cont`d - London Business Interruption Association

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Depreciation – Is it really a saving?
Michael Whitton
Introduction
What is Depreciation?
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Depreciation is an accounting means of recognising, on an
annual basis the amortised cost of plant and machinery, the cost
of which has been incurred at an earlier time
Damage to the plant and machinery makes no difference to:
 The fact that the cost of the plant and machinery has
already been incurred
 The fact that whatever that cost was, it is then treated in the
accounts as being depreciated annually until the end of its
useful life by which time the full cost of the plant and
machinery will have been set off against gross profit
In the case of plant and machinery which is not damaged
 In the case of plant and machinery which is damaged
The depreciation charge is accelerated
Synergy – The Facts
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Part of the Synergy Group providing laundry and
related services to the NHS
Substantial modern laundry facility in Dunstable
Commercial combined policy 30 April 2006 to 29 April
2007
On 3 February 2007 the Dunstable laundry was
substantially damaged by fire
The basis of the defence
Synergy made a secondary claim of breach of duty
against the brokers
The Depreciation Issue

The relevant wording
“Gross profit/Estimated gross profit – the insurance under this item is
limited to loss of gross profit due to (a) reduction in Turnover and (b)
increased cost of working and the amount payable as indemnity
thereunder shall be:
a) In respect of reduction in turnover …
b) In respect of an increase in cost of working ...
Less any sum saved during the indemnity period in respect of such of
the charges and expenses of the business payable out of gross profit as
may cease or be reduced in consequence of the Incident.”

How Synergy dealt with depreciation in respect of plant and machinery
at Dunstable pre fire

How depreciation was dealt with post fire

Did the fact that depreciation was not shown in the management
accounts for Dunstable post fire represent a saving to be deducted from
the increased cost of working
The Evidence


Experts’ reports on behalf of both parties
Synergy’s position

Depreciation represents an accounting entry to write off the cost
of fixed assets over a period of time – it does not represent cash
flow

As stated in the policy, savings represent “the charges and
expenses of the business payable out of gross profit”

Depreciation is fundamentally different from other items taken as
savings

Reduced use of machinery at Dunstable was counterbalanced by
increased use at other facilities

There was no saving because £2.841 million was written off in
Synergy’s audited accounts due to fire damage

Synergy was entitled to an indemnity on a new for old basis.
Applying a depreciation saving had the effect of reducing it to an
indemnity policy
The Evidence – The Defendants position



