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The Institute organized an evening seminar on the subject “Substituted Expenses in General Average per York-Antwerp Rules” on 20th March 2018, a workshop in Hong Kong following the English Supreme Court’s decision on “The Longchamp” case, which was reported in the last issue of “Seaview”.

The Editor was not surprised to receive a question: “What about the substituted expenses in Particular Average?”.

It is worth recalling that the principle of substituted expenses is not generally recognized under English law, which position is, however, varied by the York-Antwerp Rules in the case of general average.

In the case of Wilson v. Bank of Victoria [1867] (which case pre-dates the York-Antwerp Rules), an auxiliary sailing ship, on a laden voyage from Australia to Britain, struck an iceberg and sustained damage, being dismasted.  The ship put into Rio de Janeiro where, on account of the prohibitive cost of repairs, only temporary repairs were carried out allowing the ship to proceed to destination under steam with coal being purchased at Rio and at Fayal for such purpose.  A claim was made by the Shipowners for contribution towards the cost of the coal purchased on the grounds that they were substituted expenses for the expenses that would have been incurred at Rio if permanent repairs had been effected there.  The claim was disallowed by the court holding that the use of the auxiliary engine to bring the vessel home, and the consequent expenditure on coal, was merely the performance of a service by the Shipowners to the owners of the cargo carried and was therefore not a subject for contribution.

The Editor has some notes on the subject of “Substituted Expenses in Particular Average” made by his former partners and colleagues who are highly respected average adjusters and would like to share these with readers of “Seaview”.

Particular Average, as defined by section 64(1) of the Marine Insurance Act 1906, is a partial loss of the subject matter insured caused by a peril insured against, and the measure of indemnity for the partial loss of ship is the reasonable cost of repairs, as provided by section 69 of the Act.

It is perhaps a fallacy to think that alternative means of repair are open to the Shipowners in circumstances where they are obliged (vis-à-vis their Underwriters) to effect repairs at the most reasonable cost.  There may in theory be several ways in which a Shipowner can go about effecting a particular repair, but only one of those ways can be the most reasonable.  Once the most reasonable course of repairs is determined, the other alternatives cease to exist and it therefore follows that the course adopted cannot have been a substitution for another alternative.

This was the gist of Wilson v. Bank of Victoria, i.e. that for there to be a substitution an alternative must exist.  It was held in that case that, in as much as the Master could, by the expenditure of a small sum on temporary repairs and coal, bring the ship safely to destination, it was his duty under the contract of carriage to do so.  Consequently, the perceived alternative of landing the cargo and repairing at the port of refuge was not an alternative open to the Shipowner at all and it was therefore a fallacy to say that the cost of the coal (which the Shipowners were seeking to recover in General Average) was incurred in substitution for those measures.  The principle can therefore be applied to Particular Average claims that, as the Shipowners are obliged to effect the most reasonable repair, the claim must be based on the actual cost thereof and not on the cost of some alternative prohibited from taking.

For Particular Average on ship, the test continues to be “the reasonable cost of repairs” and hence any cost which is not a repair cost cannot be allowed as part of the claim without the specific agreement of Underwriters.  An example of a non-repair cost which Underwriters do agree to bear or contribute to, depending on the circumstances, is the cost of removal from one place of repair to another because the latter is cheaper.  On the face of it, this appears to be no different to the situation where the Shipowners incur extra fuel costs, say by burning diesel instead of fuel oil, to get from a port of refuge, where repairs are expensive, to destination, where repairs are cheaper.  However, in the first example, Owners have derived no operational benefit from the removal cost.  That is not the case with the second example, where the voyage on which the extra operating costs have been incurred is a freight-earning voyage.

Mr. John Crump, in his address on “Reasonable Cost of Repairs” at the annual general meeting of the British Association of Average Adjusters in May 1992, highlighted a few interesting cases on which he commented as follows:

QUOTE

(A) A vessel has damage to her steering gear in an area where repairs are expensive. Class agrees that the vessel may continue to trade for a limited period until she reaches a cheaper repair area provided extra tugs are employed when entering and leaving ports.

(B) A vessel has a main engine damage and Class agrees a temporary repair until she reaches a more appropriate and cheaper repairing port. The repair adopted, however, involves burning diesel oil instead of the customary fuel oil during the interim period.

(C) Damage to a winch, or winches, is sustained during discharge. Rather than effect repairs at the discharge port, which is an expensive one, equipment is hired to enable the affected hold(s) to be discharged, thus enabling the vessel to repair later at reduced cost.

In case (A) the assured claims for the cost of extra tugs, in case (B) he claims for the extra cost of diesel oil over fuel oil consumption and in (C) the claim is for hire of equipment for discharge. In each case the claim is based on the fact that the extra costs incurred saved greater repair costs for which Underwriters would otherwise have been liable.  At the same time, I would submit that it is difficult, if not impossible, to argue that any of them in themselves form part of the cost of repairing the ship.

The only law case of which I am aware which is sometimes quoted as authority for applying the “substituted expenses” idea to insurance claims is Lee v. Southern Insurance (1870) LR5, CP397.

That case in fact involved not an insurance on ship but an insurance on freight and the facts were as follows:

A vessel was bound for Liverpool with a cargo of palm oil and stranded off the Welsh coast.  Cargo had to be discharged and the Shipowner arranged to forward it by rail to destination at a cost in excess of £200, thereby earning his freight which was at risk.  The vessel was then towed to Caernarfon, where she was made seaworthy for the rest of the voyage.

