Federal Court of Australia

Rheem Australia Pty Ltd v Mitsui Sumitomo Insurance Company Ltd [2023] FCA 1570

ORDERS

THE COURT ORDERS THAT:

1.    The separate questions be answered as follows:

Question (a): Is the Applicant entitled to an indemnity under:

(i)    the endorsement for Machinery Breakdown (MKIV ISR) (Mitsui Endorsement) to Section 1 of an Industrial Special Risks policy no. 01.ISR.0013817 issued by the First Respondent (the Mitsui Policy); and/or

(ii)    Section 2 of the Mitsui Policy; or (alternatively)

(iii)    the Fusion Clause to the Mitsui Endorsement

in respect of any loss, destruction or damage to property or business interruption arising from the Event identified in paragraph 5 of the Concise Statement?

Answer: Yes, in relation to (i) and (ii), but No in relation to (iii).

Question (b): Does clause 2(d) of the Mitsui Endorsement exclude part or all of any entitlement the Applicant has to an indemnity under the Mitsui Policy?

    Answer: No.

Question (c): Is the Applicant entitled to an indemnity under:

(i)    the Machinery Breakdown (Tokio Marine Endorsement) to Industrial Special Risks Policy no. 17/01007939 issued by the Second Respondent (the Tokio Marine Policy); and/or

(ii)    Section 2 of the Tokio Marine Policy; or (alternatively)

(iii)    the Fusion Clause in the Tokio Marine Endorsement    

in respect of any loss, destruction or damage to property or business interruption arising from the Event identified in paragraph 5 of the Concise Statement?

Answer: Yes, in relation to (i) and (ii), but No in relation to (iii).

Question (d): Does clause 2(d) of the Tokio Marine Endorsement exclude part or all of any entitlement the Applicant has to indemnity under the Tokio Marine Policy?

Answer: No.

2.    The respondents pay the applicant’s costs in relation to the separate questions.

3.    The matter stand over to 9.30 am on 9 February 2024.

Note:    Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011.

REASONS FOR JUDGMENT

JACKMAN J

Introduction

1    On 23 May 2023, I ordered pursuant to r 30.01 of the Federal Court Rules 2011 (Cth) that four questions be heard and determined separately from the other issues in the proceedings. Those questions involve questions of construction of endorsements to an Industrial Special Risks insurance policy (the Policy) issued to the applicant, Rheem Australia Pty Ltd (Rheem), by the respondents, being Mitsui Sumitomo Insurance Company Ltd (Mitsui) and Tokio Marine & Nichido Fire Insurance Co Ltd (Tokio Marine).

2    Rheem is a company that manufactures and supplies commercial and residential hot water systems and some solar products. Rheem operated its manufacturing activities from a number of locations, including premises at 55 Brodie Street, Rydalmere, NSW (the Premises). Two of the buildings at the Premises were used for manufacturing activities, known as the Cylinder Building and the Final Assembly Building, and an upper level of the Cylinder Building contained a switch room which housed two main switchboards, referred to as Main Switchboards 3A and 3B.

The Incident

3    On 4 October 2018, an electrical arcing event (which is a type of severe electrical fault) occurred in a main switchboard (being Main Switchboard 3B) at the Premises. The arcing event originated in a protection device in the main switchboard, known as a combination fuse switch unit (CFS), and caused significant damage to the switchboard and an extended power outage at the Premises: report of Mr John Gardner, expert witness engaged by the respondents, of 16 October 2023 at [12]. A CFS is a type of “switchgear”, which is used for controlling (that is, turning on or off) a circuit, and it also incorporates fuses (being a protective device) which are there in the event of a short circuit occurring on the connected circuit and which rupture in order to prevent the short circuit from becoming a more serious problem, such as a fire: report of Mr Chris Katsikas, expert witness engaged by Rheem, of 21 July 2023 at [14].