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
The fact that when depreciation is deducted from the financial
accounts, it is referred to as a depreciation charge or expense
Depreciation is deducted from gross profit and therefore is
payable out of gross profit
If depreciation ceases and no depreciation saving is taken then
net profit is higher than that achieved but for the incident and
additional profit would be generated
In arriving at the net profit in the management accounts at
Dunstable, no depreciation on plant and machinery was charged
from February to November 2007
In relation to other heads of claim, accounting profit, not cash
flow is considered so there is no reason why the word “payable”
would have a strict cash sense in respect of savings
The Judgment
The Honourable Mr Justice Flaux held as follows: Synergy ceased making a deduction in its accounts for
depreciation of plant and machinery at Dunstable after the fire.
The Defendants submit that if Synergy does not give credit for
what might be described as the cessation of depreciation for the
period until new machines were installed and depreciation
resumed in subsequent accounting periods, Synergy will recover
an indemnity for more than its actual loss in respect of business
interruption. This is for the simple reason that, had the fire not
occurred, Synergy could not have earned its gross profit (by
reference to which any indemnity under the business
interruptions section of the policy is calculated) without having
the use of the machines, in respect of which a sum for
depreciation would be deducted from the gross profit in each
accounting period.
The Judgment cont’d
It seems to me that, as a matter of principle, this analysis
is unanswerable and plainly correct. On that basis, to the
extent that, during the Indemnity Period, the deduction in
respect of depreciation ceased to be made, that was a
saving against what would otherwise have been the
charges and expenses of Synergy’s business. It follows
that, in principle, that saving should be offset against any
claim under the business interruption section of the
policy, unless the wording of the policy requires some
different conclusion.
The Judgment cont’d
Synergy submits that credit does not have to be given against its
business interruption claim for any saving in respect of depreciation,
on two grounds which it submits are the consequence of the correct
construction of the policy. First it is submitted that if it was intended
that the “sum saved during the Indemnity Period in respect of … the
charges and expenses of the Business” in the closing phrase of the
provision quoted above was intended to include savings in respect of
depreciation, the provision could and would have said so. Reliance
is placed upon the fact that in other provisions of the policy where it is
intended that depreciation should be taken into account express
reference is made to depreciation [reference to the definition of Gross
Profit].
The Judgment cont’d
It does not seem to me that this point has any real force
for two reasons. First, given that the definition of gross
profit itself contemplates a deduction for depreciation, it
would be very odd if the savings made during the
indemnity period which would reduce gross profit but for
the insured event, somehow excluded a matter which,
because of the insured event was no longer a deduction
from the gross profit. Second it seems to me that there is
no reason for the closing phrase of the insuring provision
to expressly identify a saving in respect of depreciation as
a saving in respect of the charges and expenses of the
business any more than any other saving.
The Judgment cont’d
More formidable is the second ground upon which
Synergy submits that any saving in respect of
depreciation does not have to be brought into account
upon the true construction of the policy. This is that
depreciation is simply not a charge or expense “payable”
out of gross profit within the meaning of the provision.
Synergy submits that the word “payable” connotes
something that would be “paid” to somebody whereas
depreciation is never paid in that sense. Rather it is an
accounting exercise that spreads the cost of assets over
a number of years.
The Judgment cont’d
The Defendants seek to counter that argument by
contending that the correct approach to the provision is
that it is unlikely that the word “payable” was used with
the intention of only requiring certain types of saving to be
deducted from any claim so that other types of saving did
not have to be deducted, with the consequence that the
insured recovered more than a full indemnity. Rather the
likelihood was that “payable” was used not as a word of
limitation but because the sort of expenses which would
ordinarily be deductible for this insured’s business such
as electricity and washing powder would be “payable” in
the ordinary sense.
The Judgment cont’d
Although the Defendant’s construction stretches the word “payable”
somewhat, it seems to me that it is to be preferred to Synergy’s
construction which leaves the saving in respect of depreciation out of
account. My principal reason for that conclusion is that it seems to
me that, as a matter of principle, a policy should be interpreted as
providing an indemnity for the loss suffered not for more than such an
indemnity. Of course if the wording is incapable of any other
construction, a court might be driven to the conclusion that something
in excess of the full indemnity was intended, but given the
unlikelihood and unreasonableness of such a conclusion, the court
should not arrive at it unless no other conclusion is possible.
The Judgment cont’d
It seems to me that Synergy’s construction would lead to
that unreasonable conclusion, but that construction is not
inevitable if “payable” is given a purposive meaning.
Synergy sought to counter the suggestion that it would
otherwise recover more than a full indemnity by
contending that depreciation had not in fact been saved
because it had been accelerated due to the write off of
damaged assets following the fire. The short answer to
that point is that, on the basis that the policy has
responded (as I have found it must), the insurers will
have indemnified Synergy for the cost of replacement of
the machines on a reinstatement basis meaning that
Synergy is better off to that extent.
The Judgment cont’d
Furthermore, in my judgment the word “payable” does not have as
inflexible and narrow a meaning as that for which Synergy contends.
I agree with Mr Southern [counsel for the brokers] that, whilst
accountants might not ordinarily refer to depreciation being payable,
in accounting terms depreciation is a charge or expense deducted
from gross profit to arrive at net profit and to that extent, as Ms
Rawlin said, something payable out of gross profit. Thus an
accountant would understand why a saving in depreciation was a
saving in respect of charges and expenses of the business payable
out of gross profit. Accordingly, in my judgment, Synergy has to
deduct from its business interruption claim the savings it has made in
respect of depreciation.
The Appeal - The first ground of appeal
The Judge was wrong to find that depreciation should be deducted
as a saving because:
The true characteristic of depreciation

