Commentary

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Chapter 7: Co-insurance of mortgagees

  • General

    There were no amendments to the clauses in Chapter 7 in 2016, but the Commentary to all Chapter 7 clauses was rewritten, as well as this introduction to the Chapter.

    Co-insurance of a mortgagee's interest is part of a larger set of problems concerning co-insurance of third parties. In the Plan, the rules on co-insurance of third parties are split between two chapters. Chapter 8 contains the general rules on co-insurance of third parties, whereas the rules relating to co-insurance of mortgagees are dealt with separately in this Chapter 7. This is due to the practical importance co-insurance of mortgagees has played with loan agreements usually containing provisions relating to insurance of the interests of the mortgagee.

    Under the heading General in the Commentaries to Chapter 8, the concept and use of co-insurance in traditional Nordic insurance law is explained. As mentioned there, the most common and practical co-insurance of third parties is that of the mortgagee. Chapter 7 provides an automatic cover of the mortgagee’s interest under the insurance. This means that the mortgagee is co-insured, regardless of whether the insurer has received any declaration to that effect. This is in contrast to the general rules of Chapter 8, where there is no automatic cover under the insurance to other third parties. The protection of the mortgagees is regulated exhaustively in Chapter 7, but does not provide the mortagees with an independent cover. The mortgagee will lose protection due to acts or omissions on the part of the person effecting the insurance or the assured who is responsible for the operation of the ship, see Cl. 7-1 in fine. However, extended cover of the mortgagee’s interest can be provided by giving the mortgagee independent co-insurance, or by establishing a completely independent cover, i.e. cover that is not linked to the owner’s insurance. Cl. 8-7 allows for the possibility of independent cover of a third party’s interest, including a mortgagee, linked to the shipowner’s insurance. As mentioned in the Commentaries to Cl. 8-7, the cover provided for the mortgagee in Cl. 8-7 is limited to the insurance to which it is attached and cannot be a complete substitute for a so-called Mortgagee Interest Insurance. 

    In practice, the position of the mortgagee is often specifically regulated in the insurance contract. Such specific provisions in the contract will have priority over the rules in Chapter 7. If the position of the mortgagee is incomplete in some respect in such provisions, the rules of Chapter 7 may supplement them.

  • Clause 7-1. Rights of a mortgagee against the insurer

    The Commentary to this Clause was rewritten in 2016.

    Sub-clause 1 states that the mortgagee's interest is automatically covered. The mortgagee is co-assured even though notice is not given pursuant to sub-clause 2. The consequence of failure to give such notice is simply that the mortgagee will not have the benefit of the protection provided for in Clauses 7-2 to 7-4. This approach with automatic co-insurance for holders of registered charges is in line with relevant Nordic ICAs.

    The Clause applies when the ship is "mortgaged", that is when a charge is created by agreement. Chapter 7 does not protect maritime liens and similar liens. It is not necessary that the charge is registered, but if the mortgagee's right is not legally protected, his right as a co-assured will not be protected against the creditors of the shipowner, cf. Rt. 1939.343 NH.

    Sub-clause 1 also establishes the principle that the co-insurance is not independent. This is achieved by way of a reference to the general rules governing identification in Cl. 3-36 to Cl. 3-38. On this point the Plan deviates from the solution in the relevant Nordic ICAs.

    The rule in Cl. 3-37 implies that the mortgagee must be identified with the assured or co-owner who has decision-making authority for the operation of the ship. This means that the mortgagee does not acquire any greater rights than the person who is responsible for the operation of the ship. If the party in charge of the operation of the ship is responsible for a breach of safety regulations or sends the ship into excluded trading areas without the insurer’s consent, the mortgagee will thus have to accept a loss of cover under Cl. 3-25 or Cl. 3-15, sub-clause 5, provided that the other conditions for applying sanctions against the assured are met.

