04 Sep 2014

Mitigating your claim away: An unmitigated disaster

by Fred Hawke

Just how far must the insured go in mitigating its loss, at common law or pursuant to an express policy obligation and what, if anything, can claim from its insurer to cover its costs of mitigation?

The principle that a policyholder who sustains an insured loss must take all measures reasonably within its power to mitigate it is treated as axiomatic in insurance law. But how does the obligation arise and what does it mean in practice? It is sometimes said that the obligation is properly to be regarded as a manifestation of the law relating to causation: The point being that a failure to mitigate when it was reasonable to expect the insured to do so means that subsequent loss will not have been proximately caused by the event which triggers the policy. This analysis is based ultimately upon the notion of contingency, the point at which the insured could effectively intervene to prevent further loss being the last point at which such loss remains a possibility, as opposed to an inevitability. An alternative view treats the concept of loss mitigation as an obligation or duty on the part of the insured, whether under contract, pursuant to statute or both, which has the advantage of enabling proper limits to be set. Most of the cases involve policies in which an obligation to mitigate is a feature of the contract, either an express term or implied by statute. This article examines these principles and the question of just how far the insured is obliged to go in mitigating its loss, at common law or pursuant to an express policy obligation and what, if anything, it can claim from its insurer in respect of the costs of doing so.

Introduction

It is a truth universally acknowledged, that an insured who sustains a loss must take all reasonable measures to mitigate it. [1] What does this mean, though, in practice; and especially in the case of professional indemnity and related insurances where the options to mitigate claims which may be made against the insured, may include preventing them from being made? Must the insured incur an uninsured loss in order to avoid or reduce a claim upon insurance? Just how far is the insured obliged to go in mitigating its loss, at common law, pursuant to an express policy obligation or pursuant to the statutory duty of utmost good faith [2] and what, if anything, can it claim from its insurer in respect of the costs of doing so?

This article will examine the nature and extent of loss mitigation obligations and coverage for mitigation costs, from first principles as well as by reference to case law and with particular reference to claims-made liability insurances such as professional indemnity. The starting point for the enquiry is to analyse the nature of the mitigation ‘obligation’ or ‘duty to mitigate’ itself. Is it really an obligation cast upon the insured, by the general law or by the express terms of the contract, or is it merely an example of the inexorable working out of the law of proximate causation in the context of an unfolding insured loss?

Mitigation as causation issue or mitigation as duty

It is often said that the obligation cast upon the insured to mitigate an insured loss is properly to be regarded as a manifestation of the law relating to causation: the point being that covered loss must have been proximately caused by an insured peril and a failure to mitigate when it was reasonable to expect the insured to do so, means that subsequent loss will not have been proximately caused by the happening of the event insured against. [3] It is necessary to unpack that analysis, however, in order to see just how and under what circumstances an insured’s omission to do something which it was within its power to do, can constitute an intervening, operant cause. In the writer’s view, the issue is bound up with the notion of contingency.

Contingency, the characteristic of something which might or might not occur, is a fundamental concept of insurance. To be insurable, an event must be characterised by an element of uncertainty, as to whether or when it will occur or what the consequences will be. Uncertainty, however, lies only in the future, which ineluctably becomes the past even as we try to grasp and contemplate it. [4]

The old insurance adage says that you cannot insure an already burning house, however, that is merely a convenient way of saying that you cannot insure against damage which has already taken place. Theoretically, if the timing issues could be managed, there is no reason why an insurance could not be underwritten against the risk of a fire, which had already partially damaged a house and was under control but not extinguished, flaring up again and destroying the remainder of the property and possibly also adjacent property. The obvious example which comes to mind is the Hazelwood Coalmine fire. Another one is so-called ‘after the event’ litigation insurance. ‘After the event’ is a misnomer of course: what is actually being insured against is the still contingent risk of an adverse outcome to litigation which is already on foot. In both examples, the necessary elements of uncertainty as to the final outcome and the consequences of it in terms of loss, are clearly present. Insurance, therefore, is conceptually possible: it is just a matter of determining value at risk, probability and the calculation of an appropriate premium.

That element of contingency only remains, however, and insurance is only possible, as long as the future unfolding of events remains uncertain and capable of being influenced by contingent factors. It can be argued, therefore, that where the insured perceives a contingency looming in his or her immediate future, about to become a reality, absent intervention, but which by intervention he or she has the power to prevent, the element of uncertainty is lost once the insured chooses not to exercise that power. From the insured’s perspective, by electing not to intervene they have removed the last random factor, the last uncertain possibility which made the event a contingent one and transformed it into a certainty. The contingency has become an inevitability, due to the insured’s choice.

Can it then be said that the insured has caused the resultant loss, by allowing it to happen? On an a priori basis, perhaps, but philosophical causation is not the same as legal causation. Nevertheless, this seems to be the only basis upon which the concept of an insured’s failure to mitigate loss as an issue of causation, by interrupting the causal connection between the insured event and some or all of the resultant loss, can be explained. The other way of looking at it is as a breach on the part of the insured, whether of the duty of utmost good faith, another term of the contract or otherwise, sounding in damages for the insurer and entitling it to a set off against the claim, in respect of just so much of the loss as would have been avoided by mitigation. It is not self-evident how inaction on the part of an insured can constitute, effectively, an intervening cause. Mere inertia does not sit well with the concept of a supervening operant or proximate cause, severing the chain or interrupting the flow of causation from an earlier one. If, however, the insured is cast in the role of an actor with the power to influence events or their outcomes, and the decision whether or not to exercise that power is seen as an active choice, then the analysis makes sense. Some limits must be set to the principle, however, or causation would be interrupted and cover lost every time an insured failed to exercise an effective power of intervention, regardless of what the ancillary consequences of that intervention might have been. It is here that the concept of loss mitigation as a duty on the part of the insured has its role to play, since duties may be placed in context and appropriately circumscribed.

