Is Rust/Corrosion Covered in All Risk Policies ?

Reference was made earlier to an Indian case, Bharat Heavy Plate & Vessels Ltd vs M/S. National Insurance Company (2009), before the A. P. State Consumer Disputes Redressal Commission, which allowed a corrosion damage claim. The claim related to an MCE policy and the project concerned a turnkey project from IOCL. The insured gave an order to M/s. Ingersoll Rand for the erection of two air compressors. The policy commenced from the date of despatch of the first consignment and remained in force till the completion of the project. However, due to heavy rains, the civil foundation of the project could not be laid immediately, and the consignment was stored for 70 days, after which the air compressors were taken out and were successfully erected on respective foundations under the same roof.

In a joint inspection with the principal, it was found that there was accumulation of rainwater and patches/pitting. The insurer was informed, and the surveyor was appointed, and as permitted by him repairs were carried out. After receiving the survey report, the insurer appointed a second surveyor. The insurer thereafter denied the claim. It was stated that it was only one year after commissioning of erection that M/s. Ingersoll Rand reportedly found water accumulation. The insurer stated that the rust observed on the internal parts was excluded as per the exclusion clause (c) of Schedule-I, Part-II of the MCE policy. This was what the second surveyor clearly said.

It was observed by the 1st surveyor that after the transit was over there was no apparent physical damage to the packages and the consignee gave a clean chit to the carrier. The consignment thereafter was kept at site and reported to have been covered by tarpaulin. After discussion with all concerned the surveyor observed that the rusting had occurred because of the trapped moisture. Once the process of rusting and corrosion started it progressed and caused pitting. There was sufficient time for the process of corrosion to set in as these parts were in enclosed steel body and the damage was observed only during commissioning on 23.6.2002 i.e., almost after 13 months after the arrival of goods at the destination. Finally, he made the following remarks:

1) The loss does not fall under any of the exclusions of the policy.

2) There is no breach of policy terms and conditions in our opinion.

3) The risk has been reinstated to the satisfaction of the insured.

4) There is no under insurance.

5) The salvage value has been deducted.

As the insurer did not like this conclusion, they appointed another surveyor, who according to the court, without mentioning any details contradicted the report of the first surveyor by giving specious reasons. It just opined that the claim falls under exclusion clause vide Section-I Part-II of the policy which stated: “( c ) normal wear and tear, gradual deterioration due to atmospheric conditions or otherwise, rust, scratching of painted or polished surfaces or breakage of glass.” The court found that the insurer could not show any fallacy in the report of the first surveyor and the second surveyor was appointed 6 months after the 1st surveyor, but they could not give any cogent reasons. Hence the case was allowed.

Rust/Corrosion issue - a controversial topic

The “rust/corrosion” exception remains a hotly debated topic. Traditionally the US insurers and the courts there denied any type of indemnity for losses caused by corrosion. However, other countries following the UK model of law, and distinguished between corrosion caused by a fortuitous cause as against loss caused by gradual corrosion. This is because the rust/corrosion exclusion is part of the wear and tear clause. Courts have allowed coverage for corrosion caused by an accidental or fortuitous event, say for example a negligent installation of steel tubes to transmit steam, which escaped and mixed with other acids and result in corrosion (Burts & Harvey Ltd v Vulcan Boiler and General Insurance Co Ltd [1996] 1 Lloyd's Rep. 161). The Supreme Court of Canada in the case CCR Fishing Ltd v Tomenson Inc (The La Pointe) [1991] 1 Lloyd’s Rep 89) stated: “I turn first to the question of whether the failure of the bolts can be viewed as "ordinary wear and tear."?In my view it cannot.?There was nothing ordinary about the failure of the cap screws.?Their failure was extraordinary, resulting, as the trial judge found, from the negligent act of the repairers who installed them.” The cap screws had failed on account of rusting.?

In considering the rust exclusion, one has to grapple with the fundamental, but not always easy, question of fortuity. It is accepted that where an exclusion clause refers to a sequential list of processes to be excluded from cover as seen in the rust exclusion quoted above in the MCE policy, which includes a number of naturally occurring processes, the exclusion is to be interpreted in line with the surrounding collective language (as per the doctrines of ejusdem generis and noscitur a sociis). If read in this context, the corrosion exception is applicable only where the corrosion is of a gradual nature rather than by any other form of violent sudden corrosive action.

It appears that courts in the USA disallow damage by rust in all cases because they are afraid of the misuse of corrosion coverage in operational risk policies. The same apprehension is now gripping insurers in UK and elsewhere. It is now reported that in order to avoid fortuitous “corrosion” risk getting covered owing to the exclusion being tied to the “wear and tear” clause, underwriters have now started to make a separate clause for excluding corrosion. The “rust or corrosion” exception thus remains a hotly debated topic owing to the dilemma faced by insurers. It is also reported that the London Engineering Group (LEG) is thinking of similar amendments.