Scottish Court of Session Decisions

OUTER HOUSE, COURT OF SESSION [2009] CSOH 69
CA79/08	OPINION OF LORD HODGE in the cause BELL TAVERNS (SCOTLAND) LIMITED Pursuers; against THE NATIONAL INSURANCE AND GUARANTEE CORPORATION LIMITED Defenders: ­­­­­­­­­­­­­­­­­________________

Pursuers: J Thomson; Gillespie MacAndrew LLP

Defenders: Lake, Q.C.; Ledingham Chalmers LLP

15 May 2009

[1] The pursuers are the owners of a hotel in the High Street, Errol, Perthshire. On 4 September 2006 a fire caused significant damage to the hotel premises. The pursuers held a contract of insurance, policy number 004145882, issued by the defenders, which was described as a "Hotel Insurance Policy" ("the policy"). The policy made provision for loss and damage caused by fire. A dispute has arisen between the parties as to the amount to which the pursuers are entitled under the policy. In the debate which I have heard, counsel discussed two issues of construction of the policy, namely the meaning of the average provision and the provision imposing a limit on the liability of the defenders. As the parties had set out in a schedule rather than in their written pleadings their contentions in relation to the sums claimed, I was invited to answer three questions and then put the case out By Order to determine further procedure.

The insurance contract

[2] The policy comprises a renewal schedule dated 7 February 2006 and a policy document. The schedule contains the provisions which are specific to the particular insurance contract and the policy document contains the standard policy terms. The schedule describes the premises as "High Street, Errol, Perthshire" and the business as "hotel". It contains nine Sections each of which describes what is insured and either the sum insured, the indemnity limit or the maximum amount in relation to the specified subjects. In this case we are concerned only with the insurance of the structure, which is set out in Section 1 of the schedule. Section 1 is in the following terms:

"SECTION 1: THE STRUCTURE

DESCRIPTION SUM INSURED

The buildings £85,888

Subsidence Excess £ 1,000

Extensions operative: 4

Endorsements operative: A

Excesses Amount

Excess £200"

[3] In the introductory part of the policy document is a page which is entitled "How to Use Your Policy". It states, among other things, that the policy contains details of the extent of the available cover, what is excluded from the cover and the conditions on which the policy is issued. It also explains that the schedule provides details of the insurance protection provided, the sections of the policy which are operative "and the levels of cover you have".

[4] The policy document contains definitions of, among other terms, "premises" and "property" but nothing turns on those definitions. "Damage" is defined as "loss, destruction or damage". I refer to one other definition, as counsel for the pursuers founded on it in his submissions. That is the definition of "Reinstatement Basis". It is in the following terms:

"Whenever Claims Settlement is declared to be on a Reinstatement Basis, the basis upon which the amount payable in respect of the Property insured is to be calculated shall be as follows:

1 The rebuilding or replacement of Property lost or destroyed which provided Our liability is not increased may be carried out

a. in any manner suitable to Your requirements

b. upon another site

2. The repair or restoration of Property damaged

in either case to a condition equivalent to or substantially the same as but not better or more extensive than its condition when new."

[5] The provision relating to average is special condition ii. The parties did not dispute that the provision applied in this case. Their dispute was over the meaning of the words which I have put in italics below. The provision is as follows:

"If at the time of reinstatement the sum representing 85% of the cost which would have been incurred in reinstating the whole of the Property covered by any item subject to this Clause exceeds its Sum Insured at the commencement of any Damage, Our liability shall not exceed that proportion of the amount of the Damage which the Sum Insured shall bear to the sum representing the total cost of reinstating the whole of such Property at that time."

[6] In the policy document Section 1 relates to "the Structure". Within that section the word "Buildings" is defined as "Buildings at the Premises...". The cover under the section is described as follows:

"Cover

We will Indemnify You in the event of Damage to the Property described by each Item in the Schedule caused by any of the following Contingencies:

.....Fire, ...".

[7] Section 1 of the policy document also lists eight extensions to the insurance cover which this Section gives. The extensions include accidental damage to underground service pipes and cables, two years ground rent if the premises were rendered temporarily uninhabitable, the additional cost of complying with public legislation in reinstating the property, capital additions and damage to gardens caused by the emergency services. Three of the eight extensions are directly relevant to the dispute in this case. They are as follows:

"3. Public Authorities

This insurance by this Section is extended to include the additional cost of reinstatement of the Property sustaining Damage thereby insured and undamaged portions thereof incurred solely to comply with European Community legislation, regulations under Acts of Parliament or local authority bye-laws ..."

"4. Fees

The insurance by this Section is extended to include Architects Surveyors Legal and Consulting Engineers Fees necessarily incurred in the reinstatement or repair of the Property insured consequent upon its Damage but not for preparing any claim."

