Understanding Constructive Total Loss in Marine Insurance

Introduction to Constructive Total Loss (CTL)

Cogo Insurance is presenting to you information shared by Prof. Peter MacDonald Eggers KC, and Richard Sarll, an insurance expert from the UK.

In marine insurance, a constructive total loss (CTL) occurs when a ship or cargo is not actually lost, but there are compelling commercial reasons to treat it as if it were lost. The concept is a hybrid one – while total loss exists in both marine and non-marine insurance, constructive total loss as a legal concept is unique to marine insurance.

With approximately 50,000 merchant ships sailing daily, sometimes in perilous conditions, vessels occasionally experience severe damage, as may their cargoes. When damage is so extensive that repair costs would exceed the vessel’s value (similar to a “write-off” of a car), we enter the realm of constructive total loss.

Types of Total Losses

The Marine Insurance Act defines two types of total losses:

1. Actual Total Loss (ATL) – Defined in Sections 57 and 58
2. Constructive Total Loss (CTL) – Defined in Section 60

These definitions are exhaustive – if circumstances don’t fit within these statutory definitions, there is no total loss. They apply only to property insurance, not to liability or financial loss insurance.

Total losses typically occur in two major scenarios:

• Physical damage to the property (ship, cargo, offshore platform)
• Deprivation of possession

Actual Total Loss vs. Constructive Total Loss

Actual total losses are based on the notion of it being legally or physically impossible to recover the insured asset. For example:

• A ship destroyed by explosion
• A vessel taken by unknown parties with no prospect of recovery
• A ship condemned and sold at auction in a foreign port

Constructive total losses, by contrast, are based on commercial impracticability. In these cases, recovery or repair of the insured property is possible but commercially impractical. This concept allows insureds to recover on a total loss basis when it would be financially unreasonable to repair a vessel.

Types of Constructive Total Loss

Section 60 of the Marine Insurance Act identifies three types of CTL:

1. CTL by Abandonment (Section 60(1))

This occurs when the subject matter is reasonably abandoned because:

• An actual total loss appears unavoidable
• The property cannot be preserved from becoming an actual total loss without incurring expense exceeding its value

This refers to abandoning the property “to the world” (like “abandon ship”), not abandonment to the underwriter. This type of CTL is extremely rare in modern times, as vessels worth millions are unlikely to be abandoned in any circumstances.

The Institute Cargo Clauses (Clause 13) state that no claim for CTL will be allowed unless the cargo has been reasonably abandoned. This potentially restricts other types of CTL for cargo.

2. CTL by Deprivation of Possession (Section 60(2)(1))

This occurs when:

• The assured is deprived of possession of the vessel/cargo by an insured peril
• It is unlikely that recovery is possible within a reasonable time (typically 12 months for vessels)
• The cost of recovering the vessel/cargo would exceed its value when recovered

“Deprivation of possession” means the insured’s inability to exercise control or free use of the vessel, even if the crew remains physically on board. Examples include vessels detained in foreign ports or captured by pirates.

3. CTL by Physical Damage (Section 60(2)(2))

This occurs when the cost of repairing damage would exceed the value of the ship when repaired. Under Institute Time Clauses (Hulls 83), this is measured against the insured value rather than actual value.

Proving a CTL “on figures”

When claiming a CTL based on repair costs exceeding the vessel’s value:

1. The assessment is typically hypothetical, as no one would actually repair a vessel when repair costs exceed its value.
2. Best practice involves:
   • Joint survey of damage
   • Agreed repair specification
   • Obtaining quotes from agreed shipyards
   • Itemizing disputed damage separately
3. Costs that can be included in CTL calculations:
   • Salvage operations (post-casualty)
   • Towage to repair yard
   • Insurance costs
   • Temporary repairs
   • Dry docking costs, port dues
   • Repair yard costs (labor, materials)
   • Future general average contributions
   • A “margin” (typically 10%) for unforeseen extras
4. Costs typically excluded:
   • SCOPIC expenditure (Special Compensation P&I Club Clause)
   • Cost of investigating the claim
   • Expenses for advertising the vessel for sale

The Notice of Abandonment

When claiming a CTL, the insured must tender a Notice of Abandonment (NOA) to the insurer, communicating their decision to claim a CTL and abandon the ship to the insurer. This must be done with reasonable diligence after receiving reliable information about the loss.

If the insured fails to tender an NOA in time, they lose the right to claim for a CTL and must claim for a partial loss instead. The NOA can be revoked if the insured acts inconsistently with the insurer’s potential rights over the vessel.

Notices of Abandonment are not required in cases of:

• Waiver by the insurer
• No possibility of benefit to the insurer through abandonment

Insurer’s Rights Upon Payment of a CTL

If a CTL claim is paid, the insurer acquires the right to take over the vessel or cargo under Section 79 of the Marine Insurance Act. This means:

1. The insurer becomes the owner of the ship/cargo from the date of casualty
2. The insurer receives all benefits of ownership (income, capital appreciation)
3. The insurer bears all burdens of ownership (liabilities, expenses)

Recent Important Cases

Recent years have seen important decisions on CTL including:

• The B Atlantic
• The Brillante Virtuoso
• The Renos

In the Brillante Virtuoso case, the agreed value was $55 million (purchased at market height), while the market value at the time of incident was only $12 million. This created a situation where for a CTL, insurers would pay out $55 million, but if claimed as unrepaired damage, it would be about $6 million.

Conclusion

Constructive total loss remains a complex area of marine insurance law and practice. While the Marine Insurance Act provides the framework, court cases continue to refine and interpret how CTL is applied in modern maritime situations. The concept balances commercial practicality with the traditional principles of marine insurance.