    If the ship sails into a conditional trading area without prior notice to the insurer, the sanction is that the assured, in the event of damage, only receives compensation subject to a deductible of one fourth, however, up to a maximum of USD 200,000, cf. Cl. 3-15, sub-clause 3. This will also apply in relation to the mortgagee.

    If the responsible assured has delegated decision-making authority which is of material significance for the insurance to another organisation or person, Cl. 3-36, sub-clause 2, cf. Cl. 3-37, entails that the mortgagee must also be identified with that person or organisation. If responsibility for the operation of the ship has been delegated to several parties, the mortgagee must be identified with all of those responsible parties. Nor does the mortgagee acquire any greater rights than the assured if the insurer has paid out compensation to which it subsequently turns out the assured was not entitled. If the condictio indebiti rules lead to the assured having to pay the compensation back to the insurance company, the mortgagee must do so as well, cf. ND 1985.126 NH BIRGO and Rt. 1995.1641 TORSON.

    The cover is, however, independent in relation to other co-assureds who are not responsible for organising the operation of the ship, for example co-owners without such responsibility or other mortgagees. If they make a mistake, the cover of that mortgagee remains intact.

    It also follows from the reference to Cl. 3-38 that the mortgagee must be fully identified with the person effecting the insurance. If the person effecting the insurance breaches his obligation to give correct and complete information or to pay the premium, the mortgagee will not have any rights against the insurer, either. General principles of contract law dictate that the mortgagee must also be identified with any agents or sub-contractors the person effecting the insurance may use, for example, if the contract is entered into through a broker.

    Naturally, the mortgagee does not acquire any greater rights than the assured in relation to limitations of the scope of cover that are not linked to the issue of breach of obligations for the assured, for example, the war risk exclusion in an insurance against marine perils or the exclusion for insolvency. This is true even though the limitation of cover may seem like a reaction to negligence on the part of the assured, but is drawn up completely objectively, e.g., the limitation of liability for damage caused by inadequate maintenance in Cl. 12-3. It is unnecessary to spell this out explicitly in the Plan text.

    The principle of dependent co-insurance creates a degree of uncertainty for the mortgagee. If, for example, the ship is lost due to a breach of a safety regulation for which the assured must be blamed, the mortgagee risks being left without cover. For insurance of ocean-going ships, this "subjective risk" is extremely small. It is, however, conceivable that the mortgagees may wish to insure themselves against this risk as well. This can be done through independent mortgagee cover in connection with the shipowner's insurance, cf. Cl. 8-7. For ships trading in American waters, the mortgagee may also need to take out Mortgagee Interest Additional Perils (Pollution) insurance (MAP) to ensure priority for his mortgage in situations where clean-up costs, etc. in relation to the American Oil Pollution Act give maritime liens on the ship priority over charges created by agreement.

    The fact that the mortgagee's cover is not independent does not mean that the person effecting the insurance may arbitrarily give up his, and thereby the mortgagee's, rights under the insurance. Several provisions in Clauses 7-2 to 7-4 serve to protect the mortgagee against this eventuality and against the prospect of compensation being paid out by the insurer without it benefiting the mortgagee. To achieve this protection, however, the mortgagee must arrange for the insurer to receive notice of the creation of the charge, see sub-clause 2. If the mortgagee fails to give notice but the insurer learns of the creation of the charge in some other way, this must however be sufficient for the expanded protection to apply.

    The rule in sub-clause 3 is not a substantive rule, but only intended for informative purposes: the mortgagee is covered pursuant to Cl. 7-2 to Cl. 7-4 even if the insurer neglects to give the prescribed notice.

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    Clause 7-1. Rights of a mortgagee against the insurer

    If the interest covered by the insurance is mortgaged, the insurance also covers the mortgagee's interest, but the insurer may invoke the rules relating to identification in Cl. 3-36 to Cl. 3-38. If the insurer has been notified of the mortgage, the rules contained in Cl. 7-2 to Cl. 7-4 shall...

  • Clause 7-2. Amendments and cancellation of the insurance

    The Commentary to this Clause was rewritten in 2016.

