England and Wales Court of Appeal (Civil Division) Decisions

IN THE SUPREME COURT OF JUDICATURE
COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM THE HIGH COURT, CHANCERY DIVISION
(HIS HONOUR JUDGE MACKIE QC)

		Royal Courts of Justice Strand, London, WC2A 2LL
		16th November 2007

Lord Justice Tuckey:

1. This appeal raises questions about the construction and application of a standard form exclusion clause in a contractors all risks policy of insurance. The clause in question is one of several industry standard wordings broadly designed to ensure that insurers only bear the risk of fortuities causing loss or damage to the works and not the risk of the contractor's defective workmanship which he would have to rectify in any event. The wording with which we are concerned says:

"This policy excludes loss of or damage to and the costs necessary to replace repair or rectify

a) Property insured which is in a defective condition due to a defect in design plan specification materials or workmanship of such Property insured or any part thereof.

b) Property insured lost or damaged to enable the replacement repair or rectification of property insured excluded by a) above.

Exclusion a) above shall not apply to other Property insured which is free of the defective condition that is damaged in consequence thereof.

For the purpose of the Policy and not merely this Exclusion the Property insured shall not be regarded as lost or damaged solely by virtue of the existence of any defect in design plan specification materials or workmanship in the Property insured or any part thereof."

2. The appeal is from a decision of HHJ Mackie QC, sitting in the Commercial Court. His judgment is reported at [2007] EWHC 94 (Comm). He held that the defendant insurers had not shown that the clause excluded the claimant contractor's (Blackwell) claim for damage caused to earthworks which it was carrying out as part of the construction of the M60 around Manchester.
3. As well as the issues relating to the exclusion clause the judge had to decide whether the policy was an All Risks policy and if so whether the damage alleged had the necessary element of fortuity. He answered these questions in the affirmative and there is no appeal from this part of his judgment. The insurers also alleged that Blackwell was guilty of wilful misconduct. The judge rejected this allegation and permission to appeal this part of his judgment was refused on the papers.
4. Some of the facts relating to the applicability of the exclusion clause were in issue at trial and one of the judge's findings of fact is challenged on this appeal, so it is necessary to set out the facts in a little detail.
5. Balfour Beatty was the main contractor employed by the Highways Agency to design and build this 9 kilometre section of the motorway. It employed Blackwell as the earthworks subcontractor on a fixed lump sum basis. 16.5% of its price related to unforeseen ground conditions and weather risks. The following facts, which I gratefully take from the judge's judgment, were common ground.
6. Work started on 30 April 1998 and was due to finish on 25 June 2000. The road was to be constructed of the following layers after the initial earthworks creating the basic cuttings or embankments along which it was to run. First there was the sub-formation: this was the level in the material in situ to which Blackwell excavated or filled and which it then compacted and "profiled" to the same profile as specified for the finished surface. Secondly there was the formation: this was a level created by the spreading of imported material known as 'capping' which Balfour Beatty brought in and which Blackwell spread, compacted and profiled as specified for the finished surface. Above this was a level created by the spreading of imported material of a different specification to the capping which was bought in and spread by Balfour Beatty. Finally there were to be asphalt layers, all three of which were to be the responsibility of Balfour Beatty. Responsibility for ensuring adequate temporary drainage for the earthworks lay with Blackwell.
7. During 1998 bad weather affected the works on several occasions and delayed the start to that year's spring earthmoving season until after Easter. By August 1999 there were concerns that it was extremely unlikely that the bulk earthworks could be fully completed as planned before the end of the 1999 season. There was further rain in September and then two incidents which caused damage to the capping layer and an area of sub-formation -- the first between 29 September and 2 October and the second between 3 and 6 December. The second incident was far more significant, as appears from the fact that the loss adjuster agreed £46,000 for the first loss and £488,975.15 for the second, in each case net of deductible.
8. But for the earlier delays the capping work being carried out in October and December would have taken place earlier in the year when conditions would have been easier. On 25 August 1999 the employer agreed to a request by Balfour Beatty for the use of shale as a capping material after taking advice from its own consulting engineers, Mouchel. Shale had been used in the area since January 1999 despite it being known to be a material which degrades as its moisture content increases, eventually breaking down and turning to slurry.
9. Precisely how Blackwell protected its earthworks from water damage during the course of the works was the subject of a good deal of evidence at trial. The steps it took had to change day by day as the work progressed and there were no reliable contemporary records to show what the situation was at the times when the damage occurred. In the end the judge accepted the evidence of Mr Kettyle, the Blackwell senior executive responsible for this contract who had been on site most days. The judge summarised his evidence as follows:

"23. …Temporary drainage involved more than the use of pumps and tankers. The strategy during bulk works consisted first of shaping earthworks laterally and longitudinally day to day so as to shed water to collection points prior to its discharge into adjacent streams. Where this was not possible sacrificial "grips" (shallow temporary excavated channels which lead water to collection points) and trenches would be excavated to drain water. He said that once the final profile of the earthworks was reached there was a risk of rainwater collecting in the low points of the incomplete works and from that point the installation of temporary trenches would not be possible without causing damage to the permanent works. Water was shed laterally and longitudinally to the collection points in the vertical alignment. Grips were cut where necessary to assist the flow. At the collection points sumps were excavated where there was space. Pumps and tankers were in use only where direct discharge to collection points or silt traps was not possible because of the remoteness of the outfalls…

24. The rainfall which occurred at the time of the incident was of a level that had occurred during the previous year's construction period but the consequences were then much less because of the earlier stage of the earthworks."

10. It had been Blackwell's case that the rainfall at the time of the incident had been exceptional, but the agreed expert evidence at trial was that it was "not exceptional, without precedent or unforeseeable".
11. The insurers called an expert, Mr Edwards, who gave evidence about the factors which he considered had led to the incidents of damage. These were: the quality of the shale-capping material; earthworks being undertaken out of season; the stage which the work had reached, which meant among other things that the surfaces had become less pervious, and the state of the temporary drainage of the site. Of this evidence the judge said:

"38. …Mr Edwards's appraisal of the factors that led to the incidents is one I accept both because of the weight of his evidence and because of its consistency with common sense. I accept Mr Edwards's evidence that an adequate temporary drainage system needs to have more to it than bringing in tankers and pumps after the event. But properly considered the evidence of Blackwell, which I accept, is that it did have a more 'proactive' system, which altered day by day as described by Mr Kettyle. Further whilst recognising the force of what Mr Edwards had to say about the use of shale his conclusion that disaster was inevitable with work continuing through October to December was based on the assumption, which he had been entitled to make from his instructions at the outset, that there was no proactive temporary drainage, nothing additional to the pumps and the bowsers."

12. The insurance covered the years 1998 and 1999. Section 1 of the policy indemnified Blackwell against:

"…all Damage (meaning Physical Loss, Physical Destruction or Physical Damage) of whatsoever nature sustained during the period of insurance to: a) the Works whether permanent or temporary, materials incorporated or for incorporation therein…and any other property of whatsoever nature…the property of the insured."

The policy defines the words "the Works" to mean:

"the undertaking described in and which forms the subject matter of any contract executed or in the course of execution by the Insured."

and "property" to mean "material property". I have already quoted the exclusion clause which was the fourth of a series of unrelated exclusions to section 1 of this policy.

13. Having rehearsed the parties arguments about the construction and application of the exclusion clause, the judge expressed his conclusions as follows:

"61. …What is the 'property insured' for this purpose, defined as it is as 'material property' in the definitions? It is, as both parties in a sense recognise, the capping and damaged sub-formation. The temporary drainage is not of itself property. It is a series of measures combining items like tankers with methods of doing things which include changes, such as cutting and channelling, to the capping which is part of the Insured Property. Some of these measures are protection for the capping and distinct from it. To this extent Mr Walker is right to separate drainage from capping so that if the exclusion is triggered that property falls within the limitation. So presumably would the sub-formation which is also part of the claim. However a failure to cut and channel the capping so as to make it reasonably proof against incidents such as those in this case, if demonstrated and material (which is not the case here), might well mean that the property is in a defective condition due to a defect in design or, say, materials. The difficulties identified in argument spring, as I see it, not from inadequacies in the wording but from the continuous, extensive, protean and eventually hidden nature of the insured property in this case.

