Limiting the damage

How much will a product liability policy cover economic losses arising from a product defect? That has been the subject of several judgments and has received further consideration and clarification in a recent case.

The judgment by the Court of Appeal in Horbury Building Systems v Hampden Insurance NV stresses the need for losses to be directly linked to the defective product supplied.

Cases such as AS Screenprint v British Reserve Insurance Co [1999] and Rodan International v Commercial Union [1999] concerned the question of insurers’ liability for the economic losses of third parties arising from the sale of defective products.

But Horbury Building Systems v Hampden Insurance [2004] presented a new problem: what if the product supplied might result in damage to third party property leading to precautionary measures being taken? Are those losses covered by the standard product liability insuring clause?

Horbury concerned the supply of interior fittings and services to a cinema complex in Manchester operated by a company, AMC.

The main contractor for those services was Galliford, which sub-contracted the installation of partitions and ceilings to the claimant, Horbury.

As a result of the use of unsuitable washers, sections of a suspended ceiling were not sufficiently secured, ultimately causing the ceiling of one auditorium (cinema 6) to collapse.

Horbury had installed the incorrect washers in five out of 16 auditoria. AMC voluntarily closed the entire cinema complex given the risk of similar collapses. Galliford settled the claim brought by AMC and subsequently pursued Horbury under its contract. Horbury claimed under the product liability section of its policy.

A dispute arose between Horbury and its insurer in respect of the extent of cover for economic losses caused by closure of the entire cinema complex, for example, loss of ticket sale revenue and other retail losses.

The policy included the following insuring clause: “The company will indemnify the insured against

liability at law for damages and claimants’ costs and expenses in respect of injury to any person and loss of or damage to property occurring within the territorial limits during the period of insurance and caused by any products after they have ceased to be in the custody or under the control of the insured.”

The policy contained the usual exclusions for assumed contractual liability and for the costs of repairing the defective products supplied.

Prior to Horbury’s liability being ascertained and therefore before the basis of any liability had been established, or the factual basis of any such liability had been found or agreed, Horbury sought a declaration as to the extent of the cover provided by the policy.

Approving the decision of the deputy High Court judge at first instance, the Court of Appeal drew upon the reasoning of the AS Screenprint and Rodan cases. It was not sufficient to establish that the losses suffered had some connection with the insured event.

To allow such recovery would convert the insurer’s liability from one of product liability to one extending to general contractual liabilities.

The Court of Appeal rejected the insured’s argument that the insuring clause provided cover that is

co-extensive with the liability of the insured. Any recoverable loss had to have been caused by the physical damage. It was found that the policy did cover “liability for the physical consequences of the collapse of

cinema 6 and such economic losses as were caused by that physical damage”.

The parties were in agreement that if the defects in the suspended ceiling of cinema 6 had been discovered before any collapse, and the collapse had been prevented, Hampden would not be liable for Horbury having to pay damages for profits lost by closing cinema 6.

Accordingly, Hampden would not be liable if, in such a case, the rest of the complex had been closed to see if faults were repeated elsewhere, and Horbury held liable in damages for the resulting loss of profits.

That must be because, in relation to both cinema 6 and to the rest of the complex, such damages would not be in respect of damage to material property.

The mere existence of a defective product and the risk of future physical damage were not damage to physical property and as such the insurer’s liability did not “embrace the losses resulting from the wider closure”. Any losses caused by AMC’s preventative actions were therefore not covered.

Lord Justice Keene went on to highlight two further reasons in support of his conclusion. The first was that the insurer had not relied upon the general law of tort in support of its argument, but would have instead pointed to its contractual liability to the insured.

The second was that a “contractor is not liable in tort to the buyer or occupier of a building if a defect is discovered before any personal injury or physical damage is caused by the defect...it is only if the defect causes damage to other property that damages may be recovered…”.

As referred to above, this dispute took place prior to Horbury’s liability, for which cover was sought, had been determined.

The court was willing to make a declaration as to the extent of cover provided by the policy, however. Lord Justice Keene observed that making such a declaration when the claimant did not seek to identify whether liability to a third party was based in contract or tort, or the party to whom it would be so liable, left “a great deal to be desired from the point of view of the court”.

Despite these reservations it appears that the court will nevertheless make declarations relating to the scope of a liability policy where the issue is sufficiently defined.

The decision in Horbury gives certainty as to the basis and extent of insurers’ liability in this area and demonstrates that the court is unwilling to impute any liability beyond that contemplated by the policy. As a result a product liability policy will be given a narrow interpretation.