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High Court of New Zealand Decisions |
Last Updated: 15 November 2012
IN THE HIGH COURT OF NEW ZEALAND CHRISTCHURCH REGISTRY
CIV-2012-409-000295 [2012] NZHC 2954
BETWEEN RIDGECREST NZ LIMITED Plaintiff
AND IAG NEW ZEALAND LIMITED Defendant
Hearing: 26 September 2012 (Heard at Wellington)
Counsel: C R Carruthers QC and P A Cowey for plaintiff
B D Gray QC and P M Smith for defendant
Judgment: 8 November 2012
RESERVED JUDGMENT OF DOBSON J
Contents
Background, and the preliminary question ..................................................................................... [1] The policy ............................................................................................................................................ [6] Competing contractual interpretations .......................................................................................... [16] Interpreting the terms of the contract ............................................................................................ [25] Merger............................................................................................................................................... [37] Frustration ........................................................................................................................................ [54] Conclusion......................................................................................................................................... [77]
Background, and the preliminary question
[1] These proceedings involve a dispute between an insurer and insured in relation to the extent of the insurer’s liability for damage to a commercial building in Gloucester Street, central Christchurch. The building was damaged on a number of
occasions by some of the more severe of the earthquakes suffered by Christchurch in
RIDGECREST NZ LIMITED v IAG NEW ZEALAND LIMITED HC CHCH CIV-2012-409-000295 [8
November 2012]
the relevant period. Eventually, the building suffered irreparable damage and has subsequently been demolished.
[2] In those circumstances, the defendant (the insurer) has paid the plaintiff (the insured) the amount that represents the limit on liability under the policy for any one happening of $1.984 million. The insurer had earlier incurred some $125,000 as the partial cost of repairs needed on account of damage caused in earlier earthquakes. The insurer treats these payments as fully discharging its liabilities under the policy.
[3] In contrast, the insured claims that it is entitled to additional sums comprising the estimated costs of all repairs that would have been necessary to restore the building to its pre-earthquake condition, after each of the earlier earthquakes. The extent of such repairs had been assessed by quantity surveyors on each occasion.
[4] For the purposes of determining the preliminary question to which this judgment relates, the parties agreed on a statement of facts which included the
following:
At material times, there was a policy of insurance between
the parties whereby the insurer provided replacement cover for the
insured’s
commercial building situated at 215 Gloucester Street for
events including earthquake damage, with a limit of $1.984m
for
each
happening.
The building sustained damage in an earthquake on 4
September 2010.
The cost of repairing that damage was assessed and estimated to be between $110,115.09 (inclusive of GST) and $196,352 (plus GST). Such repairs had been commenced but were not completed by the time the
second relevant earthquake occurred.
In a second relevant earthquake on 26 December 2010,
the building suffered further, distinct damage. The cost of
repairing
the building following that earthquake was assessed and estimated to be
between
$200,000 (inclusive of GST) and $337,056 (plus GST). Such repairs had
been commenced but had not been completed by the time of the third
relevant earthquake.
The building sustained further distinct damage as a
result of a third earthquake on 22 February 2011. The insured contended
that
the cost to repair the damage caused by the 22 February 2011 earthquake
was assessed and estimated to be $1.924 million
plus GST. The insurer’s
position was that the building was damaged beyond repair as a result of the 22
February 2011 earthquake,
or that the cost of repairs exceeded the
sum insured.
A fourth earthquake on 13 June 2011 caused additional
damage to the building. The insured considered this was further and distinct
damage, whereas the insurer considered that the June 2011 earthquake only
exacerbated existing damage. The insured treated the damage
from the
13 June 2011 earthquake as sufficient to render the building irreparable. The insurer considered that having paid the limit of its liability, it had already performed its obligations under the policy and in addition contended that the building had been damaged beyond repair prior to the
13 June 2011 earthquake.
[5] The parties formulated a preliminary question for determination in the proceedings in the following terms:
Where –
1. There have been four happenings within a period of insurance;
2. Each happening caused damage to the Plaintiff’s building;
Then:
The policy
[6] The relevant contract of insurance was for the period from 10 August 2010 to
10 August 2011.[1] The policy provided cover in respect of business assets with the building at 215 Gloucester Street being particularised. In terms of the scope of the insurance, under a heading “The Insurance”, the policy provided:
This Policy covers only those Parts for which a Limit is shown in the Schedule and the maximum amount you can claim under any Part in respect of any one happening (inclusive of fees and costs) is the current Limit for that Part.
[7] The limit of the insurer’s liability was $1,984,000 and an option providing that the cover would be on replacement terms was confirmed as applying.
[8] The insurance was for sudden and accidental loss of, or damage to, the business assets of the insured and Part C of the policy began with the following provisions:
C. THE AMOUNTS YOU CAN CLAIM
1. This insurance will pay the amount of loss or damage or the estimated cost of restoring your Business Assets as nearly as possible to the same condition they were in immediately before the loss or damage happened using current materials and methods.
2. Where Replacement cover has been agreed by us and specified in the Schedule and following loss or damage you restore or replace the lost or damaged Business Assets this insurance will pay
(a) for Buildings
(i) where repairable, the cost of restoration of damage to the same condition when new,
or
(ii) if unable to be repaired because of such damage, the cost of replacement by an
equivalent building which meets your requirements at any site provided we shall not pay more than the cost of replacement at the Site stated in the Schedule.
