Partner London
"The English court has, for the first time, considered the wording of a mortgagee’s interest insurance policy on the Institute Mortgagees’ Interest Clauses – Hulls (1/3/97 CL337-1997)."
In the recently reported case of Oceanus Capital Sarl v Lloyd’s Insurance Company S.A. (the m/v “Vyssos”) [2025] EWHC 3293 (Comm), the English court has, for the first time, considered the wording of a mortgagee’s interest insurance (“MII”) policy on the Institute Mortgagees’ Interest Clauses – Hulls (1/3/97 CL337-1997) (“IMIC 1997”) wording, which is the standard wording published by the International Underwriting Association¹ for use in the London insurance market. In its judgment, the court provided some helpful insights into the nature and scope of MII cover, for an MII claim that arose from the loss of the mortgaged ship after being struck by a mine in Ukraine. The mortgagee knew the ship was trading to Ukraine but had not taken steps to prevent the voyage, relying instead on a cover note for additional war risks that the mortgagee only discovered to be a forgery after the loss. In this article, we consider the decision and its implications for ship financiers.
The factual background
The mortgaged ship, the “Vyssos”, was insured for war risks under the Institute War & Strikes Clauses (Hulls) with Lloyd’s underwriters for worldwide trading, subject to a warranty that the ship would not enter any ‘Listed Areas’ – which included Ukrainian territorial waters – unless agreed with war risks insurers in return for payment of additional premium. The mortgagee took an assignment of the owner’s marine policies in the usual way and placed MII cover on IMIC 1997 terms with Lloyd’s Europe, reinsured 100% by members of two Lloyd’s syndicates.
The mortgagee’s loan soon went into default when the mortgagor owner/borrower missed the first scheduled quarterly repayment. To make matters worse, the ship was arrested by its sub-charterers in Romania after the owners failed to provide or pay for necessary crew supplies. The mortgagee then funded the ship’s release from arrest. However, unbeknown to the mortgagee, the owner, charterer and sub-charterer had concluded a tripartite settlement agreement under which the owner agreed to perform between 2-5 trips to Ukraine. A trip to Odessa took place in November 2023 after a cover note for additional war risks cover was provided to the mortgagee. Thereafter, when the mortgagee learned that a further voyage to Ukraine was to be performed in December 2023, it requested both the owner’s Greek managers and the charterer (that was liable under the charter to pay for the additional war risks cover and had provided the cover note for the November voyage) to provide proof of the cover and payment of additional premium. Eventually the charterer provided a cover note, which was only later discovered to be a forgery. Although no proof of payment of premium was provided, the mortgagee relied on the cover note to withdraw its objection to the voyage. On the very next day (26 December 2023), the ship was struck by a mine in Ukrainian waters. It was then beached to attempt to save the hull and to avoid a collision before being towed by salvors up the Danube to the port of Izmail, Ukraine and declared a constructive total loss.
The MII claim
The owners’ war risks insurers declined the mortgagee’s claim (as assignee of the owner’s war risks policy) on grounds of the owner’s breach of trading warranties. No claim could be brought against the apparent insurers of the additional voyage as the cover note was a forgery and no such cover had in fact been placed. Thereafter, MII underwriters declined the mortgagee’s MII claim and defended the claim on three grounds, all of which were later dismissed by the Commercial Court in London at first instance. The judge has, however, given MII insurers permission to appeal, so there remains a possibility of this decision being overturned on appeal.
First, MII insurers submitted that the proximate cause of the mortgagee’s loss was the “invalidity or nullity” of the forged additional war risks policy that was supposed to provide prima facie cover for loss of or damage to the ship but in fact was “null and void ab initio”. They argued that the purpose of an MII policy is not to provide “seamless cover” to a mortgagee in the event of the owner’s primary policies proving ineffective. Nor was its purpose to insure a mortgagee against an owner’s fraud or deceit (unless the relevant conduct falls within the definition of a named peril, as it would, for example, in the case of a scuttling). The risk of non-payment because the owner’s policy is null and void ab initio is not, MII insurers contended, an “insured peril” under Clause 2.1 of IMIC 1997. MII insurers also relied on the earlier judgment in The ZouZou [2022] EWHC 1169 (Comm) that concerned a claim under a differently worded MII policy in which the judge had described the mortgagee’s interest as “Assignees and Loss Payees under the owners Policies” rather than “as mortgagee of the ship” (para 231(v)).
