Australia: Australian Decision Takes Opposite View To The English Court On Whether Depreciation Amounts To A Saving In Business Interruption Calculation

Last Updated: 3 September 2019
Article by Tony Dempster and Lea Munk

An Australian state Court of Appeal decision has expressly rejected the reasoning of Mr Justice Flaux (as he then was) in the English High Court case of Synergy Health (UK) Ltd v CGU Insurance Plc [2010] EWHC 2583 (Comm), finding that depreciation is not to be deducted as a “saving” when quantifying loss of Gross Profit under a business interruption policy.

Background

A warehouse owned by the policyholder (Mobis Australia) collapsed during a severe storm, causing damage to plant and equipment. The policyholder claimed indemnity for losses arising from the collapse under its property damage and business interruption insurance policy: Mobis Parts Australia Pty Ltd v XL Insurance Company SE [2018] NSWCA 342.

Under the policy, the policyholder was covered for loss of “Gross Profit” as a result of business interruption consequential upon loss of or damage to insured property. The policy provided for the assessment of loss of Gross Profit on the following basis:

“The insurance under this chapter is limited to loss of Gross Profit due to (a) Reduction in Turnover and (b) Increase in Costs of Working, and the amount payable as indemnity under this Policy shall be:

(a) in respect of the reduction in Turnover: the sum produced by applying the Rate of Gross Profit to the amount by which the Turnover during the Indemnity Period shall in consequence of the Damage fall short of the Standard Turnover

...

less any sum saved during the Indemnity Period in consequence of the Damage in respect of such of the charges and expenses of the Business payable out of Gross Profit“.

(emphasis added)

The parties agreed that, in the 12 month period after the damage to the warehouse had occurred, the policyholder would have, but did not, make provisions totalling $1,449,509 for depreciation of plant and equipment destroyed in the collapse.

Decision

One of the issues in the case was whether a reduction on non-cash costs such as depreciation following insured damage amounts to a “saving” to the policyholder which is to be deducted from insured Gross Profit when calculating business interruption losses.

At first instance, the trial judge followed the decision of Flaux J in Synergy Health in the English High Court (in relation to a policy which had terms indistinguishable from those under consideration in this case), finding that the depreciation expense which was no longer recorded in the policyholder’s financial records because the assets in question were destroyed was an “expense...payable out of Gross Profit” which had been “saved” for the purpose of quantifying the indemnity under the policy. This meant that the depreciation expense was to be offset against any indemnity.

The NSW Court of Appeal unanimously reversed the trial judge’s decision and expressly rejected the reasoning of Flaux J in Synergy Health. The NSW Court of Appeal defined depreciation as:

“the systematic allocation of a tangible asset’s cost (less its anticipated scrap value) as a series of expenses over its expected useful life...Each depreciation expense appears in the income statement as an expense deducted from gross profit for the purpose of calculating net profit...but the process of depreciation has no direct impact on cash flows”.

The NSW Court of Appeal concluded that the use of the word “payable” in the phrase “payable out of Gross Profit” as opposed to the word “deducted” suggested the exclusion of charges and expenses that are not liable to be paid away, such as depreciation.

The different conclusions reached by the English High Court in Synergy Health (as followed by the trial judge) and the NSW Court of Appeal largely turned on a difference of opinion as to the weight to be placed on the indemnity principle of insurance in the face of the language of the policy contract.

Flaux J in Synergy Health found that the policyholder would “recover an indemnity for more than its actual loss in respect of business interruption” if depreciation was not deducted from Gross Profit and concluded that such an outcome should not be reached “unless no other conclusion is possible”. The result, as he has admitted, somewhat stretched the language in the policy. In effect, the English High Court determined that the indemnity principle coloured the meaning of the language of the provisions for the assessment of loss.

In contrast, the NSW Court of Appeal placed greater weight on the importance of upholding the bargain that was struck between the contracting parties, as expressed by the words of the insurance contract. It concluded that the formula for the assessment of insured loss of Gross Profit qualified the application of the indemnity principle insofar as it might be said to depart from perfect indemnification. The NSW Court of Appeal favourably cited Greer J in Henry Booth & Sons v The Commercial Union Assurance Co Ltd (1923) 14 Lloyds LR 114, stating:

“It is common practice in policies of this sort, in order to prevent lengthy disputes, that there should be an agreed method of ascertaining the loss. Sometimes the assessment of the loss is in favour of the assurance company and sometimes the assured...”

The NSW Court of Appeal also hinted at the fallacy of the assumption that, if depreciation was deducted as a saving, perfect indemnification would necessarily be achieved. For example, it noted that depreciation charges are often overstated in the early years of an asset’s life, meaning that if the equipment is destroyed during this period the “saving” on depreciation that is charged in the accounts of the business may not reflect the actual cost of depreciation. Similarly, although the policyholder may in one sense be over-indemnified if replacement property is in better condition than the destroyed property at the time of damage, this benefit may be offset by adjusted depreciation costs into the future.

As the NSW Court of Appeal highlighted, inquiries as to whether a policyholder has been over or under indemnified (which could easily manifest in a dispute), are intended to be prevented by the application of a formula for the assessment of the loss.

Comment

The decision of the NSW Court of Appeal which appears based on sound reasoning may well open up the debate again about the treatment of depreciation charges in business interruption policies and in particular whether “charges and expenses of the Business” that are “payable out of Gross Profit” mean only cash reductions or include all expenses in the accounts deducted from gross profit for the purpose of calculating the net profit of the business.

The Insurance Institue of London in collaboration with the Chartered Institute of Loss Adjusters published a report in October 2012 titled ‘Business Interruption Policy Wordings – Challenges Highlighted by the Claims Experience‘. On the topic of depreciation savings, the report recommended that insurers revised policy wordings to make it clear whether savings were inclusive or exclusive of depreciation. Clarity in the policy wording would enable insurers to charge a premium that properly reflected the risk assumed, while brokers and policyholders would gain clarity on the scope of cover. Despite the report’s recommendation and the publicity this topic has received in recent years, the majority of policies remain silent on the issue. We are only anecdotally aware of a handful of policies that explicitly state that depreciation is not a saving.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
 
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions