between them. Most defect claims nowadays will have an insurance aspect to them as companies will look to identify all applicable insurance policies and contractual guarantees and indemnities in order to recover losses. In Sydney, mention was made to the High Court decisions in Brookfield Multiplex Ltd v Owners Corporation Strata Plan 61288  HCA 36 and Astley v Austrust Limited  HCA 6 in relation to the concept of recovery. In Brookfield Multiplex the High Court held that the builder of a strata-title apartment complex did not owe a duty of care to the Owners Corporation to avoid causing it economic loss resulting from latent defects in the common property. In Astley it was found that liability for a lack of care in breach of contract is not reduced by contributory negligence, unless expressly provided for in the contract. Parties should always revert back to the instrument that they agreed upon in the first instance, including a consideration of the obligations on each party and any relevant limitations of liability.
In Indonesia, parties are often reluctant to litigate through the Courts where the insurance policies are often required to be translated with many of the nuances lost. This has resulted in a growing preference amongst insurers to arbitrate. Alternate dispute resolution is being utilised more and more, with only a small number of disputes in London now making it the full way to trial. In Australia, there is a similar reliance on alternate dispute mechanisms, with Court lists reducing in size.
Often insurance policies and commercial contracts can include waiver of subrogation clauses. In the UK there is a growing trend for Courts to apply a strict interpretation of such clauses. In the case of Gard Marine & Energy Ltd v China National Chartering Co Ltd  EWCA Civ 16 the question that arose for consideration was whether subrogation rights can exist against a co-assured. The Court found that the existence of subrogation rights rests upon the true construction of the agreement between the co-assureds; however, a presumption arises against subrogation.
Contractual caps of recovery are frequently included in construction contracts and often used as a mechanism of risk transfer in the construction industry. For example, it is common for there to be limitations concerning consequential loss arising from work health and safety action.
In Asia many jurisdictions have pre-litigation protocols in place requiring letters of demand to be issued and alternate dispute resolution to be engaged in before the commencement of proceedings. It is also vital that parties have limitation periods in the forefront of their mind as they can differ across jurisdictions.
The New South Wales Court of Appeal in Cyril Smith & Associates Pty Ltd v The Owners Strata Plan No 64970 NSWCA 181 found that where there has been negligent construction of a building, the relevant loss accrues "when the defects become manifest or are otherwise discovered": Scarcella v Lettice  NSWCA 289.
The final topic discussed by the panel was contra proferentem. In relation to the approach in Australia two significant authorities were discussed, Cornish vs the Accident Insurance Co. (1889) 23 Q.B.D. 453 and McCann v Switzerland Insurance Company  HCA 65.
In Cornish vs the Accident Insurance Co. (1889) 23 Q.B.D. 453, Lindley LJ stated that contra proferentem "ought only to be applied for the purpose of removing a doubt, not for the purpose of creating a doubt, or magnifying an ambiguity, when the circumstances of the case raise no real difficulty".
The High Court of Australia in McCann v Switzerland Insurance Company  HCA 65, confirmed that the doctrine is one of last resort, with Kirby J stating that it is "preferable that judges should struggle with the words actually used as applied to the unique circumstances of the case and reach their own conclusions by reference to the logic of the matter, rather than by using mechanical formulae".
In the UK, at first instance Courts will often readily find ambiguity however the Courts of Appeal have tended to focus more on commercial purpose to avoid a finding of ambiguity. In Australia, there has been a growing trend to use context as a means to construe insurance policies against the drafter much earlier in the construction process than the contra proferentem rule would ordinarily allow. In other words, the effect of the contra proferentem is increasingly being felt not as a last resort and without strict application of the rule.
Cyber incidents pose a serious risk
The risk posed by cyber hacks is already significant and rising rapidly. Based on figures in the United States, 32 attempted hacks were discovered in the critical manufacturing sector in 2013 with this increasing to 97 in 2014. Another area of particular concern is the effect of cyber hacks on key infrastructure and services. In the past few months there have been a number of examples of this, including the hacking of a Ukraine-based power station, a ransomware attack on a hospital in California and a recently discovered attack that altered the chemical levels at a water treatment plant.
Manufacturing has been identified as a sector that is particularly vulnerable to a cyber breach. The reason for this is that historically the focus has been concentrated on productivity rather than security. Manufacturers commonly have complex systems connected to networks and the internet, which present a large 'attack surface' that can be difficult to manage and secure. Typical risks in the manufacturing space include phishing to obtain employees' login credentials, malware to infiltrate systems and hardware, ransomware to prevent access to data until ransom is paid and theft by employees of confidential information.
There are currently a number of different cyber liability wordings offered in the market, with varying levels of business interruption cover available. The typical trigger for cover across these policies, however, is a loss of income as a result of a data breach. This is typically limited to intangible loss as property damage is almost inevitably excluded. Insureds in the manufacturing sector are now seeking clarity as to how loss is quantified, and pushing back on particular exclusions, listing cover for this type of loss as a key aspect of cover, and seeking more clarity as to indemnity periods.
There is also some inconsistency as to how loss will be quantified under a cyber business interruption policy. In particular, questions remain as to whether loss will be measured against gross profit or net profit. While it seems likely that the orthodoxy of property business interruption insurance will be adopted in measuring loss, this has not yet been established as market practice. Similarly, it is expected that there will be varying degrees of consistency in how intangible loss is quantified – in particular in the case of reputational damage, which will often be either expressly or implicitly included in cover. There is also a level of uncertainty as to whether the increased costs of working will be covered under a cyber policy – noting that it would traditionally be covered under a property business interruption policy. The measurement of loss under a cyber policy will therefore need careful consideration and it is essential that insureds, brokers and insurers work together to ensure clarity as to what is covered, and how loss will be quantified.
One particular exclusion that typically poses a level of difficulty is one that requires an insured to maintain internet security. There are many differing standards of internet security around the world and it would be difficult to predict with certainty what level of security is required in the context of an international insured, with operations across a number of markets and jurisdictions. While applying a 'reasonable' test to the security may be a fair middle ground, this may be problematic as it is often difficult to anticipate what 'reasonableness' in terms of internet security actually means, given the different standards applied across jurisdictions, sectors, industries and organisations.
Seminars were also held in Singapore on 20 and 21 April and Hong Kong on 22 April.
For further information, please contact:
Dean Carrigan, Partner, Clyde & Co