It all depends on the circumstances: notification under professional indemnity insurance

The recent decision of Mrs Justice Moulder in Euro Pools plc v Royal and Sun Alliance Insurance plc [2018] EWHC 46 (Comm) considered various coverage issues that can arise in the context of professional indemnity insurance policies. This article focuses on just one: notification.

Notification: an introduction

Professional indemnity insurance is a species of ‘claims-made’ insurance. This means that the insurer’s obligation to indemnify is triggered not by the occurrence of a loss (the ascertainment of the insured’s liability to a third party), but by the prior occurrence of a third party making a claim against the insured. The rationale for this is that insured would otherwise struggle to renew cover: if a claim is made in year 1, the insured would have to disclose it to the insurer when renewing for year 2 (the duty of fair presentation under section 3 of the Insurance Act 2015), but the insurer would either refuse to cover the risk or would charge an exorbitant premium for doing so. If, however, the making of the claim against the insured were the trigger for cover, the year 1 policy would respond, and the problem would fall away.

A further strand to claims-made insurance is the insured’s ability to notify ‘circumstances’ that may give rise to a claim. This has a similar rationale. Suppose the insured knows it has done something wrong which may lead to a claim in the future. If the insured gains this knowledge in year 1, it would likely be required to disclose it to the insurer on renewal for year 2. Again, the insurer would not want to cover the liability resulting from this circumstance without charging a commensurate premium. The solution is for policies to provide that if the insured notifies the insurer in year 1 of the relevant ‘circumstance’, the resulting claim will be deemed to have been made in year 1 and the year 1 policy will respond accordingly. In turn, the year 2 policy will exclude claims that arose from circumstances that were, or which ought to have been, notified in year 1.

Euro Pool – the facts

The claimant, “Euro Pools”, specialised in the installation and outfitting of swimming pools. Amongst its offerings were (i) movable floors that could be raised or lowered to decrease or increase the depth of the pool, and (ii) a booms system comprising vertical walls that could be raised or lowered to reconfigure the pool into different swimming zones.

Euro Pools was insured by the defendant, “RSA”, under a professional indemnity policy that it renewed yearly. The case concerned the policies covering the periods June 2006 to June 2007 and June 2007 to June 2008 respectively.

The booms system worked by filling a stainless-steel tank with air. In February 2007, Euro Pools discovered that the bottom of the tank wasn’t airtight, meaning that it would not rise as intended. It notified RSA but said that it did not believe that it would make a claim since it had a remedial solution (the use of air bags) that would cost less than its policy excess. However, it later encountered problem with the air bags, and in May 2008 it told RSA that it wanted to change to a hydraulic system. The cost of this solution did exceed the excess, and so Euro Pools made a claim under the mitigation costs section of the policy.

Moving back to February 2007, Euro Pools also notified RSA about a “major design fault” in the movable floors system and said that it intended to change to a mechanism involving stainless steel rope and hydraulics. It said that it wished to claim the cost of this under the policy.

On 25 October 2007, the movable floor of a diving pool in Leeds jammed and on 26 November 2007, Euro Pools notified RSA of this, being a circumstance “which might reasonably be expected to produce a Claim” (condition 2 of the policy). Euro Pools later made a claim for the remedial works to the pool.

The notification issue

The question that arose at trial was whether the claims for the cost of (i) the new booms system and (ii) remedying the Leeds diving pool were covered by the year 1 policy or the year 2 policy.

The booms claim

On the booms claim, Euro Pools’ case was that it was the 2008 notification, not the 2007 one, that triggered policy cover. It argued that the relevant loss was the failure of the air bags, not the original tank failure that led to the air bags system, which it did not know about until after renewal. It relied on Kajima UK Engineering Limited v The Underwriter Insurance Company Limited [2008] EWHC 83 (TCC), where at [99] Akenhead J set out the following principles:

“It is only circumstances of which the Insured is actually aware which can be the subject matter of a notification.”

“The factual context is important, not only as a matter of interpretation of the notification but also, because it is only matters of which the insured is aware that can form the basis of a valid notification.”

Furthermore, it submitted that if a third-party claim had been made in connection with the failed booms, it would have had no causal connection between the earlier notified circumstance (the leaking steel tanks). In this regard, it relied again on Kajima at [99]:

“There must be some causal, as opposed to some coincidental, link between the notified circumstances and the later claim.”

“The claim which is later pursued must arise not only from the notified circumstances but also only from the circumstances of which the Insured was aware. It cannot arise from any other circumstances which may have happened or been discovered either after the notification or in any event after the expiry of the insurance cover.”

In response, RSA said that this was too narrow an application of the guidance in Kajima. The initial tank failure and the later air bag failure were both symptomatic of a broader design flaw. As recorded by Moulder J at [25], it said:

“The constant pressurisation and depressurisation of tanks caused them to flex resulting in cracks and weld failures. The claimant endeavoured over time to rectify the problems engaging in a series of efforts including modifying tanks, use of airbags, modifying airbags and using a fibreglass tank. These continuing efforts led to the installation of a hydraulic system and later to the replacement of the hydraulic equipment.”

The Judge preferred Euro Pools’ submissions. She found, by reference to the expert evidence, that the later failure in the air drive system was not causally connected to the tank failure notified in February 2007. But even if both failures were symptoms of the same underlying cause, Euro Pools crucially did not know this when it made the earlier notification. As she stated at [76]:

“In accordance with Kajima the claim which is later pursued must arise from the circumstances of which the insured was aware. I find that on the evidence the claimant was not aware in February 2007 of problems with the air drive system such that it could not notify the circumstances which led to a claim for the expenses of the move to a hydraulic system.”

Accordingly, the Judge held that the claim attached to the year 2 policy.

The Leeds pool

Similar arguments were made in connection with the Leeds pool claim. Euro Pools’ case was that the failure of the Leeds pool was independent of the February 2007 notification. The earlier incident was the design flaw in the rope and winch system then being operated; the Leeds pool failure related to the new hydraulic system. There was thus no causal connection between the claim and the circumstance that was notified in February 2007.

RSA submitted that the February 2007 notification was of broad scope, relating to a “wide range of failures at different sites which were causing pool floors not to rise properly”. The notification was of a failure to develop a working design for pool floors, and the Leeds pool failed because the Euro Pools had still failed to develop a working pool floor design.

Moulder J again preferred Euro Pools’ submissions. The design defect in the Leeds pool was a matter of which Euro Pools was unaware in February 2007 and so could not fall within the scope of the circumstance notified then; and in any case, there was no causal link between the failure of the rope and winch system and the design failure which occurred at the Leeds pool.

Discussion

The decision is an interesting application of the reasoning in Kajima about the criteria for judging whether a claim arose out of an earlier circumstance. It is fair to say that a different judge may have taken a broader view of the nature of what was notified in February 2007. At that stage, Euro Pools knew that its design for the movable floor system and the booms system was defective. This, it could be said, causally connected the circumstances notified in February 2007 to the later claims under the year 2 policy. But for the original design failures, those claims would plainly not have been made.

Be that as it may, the lesson is that careful consideration must be given to the way in which a notification is framed. The more specific the notification, the narrower the opportunity for later claims to fall within its scope. By contrast, if the notification focusses on the symptom of the problem rather than its cause, it becomes more likely that a later claim will attach to the policy under which that notification was made.