"The court rejected these arguments and held the proximate cause of the mortgagee’s loss to be the loss of or damage to the ship caused by the mine."
In this case, MII insurers sought to rely on this earlier judgment to argue that the mortgagee’s loss was the financial loss caused by reason of the additional cover not responding, and the relevant risk insured by the MII policy was financial loss due to the non-payment by the owner’s insurers as a result of one of the specific perils named in the MII Policy, that included breach of warranty and material non-disclosure by the assured but did not include cover that is forged.
The court rejected these arguments and held the proximate cause of the mortgagee’s loss to be the loss of or damage to the ship caused by the mine. The judge held that what was important was the specific terms of the MII cover which insured the mortgagee against loss “resulting from a loss of or damage to or liability of the Mortgaged Vessel” and a claim which would have been prima facie payable under the owner’s “Policies and Club Entries” but for an insured peril referred to in the MII policy, that included a breach by the owner of the trading warranties in the owner’s war risks policy (para 46).
The court held the mortgagee’s interest to be as mortgagee, not as assignee of the owner’s policies, observing that a mortgagee’s interest as assignee is one that is not lost if the owner’s policies do not respond to a claim (para 50), that would leave the mortgagee with nothing to claim under its MII policy (para 35). The judge also doubted (para 52) whether it matters if the mortgagee’s interest under an MII policy lies in the ship itself or in the proceeds of the owner’s policies where it is clear on the MII policy wording that the loss insured is the loss of/damage to the ship and the proximate cause of the inability to recover under the owner’s cover is an insured peril under the MII policy. The judge also observed that, in The ZouZou, the nature of the mortgagee’s interest was common ground between the parties and that finding was obiter to the judgment in The ZouZou (para 51).
Secondly, MII insurers submitted that the mortgagee was privy to the breach of trading warranties in that the mortgagee knew the ship was sailing to Ukraine but nevertheless consented to the owner’s breach through its passivity in failing to hold the ship back. The judge disagreed and held that the mortgagee had requested the ship not to enter Ukrainian waters until additional cover was in place before being duped into believing that additional cover had been placed. The judge also considered it “highly doubtful” that owners would have surrendered possession of the ship to the mortgagee had the mortgagee attempted to take physical possession, given the owners’ and charterers’ commitment to their settlement agreement as well as the fact they had gone so far as to produce a forged cover note to the mortgagee (para 74). The judge further found it difficult to see the commercial sense in a mortgagee which is lied to being in a worse position under an MII policy than a mortgagee which is kept in the dark (para 75).
Thirdly, MII insurers submitted that the mortgagee’s loss, which they submitted was the non-payment by war risks insurers, was not fortuitous because it was the inevitable consequence of the mortgagee’s voluntary conduct in not holding or even attempting to hold the ship back. The court, having held the proximate cause of the mortgagee’s loss to be the mine strike rather than the additional war insurers’ non-payment, held that (i) the mine strike was clearly fortuitous and was not an inevitability and; (ii) the mortgagee’s loss was not bound to result from conduct voluntarily entered into (quite apart from the fact that the mortgagee was “fundamentally deceived” by the forged cover note).
Lessons learned
This case provides a further illustration of the strongly held view of the London market that MII insurance does not provide ‘seamless cover’ to a mortgagee wherever the owner’s underlying cover proves ineffective, but rather merely covers a mortgagee (other than in cases of scuttling) where the owner is prima facie insured but the owner’s insurers rely on a breach to which the mortgagee is not privy to decline the owner’s claim. Although the court held in this case that the prima facie coverage was that provided by the owner’s genuine war risks policy and not the cover which had not been provided by the fake additional war policy, the requirement for prima facie coverage was not in issue. It follows that where an owner’s claim is declined because the peril is not prima facie covered but is rather excluded, e.g. where the ship is lawfully confiscated after narcotics are found onboard, an MII policy will not normally cover the mortgagee, unless it expressly provides stand-alone cover for loss resulting from such excluded perils, that is not the market norm. This lacuna in MII coverage is not widely appreciated by ship financiers when evaluating their security risk. This case does nevertheless suggest that the description of the assured mortgagee’s interest in an MII policy, whether expressed as ‘assignee of the owner’s policies’ or as ‘mortgagee’, will of itself be unlikely to affect the prima facie coverage requirement or indeed to the nature of the loss that the MII policy insures.
