A Greek appeal court was recently called upon to interpret the exclusion under the Contractors’ Erection All Risks Policy which read:

the insurer shall not Indemnify the Insured for … The cost of replacement, repair or rectification of loss due to defective material and/or workmanship. This exclusion shall be limited to the insured items directly affected, whilst material damage to correctly executed items resulting from an accident due to such defective material and/or workmanship is covered”.

The insured had been awarded a turn-key contract for the design and construction of an optical fibre grid. A large number of pipes supplied in the installation didn’t meet the agreed standard of pressure and approximately 35 kilometres of 95 kilometres of an already constructed grid had to be abandoned and replaced.

The pipe supplier assumed the cost of replacement of the defective materials in itself. For the 35 kilometres, a new trench had to be excavated for the new conduit. The contractor claimed the cost of all the relevant trenching, digging, padding, backfilling and extraction of defective material work.

The insured’s claim failed both in the lower and the appeal court.

The insured argued unsuccessfully that the exclusion was complex and ambiguous and properly included works that were correctly executed and then as a result of a defective material sustained material damage, in the sense that they became useless and had to be dug all over again.

The insurer’s argument that the cost of replacing defective material was unambiguously excluded from cover was upheld. Trenching for the installation of new pipes could not be construed to fall under the scope of ‘material damage’ to correctly executed items resulting from an accident due to such defective material. There was no accident due to defective material. Nor was there material damage to correctly executed items.

The interpretation of similar wording is frequently dealt with by courts around the world.

The United Kingdom Court of Appeal in Pilkington v CGU [2004] held that the risk of future damage doesn’t mean that glass panes installed in the glass roof of the Eurostar terminal at Waterloo station were actually damaged (although they were prone to fracture). The court said damage required some altered state which was absent at the time of the claim. Physical injury is the condition that the policy pays.

That court said:

In the context of insurance law, (this finding) makes commercial sense of an agreement which is designed to protect the insured against liability for physical damage to physical property and not to afford an indemnity by way of guarantee for the quality and fitness of the commodities supplied”.

South African courts have and will adopt a similar approach.