Australia: War, piracy and the Costa Concordia: what is a constructive total loss?

In brief - Insured must give up possession of the property to the insurer

The marine insurance market establishes loss that is not actual total loss by defining it as constructive total loss. However, shipowners who wish to make this type of claim must give their insurers notice of unconditional abandonment and give up possession to the insurer or risk having it treated as a partial loss.

Costa Concordia accepted as a constructive total loss

Despite significant improvements in navigational and sonar technology since the days of the Titanic, ships still run aground or are badly damaged by underwater obstacles.

In 2012, the cruise ship Costa Concordia struck an underwater rock off the coast of Italy, capsized and sank costing the lives of 32 people. She was accepted as a constructive total loss with her salvage being one of the largest and most expensive operations in history.

Ship stuck in Persian Gulf during war found to be a constructive total loss

In the 1980s, the London insurance market had to grapple with the insurance consequences of a large number of ships being stuck in the Persian Gulf for lengthy periods during the Iran-Iraq war. Some 70 ships were involved.

The English High Court judge, Justice Staughton, with the agreement of the Lord Chief Justice, sat as an arbitrator in, effectively, a test case called the "Bamburi" where he determined that the vessel was a constructive total loss, as the owners had been deprived of possession and it was unlikely that they could recover the vessel within a reasonable time.

A number of recent cases have grappled with whether the hijacking and holding of a vessel for ransom qualifies as a constructive total loss. With Indian Ocean piracy and "hot-zone" geopolitical instability adding to the threats facing ships, shipowners and insurers face the question of constructive loss and actual loss on a recurring basis.

Total loss distinguishes between actual and constructive

Marine loss is either total or partial. A total loss can be either:

  • an actual total loss, or
  • a constructive total loss

The distinction here is important.

Actual total loss includes the complete destruction of the ship (or relevant insured property). A constructive total loss may be declared in a range of different circumstances which do not necessarily result in the vessel's destruction.

Actual loss includes total destruction, damage and deprivation of insured property

Actual total loss can occur in a number of ways, namely:

  • total destruction of the insured property - for example, a ship is destroyed by fire or sinks
  • damage that entirely changes the character or nature of the property insured - for example, a ship runs aground and fails to retain its character as a ship and is instead regarded as a wreck
  • irretrievable deprivation of insured property - for example, cargo is sold to an unknown third party prior to delivery

When a ship is missing for an extended period of time and no news has been received from the vessel, it can be treated as an actual total loss.

As can be imagined, it is fairly easy from a practical point of view to gather evidence to establish an actual total loss: wreckage can be inspected, distress communications reviewed, and locations analysed and investigated.

Constructive total loss defined in the Marine Insurance Act

There are times, however, when the usual ways of establishing a loss are not available. The world's oceans are not as well understood as lay observers might think. The marine insurance market resolved this issue with the concept of constructive total loss.

Under the Marine Insurance Act 1909 (Cth) (which was modelled on the UK Marine Insurance Act 1906) "constructive total loss" is defined in section 66 as:

  • reasonable abandonment of the insured property when actual total loss appears unavoidable
  • reasonable abandonment of the subject matter when the cost of its preservation from actual loss would exceed its value after recovery
  • deprivation of possession where it is unlikely that the ship or goods can be recovered
  • deprivation of possession where cost of recovery would exceed value of goods when recovered
  • damage to a ship where the cost of repair would exceed the value of the ship when repaired - for example, where the cost of salvage and repair of a ship following a collision surpasses its market value following the salvage. Depending on the terms of the hull policy, the insured value may be required to be treated as the repaired value
  • damage to goods where the cost of repair and forwarding of the goods to their destination would exceed their value on arrival

Notice of unconditional abandonment is essential in constructive total loss claims

An insured cannot keep possession of the property and still claim constructive total loss. It must give up possession to the insurer. It must make an election either to treat the loss as a partial loss or abandon the insured property to the insurer. If no such notice is provided, the loss is only treated as a partial loss.

The Marine Insurance Act sets out how and when notice of abandonment is to be given and the effect of acceptance (or non-acceptance) of the abandonment by the insurer.

The notice can be in writing or verbal, but must make it clear that the insured unconditionally abandons its interest in the property to the insurer.

Insurer entitled to exercise salvage rights, obliged to indemnify insured

Upon accepting the abandonment, the insurer takes on the interest of the insured in whatever remains of the insured property and is entitled to exercise salvage rights and (provided the policy terms are otherwise met) is obliged to indemnify the insured for the insured value of the property.

One consequence of acceptance of the abandonment may be the obligation to meet any demands by the local port or harbour authority to remove the wreck in the case of a ship (this liability may be excluded under the hull policy).

Stuart Hetherington
Marine insurance
Colin Biggers & Paisley

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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