Up in smoke – Relief for first-party property insurers

Mitchell Ogilvie Menswear Pty Ltd v Rapid Edge Pty Ltd [2019] QSC 136

Should a property insurer faced with a catastrophic loss, quickly quantify as best it can and pay the claim, and then look with confidence to recover this amount from the negligent party? Or can the negligent party challenge the reasonableness of that payout for lack of certainty, months or even years down the track?

The Queensland Supreme Court considered this issue in the context of the salvage value of luxury menswear damaged by soot and smoke from a fire. The decision will relieve first-party property insurers that the current claims assessment process, of valuing the loss suffered as at the time of the loss is favoured by the Courts.

Where there’s fire, there’s smoke

The fire was caused by a faulty vacuum igniting in a basement tenancy, which neighboured the Mitchell Ogilvie store. Smoke and soot from the fire rose through the air ducts into the menswear store and settled in a fine grey layer across the stock of luxury suits on display in the store. A variety of cleaning processes were attempted, including vacuuming, chemical wipes, and ozone treatment. The efficacy of these processes in returning the exceptional quality suits to their previous state was expressed by Justice Applegarth:

‘the high quality and high retail value of the stock made it practically impossible to bring the items back to their pre-fire condition.’

What to do with the damaged goods?

The disposal of the damaged menswear was pivotal to the issues at trial. Once a determination was made that the items were irreparably damaged, it was necessary to decide what to do with the damaged goods. The wholesale value of the damaged stock immediately before the fire was $1,465,367 with a retail value of approximately $4,500,000. Under its Commercial Special Risks policy, Allianz took ownership of the damaged goods when it made a payout under the policy. However, Mitchell Ogilvie offered a sum of $150,000 - $200,000 to retain the damaged goods, in order to protect the risk to trade, goodwill and reputation should a competing retailer gain access to the goods at auction and subsequently, sell them at a significantly discounted price. Allianz decided to engage a fire sale auctioneer to get a better feel for the likely value of the suits and determine what price they might achieve at auction. The auctioneer felt that an auction might recoup approximately 5-10% of the retail value, equating to a range of $225,000 - $450,000. The auctioneer offered Allianz a guaranteed return net of costs and commission of $195,000 to sell the suits, with any additional proceeds payable to Allianz at a higher commission. Mitchell Ogilvie then increased his offer to $225,000, to which Allianz agreed. This sum was consequently deducted from the insurance payout to give a net loss of approximately $1.24 million.

Liability insurer pursued ‘alternative measure’

The liability insurer for Rapid Edge Pty Ltd, took issue with the salvage value assigned to the damaged goods, pleading at trial that $225,000 did not reflect the market value of these goods. The defendant’s allegations were based on the findings of a forensic accountant that in the years after the fire there was no real discernible difference in the store’s profit margins. Following this logic, the defendant argued that the suits were worth more than the salvage values paid by Mitchell Ogilvie. The defendant pleaded that the damaged value of the menswear stock should be valued using an alternative test, working backwards from the ultimate retail sale price achieved by Mitchell Ogilvie for each of the damaged items. As the store’s financial records did not descend to this level of detail, broad calculations were made across all the damaged stock sold and retail sales achieved.

The Court’s decision: immediate crystalisation of loss

The Court decided there was no good reason, in this case, to depart from the normal measure of loss, being the difference in valuation immediately before and after the damage event. The defendant asserted the store had largely mitigated or avoided its loss by selling the damaged stock very well in a subsequent fire sale or normal trade. Alternatively, this showed the salvaged stock had been undervalued. The Court found the accounting evidence did not establish this as it could not exclude numerous variables and was based on several unfounded assumptions. It also failed to take into account the risk assumed by Mitchell Ogilvie in reacquiring the damaged stock that may sell poorly.

The evidence from the auctioneer and the subsequent negotiations between the insurer, its assessor and the insured, were the best evidence of the true value of the damaged stock immediately after the fire. Mitchell Ogilvie’s motivation for purchasing the stock was to protect the reputation of his brand and trade connections, which had taken decades to establish. The Court reasoned that the purchase was not legally required by the insured, and that in purchasing the goods Mitchell Ogilvie adopted a significant amount of uncertainty as to the outcome of any proceeds of sale. The Court found that the purchase price of $225,000 represented the market value of the goods, as the competing offers of three commercially knowledgeable parties had been involved in determining the amount. Justice Applegarth considered the hypothetical situation where an alternative measure was adopted and found it would be too costly, complicated and probably unlikely to produce a compelling result. On the balance of these factors, the Court comprehensively decided that the Defendant had failed to form a persuasive argument on any ground. Justice Applegarth relied on the established approach that the application of the general compensatory principle is applied at about the time the loss was sustained. The plaintiff succeeded for its full claim plus interest.

Relief for insurers and insureds alike

Insurers and insureds alike should be relieved about the outcome of this trial. The Court declined to set a precedent that would require the parties to wait months or years to trace the eventual sale of all damaged goods in order to decide the true value of a claim. Such a precedent would undermine the current approach of insurers to settle claims as efficiently and quickly as possible and allow all parties to move on. The alternative is stark to contemplate, with insurance claims dragging on indefinitely and insureds unmotivated to make any extra effort to mitigate their loss that would only reduce their end payout. Common sense and commercial practicality have triumphed over an illusory search for certainty. The decision reinforces that the Court supports the current method of insurance claims assessment whereby the value of damages should be determined at about the time the loss was sustained.

This article was written with the assistance of Ben Wilson, Paralegal.