62. On the facts I do not consider that Gerling has been able to establish that property was in a defective condition due to a relevant defect. It does not follow from the fact that the incidents occurred as a result of the coincidence of factors identified by Mr Edwards that there was, even if some negligence on the part of Blackwell were established, a defect in design, materials or workmanship. I have no reason, as I have said, to doubt that Blackwell were operating an essentially sound system of drainage to prevent incidents of the kind which did in fact occur. I return to the difficulties and obstacles which it seems to me lay in the way of Gerling in establishing their case on wilful misconduct. There is insufficient evidence available to warrant a conclusion that the property insured for which claims are made was in a defective condition within exclusion 4."

14. So what I think the judge is saying in this passage is:

a) the property insured which has been damaged is the capping and the sub-formation;

b) the temporary drainage is not property insured, but if it is and it was defective it is distinct and separate from the capping and sub-formation so the limitation to the exception applies and damage to the latter, is not excluded;

c) in any event, the property insured was not defective.

15. Mr Reid on behalf of the appellants submits that the judge should have held that the temporary drainage was property insured. Temporary works and any other property whatsoever formed part of the insured property so all measures taken to provide temporary drainage including channels, sumps, bowsers and pumps formed part of the property insured. Moreover, Mr Reed submits, as these measures included shaping the capping and sub-formation material so as to shed water they formed an indivisible part of the damaged works and the judge was therefore wrong to conclude that the limitation to the exception applied. Finally Mr Reid submits that the judge was wrong to conclude that it had not been established that the property insured was defective. Blackwell's case had been that the damage was the result of exceptional rainfall. That case had failed and the only other explanation for what had happened was that the temporary drainage was defective.
16. Before engaging with these submissions it is I think important to construe the exclusion clause without regard to its application to the facts of this case. Its purpose is clear. It prevents the insurer from having to pay for the replacement, repair or rectification of property which was already in a defective condition at the time the fortuity covered by the policy occurred. If the defect is one of design, plan, specification, materials or workmanship the property would have had to be repaired, etc. by the contractor or others in any event.
17. What is important to note is that the exclusion is not of loss or damage caused by a defect in workmanship, etc. The cause of the loss or damage is irrelevant. Provided the insurer can show that the property was in a defective condition the exclusion applies. So, taking the example given by Mr Ronald Walker QC for Blackwell in his skeleton argument, if the capping and sub-formation were in a defective condition when damaged the exclusion would apply even if the damage had been caused by a bomb falling onto it. Conversely, if it was not in a defective condition, but the damage had been caused by a failure, say, to cover some part of the road with a tarpaulin, the exclusion would not apply. The damage would have been caused by defective workmanship but the property insured was not in a defective condition. The insurers might have protected themselves by a policy condition requiring the contractor to take reasonable precautions to prevent loss or damage, but this policy contained no such condition.
18. All this is, I think, self-evident from the wording of the exclusion. What is more difficult is to discern how wide the words "property insured" are intended to be.
19. Mr Reid submits that they bear a very wide meaning and that one should not attempt to divide the indivisible. He referred us to a report by the Advanced Study Group of the Institute of Insurance which gives the history of such defect exclusion clauses. Five standard clauses were devised and amended in 1995 which provide for varying degrees of exclusion. The clause in this case is in form DE3. Form DE4, designed to be more generous to the insured, excludes damage to "any component part or individual item of the property insured which is defective in design" etc. but does not apply "to other parts or items of property insured which are free from defect but are damaged in consequence thereof". Mr Reid submits that the judge's finding that the temporary drainage was separate from the property damaged would have been open to him on wording DE4 but not on wording DE3.