In this writer’s opinion, the concept of loss mitigation is better formulated as an obligation or duty on the part of the insured, whether under contract, pursuant to statute or both, rather than as a manifestation of the law of causation, if only to enable proper limits to be set. After all, the question of whether or not the chain of causation between the insured event and resultant loss has been broken by the insured’s decision not to intervene to prevent the latter, when it was within its power to do so, would be an entirely objective one. It could take no account of the reasonableness or otherwise of the insured’s conduct or even of any extraneous considerations, such as the cost of that conduct to the insured as compared with the value of loss forestalled. Although cases dealing with causation in the context of a failure to mitigate damage are comparatively scarce, the notion does not appear to have been explicitly disapproved by the courts. Almost all the cases, however, involve policies in which an express obligation to mitigate is a feature of the contract, either as an express a term or implied by statute. [5]

Formulating the concept of loss mitigation as a duty of the insured is also consistent with the general law of contract, if one accepts the somewhat artificial concept of a claim on the policy as being in reality a claim for unliquidated damages for breach of contract, the insurer’s breach consisting in having failed to preserve the insured from suffering the loss to which the policy responds. [6] Whatever one thinks of that notion, it is consistent with the idea that there should be an obligation on the insured to mitigate his or her damages flowing from the breach, with or without an express contractual or statutory term.

The rub is that the few cases dealing with mitigation of loss in the absence of such terms by no means favour the existence of a duty to mitigate at common law. [7] This rather gives the lie to the notion of the insurance claim as a claim for damages for breach of contract, since in the case of a breach of any other sort of contract the obligation to mitigate damage would be well established. [8]

It would seem, therefore, that the concept of loss mitigation and the consequences of the insured’s failure to perform it, are not to be interpreted as purely an interruption to the flow of causation or as a general duty at large under the common law. Rather, mitigation is an obligation imposed under the terms of the contract and one which will generally need to be express rather than implied. In the absence of an explicit policy term requiring the insured, upon the occurrence of an event insured against, to take all reasonable measures to avoid or mitigate loss, there will be no such duty imposed under the general law or by statute save in respect of those specialised forms of policy to which the Marine Insurance Act applies. It is also hard to see how the insured’s failure to intervene to avoid or truncate loss, unless particularly egregious, can be regarded as having broken the chain of causation between the insured event and resultant loss. [9]

In the case of an especially flagrant and deliberate refusal on the part of an insured to intervene to obviate or reduce loss resulting from an insured peril, in circumstances where it was perfectly well able to do so and had no reasonable justification for refraining, it is possible that s 13 of the Insurance Contracts Act 1984 (Cth) might come to the insurer’s rescue. The argument would be that the implied term in the policy, that the parties would act toward each other with the utmost good faith in relation to all matters arising under or in connection with the policy, would be breached if the insured simply sat on its hands and allowed losses to unfold which it easily could have prevented, at no cost to itself, notwithstanding that they were set in train by the occurrence of an insured peril. The remedy would sound in damages for breach of the policy, equal to the amount of the claim in respect of the losses which could have been prevented, and a set off would lie. It would not be necessary to invoke the concept of an intervening cause disrupting proximity. While the insurer might argue in the alternative that the causal chain had been broken and that such losses were not, in fact, caused by the peril insured against but rather by the insured’s decision not to intervene, the difficulty with that, is that it is hard to see how a limit can be set to the operation of such a principle. If fortuity is lost and causation interrupted in circumstances where the insured has the power to intervene to prevent loss but elects not to do so, then that would be the case in all such circumstances irrespective of the difficulty or the other consequences to the insured of such intervention. It is difficult to reconcile such an argument with the insurer’s own obligation to act toward the insured with the utmost good faith, in relation to the claim. There must, therefore, be some element of a value judgment as to the appropriateness or otherwise of the insured’s conduct, before the flow of causation will be said to have been interrupted.

It is, accordingly, the merit and appropriateness of the insured’s decision not to intervene, rather than merely the fact of the insured’s power to intervene, which determines whether the losses which could have been avoided remain proximately caused by the insured peril. Alternatively, these determine whether an obligation to mitigate loss, including an obligation which arises as a manifestation of the duty of utmost good faith, has been breached. In the absence of a duty at large under the common law to mitigate loss, it is in the context of an express or implied term of contract or a statutory obligation that the justification for the insured’s decision falls to be evaluated.

All this hair-splitting and barber-shaving, of course, may be of interest only to lawyers. [10] The main concern of practical people, and especially professional indemnity claims managers, is with the manner of operation of explicit terms which impose such an obligation, as acted upon by statute. If we accept that the chain of causation between insured event and loss will only be broken in circumstances where the insured’s failure to intervene constitutes a falling short of the level of obligation imposed upon the insured by such terms, then the interpretations can be reconciled and the analysis focused on the really essential question: how far does the insured actually have to go in mitigating a loss, once the event which triggers the policy has occurred and the consequences are either imminent or already in train.

Origins of mitigation

There is case law to the effect that in the absence of an explicit, contractual obligation to avoid or minimise loss, the insured will not be able to claim under the policy for the costs of doing so.[11] Nor is the insured entitled to claim the cost of taking measures, however reasonable, to avoid the occurrence of an insured peril which is imminent but not yet underway. [12] This, however, is an issue of prevention of loss and not to be conflated with the concept of loss mitigation proper.

The origins of the insured’s contractual obligation to mitigate its loss, in the face of an insured peril which has manifested itself, are to be found in marine insurance and specifically the ‘sue and labour’ clause. The classic formulation of this provided that ‘it shall be lawful’ for the insured to ‘sue, travel and labour’ for the purpose of preserving a ship and her cargo from a peril of the sea which had manifested itself and entitled the insured to claim the costs of doing so, in proportion to the interest protected. More modern forms of the clause explicitly require the insured to do so whereas it was arguable that the older version did not, and that no such obligation could be implied.[13] In the absence of an obligation, express or implied, on the insured to mitigate loss, no entitlement to indemnity from the insurer for the costs of doing so could be read into the policy either.

A corollary to the marine sue and labour clause was the principle that the costs of suing and labouring should be shared between the parties interested in the marine adventure, in the proportions of their respective interests, in a manner not dissimilar to that in which general average losses are adjusted between hull and cargo interests pursuant to the York-Antwerp Rules. Thus, an under-insured policyholder could be under an obligation to incur sue and labour costs for the preservation of the vessel and its cargo, and be its own insurer for the proportion thereof corresponding to the shortfall in coverage. This principle has, however, been expressly restricted, if not to marine insurance then certainly to direct insurances over property where the value at risk and the sum insured can easily be compared.[14] A question arises, therefore, as to the extent to which these principles derived from marine and property insurance may be capable of extension to financial liability coverages, such as professional indemnity, trustee’s liability, errors and omissions and the like.

