Editors: George N. Proios
Gene B. George
Joshua S. Force

I. NEWS AND INFORMATION
 
 

Bumbershoot Policy Held Not to Cover Damage to Insured’s Own Vessel from Normal Wear and Tear

Reliance Ins. Co. v. Keystone Shipping Co., 102 F. Supp. 2d 181 (S.D.N.Y. 2000)

In this case, four underwriters subscribing to a standard form Bumbershoot policy commenced a declaratory judgment action seeking a declaration that the Bumbershoot policy did not provide coverage for a claim made by the insureds, Keystone Shipping Company and Intercoastal Bulk Carriers (collectively “Keystone”). Keystone claimed that the damage to its own vessel, the ENERGY INDEPENDENCE, a dedicated coal carrier, was covered under the Bumbershoot policy. Specifically, Keystone asserted that it was entitled to be indemnified for more than $6,000,000, which it had paid to defend and settle an arbitration proceeding commenced by New England Power Company (“NEP”), who had purchased the ENERGY INDEPENDENCE from Keystone. It was NEP’s position at the arbitration that the ENERGY INDEPENDENCE was sold to it out of class and in need of substantial repairs to the cargo holds.

The ENERGY INDEPENDENCE was built in the early 1980’s by NEP and Keystone and launched in 1983. From December 1983 through September 1995, the vessel carried coal from various points in Virginia and Maryland to New England where the coal was delivered to NEP’s coal burning power plaints. In 1989, Keystone and NEP entered into a charter party agreement. Under the charter, Keystone became the owner of the vessel and NEP the charterer. The charter included a buy-out provision in which NEP could terminate the charter and offer to purchase the vessel at a set price. NEP invoked this provision and the vessel was sold and delivered to NEP in September 1995. Post sale surveys of the vessel revealed extensive corrosion in the cargo holds requiring extensive repairs and renewal of steel.

NEP commenced an arbitration against Keystone, alleging that Keystone had breached the charter by failing to keep the vessel in class and in good repair. Keystone defended the action, claiming the vessel had been sold on an “as is” basis. After extensive arbitration proceedings, Keystone settled with NEP for $3,250,000. Keystone then submitted claims to its general liability, hull and P&I underwriters, as well as to Bumbershoot underwriters, seeking the amount it paid in settlement plus the cost of defending the arbitration proceeding. In all, Keystone sought approximately $6,000,000 from its Bumbershoot underwriters.

The insureds’ general liability underwriter denied the claim, relying on the watercraft exclusion. The P&I underwriters also denied the claim, relying on their exclusion for damage to the hull of an insured vessel. Finally, the hull underwriters declined the claim on the ground that it was a “liability claim” and went on to suggest that coverage should be sought from the Bumbershoot underwriters. However, Bumbershoot underwriters also denied Keystone’s claim on the grounds that the policy did not cover damage to the insureds’ property, there was no occurrence under the policy, and the damage was not fortuitous since it had been the result of wear and tear and lack of maintenance.

At trial, Keystone relied upon the drop-down provisions of the Bumbershoot policy and argued that there was coverage pursuant to Clause(1)c of the Standard Bumbershoot Wording which provided that the policy would indemnify the insured for:

All other sums which the Assured shall become legally liable to pay or by contract or agreement become liable to pay in respect of claims made against the Assured for damages of whatever nature on account of-

(ii) Property Damage

caused by or arising out of each occurrence happening anywhere in the world.

The definition of Property Damage contained in the Bumbershoot-Supplementary Clauses excluded property owned by the insured. But, the Supplementary Clauses also stated that the definition of Property Damage did not apply to liability arising out of ownership, charter, use and maintenance of a vessel. Thus, Keystone argued that the definition of Property Damage excluding vessels owned by the insured was inapplicable because the damage to the ENERGY INDEPENDENCE had resulted from ownership, charter, use and maintenance of the vessel. Keystone, therefore, argued that Property Damage should mean damage to any property, even property owned by the insured.

Keystone also presented a unique theory in its effort to show an occurrence under the policy. Keystone argued, and presented evidence at trial through several expert witnesses, that the cause of the corrosion to the steel was not the result of normal wear and tear or lack of maintenance occurring over the life of the vessel, but had occurred over a four-month period due to a phenomenon known as microbially-influenced corrosion (“MIC”). MIC is a recognized phenomenon in coal-carrying railroad cars, in which microbes actually eat away at steel, causing corrosion at an accelerated rate.