Such restoration will use current materials and methods and include the cost of changes to meet the lawful requirements of any local authority or statute but not for work you have already been instructed to do prior to the loss or damage.
[9] The policy did not contain any definition of what constituted a “happening”. Nor were there any provisions addressing the terms that would apply in a situation after a claim had been made during the period of insurance. In contrast, some policies of this type include a procedure for reinstatement of cover after a claim has been met by the insurer, usually affording the insurer an opportunity to re-assess the
risk, and charge an additional premium.[2] In this policy, the insurer was limited to
cancelling the policy (which had to be on 30 days’ notice) in the event that
circumstances material to the extent of risk changed.
[10] Mr Carruthers QC accepted that it is relatively common for material damage policies to include a provision that gives the insurer an option, at its election to
either:
supervise repairs to insured property, thereby keeping
control over the
contractors involved, and presumably the costs incurred; or
leave the supervision of repairs to the insured, so that
the insurer pays the insured amounts either projected to be incurred,
or
in fact already
incurred by the insured.
[11] There is no such provision in the present policy. The insurer’s obligation under both clauses C1 and C2 was simply to pay quantified amounts. However, notwithstanding the absence of a provision authorising repairs to be effected under the control of the insurer, the repairs to the building that were undertaken after the
first and second earthquakes were arranged by consultants retained by the insurer.
Those consultants and physical works were paid for by the insurer. That occurred notwithstanding the insured purporting to reject the services of the project manager appointed by the insurer in December 2010, and notifying its election to take a “cash settlement” in respect of the damage caused by the first earthquake. There was no explanation as to the grounds relied on by the insurer to resist that course.
[12] The agreed facts make no reference to the timeliness of the repairs that were being undertaken at the direction of the insurer. Disruption to the works being undertaken after each of the first two earthquakes that was caused by the next relevant one can be seen as an unforeseen fortuity.
[13] Within this dispute, the timing of the respective earthquakes and their severity have ironically created a windfall for one party or the other, depending on whether the insurer or the insured prevails on this preliminary question. If the insured succeeds, it will recover more than the insured loss suffered by the end of the period of insurance in the sense that it would be paid for repairs that were not undertaken, and which would not have restored value to the building when it was to be rendered irreparable within the period of the insurance. If the insurer succeeds, then the timing of the subsequent earthquakes has relieved it of the obligation to pay more for the cost of repairs that it would otherwise have undertaken, even although subsequent history has established that such costs would have been incurred in vain, and however much was paid did not lessen the insurer’s obligation to pay the full limit of its liability on whichever happening rendered the building irreparable.
[14] There can be no criticism of the parties in presenting the preliminary question for determination by the Court without the encumbrance of the likely extent of ramifications of the decision. I am mindful of the adverse consequences that could follow from imposing greater liabilities on insurers than is required to indemnify insureds for the actual losses they suffered at the end of the relevant sequence of earthquakes. In particular, if it was acknowledged as having broad precedential impact, a decision entitling insureds to more than their ultimate net insured loss may have important consequences in exacerbating the restoration of a reasonable market for insurance services in the post-earthquake environment in Christchurch.
[15] However, the context for this preliminary question is the interpretation of the individual contract in its own commercial context. These parties made this bargain, and it is to be enforced as interpreted, subject to the limited respects in which the law recognises the prospects of varying the application of its terms.
Competing contractual interpretations
[16] In its written submissions filed before the hearing, the insured relied on an interpretation of clause C2 of the policy, to argue that in the absence of a contractual option to effect repairs rather than pay for them, the insurer was liable to pay the projected costs of restoring the damaged parts of the building to the same condition they would have been in when new. Those were separate obligations arising when each happening occurred, and were not altered by later happenings. When (after the third or fourth earthquake) the extent of further damage rendered the building unable to be repaired, then the insurer was additionally liable for the cost of a replacement building. Because it was accepted that the building was under-insured, in practical terms that amount was capped at the limit of the insurer’s liability for that happening.
[17] In oral argument, and particularly in reply, Mr Carruthers expanded the argument for the insured somewhat, arguing that liability arose first under clause C1 of the policy. On its terms, the insurer was arguably liable to pay the estimated cost of repairing damage as soon as a happening occurred. That liability was quantified at the estimated cost of repairing the damage sustained in the happening to restore the building to the condition it was in before that happening – colloquially, the insurer was liable under clause C1 to pay what it would cost to effect “old for old” repairs. The insurer was liable on this basis, whether the repairs were actually carried out or not.
[18] In addition, because the insured had opted to have replacement cover, clause C2 would apply as well if the insured did proceed to restore the damage, and in that event the insurer became liable for the restoration of damage to the same condition as when the building was new (ie under clause C2(a)(i)) – colloquially “new for old” repairs, if they were actually carried out. Further, once the building became
irreparable, then clause C2(a)(ii) applied if the insured elected to rebuild, to impose liability on the insurer to pay the replacement cost of the building (subject always to the limit of liability agreed in the policy).