Assuming an attempt is made to extend them by way of an express condition in the policy, to the effect that the insured shall use due diligence and take all reasonable measures to avert or minimise a loss, what will be the effect on coverage if the insured either mitigates, or fails to mitigate, its loss in accordance with such a condition? Given the nature of such coverages and especially the fact that they are invariably underwritten on a ‘claims made’ basis, the insured has something of a tightrope to walk. Unless the policy, in addition to the obligation on the insured to incur mitigation costs expressly provides coverage for them, the insured which is faced with the prospect of incurring substantial losses due to breach of professional duty or civil liability, which could reasonably and responsibly be mitigated but at a cost, might lose its claim under the policy regardless of whether it incurred, or did not incur, the costs of mitigation. How might this come about?

Put simply, if a claims made financial liability policy contained a term requiring the insured to take at its own expense all reasonable and necessary measures to avert or minimise further claims against it arising from its breach of professional duty or other civil liability, could such a condition be construed as requiring the insured, before or after an actual claim had been made against it, pre-emptively to settle or otherwise make good third party losses so as to preclude further covered claims against it from arising? Or would it merely require the insured to rectify the conditions which gave rise to the losses, so as to avoid adding to the number of putative future claimants? The question is how far is the insured obliged to go in complying with such a provision, thereby effectively converting future insured losses into present uninsured ones, for the benefit of its insurer?

That it may well be to the insured’s benefit also to do so, due to reputational, regulatory or other factors in play is a pertinent consideration, as is the nature of claims made insurance. Reference may be made here to the old case of Waltons v NEM Insurance,[15] in which a firm of stockbrokers inadvertently short-filled a client’s order. They realised their mistake and quickly bought in the remainder of the shares, however, the client had proved perspicacious and the price had risen during the delay. The firm bore the difference. What would have been an undoubted professional negligence claim against the firm was averted, however, so was any claim by the firm on its PI insurance which responded only to claims made against the insured, not to the cost of avoiding them.

Mitigation in operation

There is a distinction, of course, between avoidance and mitigation and a more recent case, directly in point, is Standard Life Assurance v Ace European Group, [16] a 2012 judgment of the English High Court, upheld the same year on appeal. Briefly, one of Standard Life’s financial products was a unitised pension fund, described in the product information literature as very conservatively invested and almost equivalent in security to a bank deposit. By 2007, however, the fund had become substantially invested in asset backed securities which, at that time, were becoming increasing illiquid. This called the unit pricing into question and a decision was made in early 2009 to reprice on a different basis. This resulted in an immediate drop in the overall value of the fund of approximately 4.8%, around £100 million, and a lot of unhappy investors.

The issue was not so much the appropriateness of the re-pricing but the illiquid nature of the investments and the fact that, according to the product disclosure materials, that wasn’t supposed to happen.[17] Standard Life received a number of complaints and some claims from customers, as well as adverse attention from both the Financial Services Authority and the media. Further claims were clearly to be anticipated and the total loss to the organisation would not necessarily have been limited to the amount of diminution in value of the fund, indeed, it was likely that it would have far exceeded it. Accordingly, Standard Life made a business decision, the reasonableness of which was not challenged, to make good the drop in value of the fund by a one off payment of £100 million out of shareholder funds. This had the entirely beneficial effects of forestalling the majority of further claims, placating the regulator, stymieing the class action sharks who had been circling and shutting down the business media pundits’ paroxysms of outrage. Does this sound familiar? [18]

Standard Life’s PI policy contained mitigation costs cover and the issues in the case were, essentially, to what extent the £100 million payment represented mitigation of covered claims, or even liabilities, as opposed to a brand protection or regulatory compliance expenditure; and whether the co-insurance or proportionality of interest principle from the sue and labour cases should be applied to the cover, in light of the collateral benefits which Standard Life derived from making the payment in addition to the mitigation of covered loss. In the event, the fund remediation payment was held to fall within the policy’s definition of a mitigation cost and it was irrelevant that it might also have served the collateral purpose of protecting the insured’s brand and its relationship with the regulator, such purposes not being expressly excluded from cover. [19] The policy wording did not provide any basis for apportionment of the mitigation costs on the basis of the parties’ respective interests served by making of the payment. The Court of Appeal went further on this point and held explicitly that it was inappropriate to extend such an ‘averaging’ principle beyond the context of two-party direct loss coverage and into liability insurance, because of the inherent difficulty involved in quantifying the respective interests, especially uninsured interest, that were assumed to have benefited. [20]

The real interest of the case for present purposes, however, lies in the counterfactual. In deciding whether to make the remediation payment, Standard Life gave careful consideration to two options. The first of these involved setting up a complaints investigation process and inviting aggrieved investors to bring claims against it, in respect of losses they had allegedly sustained due to reliance on the misleading description of the fund’s underlying investments in the product information literature. The second option also involved a claim invitation and evaluation process but preceded by the fund remediation payment.

Option 2 was the one they went with and the decision is unlikely to have been influenced by the presence of mitigation cost cover in the PI policy, given the size of the fund relative to the remainder of Standard Life’s business. If, however, there had been no such cover in the policy, but merely a term requiring the insured to take all reasonable and necessary measures to avoid or mitigate losses arising from circumstances giving rise to covered claims against it, then had the insured chosen not to make any remediation payments but merely to go with the first option, would that term have been breached and what might the consequences have been for coverage in respect of the resultant claims?

Mitigation a bridge too far

A clear message from the case law is that the insured which is contractually bound to mitigate its loss is not obliged to do so at all cost and without any regard to its own commercial interests. This is consistent with the concept of mitigation being interpreted not merely as an interruption to causation but rather as a positive obligation of the insured, the content of which may vary according to the circumstances of the case and breach of which on the part of the insured entitles the insurer to an adjustment remedy.

The two situations in which the question of the extent of the insured’s obligation to mitigate loss will commonly arise are:

1. Where the insured has the opportunity to reduce or truncate an insured loss arising from an insured event which has already occurred or is in progress, but only at the cost of incurring an uninsured loss; and

2. Where the insured is in a position to prevent an insured event from taking place, but again at the cost of incurring an uninsured loss.

The fundamental question in each case is how far can the insured reasonably be expected to go, in placing its underwriters’ interests ahead of its own. The point of principle would seem to be that while the insured ought be obliged to take at its own cost all reasonable measures to preclude insured events from occurring, once such an event has taken place they are not required effectively to convert an insured loss into an uninsured one for the underwriters’ benefit. That seems clear and reasonable enough, however, as can be seen from the facts of the Standard Life Assurance Ltd case, it has the potential to give rise to particular difficulties in the context of professional indemnity and related insurance classes. The reason is simply that these are liability policies which commonly insure not the liability itself but the making of a claim upon the insured in respect of it. In other words, the event insured against is the making of a claim upon the insured and until that happens, the ‘insured event’ has not occurred, however imminent it may be.

Let us consider the first type of scenario, where an insured event has occurred or is in progress and the insured has the opportunity of truncating the resultant loss. In the case of City Tailors v Evans, [21] the insured’s business premises were damaged by fire resulting in a complete halt to production at that location. The question arose whether revenue from production at alternative premises, which the insured had the opportunity to lease but upon uneconomic terms in order to meet its contracts, could be taken into account in adjustment of the business interruption loss. The court held that it could not: as the insured was not obliged to assume the further contractual obligation in order to reduce the covered consequential loss. [22]

In AFG Insurances Ltd v Mayor, Councillors and Citizens of the City of Brighton, [23] a similar question arose as to whether, following a fire, the insured ought to have exercised a right under its lease to demolish the damaged premises, thereby precluding the lessor from requiring reinstatement. In the words of Professor Sutton:

An insurer cannot force the assured against her or his will and to her or his disadvantage, to exercise rights against a third party not related to the occurrence of the loss, in order to give the insurer an answer to the assured’s claim which would otherwise fall squarely within the indemnity for which the premiums have been paid. [24]

The principle involved is very succinctly summarised in a passage from the High Court, in the judgment of Mason J (with which McTiernan and Menzies JJ concurred):

"To say, as it has been said, that the insured should take reasonable steps to extinguish the fire, to allow firemen access to the fire, to remove his property to a place of safety and (in the case of an insurance against loss of profits) to keep up his output is to say no more than that the insured should take those practical and reasonable steps as a matter of self-help which his own self-interest would dictate. It is quite another thing to say that after the fire has taken place and caused loss the insured should exercise a legal right in circumstances where its exercise will work a radical change in the nature of the property of which the insured is lessee and will diminish the value which the right would otherwise have for him. The consequence to the respondent would be to make it the lessee of unimproved land for the balance of the lease and to leave it liable on the covenant to pay rent. Plainly it would be to the advantage of the respondent to retain the insurance monies and rebuild the premises. The respondent would in that event be restored to his enjoyment of a lease of premises with the same improvements as before the fire. The right of removal attaching, as it would, to the entire building, would, if exercised, have a greater value than the right if exercised in relation to the charred remains of the existing structure.

When regard is had to these circumstances it cannot be said that the respondent was under a duty to the appellant to exercise the right conferred by Clause 3(e) of the lease. To so hold would be to compel the respondent to pursue a course which was disadvantageous to it and which would work a detriment to it.

Although an insured person is in general not entitled to recover more than an indemnity under a policy of fire insurance, he is entitled to recover a full indemnity". [25]

More recently, in Orica Australia Pty Ltd v Limit (No 2) Ltd, [26] the insured chartered a vessel to carry a cargo from a Canadian port to one in Northern Queensland. Not long into the voyage the cargo shifted in stow, threatening the safety of the ship and forcing it to make port of refuge in the United States. This resulted in a delay of some weeks to the voyage while the cargo, which was of a hazardous nature, was unloaded, partially containerised and re-stowed. Substantial costs were incurred by the vessel’s owners in the form of port charges, stevedoring charges, vessel maintenance costs and detention fees, all of which were claimed against the charterers who were insured under a Charterer’s Liability policy. [27]

Relatively early during the vessel’s sojourn at the port of refuge, when it had become apparent that restowage of the cargo would be a difficult and protracted exercise, the owner made an offer to the insured that it would treat the voyage as having terminated if the insured would accept delivery of the cargo, all of which was at that time in temporary storage at the port, and allow the ship to depart. This would have truncated the detention and other costs from the date of departure but left the insured with the problem of disposing of approximately 6500 tonnes of highly dangerous cargo, which the US authorities did not wish to see permanently landed and which, moreover, the insured urgently needed for its plant in Australia.

The owner’s offer accordingly was rejected and eventually the ship made it to its original destination with the greater part of its cargo. Underwriters of the Charterers’ Liability policy, however, contended that the insured ought to have accepted the offer, which would have substantially reduced the claim upon their policy. They argued that the failure to do so amounted to a breach of the insured’s duty to mitigate loss or, alternatively, an intervening cause between the occurrence of the peril insured against and the balance of the detention and related costs.

There was an issue in the case whether the owner’s offer was, in fact, capable of acceptance by the insured, in light of evidence that the relevant US authorities were very reluctant to allow any of the cargo to be permanently landed and were eventually persuaded to issue an import permit only in respect of the portion of it which could not be containerised and re-stowed. The court accepted the insured’s evidence on this point and also as to the substantial, additional costs which it would have incurred had it been able to effect a complete discharge of the cargo.

