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Central notions in CAR policies: material damage and inclusion of inherent defects

In the Netherlands, the central notion in the description of coverage of a Construction All Risk (CAR) policy is material damage. Without material damage there is no coverage under the CAR policy.

If, for example, it comes to light during the building period that the balconies in an apartment building would collapse in case of heavy load, the damage resulting from the necessary replacements of those balconies is not covered under CAR insurance. If the lacking strength of the balconies has led to cracks in the balconies, however, the cracks would be regarded as material damage. As a result, the cracks and all damage resulting from them would be covered under CAR insurance.

In terms of CAR coverage in the Netherlands, it is not relevant whether or not the cracks are the result of an inherent defect. As long as one can point to any material damage as a result of the inherent defect that has occurred during the building period, the defect and all damage resulting from the defect is covered under CAR insurance. However, there are exceptions to said principle. The notion of material damage in CAR policies includes a concealed exclusion of coverage for a certain group of inherent defects.

Concealed exclusion for objects which were damaged from the beginning

The idea is that the requirement of material damage cannot be met if an object has never been flawless, i.e. if the object was damaged from the beginning. This idea is regularly seen in Dutch case law and Dutch legal literature. The underlying reasoning is that an object which has never been flawless cannot be (materially) damaged as it was never a proper object in the first place. This idea has developed into a central tenet in Dutch CAR cover cases.

The question then arises: when can an object be qualified as being damaged from the beginning? How do we make a distinction between an object with an inherent defect and an object which was damaged from the beginning? Is it not that every object with an inherent defect can be regarded as an object which was damaged from the beginning?

Case law from 2018

In general, Dutch courts set high requirements in CAR cover cases for the argument of insurers that the object in question has never been flawless. Such is understandable given the aforementioned fact that CAR policies – explicitly – provide coverage for inherent defects.

Two decisions by lower courts given last year show that there is a fine line between coverage and no coverage in cases of inherent defects.

In the first case[1], a coating layer had been applied onto an ice skating track. After two weeks the layer showed blisters. Research showed that the coating layer had been applied too thick, as a result of which the solvent in the coating layer had not been able to evaporate causing blisters on the coating layer. The CAR insurer took the position that the coating layer had never been flawless and denied coverage for the damaged coating layer and all damage resulting from it. In assessing the question whether the coating layer had been materially damaged, the court considered that the deciding factor is whether the coating layer had been flawless at the time it was applied onto the track. The court specified that if the coating layer met all characteristics and requirements to become a coating layer without any defects at the time it was applied, the blisters on the coating layer could be regarded as material damage. The court considered that correct application is a precondition for a coating layer to become a flawless one. As the coating layer in question had not been applied correctly there was never a moment in time at which the coating layer had been flawless. Thus, the court concluded that there was no material damage, resulting in the claim not being covered under CAR insurance.

In the second case[2], the result was different. In this case, several welds had been applied to steel structures creating so-called skid beams, used in offshore industry. After application, the welds were examined by ultrasonic testing to ensure the absence of flaws. After two skid beams had been approved for delivery, they were examined again by ultrasonic testing after they had been delivered to their purchaser. During the second examination, indications were found for the presence of flaws. The skid beams were cut open and ruptures were found. They were repaired swiftly given the time pressure of the whole project. Insurers did not get the chance to observe the ruptures themselves. During the proceedings, insurers queried the results of the ultrasonic testing by pointing to the unreliability of the method and argued that the welds had never been flawless. Furthermore, insurers pointed to the fact that the flaws had been the result of a design fault combined with faults made during welding. According to insurers, the chosen method of welding could never have led to proper welds. The court assumed on the basis of the statements given by the experts who performed the ultrasonic testing that the welds had ruptured after they had been flawless. The court also found that CAR policies providing coverage for all damage no matter what cause, also provide coverage for design faults if the object does not show any flaws at first, as a result of good workmanship, but only at a later stage. Based on these considerations, the court granted the insured’s claim for coverage.

Conclusion

It can be difficult to divide between covered and uncovered claims in cases of inherent defects. Taking into consideration the aforementioned case law, it seems that as long as the insured can point to a moment in time at which the built object has been flawless, there is coverage under CAR insurance. This can be a quite difficult and very factual discussion.