[19] The insurer’s first argument in response was that the provisions in clauses C1 and C2 are mutually exclusive alternatives, depending on whether the building was insured on a reinstatement or a replacement cover basis. Where, as here, the insured had opted to have replacement cover, then so long as the building was repairable, the insurer’s liability was to meet the cost of those repairs once they had been done. The insurer was liable for a potentially higher amount than it would be under reinstatement insurance because its liability extended to the costs of restoring the building to an “as new” condition, in contrast to the reinstatement cover which only obliged the insurer to repair the building to the condition it was in prior to the happening.
[20] On this approach, the insurer’s liability to meet costs of repair work ceased when supervening events rendered that impossible. The insurer then became liable for replacement cost (up to the limit in the policy) under clause C2(a)(ii).
[21] If the insurer’s stance treating clauses C1 and C2 as mutually exclusive options was wrong, so that liability of the type provided for under clause C1 could arise notwithstanding that the insurer had contracted to provide replacement cover, then the insurer still maintained that the extent of payments already made has fully discharged its liabilities under the policy. The insurer argued that its liability to provide cover for damage arising from any happening within the period of insurance cannot be quantified without taking into account what occurred during the remainder of the period of insurance.
[22] Here, where repairs were underway but were rendered impracticable or impossible by the subsequent earthquakes, that brought to an end any further liability to indemnify the insured for repairs that would not be made. Once the building was damaged to the extent of being irreparable, that triggered the insurer’s liability to make a payment of the limit of its liability towards replacement of the whole building, and that became the relevant measure of its liability. Had the building been
fully insured, then that payment would have provided for the entire cost of a replacement building so that any additional payments to the insured for previous repairs would have been a windfall.
[23] Mr Gray QC argued for the application of the doctrine of merger of liabilities in the circumstances of successive claims within the term of the policy. He also argued that the doctrine of frustration arose once repairs to the damaged building were rendered impossible by a subsequent insured event.
[24] On either basis, earlier liabilities for claims under the policy were effectively subsumed when the insurer accepted liability to meet a claim under the policy for the replacement cost of the building, subject to the limit specified in the policy.
Interpreting the terms of the contract
[25] The parties agreed that the general principles of interpretation of contracts apply to insurance policies. The aim is the objective ascertainment of the meaning that reasonable persons would consider the parties intended their words to bear.[3]
[26] Mr Carruthers cited authority for the proposition that where there is ambiguity in an insurance contract, the contra proferentem rule is generally applied against the insurer.[4] Mr Gray accepted the application of this principle, subject to the requirement that there be realistic rigour in testing whether in fact a relevant ambiguity indeed arose.
[27] I do not accept the insurer’s first proposition, namely that the provisions on the amounts that an insured can claim in clauses C1 and C2 are mutually exclusive. Rather, I consider that both provisions will potentially apply where the insured has contracted for replacement cover. If replacement cover only gave the insured an entitlement under clause C2, then the insured would have to commit to restoring the
damage, before the insurer had any liability at all. The terms of clause C2 “and you
restore or replace” makes the insurer’s liability under clause C2 conditional on the insured electing to effect repairs. Limiting the cover for an insured to circumstances where repairs are undertaken seems commercially unrealistic, when the extent and circumstances of damage will not be known in advance when the policy is undertaken. Further, if it had been intended for the two clauses to be mutually exclusive, the draftsperson could reasonably be expected to make the distinction explicit by using an introductory phrase at the outset of C1 in terms such as “Where reinstatement cover has been agreed ...”. Instead, the scope of C1 is unqualified, so that the insured is entitled to the amount that represents the cost of reinstating the pre-happening condition of the building, whether that work is done or not.
[28] Replacement cover exposes the insurer to potentially larger liabilities, and is likely to involve larger premiums payable by the insured. The difference in cost is that between funding “old for old” repairs and “new for old” repairs. It is consistent with this being more extensive cover that the scope of claims for property owners with replacement cover should be additional to, rather than alternative to, the cover applying for those with reinstatement insurance. In the absence of a specific provision in the policy, it is unlikely that the parties to a replacement cover policy intended that the insurer would not have any liability at all if the insured did not replace the damaged parts of the property after a happening.
[29] The terms of the introductory part of clause C2 contain what amount to two pre-conditions: agreement to replacement cover which has been specified in the schedule, and the insured electing to restore or replace the lost or damaged business assets following loss or damage. If those two conditions exist, then, in the case of buildings that are repairable, the insurer is liable for the cost of restoring the damage to the same condition as when new. In the case of buildings that are unable to be repaired, the insurer is liable under clause C2(a)(ii) for the cost of an equivalent building measured by reference to the cost of replacing one on the site stated in the schedule.
[30] On the wording of clause C2, the insurer’s additional obligation to meet the actual costs of restoring the building to the same condition as when the building was new only arises when such work has been done, so that the cost of it has crystallised.
These obligations on the insurer are subject to the limit specified in the definition of the insurance at the outset of the policy, namely the limit per happening of
$1,984,000 for the relevant building.
[31] Mr Gray also addressed the alternative position if the insurer was wrong in treating C1 and C2 as mutually exclusive so that C1 could apply even if the insured had opted for replacement cover (which I find to be the contractual position). If those circumstances applied, then Mr Gray argued that the state of the building during the remainder of the period of insurance is relevant to the extent of the insurer’s liability for the successive “happenings” throughout the period covered by the insurance, if the doctrines of merger or frustration applied. He submitted that they should.