The court dealt with the underwriters’ submissions regarding a failure to mitigate loss, citing both City Tailors v Evans and AFG Insurances Ltd v City of Brighton, in the following terms:

"Whether the point is put as a failure to mitigate loss or as a question of causation, Orica’s obligation to the Underwriter did not require it to sacrifice its commercial interest in favour of the insurer . . . It follows from these passages that assuming an obligation to mitigate (or assuming a question about whether the loss may be said to be considered proximate), an insured facing an incident is entitled to have regards to his, her or its own interests at least to some extent. To lose the protection of the coverage the insurer needs to show that the indemnity sought by the insured flows from something other than the incident. An insured will not be denied indemnity unless the proximate cause of the loss was ‘not the peril insured against, but the failure of the insured to take reasonable steps to protect it’. For the insurer to maintain that the claim is not within the policy it must make an affirmative case that causally links what is sought against the insurer with something beyond the insured event sufficient to break the link between loss and insured event. That has not been achieved by the underwriter in this case." [28]

It seems clear from these authorities that once an insured peril has manifest itself and either is causing or is immediately about to cause an insured loss, the insured is not required to take all possible steps to truncate or avert that loss, at whatever cost to itself. In particular, it cannot be required to incur substantial, uninsured costs on its own account in order to reduce the loss to the insurer. The situation is less clear, however, where an event which would trigger the policy has not yet taken place but is imminently to be anticipated, if the insured does not take stringent measures to prevent it. How far is the insured obliged to go in that situation and what can it claim?

Mitigation vs Prevention

In Yorkshire Water Services Ltd, [29] the insured’s sewage containment facilities were in imminent danger of failure which would have resulted in substantial third party property damage, for which the insured would have been liable. The policy would have covered such a liability. The necessary works were carried out and the insured made claim under its liability policy for the cost of them, on the basis that they had been incurred for the purpose of averting a more substantial loss in the form of a liability for which the insurer would have had to indemnify them.

It was held by the English Court of Appeal, in an analysis of the purpose and manner of operation of the liability policy, that the insured was required to bear at its own expense the cost of taking all reasonable steps to avoid or minimise third party damage which had not yet occurred. There was no express term in the policy providing cover for such mitigation costs nor any basis upon which to imply one. [30] An important distinction was drawn between an insured’s liability to pay compensatory damages for third party property damage, which a liability policy covers, and amounts paid to avert or minimise such a liability. The latter are of a different order from damages or compensation and a legal liability policy will not respond to them in the absence of an express extension of the cover for that purpose.

Accordingly, on the basis of the reasoning in this case it would seem that had the insured in Standard Life Assurance Company Ltd v Ace European Group not had in its policy an express extension of cover for mitigation costs, it could not have claimed in respect of the fund remediation payment made despite that being for the express purpose of preventing further claims from being made against it. The following passage from the judgment of Lord Justice Stuart-Smith is instructive:

"In this context ‘sums’ must mean sums paid or payable to third party claimants. No such sum arises in relation to the flood alleviation works. ‘Legally liable to pay’ must obviously involve payment to a third party claimant and not expenses incurred by the insured in carrying out works on his land or paying contractors to do so. And the liability must be to pay damages or compensation. ‘Damages’ means ‘sums which fall to be paid by reason of some breach of duty or obligation’ see Hall Brothers Steamship Co Ltd v Young [1939] 63 Lloyds Law Reports 143 at page 145. ‘Loss or damage to property’ is a reference to the property of the third party claimant and not that of the insured." [31]

The point which Stuart-Smith LJ was making was that under an insurance which responds only to the insured’s legal liabilities to third parties, there can be no indemnity until such a liability is incurred by the insured and a claim is made against them in respect of it. By extrapolation, in the case of a liability insurance with a claims-made trigger, the making of a claim for damages or compensation of some description against the insured is a sine qua non. In Yorkshire Water Services, the authority had carried out works upon its own property, which had sustained flood damage, precisely in order to prevent such third party liabilities from arising. The similarity in principle between this situation and that of the stockbroker in Walton v NEM Insurance [32] or the fund trustee or responsible entity which rectifies a poor investment decision or a unit pricing error by topping up the fund thereby preventing liabilities toward members from arising, let-alone claims being made in respect of them, is readily apparent. [33]

Having found that the express indemnity clause of the policy was not triggered, the court in Yorkshire Water declined to imply into the policy any additional cover for what were, in effect, loss mitigation costs. Such a term was held not to be necessary to give business efficacy to the contract, which does not augur well for the financial liability insured who seeks to imply such a term, although arguments could always be made. Moreover, there is authority to the effect that even the presence in the policy of an explicit obligation on the insured to incur loss mitigation expenses does not give rise to a necessary inference that such expenses can be claimed under the policy, in the absence of an express entitlement to indemnity in respect of them. [34] The insured, therefore, which promptly and diligently mitigates its loss arising from a breach of professional duty, so successfully as to avoid incurring liability and preclude a claim being made against it, may, absent an express mitigation coverage entitlement and whether or not it does so pursuant to an explicit policy obligation, find itself having done so at its own expense. That may or may not be the intention of the parties, however, it does raise some legitimate questions around the continued effectiveness of pure ‘claims-made’ liability insurance, as a risk management tool. [35]

Conclusions

There is no sound reason in principle, it is submitted, for invoking Yorkshire Water Services so as to exclude the principles of AFG Insurances v City of Brighton and Orica Australia v Limit (No 2) from applying in the context of claims made insurance, merely on the basis that the event triggering the policy had not yet occurred at the time when the opportunity arose to mitigate or rather prevent it. It is one thing to require the insured to take all reasonable measures to prevent or minimise loss, however, a policy which required the insured to prevent claims from being made against it effectively by restoring, at its own expense, the losses which might otherwise be the subject of them, would be of very limited commercial value.

The better view, it is suggested, is that notwithstanding the claims made principle, in a Standard Life v Ace type scenario the event insured against should be regarded as in progress once circumstances which have the potential to give rise to claims against the insured have arisen and been notified to the insurer, notwithstanding that the claims themselves have not yet been made. [36] On that basis, it becomes no longer a question of what it is reasonable to expect the insured to do, at its own cost, to prevent insured occurrences from happening (Yorkshire Water), but rather one of how far the insured is expected to go at its own cost in mitigating loss (Orica Australia v Limit (No 2)).

Orica Australia Pty Ltd v Limit (No 2) Ltd and related cases suggest that there is no general obligation on the insured at common law to incur uninsured loss in order to mitigate its claim on a policy, once the contingency insured against has arisen. An express term in the policy requiring the insured upon the happening of such an event to take at its own expense all necessary measures to prevent loss or further loss from resulting from it would presumably be given effect by a court, subject perhaps to some constraints around reasonableness and proportionality, and would plainly negate any implication that the costs so incurred could be claimed under the policy. [37] Even a term which was silent as to where the expense should lie would, on balance, be likely to place it with the insured.

