English Commercial Court Considers Application of Sanctions Order to Contract of Insurance

In Islamic Republic of Iran Shipping Lines v Steamship Mutual Underwriting Association (Bermuda) Limited [2010] EWHC 2661 (Comm), the English Commercial Court was asked to consider the effect on a contract of insurance of an order made by the UK Government for the purposes of preventing nuclear proliferation.

The Background

The claimant, Islamic Republic of Iran Shipping Lines (IRISL), was a member of the defendant Protection & Indemnity Insurance Club, Steamship Mutual Underwriting Association (Bermuda) Limited (the Club).

Insurance to cover liabilities in respect of bunker oil pollution is required by the International Convention on Civil Liability for Bunker Oil Pollution Damages 2001 (the Convention) for ships that trade in the territorial waters of States that are signatories of the Convention. Under the Convention’s Rules, a certificate evidencing that insurance (or other financial security) is in place is required to be carried on board. IRISL had a number of ships entered with the Club including the “ZOORIK” which was entered for Class 1 Protection & Indemnity for the period 20 February 2009 until 20 February 2010. The cover provided to IRISL under the rules of the Club was for wider coverage than that specifically required by the Convention. The Club issued a Blue Card, a document evidencing that sufficient cover was in place, to the CLC Bunkers Maritime and Coastguard Agency which in turn issued a certificate satisfying the conditions of the Convention.

On 9 October 2009, the Financial Restrictions (Iran) Order 2009 SI No. 2725 of 2009 (the Order) was made (coming into effect on 12 October 2009). The Order prohibited relevant persons (defined as a person operating in the financial sector) from entering into, or continuing to participate in, any transaction or business relationship with, amongst others, IRISL. HM Treasury issued two licences to the Club the terms of which allowed the Club to continue “to provide insurance cover under an existing contract” to IRISL for a period of seven days from the date the Order came into force. The second licence, issued on 19 October 2009, further extended the time that the Club was allowed to provide cover to the 30 October 2009. HM Treasury issued a further licence (the 30 October Licence), on different terms to the previous licences, but which included, amongst other things, the following provisions:
“6. Under this licence:
6.1 [the Club] may continue to provide insurance cover in accordance with the Blue Cards issued to IRISL, for a period of 3 months, starting on 30 October 2009, or until [the Club] is discharged from liability by the State Authorities to whom the Blue Cards have been issued, whichever is the sooner;
6.2 [the Club] may continue a business relationship with IRISL to the extent necessary in order to handle, negotiate and pay any claims arising under the insurance cover described in paragraph 6.1.”

The Club took the view that the terms of the 30 October Licence did not allow it to continue to provide insurance cover to IRISL and consequently terminated cover on 30 October. It considered that it would still be liable to third party claimants in respect of pollution incidents falling within the Blue Cards that had been issued.

On 31 October 2009, the “ZOORIK” suffered a casualty in the People’s Republic of China causing bunker oil pollution and rendering it a constructive total loss.

The Issues

Although proceedings were initially brought by IRISL against HM Treasury, an interested party in the action, concerning the validity of the Order, it was apparent that the first issue to be determined was whether the Club was prevented from providing cover to IRISL. Accordingly, Mr Justice Beatson was asked to decide four issues:

On the true construction of the Order and the 30 October Licence what, if any, insurance cover was the Club permitted to continue to provide to IRISL?
Was the effect of the Order and the 30 October Licence to discharge the insurance by reason of frustration?
Is IRISL entitled to be indemnified in respect of its costs and liabilities arising out of the casualty?
Is the Club entitled to indemnity and/or reimbursement from IRISL in respect of any liabilities that it incurs to third parties under Article 7(10) of the Convention as a result of the casualty?