[32] Mr Gray’s written submissions made two further points that were not tested closely during argument. First, he submitted that following a partial loss, the amount of that loss is deducted from the sum insured. He cited Hardy Ivamy for the proposition.[5] The passage cited does not support that proposition and, inconsistently with it, the text observes that a prior recovery by an assured in respect of a loss under the policy does not prevent him from recovering for a second or subsequent loss during the period of insurance.
[33] Mr Gray’s submission on this point also cited a second text, All Risks Property Insurance.[6] That text does stipulate that following a total loss the sum insured is reduced to nil, and following a partial loss, the amount of that loss is deducted from the sum insured so that the insured is obliged to increase his coverage to reinstate the level of cover that he originally contracted for. In the context in which those comments are made, I take them to be the authors’ perception of the
practice generally adopted by underwriters in drafting provisions about successive losses in terms of material damage policies. It is certainly not a proposition implied by law, and rather is a matter on which any presumed general practice must yield to
specific terms of the contract of insurance in issue.
[34] In the present case, the policy is cast in terms of a limit of liability per “happening”, without any requirement for the insured to request reinstatement of the extent of cover available after a claim has been met. Accordingly, I agree with Mr Carruthers’ interpretation that the limit of liability is available for the insured to claim in the event of a loss, on as many occasions during the period of the insurance as a relevant loss is suffered.
[35] The second proposition in the written submissions for the insurer was that the agreement between the parties recognised that where costs of repair caused by a single earthquake exceed the limit of liability, rendering the building “totally lost”, then in those circumstances the insurer’s obligation is to pay the limit of indemnity and nothing more. It was submitted that this reflects an agreement that once a total loss occurs, there is nothing more to insure.
[36] Whilst the first part of this proposition seems unobjectionable, it does not follow that payment of the limit of liability on any one claim would bring the policy to an end. That point may be reached in practical terms because the prospect of replacing a building within the remainder of the year’s period of insurance would not be feasible. However, conceptually at least, if the building could be reinstated before the expiry of the period, then the fact that it had been treated as a total loss, rather than suffering losses that were treated as partial losses, would not of itself mean that this policy would not continue to apply.
Merger
[37] The doctrine of merger is a well-settled component of the common law and statutory provisions relating to marine insurance. Adopting the statutory provisions from the United Kingdom, the New Zealand Marine Insurance Act 1908 includes the following provision:
77 Successive losses
(1) Unless the policy otherwise provides, and subject to the provisions of this Act, the insurer is liable for successive losses, even though the total amount of such losses may exceed the sum insured.
(2) Where under the same policy a partial loss which has not been repaired or otherwise made good is followed by a total loss, the assured can only recover in respect of the total loss.
...
[38] The House of Lords decision in British and Foreign Insurance Co Ltd v Wilson Shipping Co Ltd is cited as authority for the notion that a claim for unrepaired damage in respect of an insured vessel will, for the purposes of claims under the policy, be merged with a subsequent total loss of the vessel during the period of insurance.[7] In that case, the vessel in question was on charter to the Admiralty when it suffered a measure of damage caused by risks covered by the owners’ relevant insurance policy. Only part of that damage was repaired, leaving further repairs assessed to cost some £1,770, to be effected at a later date. Thereafter, the vessel
was lost due to war perils, which were not covered under the relevant policy, and instead that risk was assumed by the Admiralty under the charter. Because owners were indemnified by the Admiralty as if for a total loss, they were unsuccessful in claiming from the marine underwriters for the costs of the repairs to the vessel that had not been undertaken.
[39] Lord Birkenhead cited from an 1810 decision of Lord Ellenborough:[8]
... the previous deterioration becomes ultimately a matter of perfect indifference to his interests, he cannot make it the ground of a claim upon the underwriters. The object of a policy is indemnity to the assured; and he can have no claim to indemnity where there is ultimately no damage to him from any peril insured against.
[40] Lord Birkenhead continued:[9]
In whatever form the principle upon which this decision is based should be stated, the decision itself is clearly right. If not, the assured whose vessel becomes a total loss during a voyage in the course of which she meets a succession of gales, each of which causes damage, would, in a case to which s. 77, sub-s. 2, of the Act of 1906 does not apply, be in a position to claim under his policies for each of these losses in succession, although none of them is or could be repaired, and he could at the same time recover the value of the ship as a total loss if she is wrecked during the currency of the policies. Such a result would, of course, be contrary to the principles upon
which marine insurance has always been conducted. The owner would not in such a case merely be indemnified against loss, but he would receive a profit.