The insured under a policy which contains no express requirement to mitigate or coverage for mitigation costs but which nevertheless incurs them probably will bear them itself, however large the policy claim which is thereby avoided might have been. It is only when the policy contains an express extension of coverage for mitigation expenses, as in the Standard Life v Ace case, or when the policy trigger is a legal liability which has arisen and the payment made is of such a nature that it can be construed as compensation to third parties in respect of it, that the insured which incurs costs of pre-empting its liabilities from arising or pre-emptively settles them before they can result in litigation, may be able to recover those costs from insurance.

Theoretically, on the above basis, an insured in Standard Life’s position which did not have mitigation costs cover in its policy but was insured under an ordinary claims made civil liability wording could not be required to make payments at its own expense in order to preclude claims from being made against it, even pursuant to an express policy obligation to mitigate loss. [38] Had Standard Life adopted the alternative solution of merely waiting for claims to be made against it in due course and referring them to its insurers to be dealt with on their merits, the better view would seem to be that it would not have been in breach of such a policy condition. Unless it were extremely onerously worded, the condition that the insured take all reasonable measures to avoid or minimise loss would likely be construed, consistently with the firefighting analogy in the City Tailors case, to require the insured merely to remedy the conditions which had given rise to the third party losses and take all reasonable steps to enable the claims for losses that had already arisen to be efficiently and economically disposed of, rather than requiring the insured to forestall claims by making good third party losses out of its own pocket.

The difficulty, of course, is that for many insureds, especially financial institutions, fiduciaries and some classes of professional, merely sitting back and waiting for claims to be made against them in respect of known breaches of duty of care or other civil liabilities incurred will not be a practical or attractive option. Leaving aside possible legal obligations to make good deficiencies in funds under management, the reputational and regulatory risks of inertia may simply be too great. [39] Assuming, however, that it was an option for the insured simply to wait to be claimed against, notwithstanding that by making a pre-emptive payment it could avoid a future, insured claim against it which would almost certainly be larger than the payment if only by the amount of legal costs and interest, in could hardly be in the interest of the insurer for the insured to have an incentive to do so. [40]

The insurer could, presumably, insert a very onerous term into the policy effectively requiring the insured, upon becoming aware of grounds for claims to be made against it, immediately to make good the losses thereby removing the basis for the claims and preventing them from arising. Such a term would, however, seriously call into question the utility of the insurance as noted above. A PI policy which was potentially breached every time the insured became aware of a notifiable circumstance and failed to extinguish its liability before a claim could be made against it arising from the matter would, it is suggested, be of very little use to any responsible professional organisation.

The obvious alternative is for the insurance market to step up and provide a suitable form of cover in these circumstances and there would seem to be two ways in which it could be done.

Coverage provision

One option, as in the Standard Life policy, is simply to provide mitigation cost cover as an extension to existing, claims-made wordings. It would need to be for a substantial indemnity limit, however, and underwritten on the basis that the risk exposure was at least equivalent to the probability and magnitude of claims actually made. The trigger of coverage would need to be a breach of duty or other legal dereliction on the part of the insured, resulting or likely to result in third party losses and claims against the insured if not promptly made good. The other option is to dispense with the ‘claims-made’ trigger altogether, for at least those categories of professional indemnity, errors and omissions, bankers bonds and other civil liability insurances offered to industries and occupations in which pre-emptive restitution or making good is a necessary element of the insured’s legal or social obligation, in the event of the sorts of breaches of duty or other legal derelictions to which the insurance is intended to respond.

This type of cover is by no means unprecedented. Mitigation costs extensions have long been a feature of engineers professional indemnity insurance, prompted by the fortunate fact that most engineering errors tend to be revealed during the design and construction phases of projects, while there is still time to rectify them albeit at an additional cost. Moreover, a combination of proportionate liability regimes and the rising popularity of so-called ‘alliance contracting’, under which (eminently sensibly) the parties to a major construction contract agree to resolve errors and omissions in the course of the work through a consensual process and without allocation of blame or responsibility in the traditional legal sense, has prompted the emergence in recent years of a whole new class of construction insurance: the ‘Project PI’ policy. This type of policy typically covers all of the persons providing professional services in connection with a project, or designated stages of one, and responds not just to claims made against insured by external parties but also to losses incurred through their breaches of professional duty in the performance of professional services, without the need to allocate blame or work out the proportionate liability responsibilities of concurrent wrongdoers.

It is important to note that neither of these options detracts from the true nature of PI insurance, as insurance against losses resulting from the insured’s professional negligence. There is no suggestion that cover be provided for the cost to the insured of properly performing its original, contractual undertaking to carry out its professional activities and duties. Similarly, in the Standard Life v Ace scenario, the mitigation costs cover was never intended to be available merely to restore losses caused to the insured’s funds under management due to ordinary market fluctuations. There had to have been some dereliction on the part of the insured giving rise to the fund loss, or at least to consequential losses of third parties who would not otherwise have sustained them and who might thereby hold the insured accountable.

There is, it is submitted, no greater element of moral hazard entailed in this than in any other form of liability insurance. Nor should there be any less rigor in the ascertainment of the quantum of losses and the basis upon which the insured is to be held accountable for them, whether by way of mitigation or compensation. All that is dispensed with is the technical requirement for a formal process of dispute and resolution between the insured and persons affected by its conduct, bearing the name of ‘claim’. The time, it is submitted, is ripe for modification of the traditional ‘claims-made’ principle, at least as applied to fiduciary and financial institution coverages, and for a wider acceptance of the concept of mitigation costs cover in these classes.

Extensions with small sub-limits relative to the aggregate indemnity limit are no longer appropriate: what is required is recognition and underwriting on the basis that it is their liabilities for prescribed forms of misconduct which professional policy holders need to insure, not the making of claims against them in respect of them, and that it is by far more economically efficient to insure a loss directly than to add the frictional costs of the making of a claim by a third party against the insured, however streamlined and efficient the process may be made, to the total compensation bill.