4    The power outage on 4 October 2018 was caused when the high voltage protection systems detected the arcing fault current, and operated correctly by cutting off the power to the main switchboard before any further damage could occur: initial report of Mr Gardner of 20 October 2018 at [9(b)]. Mr Gardner described his observation on 12 October 2018 (as an electrical engineer engaged by the respondents’ loss adjusters) of clear evidence of damage to the CFS caused by “uncontrolled” arcing inside the CFS, including melting along the top of the three fuse connections, and heat damage to the inside of the metal door: Mr Gardner’s report of 16 October 2023 at [16]. The photographs which Mr Gardner included at [18] of that report showed damage caused by concentrated heating from the inside of the CFS and showed that concentrated heat caused by arcing had melted the solid copper links at the top of the fuse cartridges inside the CFS. The photographs also showed damage to the casing of Main Switchboard 3B in which the CFS was situated. Mr Gardner’s initial report of 20 October 2018 (at [19]) also referred to the solid copper lugs in the CFS having melted, that being consistent with “arcing” or a prolonged electrical discharge, also referred to as a “flashover” between the lugs.

5    Rheem has claimed indemnity against the respondents for the costs of a temporary switchboard and repairs, costs of a replacement switchboard and additional costs of working. The respondents have denied indemnity.

Salient Terms of the Policy

6    The Policy comprises the policy wording described as “ISR Policy-MK4” (Mitsui Policy Wording), the placing slips signed and stamped by Mitsui and Tokio Marine for their respective shares on 1 November 2017, and renewal schedules issued by Mitsui and Tokio Marine respectively. The placing slips and schedules provide that Rheem is one of the entities listed as an “Insured” and the Premises are included in the “Insured Premises”. Rheem’s business is described in the placing slips as follows:

Principally, manufacturers, distributors and services of storage gas and electric, solar, continuous flow, heat pump, pool/spa water heaters and boilers, photo voltaic products, ducted air conditioning and any other occupation incidental thereto.

A range of industrial special risks endorsements apply, relevantly the Machinery Breakdown endorsement and the Fusion endorsement (noting that a sub-limit of liability in respect of loss or destruction of or damage by, to or in respect of Fusion of $100,000 for Sections 1 and 2 combined applies). There are two sections to the Mitsui Policy Wording: Section 1 is concerned with material loss and damage, and Section 2 is concerned with consequential loss. The salient terms of the Mitsui Policy Wording are as follows.

7    Sections 1 and 2 of the Policy provide for Material Loss or Damage and Consequential Loss. They are in the following terms:

SECTION 1 – MATERIAL LOSS OR DAMAGE

THE INDEMNITY

In the event of any physical loss, destruction or damage (hereinafter in Section 1 referred to as "damage" with "damaged" having a corresponding meaning) not otherwise excluded happening at the Situation to the Property Insured described in Section 1 the Insurer(s) will, subject to the provisions of this Policy including the limitation on the Insurer(s) liability, indemnify the Insured in accordance with the applicable Basis of Settlement.

…

THE PROPERTY INSURED

All real and personal property of every kind and description (except as hereinafter excluded) belonging to the Insured or for which the Insured is responsible, or has assumed responsibility to insure prior to the occurrence of any damage, including all such property in which the Insured may acquire an insurable interest during the Period of Insurance.

…

SECTION 2 – CONSEQUENTIAL LOSS

THE INDEMNITY

In the event of any building or any other property or any part thereof used by the Insured at the Premises for the purpose of the Business being physically lost, destroyed or damaged by any cause or event not hereinafter excluded (loss, destruction or damage so caused being hereinafter termed "Damage") and the Business carried on by the Insured being in consequence thereof interrupted or interfered with, the Insurer(s) will, subject to the provisions of this Policy including the limitation on the Insurer(s) liability, pay to the Insured the amount of loss resulting from such interruption or interference in accordance with the applicable Basis of Settlement.

Provided that the Insurer(s) will not be liable for any loss under this section unless the Insured's property lost, destroyed or damaged is insured against such Damage (loss arising out of destruction or damage by explosion of boilers and/or Economisers excepted) and the insurer or insurers by which such property is insured shall have paid for, admitted liability in respect of, such Damage unless no such payment shall have been made or liability shall not have been admitted therefore solely owing to the operation of a provision in such insurance excluding liability for loss below a specific amount.