"6. Removal of debris

The insurance by this Section is extended to include costs and expenses necessarily incurred by You with Our consent in:

a. removing debris from the site of the Premises and the area immediately adjacent

b. dismantling and/or demolishing

c. shoring up or propping

of the portion or portions of the Property sustaining Damage by any of the contingencies."

I quote those extensions as the disputes in relation to the average clause were (a) whether the claims under those extensions were subject to average and (b) whether public authority requirements, professional fees and demolition or removal of debris formed part of "the total cost of reinstating the whole of such Property" where that phrase is used in special condition ii, quoted in paragraph [5] above. The schedule adds further extensions relating to the cost of locating the source of certain types of damage such as damage caused by the escape of water and also the loss of oil or metered water.

[8] Finally, Section 1 of the policy document contains special conditions applicable to that Section. They include the index-linking of the sum insured by each item of Section 1 of the Schedule, which is relevant to parties' agreement of the numerator in the average clause. The limit of liability, which is the subject matter of the second dispute, is in the following terms:

"Limit of Liability

The maximum amount payable in respect of any item insured under this Section is the Sum Insured stated in the Schedule for each item plus index linking."

For completeness, and as it related to the submissions of counsel for the pursuers, I refer also to special condition 3 in Section 1 of the policy document which states, "the Basis of Settlement for each and every Item under this Section shall be on a Reinstatement Basis".

The disputes, the three questions and parties' submissions

[9] The parties' disputes, as I have said, related to the construction of (i) the average clause and (ii) the limit of liability. In relation to the average clause, parties agreed that the costs of repair in relation to the building damage amounted to £189,323. They also agreed that sum insured under Section 1 (after index linking) was £87,769. They agreed that the effect of the average clause was to reduce the sum claimed under Section 1 of the policy by reference to the formula:

x costs of repair

The disputes in relation to the average clause concerned (a) whether the average clause applied to claims in relation to the three extensions, which I have quoted in paragraph 7 above, and (b) the denominator, namely what were "the total costs of reinstating the whole of such property"?

[10] In relation to the average clause parties invited me to answer two questions. They were:

(1) Does the calculation required by Special Condition ii of the Policy fall to be applied to claims in respect of expenditure on the matters referred to in the Extensions stated to apply to Section 1 (pages 15 and 16 of the Policy)?

(2) In carrying out the calculation required by Special Condition ii of the Policy, does the "sum representing the total cost of reinstating the whole of such Property at that time" include expenditure on the matters referred to in the Extensions stated to apply to Section 1 (pages 15 and 16 of the Policy)?

[11] In relation to the dispute on the application of the limit of liability (which is unlikely to be of financial consequence if the average clause is construed as the defenders submitted) the parties posed the following question:

(3) Does the limit of liability contained in Section 1 of the Policy apply only to the costs actually incurred in reinstating the building or does it apply to the aggregate of those sums and claims in respect of expenditure on the matters referred to in the Extensions stated to apply to Section 1 (pages 15 and 16 of the Policy)?

[12] Mr Thomson for the pursuers submitted that I should answer questions (1) and (2) in the negative. The phrase in the average clause which is the denominator in the calculation of average (in paragraph [9] above) referred to the costs of rebuilding; it did not include the costs covered by any of the extensions, some of which, such as damage to underground services and the payment of ground rent, were completely unconnected with the process of reinstatement. To discover what reinstatement involved, he submitted, one should look to the use of the word in the definition of "Reinstatement Basis" (see paragraph [4] above). It concerned the costs of rebuilding. Had the insurers wished to include the extensions within the total costs of reinstatement they could easily have done so. He referred to the wording of the summary of cover which formed part of the proposal form which, he submitted, assisted the interpretation of "the sum insured" as it is stated in relation to the Structure (see paragraph [2] above). The summary of cover in the proposal document explained that buildings were covered on a specified contingencies basis, including fire. It listed in bullet points the extensions of cover which were provided at no extra charge, namely accidental damage to underground services, loss of ground rent, alterations and additions to buildings and restoration costs for gardens damaged by emergency services. Thereafter it stated: "Additional costs and expenses covered include debris removal, architects' and surveyors' fees and the cost of complying with public authority requirements". These were, he submitted, all extras, several of which had their own specific financial or other limits. The reasonable insured, reading the summary, would look to the cost of rebuilding in deciding the appropriate level of cover and would treat the extensions as extras. While an average clause usually sought to establish a relationship between the sum insured and the total exposure of the insurer, the clause in this policy had missed the target.

[13] In relation to the limit on liability (see paragraph [8] above), Mr Thomson submitted that on a proper construction the maximum amount payable related only to the actual reinstatement costs. In other words, the figure of £87,769, which was result of applying index-linking to the insured sum for buildings stated in the schedule, related only to the actual costs of rebuilding and not the professional fees or any of the other extensions. He therefore invited me to agree with the first of the two options in question (3).