The forwarding costs were claimed under the freight policy, but the Court held that such claim must be limited to £70, which would have been the cost involved in reshipping the cargo onto the original vessel after repair.

The case thus involved a claim for particular or special charges, not a claim for particular average loss. I cannot see it as referring in any way to the “substituted expenses” concept, for the hypothetical reshipping costs of £70 were introduced solely as a test of the reasonableness or otherwise of the forwarding costs of £200. The older editions of Arnould report the facts of the case under the sub heading “Only reasonable expenses recoverable.”

Reverting to the three practical examples already mentioned, I submit that as a matter of principle the unfortunate assureds have no remedy for recovery of any of their extra costs under the hull policies.

At first sight this stance seems a harsh one, even ‘uncommercial’.  In each instance a peril covered by the policy has operated and the assured has, as a direct consequence, incurred costs.  As a result of his doing so Underwriters on the ship have been saved money.  Should they not respond on that basis?

It should perhaps first be pointed out that the assured too would almost certainly have saved substantial sums as a result of the actions taken. That, however, is not, in my view, the real point which is that the losses suffered by the assured as a result of incurring those extra costs relate to freight or earnings rather than hull insurance.  If the freight was at risk and insured for the voyage on which these various expenses were incurred, I would suggest they would form a particular or special charge on the freight policy. That is their essential character and the fact that nowadays freight is frequently at the risk of the cargo owner rather than the Shipowner so that the latter will then seldom have appropriate insurance cannot alter that character.

Could I add one final point about this type of case. It will doubtless be argued that if the assured cannot recover this type of expense from his Underwriters he may on occasion seek to avoid incurring it and allow the latter to take the rap for the increased repair costs that result.  I do not believe that argument to be realistic.  Even in those cases, probably rare ones, in which the assured himself does not gain from adopting the practical and commercially sensible course, it must be remembered that the test of ‘reasonableness’ of the ultimate repair cost must still be applied and if the assured increases the latter cost solely to save additional costs of keeping his ship operational in order to protect his freight or earnings, that increase will not, strictly, be for account of Hull Underwriters.

I submit that the concept of substituted expenses, which under English law is of doubtful validity in any context, can certainly have no application to a claim for particular average on a hull policy.

UNQUOTE

The following are few common examples where the damages are caused by perils insured against, the insurances being subject to English law and practice:

Example 1. 

Vessel sustains damage to stern-tube seals.  There are 2 alternatives open to the Shipowner – an emergency drydocking which will be claimed in full from Underwriters, or deferment of repairs for 3 months which will involve additional consumption of lubricating oil but save 50% of drydock dues.  Can the cost of lubricating oil be claimed from Hull Underwriters?

It is tempting to take the view that if it can be shown that Underwriters benefited from the extra consumption of the lube oil they should pay for it or contribute towards it.  It is submitted that since the Shipowners are obliged to effect repairs at the most reasonable cost, they do not, in reality, have the option of drydocking immediately.  The extra consumption of lube oil is thus of no benefit to Underwriters – they were only ever liable for the cost of repairs as deferred and carried out in drydock. The excess lube oil consumption is not a repair cost – it is an extra or enhanced operational cost.  There are no grounds for allowing it to Particular Average.

Example 2

Vessel under Time Charter.  Turbo charger breaks down in the South Atlantic. The vessel can continue to Santos but additional diesel oil will be consumed and will be charged by Time Charterers to Shipowners.  The alternative is that the vessel could be towed to Santos.  The vessel uses the extra diesel oil.  At Santos repairs are deferred again but more additional diesel oil is claimed on the basis that repair costs would be cheaper if repaired later.  Can the extra cost of diesel oil be claimed from Hull Underwriters?

Applying the same logic as in Example 1 above, there does not appear to be any ground that either the tugs or extra fuel getting to port could be charged to Underwriters.  The second set of alternatives, once at the port, are effectively the same as in Example 1 and cannot be allowed to Particular Average.

Example 3. 

Vessel’s crankshaft condemned but the new crankshaft will take 6 months to supply. Instead the Owners grind down existing crankshaft as temporary repair. Temporary repairs result in following –

(i) additional manning required in engine room;

(ii) turbo charger requires more frequent cleaning;

(iii) additional consumption of diesel oil;

(iv) as a result of running out of balance, some fretting results in main engine.

Can these additional costs (i) to (iv) be claimed from Hull Underwriters?

Firstly, Underwriters should recognize that the sole purpose of the ship is to be a freight or revenue earning instrument.  It is patently unreasonable to leave her out of commission for 6 months awaiting parts if, by way of a temporary repair, she can be quickly returned to employment with the permanent repair effected on delivery of the necessary parts. It follows therefore that the temporary repairs is in itself reasonable and forms a direct claim on Underwriters.

There is suggestion that where a temporary repair is reasonable, any extra operating costs which is known will result direct from the temporary repair would be treated as part of the cost of that repair.  However, it is submitted that whilst (ii) and (iv) can comfortably be allowed as Particular Average as they involve damage or quasi damage to the vessel, (i) and (iii) should be disallowed as they are merely the enhanced cost of running the vessel in semi-damaged condition.

Editor’s Note:  It is advisable that if claims are put forward at the request of the Assured, which are not in accordance with the law (and practice as it should be) then the Adjusters should seek prior agreement of the Underwriters before issuing the adjustment, making it clear to both parties what the position is.

 

(Editor: Raymond T C Wong Average Adjuster)