8    There are then various property exclusions and perils exclusions. Relevant for present purposes is Property Exclusion cl 16:

EXCLUSIONS

Applicable to all Sections

PROPERTY EXCLUSIONS

This Policy does not cover physical loss, destruction of or damage to the following property or loss under Section 2 resulting therefrom:-

…

16.    All Machinery (as defined in this exclusion), electronic data processing equipment or electronic control equipment occasioned by or happening through any mechanical, electrical, electro-mechanical, electronic or hydraulic malfunction, failure, derangement, breakdown or non-operation of whatsoever kind.

Provided that Property Exclusion 16 shall not apply to any subsequent loss, destruction of or damage to such Machinery, electronic data processing equipment or electronic control equipment occasioned by or happening through any cause or event not otherwise excluded herein which results from any of the events referred to in this exclusion.

For the purpose of Property Exclusion 16, Machinery means:

any apparatus whether or not functioning independently or as any component part of a collection of apparatus which generates, contains, controls, transmits, receives, transforms or utilises any form or source of energy or power.

…

9    Property Exclusion cl 16 (and Perils Exclusion cl 4) are deleted by the Machinery Breakdown endorsement to the Policy, which states:

Machinery Breakdown (MKIV ISR)

In respect of cover granted by this endorsement property exclusion 16 (Machinery Breakdown) and perils exclusion 4 are deleted.

The following clause is included:

The policy extends under the indemnity – Material loss or damage to indemnify the insured against any sudden and unforeseen loss, destruction of or damage to "Property Insured" (as defined hereunder) which manifests itself at the time of its occurrence and necessitates immediate repair and/or replacement to enable ordinary working to be continued.

For the purpose of this endorsement

1.    "Property Insured" shall mean any item of Plant, Machinery or Equipment including (but not limited to) individual switchgear for starting and controlling motors and interconnecting wires and/or cables, except as hereinafter excluded, as now existing or hereafter acquired the Insured's own held in trust or on commission or for which the insured may be liable or have accepted responsibility.

2.    The Insurers shall not be liable for loss, destruction or damage (as provided under this extension) arising in relation to:

(a)    Any x-ray machine, electron microscope, particle accelerator, beta gauge or spectrograph;

(b)    Any elevator, crane, hoist, power shovel, dragline or conveyor (but not any pressure vessel or electrical equipment used with such items of machinery);

(c)    Any computer or electronic data processing equipment;

(d)    Any electric wiring and fittings associated with lighting and power circuits;

(e)    Any vehicle or mobile equipment whilst being driven on a public thoroughfare (but loss, destruction or damage to such property whilst being used on the insured's premises as a tool of trade is not excluded) aircraft or floating vessel.

(f)    Penstock draught tube or well casing;

(g)    Any steam or gas turbine- generator unit of capacity exceeding 250 horse-power or equivalent;

(h)    Any sewer piping, underground gas piping, piping forming part of a sprinkler system or any water piping other than air, steam and feed water piping systems attaching to any boilers, pressure vessels and air-conditioning systems.

(i)    Any structure, foundation or setting (other than a bedplate) supporting or housing any machinery, or the lining or fire wall of any unfired vessel.

…

10    There is also a Fusion endorsement, which states:

Fusion

Property Exclusion 16 shall not apply to the actual burning out by electric current of any part or parts of electrical machines, installations or apparatus other than rectifiers, radio, television amplifying or electronic equipment of any description, lighting or heating elements, fuses or protective devices or electrical contacts at which sparking or arcing occurs in ordinary working.

Principles of Construction

11    There was no controversy between the parties as to the applicable principles of construction of an insurance policy, being a kind of commercial contract which should be construed according to the principles of businesslike interpretation which are applicable to commercial contracts generally: CGU Insurance Limited v Porthouse [2008] HCA 30; (2008) 235 CLR 103 at [43] (Gummow, Kirby, Heydon, Crennan and Kiefel JJ). Those principles were relevantly set out by French CJ, Nettle and Gordon JJ in Mount Bruce Mining Pty Ltd v Wright Prospecting Pty Ltd [2015] HCA 37; (2015) 256 CLR 104 at [46], [47] and [51] to the following effect:

(a)    the rights and liabilities of parties under a provision of a contract are determined objectively by reference to its text, context (being the entire text of the contract as well as any contract, document or statutory provision referred to in the text of the contract) and purpose;

(b)    in determining the meaning of the terms of a commercial contract, it is necessary to ask what a reasonable businessperson would have understood those terms to mean; that enquiry will require consideration of the language used by the parties in the contract, the circumstances addressed by the contract and the commercial purpose or objects to be secured by the contract; and

(c)    unless a contrary intention is indicated in the contract, a court is entitled to approach the task of giving a commercial contract an interpretation on the assumption that the parties intended to produce a commercial result; a commercial contract should be construed so as to avoid it making commercial nonsense or working commercial inconvenience.