"The judgment also contains the first and only judicial dicta on what is meant by the words ‘privity of the assured’ in an MII policy."
The judgment also contains the first and only judicial dicta on what is meant by the words ‘privity of the assured’ in an MII policy. The judge relied on three reported cases² in which these words had been considered as they also appear in s. 39(5) Marine Insurance 1906 (in the context of a ship being sent to sea in an unseaworthy state under a time policy) and held that, for an assured mortgagee to be privy to a breach of the owners’ policies, a mortgagee must:
- have knowledge of the breach (which includes ‘blind eye knowledge’ – i.e. a suspicion firmly grounded and targeted on specific facts and a deliberate decision to avoid confirming that those facts exist); and
- consent to the breach.
In The Vyssos, the mortgagee knew the ship to be sailing to Ukraine and knew that this would be in breach of trading warranties unless additional war risks cover were arranged before the ship entered Ukrainian territorial waters. However, the mortgagee did not consent to the breach but rather required the owner to arrange additional cover until, eventually, the mortgagee was duped by a forged cover note into allowing the voyage to proceed. There was no reason for the mortgagee to be suspicious of the forged cover note in circumstances where it had relied on a valid cover note for a similar voyage the previous month (para 75). Accordingly, the obtaining of the mortgagee’s consent by fraud vitiated that consent.
Mortgagees of ships do not normally track the movements of the ships they finance. However, where an owner is in default under the loan agreement, a mortgagee will likely become much more closely involved – just as happened in this case. The mortgagee will be entitled to apply for the ship’s arrest and judicial sale or to take possession and to arrange a private sale. However, the mortgagee may not wish to accelerate its loan and/or to enforce its security if the ship is trading and the owner’s defaults are remediable. Nor may a mortgagee wish to take possession of the ship and incur the liabilities of the owner by doing so. Nor may the mortgagee have any confidence that the owner would surrender possession if it tried to do so. This judgment is welcome insofar as it clarifies that a mortgagee is not necessarily to be regarded as consenting to breaches by its owner of the owner’s policies of which it has knowledge simply by virtue of not taking every conceivable step the mortgagee could take to prevent such breaches. Here, the mortgagee acted very sensibly to press the owner and charterer to provide evidence of additional cover, that had been obtained for the previous voyage and which the mortgagee presumably expected to be placed again, even at the last minute before the ship entered Ukrainian territorial waters.
However, what if the mortgagee had not been provided with the forged cover note? Should it then have ordered the ship not to continue with the voyage? No doubt it would have done so, even if it doubted the owner would comply with such orders. But should it have gone further and attempted to take possession and/or to try to fund the owner’s additional cover or to place its own additional cover for the voyage? It is certainly arguable that it should have done so in such circumstances – and one can certainly see MII insurers so asserting in the face of a claim. Given the uncertainties as to whether a mortgagee in such a situation would be expected to try to take possession of a ship on the high seas and/or to try to arrange its own insurance (if available) or to fund the owner’s additional cover, to avoid being considered as having consented to a breach by the owner of which the mortgagee has knowledge, MII policies are sometimes amended to include express wording to provide that privity will only prejudice MII cover 48 hours after the ship’s arrival at the next port (if in ballast) or at the discharge port (if laden) to give the mortgagee a proper opportunity to take possession, to arrest, or to arrange and pay for additional cover to safeguard the mortgaged ship. This case illustrates the importance of such additional wording.
The full judgment can be found here.
[1] Formerly the Institute of London Underwriters, until its merger with the London Insurance and Reinsurance Market Association in 1998.
[2] See para 57 – Compania Maritima San Basilio v Oceanus Mutual Underwriting Association (Bermuda) Limited “The Eurysthenes” [1977] QB 49; Versloot Dredging BV v HDI Gerling Industrie Versicherung AG [2013] EWHC 1666 (Comm); and Manifest Shipping Co Ltd v Uni Polaris Insurance Co Ltd and others [2003] 1 AC 469.