Underwriters disputed the claim that MIC had caused the corrosion of the vessel on the grounds that Keystone’s experts’ analysis was not based upon recognized scientific analysis and that the vessel was in the condition one would expert of an 11 year-old dedicated coal carrier which had not been properly maintained.

In a 44-page decision, the court agreed with underwriters’ position that the theory that MIC corroded the vessel was based on unreliable and unrecognized scientific analysis and testing. Moreover, the court found credible the underwriters’ expert and documentary evidence showing the vessel had not been properly maintained. As a result, the court found that the damage was caused by normal wear and tear.

The finding that the damage to the vessel was the result of wear and tear and not MIC should have ended the case because it is well settled that lack of maintenance is not a fortuitous event. The court, however, went on to interpret the Bumbershoot policy to consider whether wear and tear could be covered under the policy. The court found the policy wording was ambiguous, and thus, considered extrinsic evidence such as the underwriters’ expert’s and the lead underwriter’s testimony that the premiums were calculated based on the premiums of underlying liability policies only. Based on this evidence, the court held that the Bumbershoot policy was not intended to cover damage to the property while owned by the insured.

The decision is significant in several respects. First, in rejecting Keystone’s theory that MIC caused the corrosion of the hull, the district court relied upon the principle set forth by the United States Supreme Court in Daubert v. Merrell Dow Pharmaceuticals, 509 U.S. 579 (1993), that the methodology underlying scientific testing and theory must be recognized by the scientific community. In other words, “junk science” cannot form the basis of scientific conclusions. The case is also significant in that it stands for and confirms the principle that a Bumbershoot policy is intended to be a third party liability policy and is not intended to indemnify the insured for damage to his own property.

However, the decision is also cause for concern for underwriters in some respects. While the “Bumbershoot” policy has been used in the United States for many years, the incorporation of the amendments and supplementary clauses, which were added over time to address the changing nature of insureds’ marine liabilities, has resulted in ambiguous and arguably conflicting clauses, as found by this court.

The court’s finding of an ambiguity should place underwriters on notice of a potential for claims under a Bumbershoot policy for damage to insureds’ own property, which was traditionally not considered covered under liability policies. Under the circumstances of the Keystone case, the court found it necessary to consider extrinsic evidence in order to resolve the ambiguity in favor of underwriters. In our experience, we have encountered various revisions to the traditional Bumbershoot policy which resolve many of the potential ambiguities created by the addition of the supplemental clauses, and in the context of litigation, eliminate the need to look to extrinsic evidence. Therefore, in light of the court’s ruling, underwriters should seriously consider reviewing their Bumbershoot policies to address any ambiguities in order to avoid exposure to claims not intended to be covered under a liability policy, and specifically, damage to an insured’s own property.

Finally, it should be noted that the decision is on appeal to the United States Court of Appeals for the Second Circuit.

Newsletter Editors’ Note: The case was tried on behalf of underwriters by David H. Fromm and Timothy G. Hourican of Brown Gavalas & Fromm LLP, New York, New York. We are very grateful to David Fromm for his in-depth analysis of the case.

II. RECENT CASES OF INTEREST

Hull Policy Strikes, Riots and Civil Commotion Clause Excludes Coverage for Third Party Arson

Ferrara & DiMercurio, Inc. v. St. Paul Mercury Ins. Co., 169 F.3d 43 (1st. Cir. 1999)

A hull insurer refused to compensate the owners of a commercial fishing vessel destroyed by fire, asserting that the fire was either set by a third party, was an excluded event under the Strikes, Riots and Civil Commotion (“SR & CC”) Clause, or was arson by the owners, and thus, was an excluded event under Massachusetts law. The insureds brought suit alleging the insurer’s refusal to pay constituted a breach of the insurance contract and bad faith in violation of Massachusetts’ consumer protection statute. The District Court dismissed the assured’s bad faith claim, but held that the plaintiffs were entitled to recover under the hull policy’s Perils Clause, which stated:

Touching the Adventures and Perils which we, the said Underwriters, are content to bear and take upon us, they are of the Seas, Men-of-War, Fire, Lightening, Earthquake, Enemies, Pirates …and of all other Perils, Losses and Misfortunes that have or shall come to the Hurt, Detriment or Damage of the said Vessel …or any part thereof, excepting, however, such of the foregoing Perils as may be excluded by provisions elsewhere in the Policy….

