The danger of moral hazard

-Analysis based on a claim by Pier-owner against Ship-owner for cost of repair and loss of use of the pier
 
 
Background
 
A pier owned by “A” Port Group Company (“the Pier-owner”) was struck by the vessel “K” (“the Vessel”) owned by “B” Shipping Company (“the Ship-owner” ) and sustained damage. The Vessel was arrested on the application of the Pier-owner filed with Guangzhou Maritime Court. In order to have the arrest order lifted, “C” Insurance Company, the insurer of the Vessel (“the Insurer”) issued a letter of undertaking in the amount of RMB10,000,000 to the court to undertake to pay such sum due from the Ship-owner to the Pier-owner as damages for direct loss resulting from the accident (“the LOU”). Afterwards, the Pier-owner filed a claim before Guangzhou Maritime Court against the Ship-owner for cost of repair and loss of use  of the pier (collectively the “direct loss”).
 
Anomalous behaviors pointing to possible tacit collusion
 
During the handling of the case, the Insurer noticed a series of anomalous behaviors which pointed to presence of possible tacit collusion between the Ship-owner and the Pier-owner.
 
Firstly, after the Insurer had issued the LOU for the Ship-owner and the Vessel been released, the Ship-owner refused to appoint the lawyer recommended by the Insurer to handle the claim of the Pier-owner, and even refused the Insurer’s proposal that they each appoint one lawyer to jointly act for the Ship-owner. Instead, the Ship-owner got only its own lawyer involved in the proceedings. Secondly, without prior notice to the Insurer, the Ship-owner privately entered into an agreement with the Pier-owner who was the claimant, agreeing to entrust the appraiser and the accounting firm proposed by the Pier-owner with the assessment on the cost of repair and loss of use of the pier. Thirdly, the cost of repair assessed by the appraiser jointly appointed by the Pier-owner and the Ship-owner, which was as much as RMB10,390,000, was much higher than that assessed by the appraiser engaged by the Insurer, which was RMB1,860,000 only, while the loss of use as assessed by the jointly appointed accounting firm (RMB4,470,000)  was  surprisingly far less than the cost of repair as assessed by the jointly appointed appraiser.
 
Moral hazard faced by the Insurer
 
Since the major responsibility for damages due from the Ship-owner would ultimately be borne by the Insurer, normally speaking, before settlement of the insurance claim between the Insurer and the Ship-owner, the Insurer should, through the Ship-owner, actually participate in the proceedings commenced by the Pier-owner and to a substantial extent, control the defence of the Ship-owner who in return should actively cooperate with the Insurer during the entire process. However, the Ship-owner had not only refused to appoint the lawyer recommended by the Insurer, but also refused the Insurer’s proposal of jointly appointing lawyers to handle the claim of the Pier-owner. Under such circumstance, the Insurer, who would ultimately bear the major responsibility, was completely excluded from participation in defending the claim of the Pier-owner.
 
In essence, the Ship-owner and the Pier-owner, through tacit collusion or agreement, were attempting to wrap indirect loss as direct loss through such appraisal and assessment by their jointly appointed appraiser in order to pass it to the Insurer of the Vessel. What’s particularly unfavorable to the Insurer was that according to the general provisions on burden of proof in civil proceedings, the court could just use the appraisal/assessment report made by the appraiser jointly appointed by the Pier-owner and the Ship-owner (respectively the plaintiff and the defendant in the litigation) to assess the claim of the Pier-owner. As a result, the so-called direct loss assessed by the court would be paid by the Insurer in the end. The unfavorable outcome of the litigation could be passed to the Insurer according to the terms of the insurance policy. As the Insurer had not settled the insurance claim and obtained the right of subrogation, it could not participate in the litigation in such a way as in recovery cases. In the absence of cooperation from the Ship-owner and an actual participation in the proceedings, the Insured would have to passively accept an unfavorable outcome of the litigation.
 
 
The Insurer’s action
 
In the circumstances, we, as counsel for the Insurer, suggested and took the following action to counter and reverse the unfavorable situation and protect the interests of our client.
 
