Australia: Federal Court considers business interruption policy: the perils of poor policy – Tropical Reef Shipyard Pty Ltd v QBE Insurance (Australia) Limited

The recent Federal Court decision of Tropical Reef Shipyard Pty Ltd v QBE Insurance (Australia) Limited examined the operation of a business interruption policy and found that the insurer was unable to escape the clear meaning of the policy, with costly results. The dispute, amongst other things, concerned the proper construction of the loss calculations.

The decision highlights the dangers of an insurer offering a policy wording without fully analysing potential loss scenarios and their ramifications. The insurer will be held to what the policy says, even if this produces what it asserts is an unintended windfall for the insured. In this instance, relatively simple mechanisms could have been used to limit the extent of the losses claimed and to give effect to the insurer's interpretation.

The business interruption policy

QBE agreed to indemnify Tropical Reef pursuant to policies of insurance named "Instant Profits Insurance – Cash Flow Insurance – Simplified Business Interruption Insurance" (the BI Policy) for the period 31 October 2005 to 31 October 2006 (2005 Policy) and for the period 31 October 2006 to 31 October 2007 (2006 Policy). The BI Policy provided cover for "an amount in respect of weekly loss of Turnover" suffered as result of business interruption or interference due to property loss or damage. The loss calculation was the same under each policy. The insuring clause provided:

"for each week we will pay an amount based upon Weekly Calculations not exceeding the Weekly Sum Insured each week in respect of loss of Turnover suffered by you during the Indemnity Period ... [such payment to] be made every seven days whenever practicable."

The BI Policy required QBE to "pay [Tropical Reef] ... for each week ... the loss of Average Weekly Turnover based upon Weekly Calculations adjusted and agreed". The expression Average Weekly Turnover was not defined but Actual Average Weekly Turnover was defined to mean "the Actual Average of the Turnover for the twelve (12) months preceding the commencement date of the interruption [to be expressed as a weekly figure]".

The Claim

Tropical Reef is a provider of engineering, repair and maintenance services for commercial vessels, its major piece of infrastructure being a 3000 tonne slipway. Tropical Reef made three claims arising from the following incidents.

1. On 4 September 2006 the vessel "Castel Braz" collided with the bottom end of the slipway causing the last 15 metres to bend and detach (the first incident). A claim was made in respect of this incident for the period between the week ending 12 April 2007 and the week ending 3 April 2008. The alleged loss of turnover was $5,626,000.
2. On 2 November 2006 an incident occurred when the vessel "Mathamarfach" became stuck on the slipway causing damage (the second incident). A claim was made for loss of turnover for the period from the week ending 22 February 2007 to the week ending 14 February 2008 and an amount of $5,281,400 was claimed by Tropical Reef.
3. On 3 April 2007 an arm of the cradle of the slipway collapsed and bogies derailed from the slip while a Department of Primary Industries Pontoon was being slipped (the third incident). As a result the bogies and cradle were damaged resulting in claimed losses of $213,900 for the week ending 12 April 2007.

The dispute

QBE disputed the manner in which Tropical Reef calculated its loss of turnover. In relation to the first incident, it was alleged that there was a loss of Turnover for the period between the week ending 12 April 2007 and 3 April 2008. However, there was not a loss of Turnover in each week during that period. In some weeks, the actual Turnover was greater than the Actual Average Weekly Turnover. Tropical Reef did not seek indemnity in respect of those weeks. Tropical Reef only sought indemnity in respect of weeks where the actual Turnover for the week was less than the Actual Average Weekly Turnover. The same issue arose in relation to the second incident.

The issue with this methodology was that the loss of Turnover, if only calculated on a weekly basis, had the potential to produce a windfall gain. Finkelstein J gave the following example.

For example, if calculated on an annual basis the loss of Turnover from the September 2006 incident is $1,776,772, whereas the loss of Turnover using the applicant's [Tropical Reef] method of calculation is $11,678,735. Moreover, there was no loss of Turnover on an annual basis flowing from the November 2006 incident. In fact, there was an increase in Turnover of $591,227. Nonetheless, the loss of Turnover said to result from the November 2006 incident according to the applicant's method is $11,088,176.

QBE's principal argument was that the BI Policy ought be given a businesslike interpretation, taking into account the commercial circumstances it was intended to address. In support of this, QBE relied on the obligation of good faith and a provision of the policy which requires claims to be "adjusted and agreed". QBE asserted that amounts for each week, whether positive or negative, should be placed in a nominal running account with the final balance, if positive, being payable.

The proper construction of the BI Policy

Finkelstein J rejected QBE's method, as the BI Policy provided that "for each week [QBE] will pay [Tropical Reef] ... in respect of loss of Turnover". According to his Honour, this meant the calculations were to be made on a weekly basis. Further, this interpretation was supported by the introduction of the BI Policy which referred to indemnity "in respect of weekly loss of Turnover". The BI Policy also noted that losses must be paid within "seven days whenever practicable". Therefore, his Honour found that the policy terms provided for indemnity for losses on a week by week basis, calculated by reference to weekly figures and not on an annual or some other basis.

Finkelstein J considered that there was nothing in the BI Policy to support the introduction of a "running account". His Honour correctly pointed out that the result may be seen as a windfall gain, but this was only the case if Tropical Reef's position is considered on an annual basis.

The expensive lesson

This decision highlights the need for insurers to consider the ramifications of policy wordings and to work through the potential outcomes. Using practical examples often assists in determining whether there are unintended outcomes. In this case, close consideration of the policy wording at the time of drafting the policy could have avoided a dispute about the loss calculations. If it was the insurer's intention for the policy to operate based on annual calculations, then this should have been clearly incorporated into the policy.

Similar business interruption policies commonly include a reconciliation clause which will take into account weeks where profits are made to avoid a windfall situation.

It is often worthwhile including sample calculations in a schedule to the policy showing the way the policy is intended to operate. This can avoid a misinterpretation of the loss calculation and support an insurer's position if a dispute arises.

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