Material damage as a result of design faults seems to be covered most of the time. Material damage as a result of faults during the construction phase can also be covered, but more often the aforementioned exception seems to apply. Especially faults which occur during the making of a specific component run the risk of falling outside the scope of CAR coverage.

[1] Judgment of the Rotterdam court of 7 November 2018, ECLI:NL:RBROT:2018:9314.
[2] Judgment of the Amsterdam court of 11 July 2018, ECLI:NL:RBAMS:2018:6603.

Legal literature and case law were divided on this question. Some considered the lack of a contractual relationship uberrimae fidei (“of utmost good faith”) as an obstacle for analogous application of the statutory sanction to the relationship between a third party victim and the insurer. Others argued that the insurer is just as dependent on the claimant for the provision of reliable information in case of a third party claim as in case of a claim by the insured.

Direct claim against the insurer

In the Netherlands, as in other EU member states, drivers are obliged to have motor liability insurance. Victims of car accidents do not have to claim damages with the liable driver but have a direct claim against his/her motor liability insurer. This direct claim has its basis in EU regulation and is therefore also seen in other EU member states.

Facts of the case: was the alleged victim in the car?

In the case before the Supreme Court the victim also aimed its claim for damages directly at the motor liability insurer of the liable party. The case concerns a car accident that took place in the fall of 2001.

The victim was the mother of one of the drivers involved. She claimed to be a passenger at the time of the accident. The mother, who already suffered from health problems before the accident, had visited her doctor the day after the accident with whiplash symptoms. As from 2002, a few months after the incident, she was declared fully unfit for work.

The motor liability insurer of the liable driver refused to pay damages to the mother as the liable driver contested that the mother was in the car at the moment of the accident. In response to the insurer’s refusal of the claim, the mother produced several false witness statements. During the proceedings before the court of first instance the falseness of the witness statements came to light. The mother and some of the witnesses were convicted by the criminal court for forgery of documents, fraud and/or perjury.

Lower courts

The court of first instance dealing with the mother’s claim for damages denied the claim. The court of appeal however, granted the claim.

The court of appeal disregarded the false witness statements but found on the basis of other means of proof that the mother was a passenger at the time of the accident. These means of proof were all derived from the mother’s own assertion that she was a passenger.

The insurer brought the case before the Supreme Court, claiming that the court of appeal had wrongly denied the legal principle that a claim is denied if the third party has misled the insurer in order to obtain payment. Alternatively, the insurer claimed that the court of appeal did not give a proper ruling on the evidence of the case.

Relevant provision(s)

With its claim for a total loss of claim by the victim, the insurer refers to article 7:941 paragraph 5 of the Dutch Civil Code. This provision denies insureds the right to payment if they fail to timely notify their insurer of a claim and/or fail to provide (proper) information to the insurer in a deliberate attempt to mislead said insurer. Strictly speaking, the provision only applies in the contractual relationship between the insurer and the insured. However, the insurer in this case claimed, in line with case law of the Dutch Financial Services Complaints Tribunal and several legal authors, that the provision should be analogously applied to the relationship with a third party.

Supreme Court judgment

The Supreme Court does not concur with the position taken by the insurer. The Supreme Court rules that there is no room for analogous application of the sanction outside the relationship between the insurer and the insured, i.e. in the relationship between the insurer and a third party victim. The sanction of article 7:941 paragraph 5 DCC is justified by the character of confidence of the insurance agreement. The Supreme Court finds that said sanction does not distinguish between severe fraud cases and less severe fraud cases which makes the sanction a drastic one. Therefore, said sanction cannot be accepted in other relationships without a statutory basis.

Nevertheless, the Supreme Court rules the judgment of the court of appeal to be incomprehensible. The Supreme Court has difficulties with the finding of the court that the mother has succeeded in proving that she was a passenger at the time of the accident. Therefore, the judgment of the court of appeal is set aside. The Supreme Court refers the case back to another court of appeal for further handling.

Take away: fraud is never without consequence

The latter findings of the Supreme Court show that fraud by a third party victim also comes with consequences, however less drastic ones. In line with the opponents of analogous application of the aforementioned sanction, the Supreme Court deals with fraud committed by third parties by setting higher requirements for the evidence produced by the fraudster.

[1] Supreme Court of the Netherlands 6 July 2018, ECLI:NL:HR:2018:1103