12    Words and phrases used in a contract are usually given their ordinary meaning, unless there is a good reason to depart from that approach, such as where the term is intended to be used as a term of art rather than in its popular sense: L Schuler AG v Wickman Machine Tool Sales Ltd [1974] AC 235 at 264 (Lord Simon); Lasermax Engineering Pty Ltd v QBE Insurance (Australia) Limited [2004] NSWSC 483 at [16] and [24]. Many of the cases concerning the circumstances in which expert evidence has been admitted as to the meaning of terms used in commercial contracts were reviewed recently in Quasar Resources Pty Ltd v APG Aus No 3 Pty Ltd [2023] WASCA 171 at [45]-[59] (Beech and Vaughan JJA); [208]-[230] (Lundberg J).

13    The insuring clause and any exclusion clause must be read together in a harmonious way so that due effect is given to both, and the right conferred by the former is not negated or rendered nugatory by the construction adopted for the latter: Weir Services Australia Pty Ltd v AXA Corporate Solutions Assurance [2018] NSWCA 100; (2018) 359 ALR 314 at [54]; Woodlawn Capital Pty Ltd v Motor Vehicles Insurance Ltd [2016] NSWCA 28; (2016) 111 ACSR 377 at [133]; Impact Funding Solutions Ltd v AIG Europe Insurance Limited [2016] UKSC 57; [2017] AC 73 at [7]; and see generally LCA Marrickville Pty Ltd v Swiss Re International SE [2022] FCAFC 17; (2022) 290 FCR 435 at [56]-[57].

14    In relation to the construction of exclusion clauses, such a clause is to be construed according to its natural and ordinary meaning, read in the light of the contract as a whole, thereby giving weight to the context in which the clause appears including the nature and object of the contract, and, where appropriate, construing the clause contra proferentem in case of ambiguity: Darlington Futures Ltd v Delco Australia Pty Ltd (1986) 161 CLR 500 at 510. That approach was held to be applicable to the construction of an exclusion clause in a contract of insurance in Selected Seeds Pty Ltd v QBEMM Pty Ltd [2010] HCA 37; (2010) 242 CLR 336 at [29].

15    As to the contra proferentem rule, the rule is to be applied only as a last resort after the orthodox process of construction has failed to resolve an ambiguity; it is not a rule which may be applied to resolve “any ambiguity”: LCA Marrickville Pty Ltd at [83]-[102], in which Derrington and Colvin JJ (with whom Moshinsky J agreed) thoroughly reviewed the authorities on the point.

The Separate Questions

16    The questions for separate hearing and determination are as follows:

(a)    Is the Applicant entitled to an indemnity under:

(i)    the endorsement for Machinery Breakdown (MKIV ISR) (Mitsui Endorsement) to Section 1 of an Industrial Special Risks policy no. 02.ISR.0013817 issued by the First Respondent (the Mitsui Policy); and/or

(ii)    Section 2 of the Mitsui Policy; or (alternatively)

(iii)    the Fusion Clause to the Mitsui Endorsement

in respect of any loss, destruction or damage to property or business interruption arising from the Event identified in paragraph 5 of the Concise Statement?

(b)    Does clause 2(d) of the Mitsui Endorsement exclude part or all of any entitlement of the Applicant has to an indemnity under the Mitsui Policy?

(c)    Is the Applicant entitled to an indemnity under:

(i)    the Machinery Breakdown (Tokio Marine Endorsement) to Industrial Special Risks Policy no. 17/01007939 issued by the Second Respondent (the Tokio Marine Policy); and/or

(ii)    Section 2 of the Tokio Marine Policy; or (alternatively)

(iii)    the Fusion Clause in the Tokio Marine Endorsement    

in respect of any loss, destruction or damage to property or business interruption arising from the Event identified in paragraph 5 of the Concise Statement?