[14] Mr Lake on behalf of the defenders invited me to answer the first two questions in the affirmative and to uphold the second option in the third question. He submitted that against the background of the law of insurance both the average clause and the limit of liability should be construed as the defenders suggested as those interpretations gave the words used their ordinary meaning and the arrangement thus construed made commercial sense. He submitted that the relevant cover which Section 1 gave was an indemnity against loss and damage to the hotel premises caused by fire. This Section was laid out in a similar way to the other Sections in the Schedule, in each of which there was stated either the sum insured, an indemnity limit or a maximum amount. The extensions to the insurance in Section 1 of the policy document were each worded similarly, namely, "The insurance by this Section is extended to include....". The extensions allowed the insured to claim as part of the indemnity for building damage the costs which he incurred in relation to them. The purpose of an average clause was to make an insured his own insurer when there was a shortfall in the sum insured: Hardy Ivamy, "General Principles of Insurance Law" (6^th ed 1993) p.460. On a proper construction of the policy there could be only one claim under Section 1, which included the extensions, and average applied to all of that claim. Expenditure on any of the extensions fell to be included in the denominator in the average clause as they formed part of the reinstatement claim under Section 1. In relation to the limit of liability, Mr Lake submitted that the limit applied to the item insured, namely the buildings in Section 1, and that it encompassed all the claims in relation to the buildings in that Section, including the extensions. It made no commercial sense to specify the levels of cover in a Section and to exclude from that limit the extensions, as the specified level of cover would determine the premium charged. Accordingly, the limit applied to the whole of Section 1, including the extensions.

Discussion

[15] The questions raised in this debate concern the construction of the particular policy and raise no general questions of law. But the policy falls to be construed against the background of the general law of insurance in order to give a sensible commercial meaning to the provisions. The questions which I have been invited to answer are closely related because it would be strange if the sum insured which was specified in a section were to apply as a limit of liability to the costs including the extensions in that section but those extensions were not to be included in the calculation of average.

[16] I am satisfied that the expenditure claimed in this case in respect of the items covered by extensions 3, 4, and 6, namely the costs imposed by public regulations, the professional fees and the costs of demolition and removal of debris, are all subject to the average clause (special condition ii). It appears to me that those items are properly to be considered as part of "the costs incurred in reinstating the whole of the Property" under Section 1, namely the buildings. Those items also, as a matter of ordinary English, fall within the denominator in the average clause as they are part of "the total cost of reinstating the whole of such property at that time". Thus the costs of demolition, site preparation and professional fees are part of the costs of reinstating the building. An informed person when taking out insurance and choosing the level of his indemnity (the sum insured) would be aware that such costs were normally part of the cost of reinstating a building after a fire.

[17] For the sake of completeness, although it is not a live issue in this case, I consider that the extension for underground service pipes and cables at the premises (extension 1) would also fall within the average clause as they would form part of the subjects to be reinstated. I accept that some of the extensions, namely (a) the cost of ground rent if the premises have been rendered uninhabitable during the period needed for reinstatement, (b) the cover for capital additions, (c) the damage to gardens by the emergency services and (d) the extension of entitlement to claim to a contracting purchaser, which are extensions 2, 5, 7 and 8 in Section 1 of the policy, do not appear to fall within the average clause as they are not part of the cost of reinstating the buildings. Of those, the first three extensions contain their own financial limit and the fourth deals with a person's insurable interest and is not an item of loss or damage. While this outcome is not as neat as that proposed by Mr Lake, who urged that average should be applied to the entirety of a claim under Section 1, the language used in the average clause, which focuses on the total costs of reinstatement of the building, supports my conclusion.

[18] What the average clause addresses is the relationship between the relevant sum insured and the cost of reinstating the relevant property and the clause comes into effect when the defined proportion of the latter sum exceeds the sum insured in respect of the item. In my opinion the three extensions which are in issue in this case are costs which form part of that reinstatement cost. I derive no assistance from the definition of "reinstatement basis" (paragraph [4] above) on which counsel for the pursuers relied. That provision, as Mr Lake submitted, defines the basis on which a claim is to be calculated by excluding betterment and does not specify what is included within the reinstatement.

[19] For the same reasons I consider that the costs in relation to three extensions which are in issue in this case are to be included in the denominator in the average clause. Again, as in paragraph [17] above, I would, in a case in which it was relevant, include the underground service pipes and cables extension within that denominator.

[20] Finally, and consistently with my interpretation of the average clause, I construe the limit set by the sum insured in Section 1 in respect of buildings as covering the expenditure on those extensions which form part of the reinstatement of the buildings, namely the three extensions in issue in this case and also the cost of reinstatement of underground service pipes and cables.

Conclusion

[21] I therefore answer questions (1) and (2) in the affirmative but only in relation to extensions 1, 3 4 and 6. I answer question (3) by stating that, in my view, the cost of reinstating the buildings in this policy includes extensions 1, 3, 4 and 6. As requested by counsel, I will have the case put out By Order to determine further procedure.