[41] The concern to confine the character of a contract of marine insurance to one of indemnity dictated the outcome in that case, even although the sum paid by the Admiralty for a total loss was calculated as the assessed value of the vessel at the outset of the charter, less the sum of £1,770 on account of the repairs, which were still to be undertaken at the time of its loss, to reflect its value at the time of loss. Whilst it is correct that it would not avail the owners to pay for repairs when the vessel had been lost, in the economic sense the owners remained out of pocket in terms of full indemnification for their loss, to the extent of the cost of the uncompleted repairs. This peculiarity was treated by the House of Lords as arising from the election attributed to owners, to not repair the damage costed at £1,770, in circumstances where they would not have a claim against the hull underwriters until
either the repairs had been done, or at the end of the term of the policy.[10]
[42] Mr Gray submitted that the New Zealand Court of Appeal has recognised the more general application of the principle of merger for the purposes of insurance contracts, in the decision of Wright, Stephenson, and Co Ltd v Holmes.[11] There, the plaintiff’s motor vehicle was damaged in an accident and had been towed to a garage in Napier for repair. It was insured under a policy interpreted by the Court of Appeal as imposing a single obligation on the underwriters to repair, reinstate or replace the
vehicle, and that a stipulated alternative of settlement in money was only at the option of the underwriters. Before repairs could be effected, the vehicle was completely destroyed in the aftermath of the Napier earthquake.
[43] The Court of Appeal decided that the insurers were relieved of liability because their only obligation was to repair the car and that had become impossible so that the contract was frustrated. Having done so, the Court found it unnecessary to decide whether the doctrine of merger, as illustrated in the Wilson Shipping
decision, applied to the dispute over motor vehicle insurance. McGregor J appeared
to accept the appropriateness of wider application of the concept of merger in the following observation:[12]
It is difficult, however, to read the broad statement of the law by Lord Birkenhead, LC, in the Wilson Company’s case without feeling that His Lordship’s remarks there were of wide application, and probably would be held to extend to all contracts of insurance by way of indemnity, of which the present case is a typical instance.
[44] The learned author of Insurance Law in Australia cites the Court of Appeal’s observation at the conclusion of its judgment in Wright, Stephenson as regarding the rule on merger as being “of general application”.[13]
[45] In seeking to distinguish the reasoning on the concept of merger in the Wilson Shipping decision, Mr Carruthers raised a peculiarity of marine insurance contracts undertaken in respect of a vessel for a period of time. Lord Birkenhead’s speech treated such policies as deferring an insured’s entitlement to claim under the policy for unrepaired damage until the expiry of the policy. Again, Lord Birkenhead was reflecting analysis from an earlier case in which Lindley J had remarked:[14]
...where a ship has been injured and not repaired, the assured must wait until the expiration of the risk before he can sue the underwriters for the loss he has sustained. The assured has no vested right of action when the injury is sustained.
[46] Mr Carruthers related that to another quotation adopted by Lord Birkenhead in the following terms:[15]
The question in every case must be, did the total loss happen before the underwriter’s liability for the unrepaired damage accrued? If yes, he is not liable; if no, he is liable.
[47] Mr Carruthers distinguished the practice of deferring the liability of an underwriter until the end of the period of the risk in marine insurance, from the terms of the present material damage cover under which the insurer became liable forthwith on the occurrence of a happening that caused damage to the insured
property.
.
[48] More generally, Mr Carruthers resisted the appropriateness of any analogy because of the idiosyncratic aspects of marine insurance law. These included the on-going influence of historical features, such as that each voyage was treated as a separate maritime adventure, in mercantile arrangements for financing and insuring vessels and cargo operations.
[49] I am not satisfied that the doctrine of merger has been applied to marine insurance policies solely because the underwriters would not be liable for unrepaired damage to a vessel until the expiry of the policy. That seems more likely to be a consequence of the settled approach, rather than the rationale for it. A broader basis for merger is that the policy of mercantile law in regulating interests between underwriters and insured interests operates to moderate the extent of liabilities assumed by underwriters. The essence of such contracts is that the insured will be indemnified for losses actually incurred. This is exemplified in the concern not to produce a profit for the insured, referred to at the end of the extract from Lord Birkenhead’s speech at [40] above.
[50] Marine insurance does not contemplate “replacement” of a vessel, at least within an existing hull policy. Once either a constructive or actual total loss has been established, that exhausts the insurance over a vessel.[16] A vessel built or acquired to replace one that is lost by a marine peril is a new insurance prospect. In contrast, in theory at least, a replacement for an irreparable building could be insured under the same policy. In that sense, the occurrence of a “total loss” under a marine hull policy
brings an end to the contract, whereas a pay-out for what is a constructive total loss of a building may not. Merger applies in marine insurance policies to subsume lesser liabilities that have become a matter of indifference within an insurer’s ultimate liability. In those terms the proposition is supported by common sense in a way that arguably justifies a wider application. It certainly invites analogy with arguments for the doctrine of frustration to apply, which is considered below.
[51] The terms in which the Court of Appeal commented in Wright, Stephenson on
Lord Birkenhead’s observations about the policy having “wide application” are not a
sufficient foundation for treating the doctrine of merger as applying to wider categories of material damage insurance. As Mr Carruthers pointed out, under a marine insurance contract, the insurer is only liable for damage to the vessel when the repairs are effected, or at the end of the term of the policy. In contrast, the present policy creates liability as soon as damage caused by a “happening” occurs. It is materially easier to justify the merger of one or more pending claims than it is to re-cast the character of one or more existing claims.