This article was first published in (2014) 26 Insurance Law Journal, and is based upon a paper which the author presented at the 2014 Annual Conference of the Australian Professional Indemnity Group, 4 September 2014.

___________________________________________________________________________________ 

[1] With apologies to Jane Austen. [back]

[2] Insurance Contracts Act 1984 (Cth) s 13. [back]

[3] Petersen v Union des Assurances de Paris 1ARD (1995) 8 ANZ Ins Cases 61-244; BC9504263; affd (1997) 9 ANZ Ins Cases 61-366; Leyland Shipping Co Ltd v Norwich Union Fire Insurance Society Ltd [1918] AC 350; [1918-19] All ER Rep 443; (1918)

87 LJKB 395; 118 LT 120; City Centre Cold Store Pty Ltd v Preservatrice Skandia Insurance Ltd (1985) 3 NSWLR 739; 3 ANZ Ins Cas 60-673; National & General Insurance Co Ltd v Chick [1984] 2 NSWLR 86; (1984) 3 ANZ Ins Cas 60-579; Lumley General Insurance Ltd v Vintix Pty Ltd (1991) 24 NSWLR 652; 6 ANZ Ins Cas 61-087 CA. See also P Davies, ‘Proximate Cause in Insurance Law’ (1995) 7 ILJ 135. [back]

[4]St Augustine, Confessions, Ch 11. [back]

[5] Marine Insurance Act 1909 (Cth) s 84(4) imposes a duty on the insured ‘to take such measures as may be reasonable for the purpose of averting or minimising a loss’. The corresponding provision of the UK Marine Insurance Act 1906 has been construed as essentially a requirement to act as a reasonable uninsured, a personage closely related to but perhaps not to be confused with the better known prudent uninsured. See Integrated Containers Service Incorporated v British Traders Insurance Co Ltd (1984) 1 Lloyds Reports 154. The cost to the insured of complying with this obligation may be recovered under some policies, within limits, even in the absence of a ‘sue and labour’ clause: Emperor Gold Mining Co Ltd v Switzerland General Insurance Co Ltd [1964] NSWR 1243; (1963) 5 FLR 247; 81 WN (Pt 1) (NSW) 85; [1964] 1 Lloyd’s Rep 348. [back]

[6] See R M Merkin, Colinvaux’s Law of Insurance, 8th ed, Sweet & Maxwell, 2006, at 10–35. Notwithstanding the authorities cited, there are serious conceptual difficulties with this interpretation. It is hard to see how an insurer can reasonably be regarded as being in breach of contract, in having failed to prevent an insured’s factory from being damaged in an earthquake or its ship from sinking, and this interpretation may derive more from an obsolete concern that an insurance claim not be characterised as an outstanding debt, than from any genuine conviction of how policies are supposed to work. In the writer’s view, the insurance contractual obligation is better perceived as one of performance; the performance of an indemnity. Australian case law is consistent with this: see Bofinger v Kingsway Group Ltd (2009) 239 CLR 269; 260 ALR 71; [2009] HCA 44; BC200909276; CIC Insurance Ltd v Bankstown Football Club Ltd (1997) 187 CLR 384; 141 ALR 618; 71 ALJR 312; BC9700046; Brescia Furniture Pty Ltd v QBE Insurance (Australia) Ltd (2007) 14 ANZ Ins Cas 61-740; [2007] NSWSC 598; BC200705312. [back]

[7] City Tailors v Evans (1921) 7 Lloyds Law Reports 195; Yorkshire Water v Sun Alliance and London Insurance [1997] 2 Lloyds Report 21. [back]

[8] See J W Carter, E Peden and G Tolhurst, Contract Law in Australia, 5th ed, LexisNexis Butterworths, 2007, at [35-33]–[35-37] and the cases there cited. I am indebted also to Greg Pynt, whose comprehensive article ‘Mitigation in insurance law’ (2013) 25 ILJ 41, is a valuable analysis of all the issues in this vexed area of insurance law. [back]

[9] Netherlands v Youell [1998] 1 Lloyd’s Rep 236; [1997] EWCA Civ 2715. [back]

[10] And probably only the ones who need to get a life. [back]

[11] Yorkshire Water Services Ltd v Sun Alliance & London Insurance plc [1997] 2 Lloyds Reports 21 and the cases therein cited; King v Brandywine Reinsurance Co (UK) Ltd (formerly Cigna Re Co (UK) Ltd) [2004] All ER (D) 108 (May); [2004] Lloyd’s Rep IR 554; [2004] EWHC 1033; (Comm); cf Emperor Gold Mining Co Ltd v Switzerland General Insurance Co Pty Ltd (1962) 5 FLR 247; Bridgman v Allied Mutual Insurance Ltd (1999) 10 ANZ Ins Cas 61-448; [2000] 1 NZLR 433. [back]

[12] Ibid. [back]

[13] Netherlands Insurance v Karl Ljungberg and Co [1986] 3 All ER 767; [1986] 2 Lloyd’s Rep 19; Yorkshire Water Services Ltd v Sun Alliance & London Insurance plc [1997] 2 Lloyds Reports 21; Bartoline v Royal and Sun Alliance Insurance Plc [2007] Lloyds Report IR 423. [back]

[14] Standard Life Assurance Ltd v Ace European Group [2012] All ER (D) 159 (Dec); [2012] EWCA Civ 1713 (COMM), upheld on appeal at [2012] EWCA Civ 1713. [back]

[15] (1973) 2 NSWLR 73. [back]

[16] [2012] EWHC 104 (COMM), upheld on appeal at [2012] EWCA Civ 1713. [back]

[17] The concept of ‘illiquidity’ as applied to investments is one of the most amazing examples of economic newspeak to come out of the Global Financial Crisis. What was meant, of course, was that in the circumstances prevailing no one was willing or able to buy these securities and when that happens to an asset it has no economic value in a market economy, whatever may be its intrinsic value to the holder. It may also come to be regarded as a ‘toxic’ asset or, in other words, no longer an asset at all. Everybody of course hopes that the condition will be temporary, however, in the meantime it is necessary to find appropriate euphemisms to avoid the consequences of calling the spade a shovel. These are likely to be, at the least, a cascading trigger of default and stop-loss provisions under other financial instruments, with implications for balance sheets, regulatory intervention and systemic disruption. [back]