The Court of Appeals affirmed dismissal of the bad faith claim, but reversed as to breach of contract, holding that fires intentionally set by third parties are excluded by the SR & CC Clause. Nothing in the language of that clause excluding coverage for “malicious acts” (construed to include third party arson) limits the exclusion to only those acts committed in the context of other co-listed events (“strikes, lockouts, political or labor disturbances, civil commotion, riots, martial law, military or usurped power”). While the Perils Clause protects against loss by fire, the SR&CC Clause excludes losses from third party arson. Thus, on remand, the jury must be permitted to determine whether the fire was deliberately set by a third party. In addition, plaintiffs’ theory of arson would go to the jury on remand because the insurer had presented sufficient circumstantial evidence to establish the elements of the defense: (1) the fire was incendiary; (2) opportunity existed for agents or servants of the insured to set the fire; and (3) the insured had a motive to set the fire.

See Osvaldo Varane, Inc. v. Liberty Mutual Ins. Co., 284 N.E. 2d 923 (1972).

Tow Endorsement Held Warranty by Insured,
Not Exclusion from Liability

Commercial Union Ins. Co. v. Flagship Marine Svcs., Inc., 190 F.3d 26, 2000 AMC 1 (2d Cir. 1999)

A declaratory judgment action was filed by the insurer of a vessel assistance company seeking the declaration that the injury to the company’s master while aiding another vessel was not covered, because the vessel being assisted was not the sort described in the policy’s Tow Endorsement, which provided:

In consideration of the rate and premium charged, it is understood and agreed that coverage is hereby provided for the towage of yachts up to 50 feet in length. The towage of yachts in excess of 50 feet is subject to prior approval of underwriters with additional premium to be agreed, if any.

The vessel under tow was admittedly a non-yacht over 50 feet in length. Focusing on the term “yacht” in the Tow Endorsement, as opposed to “vessel” elsewhere in the policy, the District Court concluded that the Tow Endorsement excluded coverage for towage of yachts over 50 feet in length, but not other types of vessels, regardless of size. However, the Court of Appeals reversed, holding that the Tow Endorsement constituted a warranty that the insured would tow only yachts less than 50 feet in length, rather than an exclusion from coverage that should be construed against the insurer. Because it is uniquely difficult for marine underwriters to assess their risks, having to rely on representations by insureds as to their vessels’ condition and usage, warranties in marine insurance contracts must be strictly complied with, even if they are collateral to the primary risk. Under New York law, a breach of a warranty bars recovery; under Florida law, such breaches bar recovery if the warranty was material to the insurer’s risk. Since the Court of Appeals found the warranty to be material, its breach precluded coverage, regardless of which state’s law governed the interpretation of the policy.

Limitation of Liability Stay May, or May Not, Include Underwriters

Seabulk Offshore, Ltd. v. Honora, 158 F.3d 897, 1999 AMC 790 (5th Cir. 1998)

In a limitation of liability action following an allision between a vessel and a gas wellhead, the U. S. District Court for the Eastern District of Louisiana refused to extend a stay order to protect the shipowner’s underwriters. After passengers aboard the vessel and the wellhead owner filed a separate action against the shipowner in the Southern District of Texas, the U.S. District Court for the Eastern District of Louisiana denied the shipowner’s motion to modify the stay order. The shipowner appealed and the wellhead owner intervened.

On appeal, the Fifth Circuit held that it had jurisdiction under 28 USCA §1292(a)(1) to hear the appeal of an interlocutory order modifying an injunction in a limitation of liability case, but that under the governing case law in the Circuit it would not exercise that authority if the order merely enforced or interpreted a previous injunction. The court concluded that denial of the shipowner’s request to include its insurers in the stay order amounted to a “refusal to modify” rather than a mere interpretation of the injunction, thus allowing the court to exercise its appellate jurisdiction.