    The first sentence of the provision states that amendments to or cancellation of the insurance contract may not be invoked against the mortgagee unless he has been notified by the insurer. This expands somewhat the mortgagee's protection in relation to the general rule in Cl. 7-1, and is in conformity with the principles laid down in the Nordic ICAs. In the 2002 revision, however, it was emphasized that, upon cancellation of a war risk insurance contract, the position of the mortgagee is no better than that of the person effecting the insurance himself, see the reference in the provision to Cl. 15-8, sub-clause 1, second sentence.

    The mortgagee is entitled to be notified in the event of amendments to the insurance contract during the insurance period and in the event of renewal of the insurance. He does not need to be notified, however, if the insurance expires because it is not renewed, cf. below. The duty to notify rests with both the leading insurer and the co-insurers. The notice period is 14 days.

    In marine insurance it is not considered expedient to require the insurer to notify the mortgagee when the insurance expires. A marine insurance contract signed on the terms of the Plan lapses automatically upon expiry of the insurance unless it is renewed by the person effecting the insurance, cf. Cl. 1-5, sub-clause 3, and a duty to notify would have required the insurer to keep track of failures to renew. Furthermore, the Plan contains a number of rules to the effect that the insurance expires automatically or is suspended without the insurer having to be aware of this, cf. Cl. 3-14 on loss of the main class, Cl. 3-15 on trading area and Cl. 3-21 on change of ownership. In such cases, it will not be possible for the insurer to give notice before he has received notice himself of the reason for the expiry, which can take a long time. The issue of expanded protection of the mortgagee's interest upon sale of the ship is usually resolved by the purchaser always taking out new insurance as of the time of take-over.

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    Clause 7-2. Amendments and cancellation of the insurance

    If the insurance contract has been amended or cancelled, the rights of the mortgagee shall not be affected unless the insurer has given him specific notice of not less than fourteen days. However, this shall not apply to war risks insurance, cf. Cl. 15-8, sub-clause 1, second sentence.

  • Clause 7-3. Handling of claims, claims adjustments, etc.

    The Commentary to this Clause was rewritten in 2016.

    Sub-clause 1 reflects the situation in marine insurance where it is most practical for the person effecting the insurance or the assured who is responsible for the operation of the ship, to have authority to negotiate the settlement of the claim with the insurer. It would be inexpedient and bothersome to involve the mortgagee in every single settlement of a claim. Moreover, Cl. 7-4 ensures that the mortgagee has reasonable control over the payment of compensation, so that his interests are given sufficient protection. If, exceptionally, the mortgagee wishes to be in a better position in relation to the claims settlement, this must be agreed separately with the insurer. An agreement of this type may be reached right up to the time of payment of the compensation.

    Under sub-clause 2, the right to compensation for total loss may not be waived, in full or in part, to the detriment of the mortgagee. It could be argued that the protection of the mortgagee should be expanded to apply to every payment of cash compensation (including compromised total loss), cf. Cl. 12-1, sub-clause 4 and Cl. 12-2, but this was deemed unnecessary. The mortgagee will in such cases have the protection afforded by Cl. 7-4, sub-clause 3.

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    Clause 7-3. Handling of claims, claims adjustments, etc.

    Decisions required in respect of casualties, adjustments or claims against third parties may be made without the participation of the mortgagee. The right to compensation for a total loss may not be waived, wholly or in part, to the detriment of the mortgagee.

  • Clause 7-4. Payment of compensation

    The Commentary to this Clause was rewritten in 2016.

    Sub-clause 1 gives the mortgagee priority in the event of total loss. Parties other than the owner may also be entitled to compensation. Hence, the rule states that the mortgagee is given priority against all other possible claimants under the policy.

    Sub-clause 2 regulates the settlement of partial losses. If the compensation is used to cover the cost of repairs or possible liability towards a third party, the mortgagee's interest will normally be protected, since the value of the mortgaged object is usually restored in such cases. Consequently, the mortgagee should not be able to object to such a payment and there is therefore no reason to require his consent. The threshold for payment is 5% of the sum insured. If a lower amount is needed, a separate agreement must be reached for that purpose.