[52] In material damage insurance, parties are left to negotiate the scope of cover by contract, and it is a matter of interpreting the terms contracted for. One influence on that is likely to be the fundamental nature of material damage insurance as an indemnity against loss actually incurred, but that cannot justify imposing a rule that merger should apply automatically, or uniformly. Indeed, in the present case, there are circumstances where the insurer will be liable for more than indemnification and what amounts to betterment, if the insured restores a damaged building not to its pre- happening condition, but to “as new” condition and claims that cost under clause
C2.[17]
[53] Reflecting on these considerations, I consider that the greater variety in the terms of general insurance contracts, and the absence of any equivalent to s 77(2) of the Marine Insurance Act 1906,[18] count against the uniform adoption of merger as applying automatically to all general insurance, or material damage insurance policies. Here, the policy was on terms that the insurer could conceptually be liable for later claims in respect of subsequent happenings, even after a constructive total
loss.
Frustration
[54] The second aspect of Mr Gray’s argument resisting liability for the insurer to make payments in relation to the unrepaired damage was that the subsequent constructive total loss rendered completion of the outstanding repairs required after earlier earthquakes an impossibility. Accordingly, the relevant contractual obligation was frustrated and should not be enforced. If the contract had provided the insurer with an election to opt for effecting repairs rather than paying the insured to have them carried out, then, as in Wright, Stephenson, this sequence of happenings would have brought the dispute within the classic circumstances of impossibility of further performance, rendering the contract frustrated.
[55] In contrast to the contractual obligation in Wright, Stephenson, which was interpreted as a singular one to effect repairs, the insurer’s obligation in the present case is to pay an amount that represents the cost of repairs, and that was not rendered impossible. Quantity surveyors had estimated the cost to effect the repairs, and the insurer could still write a cheque notwithstanding the demolition of the building. Performance of the additional obligations claimed by the insured is therefore not frustrated in the narrow sense of being rendered impossible by intervening events.
[56] This analysis of the literal application of the contractual provisions ignores the factual context in which the dispute evolved. The insurer had proceeded to discharge its liability to meet claims after the first and second earthquakes by arranging to have the damage caused by those earthquakes repaired. Although the contract did not contain a provision entitling the insurer to elect to discharge liabilities in that way, that course had been accepted and was partly performed when the third earthquake occurred. Subsequent earthquakes rendered completion of performance by the mode that had been undertaken impossible.
[57] Once further repairs were impossible, the insurer discharged its obligations by payment of the sum of money comprising the limit of its liability under the policy for one happening when it was agreed that the building was irreparable. It would be artificial to ignore what had actually happened in assessing whether the insurer is liable under the policy for residual claims for earlier partial losses, having accepted
liability to pay the limit of liability under the policy for a constructive total loss in these circumstances.
[58] In Wright, Stephenson, the route by which the Court of Appeal found the contract to be frustrated was by implying a condition that if, before breach, performance became impossible without the default of either party and owing to circumstances which were not contemplated when the contract was made, then the parties would be excused from further performance.
[59] The House of Lords reviewed the rationale for the doctrine of frustration in Davis Contractors Ltd v Fareham Urban District Council.[19] Viscount Simonds postulated two possible juridicial bases for the doctrine. The first was an implied term to the effect that the parties would not have intended to be bound if certain events were to happen. Alternatively, the doctrine could rest on the impact of the law on a situation in which an unexpected event would make it unjust to hold the parties to their bargain.[20] Viscount Simonds emphasised that the latter approach to frustration “had been and must be kept within very narrow limits”. In their speeches in the same appeal, the rationale for frustration was expressed first by Lord Reid:[21]
It appears to me that frustration depends, at least in most cases, not on adding any implied term, but on the true construction of the terms which are in the contract read in light of the nature of the contract and of the relevant surrounding circumstances when the contract was made.
And Lord Radcliffe:[22]
... frustration occurs whenever the law recognizes that without default of either party a contractual obligation has become incapable of being performed because the circumstances in which performance is called for would render it a thing radically different from that which was undertaken by the contract.
...
There must be ... such a change in the significance of the obligation that the thing undertaken would, if performed, be a different thing from that contracted for.
[60] Since those observations, the notion of recognising frustration by implying an appropriate term in the contract has been relegated in favour of recognising its application in rare situations where it is necessary to relieve parties of their contractual obligations in order to impose a just and fair solution.[23]
[61] The argument for the insurer on this point is that performance should not be required of the insurer when supervening events without any fault on the part of the insurer have removed the justification for the payments that would otherwise be due. In the context of an insurance contract obliging the insurer to indemnify the insured for costs incurred in repairing material damage to the building, no further payment is required because those repairs could not be undertaken and the insured has been paid for a presumed total loss of the building.
[62] In opposing this argument, Mr Carruthers submitted that the insurer’s liability arose, in respect of each claim, when the earthquake causing damage to the building occurred. The extent of that liability (at least under clause C1) reflected the projected costs of repairs, and the liability could be quantified as soon as quantity surveyors had assessed the costs of effecting the repairs. The insurance contract does not contemplate that such liabilities could be altered thereafter by subsequent events. Instead, the contract contemplates the prospect of separate liabilities being triggered for the insurer on multiple occasions during the period of insurance, whenever there is a happening that causes material damage which is covered by the policy.