In balancing the competing interests of the parties in bringing a state court action on one hand and seeking limitation of liability on the other, the Court of Appeals has given itself latitude to forge rational and practical solutions instead of adhering to a rigid rule requiring a stay of direct actions against a shipowner’s insurers. Thus, even though the court had recently held that insurers could be included in a stay order, this is not the only course available to the District Court to balance competing interests, as long as it achieves an “equivalent result.” Finding no abuse of discretion in denial of the motion to modify, the Court of Appeals affirmed and remanded for further proceedings, stating that:

the district court could choose to stay execution of the judgment against Seabulk’s insurers on the first $727,000 of Seabulk’s insurance policy (the stipulated value of the vessel and freight). Alternatively, …the court could choose to require the claimants to stipulate that Seabulk has a priority claim on the insurance proceeds. Under either alternative, the claimants could preserve their choice of forum rights as envisioned by the saving to suitors clause, without depleting Seabulk’s liability protections.

Failure to Disclose Material Facts Voids Endorsement Adding
Yacht to Policy

HIH Marine Services, Inc. v. Fraser, 211 F.3d 1359 (11th Cir. 2000)

A marine insurer brought a declaratory judgment action seeking the declaration that an endorsement adding a yacht to an insured’s existing commercial charter policy was void due to the assured’s failure to disclose material facts in its insurance application, including that the insured had not entered into a charter agreement with yacht’s owner and did not have custody and control of the vessel at the time of the application. Affirming the District Court’s grant of summary judgment for the insurer, the Eleventh Circuit Court of Appeals held that under the doctrine of uberrimae fidei, material misrepresentations on an application for insurance void the policy. Misrepresentation, according to the court, is material “if it might have a bearing on the risk to be assumed by the insurer.” Failure to disclose that a charter party had not been executed and that an insured had not taken custody of a vessel were material, especially in light of the insurer’s earlier refusal to insure the yacht as a private vessel.

Cargo Not Required to Contribute in General Average and Is Indemnified for Salvage Contribution Where Shipowner Does Not Exercise Due Diligence to Make Vessel Seaworthy

Birmingham Southeast, LLC v. M/V Merchant Patriot, Case No. 498-007 (S.D. Ga., Savannah Division, June 15, 2000)

In a shipowner’s limitation of liability proceeding, the District Court granted the motion of the cargo plaintiff/claimant for declaratory judgment that the shipowner was not entitled to receive general average contributions or benefits. The court also granted plaintiff indemnity for salvage payments and expenses incurred.

During a voyage from Brazil to Savannah with a cargo of steel products and part of a knocked-down steel mill, the vessel’s main engine was twice shut down due to leakage from a failed pipe in the seawater circulating system. This shutdown caused loss of steerage and headway, resulting in cargo shifting, and eventually caused the crew to abandon ship. By the time the salvors arrived, a significant portion of the deck cargo had been lost overboard or damaged.

In an earlier order, the District Court had denied the shipowner’s petition for exoneration from or limitation of liability, finding that the vessel was unseaworthy when it departed Brazil, and that the owner failed to exercise due diligence to make the vessel seaworthy prior to commencement of the voyage, since a proper inspection would have detected the defective pipe. [See 2000 AMC 1015]. That order was not appealed.

Under the governing bill of lading’s New Jason Clause, the carrier was entitled to general average contributions even if it was negligent unless it was responsible for the damage under COGSA. The earlier ruling denying limitation of liability for want of due diligence implicitly established the owner’s breach of the COGSA requirement that the carrier “shall be bound, before and at the beginning of the voyage, to exercise due diligence to…make the ship seaworthy.” 46 U.S.C. §1303. Hence, the shipowner was not entitled to general average contribution from the plaintiff, which could also recover reimbursement for its salvage contribution and indemnification for attorney’s fees incurred in defending against salvor’s claims. Although attorney’s fees are not generally recoverable absent statutory or contractual authority, indemnification for attorney’s fees and costs is proper where the Court finds the carrier to be responsible for the casualty. See Complaint of Delphinus Maritima, S.A., 1982 AMC 796, 806 (S.D.N.Y. 1982).

Newsletter Editors’ Note: Items for future issues may be submitted to George N. Proios, Lyons, Skoufalos, Proios & Flood, 1350 Broadway, New York, NY 10018; Gene B. George, Ray, Robinson, Carle & Davies P.L.L., 1650 The East Ohio Building, 1717 East 9th Street, Cleveland, OH 44114; Joshua S. Force, Sher Garner Cahill Richter Klein McAlister & Hilbert, L.L.C., Twenty-Eight Floor, 909 Poydras Street, New Orleans, Louisiana 70112-1033