20. This report is instructive about the purpose of defect exclusion clauses and how they have evolved. But it cannot be used as an aid to construction of the clause in question which must be construed according to its terms. The intention of those who drafted it and other similar clauses is not relevant or admissible.
21. Mr Reed also referred us to two cases. The first Walker Civil Engineering Pty Ltd v Sun Alliance and London Insurance plc & ors [1999] 10 ANZ Insurance Cases 74-81, concerned a clause which excluded liability for loss or damage directly caused by defective workmanship etc. but limited the exclusion to "the part which is defective and shall not apply to any other part or parts lost or damaged in consequence thereof". This therefore was a clause which, unlike the DE3 clause, excluded liability for damage caused by the defect. The court held that "part" did not refer to a part such as a tank but referred to the part of the work being carried out by the contractor. I do not see how this aids the construction of the DE3 clause. Nor do I gain any assistance from the other case relied on by Mr Reid, Skanska Construction Limited v Egger Barony Limited [2002] EWCA Civ 310, which was concerned with the contractor's obligation to insure assumed in its contract with the employer.
22. So, returning to the wording of the clause in this case, the first thing to note is that it draws a distinction between "property insured or part thereof" and "other property insured". This suggests, and indeed requires, divisibility. Division is easy in some cases. The Institute report gives the example of a steel frame building with its roof, cladding and dwarf brick walls completed which collapses because the nuts and bolts used in the construction of the steel framework are defective. Under the DE3 wording damage to the steel framework is excluded but damage to the roof, cladding and dwarf brick walls is covered. I agree that this is the effect of the clause in that sort of case. By analogy one might argue in this case that the property insured refers to the entirety of the earthworks. But that cannot be what was intended by this wording. I think it must be restricted to that part of the works which has suffered damage. If that part is wholly or partly defective the exclusion applies.
23. Mr Reid's wide construction would mean that an insurer could escape liability by finding some defect remote from the damage and entirely unconnected with its cause. This would mean that the contractor's insurance would be of very little value. Parties to all risks insurance cannot have intended such a consequence.
24. So how should one apply the exclusion construed in this way to the facts of this case? There was nothing defective about the sub-formation so that part of the works was not defective; nor was there anything intrinsically defective about the condition of the capping unless it can be said that it lacked the necessary cuts and channels to protect itself from damage. The judge seemed to be prepared to accept that this might have made the capping defective and I think he was right about this if it could have been clearly demonstrated that such measures were required at this stage of the works. The evidence he had from Mr Kettyle was that such measures could not be taken by the time the works had reached this advanced stage. The judge concluded that it had not been demonstrated that such measures were required -- no doubt for the reason I have given -- and this follows I think from the findings of fact which he made.
25. But a failure, if there was one, to implement other measures which were designed to protect the capping such as the use of pumps and bowsers and the means to channel and dispose of the water on the verges cannot be characterised as a defect in the condition of the capping. The tarpaulin analogy applies. If I am wrong about this and one can characterise the works contemplated by these measures as property insured and the failure to carry them out made it defective, I would distinguish, as the judge did, between this property and the capping and sub-formation (other property), so that the exclusion does not apply because of the limitation. As the judge said, one of the difficulties of applying the exclusion clause in this case is the ever-changing and eventually hidden nature of the property insured.
26. What I have already said is sufficient to dispose of this appeal and makes it unnecessary to consider Mr Reid's challenge to the judge's finding that no defect had been established. All I need say is that here he may have been on stronger ground although I do not decide that the judge was wrong because I do not have to.
27. But because I think that the judge reached the right conclusion on the construction and application of the clause, for the reasons I have given I would dismiss this appeal.

Lord Justice Maurice Kay:

28. I agree.

Lord Justice Hooper:

29. I also agree.

Order: Appeal dismissed