[63] The insured’s claim was not quantified in its statement of claim. I assume from Mr Carruthers’ argument that the claim is for the balance of the insurer’s alleged residual liability to pay in respect of those happenings. Presumably, this would be calculated taking into account the costs actually incurred by the insurer on the parts of the repairs that were undertaken, and being a claim for the cost of the
remainder of the repairs.
[64] However, the contractual analysis insisting that the insurer’s obligation crystallised as soon as a happening occurred is less than compelling when measured against the commercial reality of what the parties had embarked on in this case. The insurer was proceeding to meet its liability in respect of the first two earthquakes, by effecting the relevant repairs. The course of that mode of performing the insurer’s obligations was disrupted by the subsequent earthquakes. Having accepted performance by the insurer by a mode inconsistent with the terms of the contract, the insured’s claim requires the insurer to revert to performance in respect of those earlier happenings in accordance with the strict terms of the policy.
[65] The chronological sequence of liabilities was disrupted in any event by payment of the limit under the policy after the third or fourth earthquake, whilst the claims for the earlier earthquakes remained unresolved.
[66] In these circumstances, it is instructive to consider the position of the parties if the contract had been performed strictly on its terms from the outset. Assume that the insurer had acceded to the insured’s claims to be paid cash settlements (implicitly under clause C1), and that quantum had been agreed and settled after the first, second and third earthquakes at, say, $200,000, $300,000 and $500,000. Assume also that the insured deferred a decision on whether to effect the repairs, leaving open the prospect that, having invested the $1 million payments elsewhere, it would manage the building thereafter in its diminished state without effecting the repairs in respect of which it had been paid. Then the fourth earthquake caused irreparable damage.
[67] Dealing with such a claim under clause C1 so that it could be resolved prior to the replacement of the building, how would the parties assess the state of the building prior to the fourth earthquake for the purposes of quantifying the cost of repairs for the new damage? It seems most unlikely that the pre-existing and unrepaired damage would not contribute in any way to the assessment of the building as irreparable. Even if the consequences of prior, repairable damage could be entirely distinguished from the damage in the fourth earthquake that rendered the building irreparable, quantification of the costs of repairs notionally required after the last earthquake to establish that the insured property constituted a constructive
total loss could not rationally ignore the costs of repairing prior aspects of damage that the insured had been paid for, but not effected.
[68] In that scenario, the insured’s claim to be paid for a total constructive loss (ie at the limit of the insurer’s liability) as a discrete claim following the fourth earthquake as a separate happening would arise after the insured had been paid
$1 million in respect of repairs not undertaken on a building insured for
$1.984 million in respect of any happening. In practice, the assessment of the fourth claim would likely be influenced by the extent to which the building was under- insured. If fully insured, quantity surveyors or valuers might assess the pre- irreparably damaged value of the building by starting with the value of the building prior to the first of the earthquakes, and then deducting from that the agreed costs of
repairs for the first, second and third earthquakes.[24] In the suggested circumstances,
it would be artificial to project the cost of repairing the additional damage sustained in the fourth earthquake (notwithstanding that the building was irreparable), ignoring the cost of unrepaired damage sustained by the building in previous earthquakes.
[69] However this exercise would be done, it would be relevant in assessing whether it was economically feasible to effect repairs to have regard to the agreed cost of repairing the damage sustained in the prior earthquakes, which repairs had not been effected. If the existence of unrepaired damage sustained in previous happenings, for which the insurer had already made payments to the insured, was excluded in assessing a claim for a total loss, then requiring the insurer to pay the full insured value on the building becoming irreparable would constitute performance by the insurer of an obligation radically different from that which was originally promised. That scenario would arguably come within the narrow boundaries in which the Court would invoke the doctrine of frustration to intervene and impose a just and fair solution. Where the analysis was done in relation to reinstatement/indemnity cover, a helpful analogy can be drawn with the principle that indemnification should be limited to reimbursement for real losses, which
underpins the doctrine of merger in marine insurance.
[70] The present position is the converse, in the sense that the insurer has accepted liability to make payment for a total constructive loss, but the insured now wishes to be paid in addition for the costs of repairs that were required after the earlier earthquakes but were not carried out. If those claims had been settled before the final earthquake, the fact that the payments had been made would arguably have affected the quantification of the insurer’s liability for the total loss under either clause C1 or C2. If not, the insurer would be performing an obligation fundamentally different to the one that was agreed.
[71] Assumption of material damage risks for commercial buildings is a stock form of indemnity insurance. It is an unlikely context in which to include an additional element of liability assumed by underwriters for sums additional to the loss suffered by a building owner by virtue of partial damage to it, when the ability to effect repairs is overtaken by a constructive total loss. Mr Gray made numerous pleas that this was not a contract of insurance with any aspect of gaming in it.
[72] In a material damage policy for a defined term (here, 12 months), insurers may assume the risks of multiple happenings throughout the whole period. Those are the applicable terms in this case. Those terms may result in the insurer being liable on successive claims for sums that exceed the limit of liability on a single claim. Realistically there would not be replacement after a complete loss before the underwriters had an opportunity to revisit the terms on which they would contract for the subsequent year’s renewal. However, the focus remains on indemnifying the insured for the loss incurred from insured events.
