What Does Physical Loss Mean in Kentucky? Can Temporary Delay Constitute Physical Loss?

Under Kentucky law, as interpreted in Century Aluminum Company v. Certain Underwriters at Lloyd’s, 1 “physical loss” means that a property owner has been tangibly deprived of their property, such as through theft, or that the property has been tangibly destroyed, like by fire. The court emphasized that “loss” by itself might present ambiguities, but the qualifier “physical” specifies that the property must have been “tangibly destroyed, whether in part or in full.” This definition implies a clear, material, and observable detriment to or the disappearance of the property.

The court also made a distinction between purely economic losses and physical losses, stating that Kentucky does not recognize detrimental economic impacts without tangible destruction or deprivation of property as “physical” losses. This delineation underscores that lost profits or diminished income streams, which lack physical manifestation, do not meet the criteria for physical loss or damage under this legal framework.

In the context of the Century Aluminum case, the temporary inability to use the alumina due to transportation delays did not constitute a physical loss because the alumina itself remained undamaged and eventually reached its destination. The court’s interpretation reinforces that physical loss or damage involves direct, tangible harm to the physical state of the insured property, not merely economic or operational setbacks.

At the heart of the controversy was Century Aluminum’s reliance on river barges for transporting alumina ore, a vital ingredient in aluminum production. The unforeseen closure of key locks on the Ohio River by the Army Corps of Engineers due to low water levels and mechanical breakdowns forced Century to find alternative transportation methods. The ensuing logistical scramble led to substantial extra costs, over $5 million, as Century turned to trucks and railcars to move alumina to its Kentucky plants.

Century Aluminum sought to recover these additional costs under its marine cargo insurance policy with Lloyd’s, which led to the legal battle. Lloyd’s contended that the policy did not cover the additional expenses, apart from a $975,000 payment, which should have been a $1 million payment, under the Extra Expense Clause, as discussed in yesterday’s post, Take The Deductible From the Loss and Not the Coverage Limit. The crux of the matter was whether Century’s losses constituted “physical losses” covered under the policy and if the alternative transportation costs fell within the scope of the policy’s coverage clauses.

The court’s analysis noted:

Under the All Risks provision, Century’s alumina did not suffer any physical loss or damage. The temporary delay never threatened to deprive Century of its ownership or control of the alumina. The company, on the contrary, retained sufficient control over the alumina to deliver it by other transportation means. Nor has Century alleged any damage. All of the alumina arrived at Century’s facilities no worse for the wear. Century, it is true, suffered a loss of profitability. But the insurance policy addressed this intangible claim under the Extra Expense Clause, not the All Risks provision. A ‘Trade Disruption policy,’ for what it is worth, could have provided additional ‘coverage for any event which disrupts service and causes a production loss,’ but Century declined to purchase that insurance from a different underwriter.

Century counters that the shipment delays created a risk of physical loss to the alumina because the lock closures ‘tangibly deprived [Century] of the ability to use its insured property in its ordinary manner.’ But that argument sidesteps the reality that the modifier ‘physical’ refers to the transformative or tangible nature of the loss to the insured interest, not the difficulties to the policyholder…. All of this explains why an All Risks policy treats the theft of a vessel’s motor as physical loss or damage. The problem is that the theft makes the vessel useless; it is not that the owner must find another way to go boating that day…. Likewise, the ‘mysterious disappearance’ of coffee beans from storage constitutes physical loss because they are no longer present, which means the owner can no longer use or sell them for any purpose. In re Balfour Maclaine Int’l Ltd., 85 F.3d 68, 77 (2d Cir. 1996). Even Century’s own authorities recognize that deprivation of use constitutes loss under an All Risks policy only when the owner has lost all ‘possession or control of the [property] since that date,’ Intermetal Mexicana, S.A. v. Ins. Co. of N. Am., 866 F.2d 71, 76 (3d Cir. 1989), or the property has become ‘unusable’ because it has become physically defective, unsafe, or otherwise ‘uninhabitable,’ Universal Image Prods., Inc. v. Fed. Ins. Co., 475 F. App’x 569, 574–75 (6th Cir. 2012). That did not happen here.

The “Risks Covered Clause,” typical in marine insurance policies, was also part of the court’s discussion. This clause traditionally outlines the various “adventures and perils” that the marine insurer agrees to bear, encompassing a range of risks from natural hazards like storms to human actions, including piracy and war. The language of the clause, often archaic, reflects its long-standing heritage in maritime law.

In the Century Aluminum case, the court’s analysis of the “Risks Covered Clause” was intricate, focusing on whether the logistical challenges faced by Century Aluminum—stemming from the closure of locks on the Ohio River—fell within the enumerated perils that Lloyd’s of London agreed to cover. Specifically, the court looked at whether these events constituted “arrests, restraints and detainments” as outlined in the clause, or any other peril that could apply to the situation.

The court interpreted these terms in a historical and legal context, referencing early 19th-century U.S. Supreme Court cases that defined “arrests” and “detainments” as actions where a government authority takes possession of a vessel or its cargo, and “restraints” as situations where a vessel is forcibly confined or prevented from proceeding on its voyage, such as through a blockade. The court concluded that Century’s situation did not align with these definitions since the government had not taken control of the barges or impounded the alumina, nor were the barges trapped or unable to escape.

Furthermore, the court examined whether Century’s circumstances could be considered “other like perils, losses or misfortunes” under the broad wording at the end of the Risks Covered provision. The analysis concluded that this catch-all phrase still required the occurrence of a peril similar in nature to those explicitly listed, such as piracy or fire, which directly impact the physical integrity or possession of the goods and the vessel. The cargo and its barges did not encounter such threats; therefore, the clause did not cover the additional expenses incurred due to transportation delays.

The court’s analysis underscores the specificity required to invoke the Risks Covered Clause. It highlighted that the coverage is limited to direct, tangible perils to the goods or vessel, not broader economic or logistical challenges. This interpretation aligns with the principle of marine insurance to provide coverage against physical perils at sea or associated with maritime transport, rather than insuring against all possible sources of financial loss.

Last week’s post, The Francis Scott Key Bridge Collapse and The Limitation of Shipowners’ Liability Act, is an example of a traditional peril of the sea.

Thought For The Day

The sea is dangerous and its storms terrible, but these obstacles have never been sufficient reason to remain ashore.
—Ernest Hemingway, “The Old Man and the Sea”

1 Century Aluminum Co. v. Certain Underwriters at Lloyd’s, No. 23-5543, — F.4th —, 2024 WL 1460451 (6th Cir. Apr. 4, 2024).