(d)    Does clause 2(d) of the Tokio Marine Endorsement exclude part or all of any entitlement the Applicant has to an indemnity under the Tokio Marine Policy?

17    The separate questions concern the proper construction of cl 2(d) in the Machinery Breakdown endorsement and the proper construction of the concluding words to the Fusion endorsement.

The Machinery Breakdown Endorsement

18    It is common ground between the parties that the CFS did not itself contain any electric wires or cables. Rather, the CFS is a lever operated switch, in which fuse cartridges are secured to lugs or terminals on a “carrier or carriage” which also forms the switch mechanism (report of Mr Gardner of 20 October 2018, [15]; Rheem’s written submissions, [48]). It is also common ground that the CFS falls within the term “Property Insured” as defined in cl 1 of the Machinery Breakdown endorsement, and it is common ground that, although the CFS is a kind of switchgear, it is not “switchgear for starting and controlling motors” within the meaning of those particular words used in cl 1. The particular issue which arises between the parties is whether the incident on 4 October 2018 involved loss, destruction or damage arising in relation to “Any electric wiring … associated with lighting and power circuits” within the meaning of the exclusion in cl 2(d). The respondents did not submit that the CFS fell within the concept of “fittings” in that provision, adopting the common ground between Mr Katsikas and Mr Gardner that a fitting is an item connected at the end of a circuit, wiring or cabling such as a light or group of lights, a power point or a machine.

19    Rheem submits that the term “electric wiring” means cables or wires in an electrical system or installation, but not a component (such as the CFS) which does not have cables or wires within it and is not itself cabling or wiring. The respondents submit that the term “electric wiring” means the complete electrical installation or system within the Premises, including switchboards, mains and submains cables, final sub-circuit wiring and power outlets. On the respondents’ argument, the CFS is part of that installation or system and therefore falls within the term “electric wiring”.

20    In my opinion, a harmonious construction of the words “electric wiring” within the Machinery Breakdown endorsement as a whole points strongly in favour of Rheem’s construction.

21    First, as Rheem submits, the definition of “Property Insured” in cl 1 of the endorsement refers expressly to “individual switchgear for starting and controlling motors and interconnecting wires and/or cables”. That expression indicates that the concept of “switchgear” was treated in the drafting of the endorsement as separate from the concept of “interconnecting wires and/or cables”. Interconnecting wires and cables are undoubtedly electric wiring, but the drafting indicates that switchgear was intended to be treated separately from that concept.

22    Second, the drafting of cl 2(d) identifies two kinds of particular components within the system or installation as a whole (namely electric wiring and fittings), and requires that they be “associated with” lighting and power circuits. That drafting indicates that cl 2(d) was not intended to apply to the lighting and power circuits as a whole. Accordingly, the drafting of the clause does not evince an intention to exclude from the cover provided by the endorsement the electrical system or electrical installation as a whole, but only the two particular kinds of components of that system or installation which are specifically referred to. Similarly, the use of the word “installations” in the Fusion endorsement indicates that that word was used where that was the intended meaning.

23    In my view, those two features of the drafting of the Machinery Breakdown endorsement demonstrate that the construction advanced by Rheem is correct. That is consistent with the ordinary meaning of “electric wiring”, namely the cables and wires used to carry electricity.

24    The respondents submit that there is no evident commercial purpose or rationale in cl 2(d) excluding wires and cables, but not excluding components of the system or installation as a whole, such as the CFS. In my view, it is not necessary for Rheem to identify such a commercial rationale. The ordinary and natural meaning of the clause is too clear and intractable for the issue to require that Rheem must identify a line of commercial reasoning for the particular language that was adopted. In a policy of insurance, the commercial purpose of the insured is to have as wide a cover as it can obtain at a reasonable premium, whereas the insurer’s interest may well lie in providing narrower cover than the insured would wish to have. Ultimately, the parties will reach agreement and will seek to express that agreement with as much precision as the circumstances allow. Clause 2 of the Machinery Breakdown endorsement reflects the evident purpose of the parties in drawing bright lines to define what is to be excluded from the endorsement. For example, there is no need for the parties to identify the commercial rationale for referring to generators exceeding 250 horsepower in para (g), as distinct from some lesser amount of horsepower; the paragraph simply means what it says. The respondents did not submit that the construction for which Rheem contends would be commercial nonsense or produce some commercial inconvenience.