The charge or expense is generally calculated by taking the cost
price of the asset and dividing that price by the number of
years of useful working life the asset is projected to have

The cost price or the liability for the cost price having been
incurred, the process of spreading the costs across many
years (amortising) is continued until there is a total reduction
in value

The more usual treatment of the cost of the plant and
equipment where the plant and equipment has come to the
unexpected and premature end of its useful working life
The Appeal - The first ground of appeal cont’d
 In this case the depreciation was accelerated
 The expected annual depreciation for plant and equipment in its
undamaged state was in fact included within the sum written off
 The result
 The judge was wrong in his reasoning in paragraph 6(i) above
 The judge was also wrong to find that Synergy was bound to give
credit for the cessation of depreciation for the period until new
machines were installed and depreciation resumed in subsequent
accounting periods, for otherwise Synergy would recover an
indemnity for more than its actual loss in respect of business
interruption
The second ground of appeal

In finding (see 6(ii) above) that to the extent that the
deduction in respect of depreciation ceased to be
made, was a saving in respect of what otherwise
would have been the charges and expenses of
Synergy’s business, overlooked or ignored and failed
to find that:
 The charges and expenses of Synergy’s
business would have reflected the annual
deduction in value of those assets
 Such a reduction in value (and more) has
occurred as a result of the end of the useful life of
the assets being accelerated
The second ground of appeal - cont’d
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Depreciation was accelerated as a consequence of
the fire and appeared as a charge or expense in
Synergy’s accounts in the year of the fire and was
described as a write off of tangible fixed assets
The Judge’s reasoning in this respect was based
on a misapprehension that the deduction for
depreciation ceased to be made
Whilst the management accounts were relied on
as demonstrating an absence of a depreciation
charge for the 10 month period after the fire, in fact
as the audited accounts revealed, the depreciation
charge was incurred
The third ground of appeal
The Judge was wrong to find (see 6(vii) – (ix) above) that the
depreciation was “payable out of gross profit”. The policy of
insurance only required a deduction for such savings to be made
when such savings were in respect of a charge or expense which
was payable out of gross profit
There were two reasons why the judge concluded that “payable out
of gross profit” was to include depreciation
Construing the word “payable” broadly so as to give it the meaning
of a “charge” or “expense” deducted from gross profit, gives the
word “payable” a purposive meaning
Since insurers will have provided an indemnity by replacement of
the machines on a reinstatement basis, Synergy would be more
than indemnified if the saving in depreciation were not deducted
The third ground of appeal - cont’d
The Judge was wrong to find that payable should be
construed to mean “a charge” or “an expense”
The cost of acquisition which had been incurred (and
the value which had been acquired) was not the subject
of repeated transactions involving the payment of
money which were reflected in the accounts according
to whether the plant and equipment could be used
Further, depreciation is different from other charges and
expenses in the profit and loss account which are
commonly taken as savings because it cannot be
realised
The third ground of appeal - cont’d
It was also wrong to find that there would be more than
an indemnity once the machines and equipment had
been replaced in accordance with the indemnity to be
provided by the insurers
Insofar as it can be said that there is over compensation
because old equipment is replaced with new equipment,
that is the inevitable consequence of the cover being
provided on a new for old basis
What happened next?