    A particular issue arises when the shipowner goes bankrupt after the repairs have been carried out but before the shipyard has received payment. If the ship is still at the shipyard, the shipyard may retain the ship to enforce payment of the entire repair invoice. The insurer will, in relation to the mortgagee, not be able to pay out the amount to the bankrupt estate unless the shipyard has been paid in full, cf. the wording "upon presentation of a receipted invoice for repairs carried out". The natural course of events may then be that the insurer pays the shipyard directly. If, however, the shipyard has not exercised its possessory lien and has let the ship sail, it is difficult to see why it should be in a better position than an ordinary creditor. In these types of situations, it is better to fall back on general rules of bankruptcy law, which entail that the insurance compensation goes into the bankrupt estate and that the shipyard only has a claim for a dividend. This approach should not create particular problems for the mortgagee.

    Sub-clause 3 states that compensation under Cl. 12-1, sub-clause 4, and Cl. 12-2 may not be paid without the consent of the mortgagee. The provision is general so that the mortgagee's right to give consent applies in relation to everyone, cf. the comments above under sub-clause 1. Since the compensation in such a case is a substitute for the reduction in the value of the mortgage, the mortgagee must be entitled to have the compensation paid to him against a corresponding reduction of the mortgage.

    The provisions in sub-clauses 1 to 3 only apply in relation to mortgagees holding security in the capital value of the ship. Sub-clause 4 gives a mortgagee holding security in the ship's freight income the same security in the event of loss-of-hire as other mortgagees have in relation to payments under the hull cover. However, mortgagees holding security in the value of the ship or other security have no claim for protection in relation to payment under the loss-of-hire insurance.

    Sub-clause 5 states that liability to a third party (collision liability, etc.) may only be paid by the insurer upon presentation of a receipt. Under some legal systems, like the Norwegian, the rule is, strictly speaking, superfluous, since the insurer is liable towards third parties if he pays compensation to others without having ascertained whether the claims of the third parties have been covered. The rule has nonetheless been retained out of consideration for the international market.

    Sub-clause 6 relates to the insurer's right to set-off. Since set-off may be relevant to amounts due to the insurer other than the premium, for example, for disbursed advances for previous damage which exceed the repair invoice, the right to set-off to is stated in general terms. However , the right to set-off  is limited to claims which arise from the insurance contract for the ship in question, since it is not possible to require the mortgagee to keep abreast of premium arrears or other claims which arise for the assured's other ships. Furthermore, it is reasonable to apply a certain time frame. The rule therefore states that set-off against premium arrears and other claims may only be made for claims which have fallen due during the last two years.

    The time limit is linked to payment of the compensation. This may entail some inconveniences if there are two years of premium arrears at the time of the casualty. In that case, the insurer will not simply be able to deduct these arrears in the compensation to be subsequently paid. The insurer must, however, have the opportunity to draw up an advance calculation as soon as the extent of the casualty has been established, and set off two years' arrears in that calculation. It is furthermore a condition that the right of set-off may only be used once per casualty. The insurer may not, in the middle of a dragged-out settlement of claim, prepare successive advance calculations and compensate more than two years' premium arrears altogether.

    The limitation on the right of set-off applies not only to payment of total loss compensation when the mortgagee is to be paid in full, but also to payment of compensation for damage. From the point of the view of the mortgagee, it is of fundamental importance that the insurance ensures at all times that the shipowner has the necessary funds to carry out repairs so that the ship may be kept in operation.

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    Clause 7-4. Payment of compensation

    In the event of a total loss, the mortgagee's interests take priority.  Compensation for loss from a single casualty exceeding 5 % of the sum insured shall, in the absence of consent from the mortgagee, only be paid by the insurer upon presentation of a receipted invoice for repairs carried out. ...