Firstly, in view of that the Insurer was not only the hull and machinery underwriter of the Vessel, but also the issuer of the LOU in the amount of RMB 10,000,000.00 and would be held jointly and severally liable with the insured for the damages due to the Pier-owner because of the accident, we suggested and timely filed an application with the court for the Insurer’s participation as Third Party in the legal proceedings between the Ship-owner and the Pier-owner. By becoming a litigant therein, the Insurer was in a position to better monitor the development of the case, exercise its rights as a litigant including the right to defend and thus protect its interest from any harm resulting from the Ship-owner’s inactive defending and even tacit collusion with the Pier-owner.
 
Secondly, after the Insurer had been admitted to the proceedings as Third Party and the relevant submissions and evidences filed with the court, considering that the amount of direct loss assessed by the appraiser jointly appointed by the Ship-owner and the Pier-owner was as high as RMB 10,390,000, far in excess of the actual loss, we strongly suggested that the Insurer arrange its own qualified appraiser to make a separate assessment of the loss without delay. As it turned out, the appraiser appointed by the Insurer managed to make a proper appraisal of the damaged pier after having overcome various obstacles and difficulties created by the pier interests and came to the objective conclusion that the estimate of the cost of repairing the damaged pier should be just RMB1,860,000. This created the conditions for the next step to be taken by the Insurer to defend the claim.
 
Thirdly, on the basis of the appraisal report made by the Insurer’s appraiser, we further suggested that the Insurer apply to the court for a forensic appraisal of an estimate of the repair cost as well. The application was granted by the court and the forensic appraisal was arranged. This helped to avoid the occurrence of such an unfavorable situation that the appraisal made by the Insurer’s own appraiser was insufficient to negate and overturn the appraisal made by the appraiser jointly appointed by the Pier-owner and the Ship-owner who were the plaintiff and the defendant respectively in this case. As it turned out, the forensic appraiser commissioned by the court made a more objective and fair appraisal report which concluded that the estimated repair cost should be in the amount of RMB2,340,000 only. By applying for the forensic appraisal, the Insurer managed to completely reverse the very unfavorable and difficult situation that it was facing due to the tacit collusion between the Pier-owner and the Ship-owner, break the strategic alliance between the Pier-owner and the Ship-owner and hence better protect its own rights and interests.
 
Finally, after being presented with the result of the forensic appraisal, the Pier-owner and the Ship-owner finally turned against each other after the tacit collusion failed, and they had no choice but accept court mediation. We once again made good use of the situation and helped to facilitate a full and final settlement of the claim for only RMB 2,450,000 on the basis of the forensic appraisal.
 
Conclusion
 
The Insurer once noticing the trace of tacit collusion between the insured Ship-owner and the claimant Pier-owner, was able to get its own lawyer involved immediately and to advise and assist it in effectively avoiding an unfavorable outcome of the litigation.   
 
Lawyers need to make a proper appraisal of the situation during the handling of a specific case, and make full use of legal weapons based on the particular circumstances of the case so as to effectively protect their clients’ rights and interests. The filing by our lawyers of the application and obtaining of the court’s approval for our client to participate in the proceedings as Third Party completely broke the tacit collusion between the plaintiff and the defendant, the arrangement of an appraisal by our client’s own appraiser created the basic conditions for the next step to be taken, and finally the filing of the application for the forensic appraisal helped to force the claimant to accept the objective, reasonable settlement level.
 
After the occurrence of an insured event, Insurers/P&I clubs can be faced with moral hazard which should never be overlooked. Once noticing that their Insured/Members are not cooperating in the handling of the occurrence or the presence of anomalous behaviors pointing to possible tacit collusion between the Insured/Members and the claimants or any other party so as to prejudice their rights and interests, the Insurers/P&I Clubs should get their own lawyers involved in the case without delay and take decisive and effective measures to avoid or minimize insofar as possible the risk of moral hazard and protect their own rights and interests.