The appeal was settled

Why?
The future

Ongoing uncertainty

Verba chartarum fortius accipiuntur contra
proferentem

Claims against brokers?
Questions
Contact details
Michael Whitton
Litigation Partner
e: [email protected]
t: +44 (0)20 7691 4000
f: +44 (0)20 7691 4177
Unravelling Settlement Agreements
Nicola Maher
Settlement Agreement
 Entered into by the parties to a dispute
 Records the terms agreed
 Conclusively determines the elements in dispute
 Binding upon the parties
 Specie of general contract – subject to the usual
principles of contract law
 Can a party later assert that it is not bound by what
appears to be a binding contract?
Grounds for Unravelling
 Incapacity
 Duress or undue influence
 Misrepresentation
 Mistake
Incapacity
 A contract entered into by a person without the requisite
capacity may be voidable
 The following categories may lack contractual capacity:
 Aged under 18
 Lacking mental capacity; and
 Intoxicated – e.g. by alcohol or otherwise
 For example, a contract concluded with a drunkard may be
invalid where he was unable to understand the nature and
effect of the transaction; it must be more than the “merriment
of a cheerful chap”
 Gore v Gibson (1845) 13 M&W 623; Pitt v Smith (1811) 3
Camp 33
Duress and Undue Influence
 A contract which has not been entered into freely
and voluntarily may be voidable
 Duress includes:
 Actual or threatened violence to a person
(Barton v Armstrong [1976] AC 104);
 Actual or threatened violence to property
(Maskell v Horner [1915] 3 KB 106) ; and
 Economic duress (North Ocean Shipping Co.
Ltd v Hyundai Construction Co. Ltd [1979] QB
705)
Duress and Undue Influence - cont’d
 Undue influence includes:
 Improper pressure applied so that a party is
prevented from exercising free and
independent judgment; and
 Taking advantage of a position of trust and
confidence
 Royal Bank of Scotland v Etridge (No.2)
[2001] UKHL 44
Misrepresentation
 A contract may be rescinded where one party has
entered into it in reliance of a material false
statement
 The statement can be: fraudulent, negligent or
innocent
 It must induce the other party to enter into the
agreement
 Not every false statement will give rise to a claim
(e.g. a mere contention or statement of position)
 Often difficult to establish on the facts
Misrepresentation
 Kyle Bay Ltd (t/a as Astons Nightclub) v
Underwriters Subscribing under Policy No.
019057/08/01 [2007] EWCA Civ. 57;
 Primus Telecommunications plc v MCI
Worldcom International Inc. [2004] EWCA
Civ. 957
Mistake – Common Mistake
 A contract may be vitiated by a common
mistake – e.g. a shared and fundamental
misunderstanding as to the state of affairs
giving rise to the contract
 Great Peace Shipping Ltd v Ttsavliris Salvage
(Int) Ltd [2002] EWCA Civ. 1407;
 Associated Japanese Bank (International) Ltd
v Credit du Nord SA [1989] 1 WLR 255;
Mistake
 A contract will be void by common mistake if:
 The parties have entered a contract under a shared and selfinduced mistake as to the facts or law affecting the contract
 Under the express or implied terms of the contract neither party
is taken as taking the risk of the situation being as it really is
 Neither part is responsible for or should have known of the true
state of affairs, and;
 The mistake is so fundamental that it makes the “contractual
adventure” impossible or makes performance essentially
different to what the parties anticipated.
Mistake - cont’d
 Incorrect facts must generally relate to the
nature and/or validity of the contract (as
opposed to the mere details, even if they
are significant details)
 Brennan v Bolt Burdon [2005] 2 QB 303;
 Bell v Lever Bros. Ltd [1932] AC 161;
Mistake - Rectification
 Where there is a common mistake in the written the
terms of the contract, the court may intervene to
rectify it
 Mutual mistake – i.e. both parties mistakenly
believe the contract gives effect to their common
intention; either party may seek rectification of that
term
 Unilateral mistake – i.e. one party mistakenly
believes that the contract gives effect to the
agreement reached, but the other party is aware of
the true position and takes advantage of this;
rectification is only available in limited
circumstances
Mutual Mistake
 E.g. Joscelyne v Nissen [1970] 2 QB 86;
 Youell v Bland Welch & Co. [1992] 2 Lloyd’s Rep
127;
 Mutual Mistake – requires common intention
between the parties together with some outward
expression of accord
Unilateral Mistake
 Thomas Bates Limited v Wyndham’s (Lingerie)
Ltd [980] EWCA Civ. 3
 For rectification of unilateral mistake
 One party must have an erroneous belief as to the
terms of the document;
 The other party must be aware of the omission or
inclusion of such a terms and be aware that it was a
mistake;
 He must have omitted to draw the other party’s
attention to it;
 The mistake must be one calculated to benefit him.
Unilateral Mistake
 George Wimpey UK Ltd v VI Construction Ltd
[2005] EWCA Civ. 77;
 The relief of rectification for a unilateral mistake
is of “drastic nature”
Questions
Contact details
Nicola Maher
Litigation Partner
e: [email protected]
t: +44 (0)20 7691 4069
f: +44 (0)20 7691 4090
Construing BI Policies: Art or Science?
Roger Franklin
Construing BI Policies
Absence of specific BI case law due to:
 Settlement
 Market agreement
Construing BI Policies cont’d
Synergy Health (UK) Ltd –v- CGU Insurance
“the needs of the many outweigh the needs of the
few”
Construing BI Policies cont’d
The Ordinary meaning of Words
“The ascertainment of the meaning which a
document would convey to a reasonable person
having all the background knowledge which would
reasonably have been available to the parties in
the situation in which they were at the time of the
contract”.
Investors Compensation Scheme Ltd –v- West Bromwich Building
Society
Construing BI Policies cont’d
Basic Principles
 Previous interpretation
 Decisions from other jurisdictions
 Ordinary meaning
 Business like interpretation
 Avoid absurdity
 Departure from ordinary meaning of words
 Trade usage
 Inconsistency and/or ambiguity
Construing BI Policies cont’d
The Insuring Clause
“The Insurer agrees (subject to the terms… of this
policy) that if… any building or other property used
by the Insured at the Premises for the purpose of
the Business be accidentally lost, destroyed or
damaged during the period of insurance… and in
consequence the Business carried on by the
Insured at the Premises be interrupted or
interfered with then the Insurer will pay to the
Insured… the amount of loss resulting from such
interruption or interference provided that…”
Construing BI Policies cont’d
The Material damage Proviso
“…..at the time of the happening of the loss
destruction or damage there shall be in force an
insurance covering the interest of the Insured in
the property at the Premises against such loss
destruction or damage and that… etc.”
Construing BI Policies cont’d
“….any building or other property…”
What amounts to property?
Ruapehu Alpine Lifts Ltd –v-State Insurance Ltd
(1998) 10 ANZ Insurance cases 61 -64
Construing BI Policies cont’d
“… any building or other property or any part thereof used
by the Insured at the Premises, or as provided herein, for
the purposes of the Business be destroyed or damaged by:

Accidental loss or damage covered by the Insured’s
material damage policy affected with state.

Boiler and/or economiser explosion on the Premises
or elsewhere.

Earthquake, geothermal activity or volcanic
eruption.
(all such loss, damage or destruction being hereafter
termed “damage”) and the Business carried on by the
Insured be in consequence thereof interrupted or interfered
with.” [Emphasis added.]
Construing BI Policies cont’d
“and in consequence the Business carried on by
the Insured at the Premises be interrupted…”
McMahon’s Tavern Pty Ltd –v- Suncorp Metway
Insurance Ltd [2004] SASC 237
Construing BI Policies cont’d
“In consequence of….”
The proximate cause, which is the event, whether
peril or exception, which, in all the circumstances
prevailing at the time, led inevitably to the loss in
question.
Construing BI Policies cont’d
“Occasioned by….”
Loss is occasioned by a peril if there is a sufficient
connection, not in the case of causation, but of
coincidence in time and space.
Construing BI Policies cont’d
“Damage arising directly or indirectly from…”
The Direct cause has been held to be the
proximate cause. By implication, ‘indirectly
caused’ refers to something less proximate.
Construing BI Policies cont’d
“Arising out of…..”
Wider than ‘directly or indirectly caused by’
Construing BI Policies cont’d
“…covering the interest of the Insured in the
property..”
Glengate – KG Properties v Norwich Union Fire
Insurance Society Limited [1996]
Conclusions
Questions
Contact details
Roger Franklin
Litigation Partner
e: [email protected]
t: +44 (0)20 7691 4044
f: +44 (0)20 7691 4090
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