[18] For a detailed analysis of this case including the Appeal Court judgments see L Burke, Case Notes, ‘Standard Life Assurance Ltd v Ace European Group [2012] All ER (D) 159 (Dec); [2012] EWCA Civ 1713 (Com)’ (2012) 23 ILJ 215 and ‘Ace European Group v Standard Life Assurance Ltd [2012] EWA Civ 1713; [2012] All ER (D) 159 (Dec)’ (2013) 24 ILJ 125. [back]

[19] This was consistent with Wayne Tank and Pump Co Ltd v Employers Liability Assurance Corp Ltd [1974] QB 57; [1973] 3 All ER 825; [1973] 3 WLR 483; [1973] 2 Lloyd’s Rep 237. [back]

[20] See also Royal Boskalis Westminster NV v Mountain [1999] QB 674; [1997] 2 All ER 929; [1998] 2 WLR 538; [1997] LRLR 523; Cunard Steamship Co Ltd v Marten [1902] 2 KB 624; Joyce v Kennard (1871) LR 7 QB 78. [back]

[21] (1921) 7 Lloyds Law Reports 195. [back]

[22] Under a contemporary ISR wording, of course, the issue would have been dealt with as an increased cost of working claim. [back]

[23] (1972) 126 CLR 655; 28 LGRA 179; 47 ALJR 31; BC7200500. [back]

[24] K Sutton, Insurance Law in Australia, 3rd ed, LBC Information Services 1999, p 553 [6.58]. [back]

[25] (1972) 126 CLR 655 at 662–3; [1972-73] ALR 897; 47 ALJR 31; BC7200500. [back]

[26] [2011] VSC 65; BC201100964. [back]

[27] Not all of the ammonium nitrate cargo could in fact be re-stowed using containers, which proved to be the only feasible method. A little under a third of it had to be imported into the United States from the Port of Davisville, Rhode Island and sold in the US market. The writer acted for Orica Australia Pty Ltd in the case and can well attest to the difficulties that were encountered in managing a cargo of this nature during the unloading and restowage process, negotiating with the owner and with the US Coastguard and related authorities, so that the balance of the cargo was eventually enabled to proceed on its way and the residual appropriately disposed of. [back]

[28] [2011] VSC 65; BC201100964 at [19] per Pagone J. Other authorities referred to in the passage are Noble Resources Ltd v Greenwood (‘the Vasso’) [1993] 2 Lloyd’s Reports 309; Netherlands v Youell [1998] 1 Lloyds Reports 236; Allison Pty Ltd v Lumley General Insurance Ltd [2004] WASC 99; BC200402994. [back]

[29] Yorkshire Water Services Ltd v Sun Alliance and London Insurance Ltd [1997] 2 Lloyds Reports 21. [back]

[30] This case may be contrasted with the Australian authorities of Re Mining Technologies Australia Ltd [1991] 1 QdR 60; (1997) 10 ANZ Ins Cas 61-389; BC9707414 and Guardian Assurance Co Ltd v Underwood Constructions Pty Ltd (1974) 48 ALJR 307. Neither of these, however, refutes Yorkshire Water in the context of liability insurance. [back]

[31] [1997] 2 Lloyds Reports 21 at 28–9. [back]

[32] (1973) 2 NSWLR 73. [back]

[33] See also Post Off─▒ce v Norwich Union Fire Insurance Society [1967] 2 QB 363; [1967] 1 All ER 577; [1967] 2 WLR 709; [1967] 1 Lloyds Reports 216; Bradley v Eagle Star Insurance Co Ltd [1989] AC 957; [1989] 1 All ER 961; [1989] 2 WLR 568; [1989] 1 Lloyd’s Rep 465.

Both these cases were cited in Yorkshire Water as authority for the basic proposition that the insured under a liability policy must, at the very least, have incurred a liability before it can claim; see also Firma C Trade Ltd v Newcastle Protection and Indemnity Association Ltd [1990] 2 Lloyds Reports 191. [back]

[34] Royal Sun Alliance Insurance Australia Ltd v Mihailoff (2002) 81 SASR 585; (2002) 219 LSJS 332; [2002] SASC 32; BC200201860; Vero Insurance Ltd v Australian Prestressing Services Pty Ltd [2013] NSWCA 181; BC201310388. [back]

[35] For a useful discussion of the cases on loss mitigation in the construction insurance context see P Mead, ‘Policy Triggers and Exclusions in Construction Insurance’ (2008) 24 BCL 184. [back]

[36] This would be consistent, in the case of a policy containing a notification of circumstances ‘deeming clause’, with the High Court’s view of such policies as ‘known circumstances’ coverage, vide FAI General Insurance Co Ltd v Australian Hospital Care Pty Ltd (2001) 204 CLR 641; 180 ALR 374; [2001] HCA 38; BC200103370. Even in the case of a policy without such a clause, since the effect of notification would be to attach cover for future claims arising from the circumstance, through the operation of s 40(3) of the Insurance Contracts Act 1984 (Cth), it could be argued that the event in respect of which the policy provided cover had occurred. On that basis, the obligation on the insured should be treated as one of doing everything reasonable to mitigate a loss in progress, rather than to take at its own expense all reasonable steps to prevent a loss from occurring, with resultant implications for the question whether an entitlement to claim in respect of the costs of doing so might arise. [back]

[37] Vero Insurance Ltd v Australian Prestressing Services Pty Ltd [2013] NSWCA 181; BC201310388. [back]

[38] City Tailors Ltd v Evans (1921) 7 Lloyds Law Reports 195. [back]

[39] The writer has written elsewhere on the limited effectiveness of the ‘claims-made’ principle, when applied to insuring the liabilities of fiduciaries and others responsible for the large scale management of retail funds. See L Burke and F Hawke, ‘Pitfalls of claims made insurance in large scale financial liability cases’ (2011) 22 ILJ 203. [back]

[40] The obvious example which comes to mind is that of a liquidator of a failed financial institution, who could not be compelled to make pre-emptive settlements by either reputational or regulatory considerations and indeed would have an incentive not to make them but to wait for compensation claims to be made against the company, if it were insured only for the latter. [back]

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.