[73] In this case, the insured has suffered a loss that is not completely compensated by payment of the insurer’s limit of liability because the building was under-insured. That cannot provide any justification for increasing the insurer’s liability beyond the amount required to indemnify the owners for damage incurred. Rather, the insured is to be seen as self-insuring the layer of risk above the limit of cover under the policy.
[74] The current test for whether frustration can be invoked to avoid performance of a contract on its original terms eschews the utility of testing whether
circumstances would warrant the implication of a contractual term that would validate a varied form of performance by the party seeking to avoid its original obligation. Nor did Mr Gray contend for an implied term that would authorise a different mode of performance of the insurer’s obligations.
[75] However, I consider that a relevant implied term would be entirely tenable in the particular circumstances that developed here. If the parties had been asked, at the time the contract was entered into, to address the scope of liability that would be required of the insurer in the sequence of events that has transpired, then a reasonable person would consider that the parties would have agreed that the scope of liability for subsequent happenings during the term of the insurance would not extend to require payment of sums greater than was necessary to effect repairs that were able to be undertaken before the building became irreparable. That limitation would address the insured’s position for claims under clause C1. Claims under clause C2 (if the limit of liability was sufficient) would also reflect the higher but actual costs incurred in replacing the building or component parts of it damaged in the relevant happenings, but would not extend beyond those repairs which had commenced before the final happening.
[76] When the present claim is analysed in light of these factors, and is tested against the converse circumstances I have postulated, I am satisfied that circumstances did arise in which frustration can be invoked to alter the outcome otherwise required by the contractual terms. The insurer is not obliged to pay any sums greater than were necessary to effect the parts of repairs that were undertaken before the building became irreparable, plus the limit of its liability under the policy in respect of the happening in which that occurred.
Conclusion
[77] In addressing the preliminary question, I find that the contractual terms would entitle the insured to be paid the further amounts claimed. I am not satisfied that the doctrine of merger should apply generally to material damage contracts of insurance. However, in the circumstances of this contract and its part performance, I am satisfied that the obligation of the insurer to meet the full extent of liability
provided for in the contract has been frustrated. Accordingly, the preliminary
question is answered “no”.
[78] I invite memoranda from counsel in respect of costs, if they cannot be agreed.
Dobson J
Solicitors:
Parry Field, Christchurch for plaintiff
Fortune Manning, Auckland for defendant
[1] The parties did conclude a further contract of insurance in respect of the building for a subsequent period, but that is not directly relevant to the present question.
[2] One example, in a statutory rather than contractual context, is the provision for reinstatement of natural disaster cover by the EQC. See commentary in Re Earthquake Commission [2011]
3 NZLR 695 at [36].
[3] Vector Gas Ltd v Bay of Plenty Energy Ltd [2010] NZSC 5, [2010] 2 NZLR 444 at [19].
[4] For example, Brown v Ocean Accident and Guarantee Corp [1916] NZLR 377; Skeggs Foods Ltd v General Accident Fire & Life Assurance Corp Ltd [1973] 2 NZLR 439 and Smith v National Mutual Fire Insurance Co Ltd [1974] 1 NZLR 278.
[5] E R Hardy Ivamy General Principles of Insurance Law (6th ed, Butterworths, London, 1993) at
456. (See also 457.)
[6] John Hanson and others All Risks Property Insurance (LLP, London, 1995) at 174.
[7] British and Foreign Insurance Co Ltd v Wilson Shipping Co Ltd [1921] 1 AC 188.
[8] Livie v Janson (1810) 12 East, 648 at 654.
[9] At 194. The United Kingdom statute referred to was relevantly in the same terms as s 77 of the
New Zealand Act of 1908 cited in [37] above.
[10] At 199.
[11] Wright, Stephenson, and Co Ltd v Holmes [1932] NZLR 815.
[12] At 826.
[13] Kenneth Sutton Insurance Law in Australia (2nd ed, Law Book Company, Sydney, 1991) at
[15.36] and [15.37].
[14] Pitman v Universal Marine Insurance Co (1881-82) LR 9 QBD 192 at 197.
[15] British and Foreign Insurance Co Ltd v Wilson Shipping Co Ltd at 198
[16] See, for example, Kastor Navigation Co Ltd v AGF MAT [2002] EWHC 2601 (Comm), [2004]
211 Rep 119 at [116].
[17] On the facts, it appears the insurer’s final payment is to be treated as made under clause C1 because the payment was not subject to a condition that the insured rebuild, and the extent to which the building was under-insured meant that it was a matter of indifference whether its quantification was calculated under clause C1 or C2.
[18] Section 77
does acknowledge the prospect of insurance contracts providing for different
liability arrangements. The provision nonetheless
sets a standard that appears
to be widely adopted and is consistent with other features of marine
insurance.
[19]
Davis Contractors Ltd v Fareham Urban District Council [1956] UKHL 3; [1956] AC
696, [1956] 2 All ER
145.
[20]
At
715.
[21]
At
720-721.
[22]
At 729.
[23] See, for example, John Burrows, Jeremy Finn and Stephen Todd Law of Contract in New Zealand (4th ed, LexisNexis, Wellington, 2012) at [20.1.2]; Laws of New Zealand Contract (on-line ed) at [367].
[24] Compare the approach to valuation of a total loss in Wilson Shipping: see [38] and [41] above.
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