The Outcome

As to issue 1, the judge held that, on its proper construction, paragraph 6 of the 30 October Licence did allow the Club: “(a) to continue to provide IRISL with insurance cover in respect of the risks required to be insured by reason of the provisions of the… Convention; and (b) to meet all claims made in respect of those risks and not only claims made by third parties pursuant to Article 7(10)’s direct right of action.” In particular, the judge held that the provisions of the Convention required the continuation of insurance cover to the shipowner, and that the provision of that cover was a necessary part of any obligation to third parties arising through the issuance of Blue Cards.

As to issue 2, the judge acknowledged the common ground between the parties that at midnight on 30 October it became unlawful for the Club to insure IRISL in respect of all risks except those required to be insured by reason of the Convention. The question then arose as to whether the Order frustrated the performance of the contract between the Club and IRISL so as to discharge that contract.

The judge, applied the accepted “classic test” for frustration given by Lord Radcliffe in Davis Contractors Ltd v Fareham [1956] AC 696, 729:

“frustration occurs whenever the law recognises that without default of either party a contractual obligation has become incapable of being performed because the circumstances in which performance is called for would make a thing radically different from that which was undertaken by the contract”. (emphasis added)

Counsel for the Club submitted that, regardless of the construction of the 30 October Licence, since it became unlawful for the Club to insure all the other risks, the contract of insurance between the parties was discharged by frustration. In deciding cases of frustration and in particular cases of supervening illegality, the court had to consider “whether (a) the purpose (or main object) as gathered from its terms has been defeated … or (b) the contractual obligation was rendered “radically different” from that which was undertaken.”

The Club felt that both tests were satisfied as the Club could no longer provide the multitude of risks covered in standard Class 1 P&I cover, for which the “ZOORIK” had been entered (therefore the insurance contract’s main terms had been defeated); and the contractual obligation was radically different as after 30 October, it was no longer a general indemnity insurance policy providing Class 1 P&I cover by way of mutual insurance.

Despite rejecting a number of IRISL’s submissions as to whether the insurance had been frustrated, the judge accepted IRISL’s submission that the insurance, by “its nature is not different [and] it remains indemnity insurance.” IRISL accepted that the scope of cover permitted was significantly narrower than it was prior to 30 October. The judge held that the terms of the 30 October Licence permitted the Club to “continue to provide insurance cover in accordance with the Blue Cards issued to IRISL for a period of 3 months [or until the Club was] discharged from liability by the State Authorities to whom the Blue Cards have been issued, whichever is the sooner”. Distinguishing the House of Lords decision in Denny-Mott and Dixon v James Fraser and Co [1944] A.C. 265, the judge held that the contract between the Club and IRISL was to provide indemnity insurance and that “[p]art of that purpose remained lawful.”

As to issue 3, following his finding that the contract was not frustrated, the judge held that IRISL was entitled to be indemnified in respect of its costs and liabilities arising out of the casualty. Conversely, as to issue 4, the Club was not entitled to any reimbursement or indemnity from IRISL in respect of any liabilities it incurred to third parties under the Convention.

At the time of writing, the Club has been granted permission to appeal this decision to the Court of Appeal although a date of the hearing has yet to be listed.

Implications

Sanctions are an increasingly common tool of states in their battle to stop, amongst other things, nuclear proliferation and terrorist financing. Operating in a global industry, insurers need to be aware of the various sanctions that are in operation and to which they are subject. In the United States, the Office of Foreign Assets Control of the U.S. Department of the Treasury administers and enforces economic and trade sanctions based on US foreign policy and national security.¹ In the UK, HM Treasury is the responsible government department for the implementation and administration of international financial sanctions.² Both departments have readily accessible lists of sanctions that are currently in operation. Insurers need to be aware of the countries, companies, and individuals that are included in these lists and ensure that they remain compliant with any further additions. In the US, violating sanctions regulations can lead to fines ranging from $50,000 to $10,000,000 and imprisonment ranging from 10 to 30 years for wilful violations. However, as can be seen from this case, insurers must remain mindful of any continuing obligations that they have to their insured, which involves a careful review of the terms of the sanctions orders, and their impact on the policies that have been underwritten.