25    There was some debate at the hearing before me as to whether the “power circuits” in cl 2(d) would include the power circuits on the goods manufactured by Rheem, such as hot water systems, for as long as those goods are situated on the Premises. I do not regard that debate as having any significant bearing on the proper construction of cl 2(d). I am inclined to think that the term “power circuits” in cl 2(d) is a reference to the power circuits in the electrical infrastructure of the Premises themselves, and that the notion that it also includes the power circuits on the manufactured goods at the Premises involves an overly literal construction of the language. However, it is not necessary for me finally to decide that point.

26    The expert evidence of Mr Katsikas and Mr Gardner sought to support the respective positions adopted by Rheem and the respondents. In my view, the proper construction of “electric wiring” in cl 2(d) is a matter to be decided on the ordinary and natural meaning of those words and on the basis of a harmonious construction of the endorsement as a whole, and does not depend on expert evidence as to “electric wiring” as a term of art. Neither expert was cross-examined and I accept that both expert witnesses have ample experience to give the opinions which they have expressed. The upshot of the expert evidence as a whole is that the term “electric wiring” is apt to mean different things in different contexts. Mr Katsikas relied heavily on definitions provided in the relevant Australian Standards, although those standards did not in fact provide a definition for the particular term “electric wiring” ([37]-[40] of his report on 21 July 2023, and [17]-[43] of his report of 15 November 2023). Mr Gardner, on the other hand, relied on his experience in the design and construction industry ([35] of his report of 16 October 2023). In the present case, the context that matters is the use of the term within the Machinery Breakdown endorsement, and within the Policy as a whole. It is not necessary for me to decide whether the evidence of one of the experts is to be preferred over the other.

The Fusion Endorsement

27    The issue concerning the Fusion endorsement concerns whether the concluding words “at which sparking or arcing occurs in ordinary working” qualify only the term “electrical contacts” (as the respondents submit), or whether those concluding words qualify all three concepts of “fuses or protective devices or electrical contacts” (as Rheem submits). The syntax of the sentence has produced an ambiguity on that question. However, Rheem accepts that, in the case of protective devices, there is no protective device of which Rheem is aware at which sparking or arcing occurs in ordinary working. Rather, the purpose of protective devices (such as the CFS) relevantly is to protect the system in abnormal circumstances of arcing. Accordingly, on Rheem’s construction, the reference to “protective devices” would be otiose. In my view, that is a compelling reason in favour of the respondents’ construction. That conclusion is fortified by the use of the word “or” (rather than a comma) between “fuses” and “protective devices”.

28    The CFS, where the damage occurred on 4 October 2018, is accepted by both parties to be a protective device. Accordingly, the exclusion of “protective devices” from the Fusion endorsement applies in the present circumstances.

Conclusion

29    Accordingly, I answer the separate questions as follows:

(a)    Yes, in relation to (i) and (ii), but No in relation to (iii).

(b)    No.

(c)    Yes, in relation to (i) and (ii), but No in relation to (iii).

(d)    No.

30    Rheem’s argument concerning the Fusion endorsement was no more than a fall-back position in the event that it failed on the Machinery Breakdown endorsement. In circumstances where it has been successful in relation to the Machinery Breakdown endorsement, Rheem is entitled to an order for costs in its favour in relation to the separate questions.

31    It is appropriate, in my view, to give the parties an opportunity to seek to resolve the remaining issues in the proceedings concerning causation and quantification of loss, and if they are unable to do so, to give consideration to the steps which should be taken for the resolution of those issues. Accordingly, I will conduct a case management hearing in this matter at 9.30 am on Friday, 9 February 2024 for the purpose of either disposing of the proceedings or setting a regime for the conduct of the balance of the proceedings.

Associate:

Dated:    11 December 2023