Defective Material & Physical Damage

The recent appeal case in the Full Federal Court of Australia, in the matter of Insurance Australia Ltd v Capral Ltd [2025] FCAFC 46, upheld the previous reasoning and decision of the Federal Court of Australia and provides a useful summary regarding property damage and policy coverage.

Amongst other things, Capral supplied aluminium products for use in the maritime industry. Capral sold and delivered plate to its customers. The plate was then used as marine-grade plate in the construction of ships, boats, barges and also a water tank.

A customer of Capral’s discovered that the plate failed testing standards. Upon enquiry, Mingtai, supplier of the plate to Capral, advised that due to a failure in the production process the plate had not undergone the requisite heat treatment necessary to meet classification society corrosion resistance requirements.

Claims were made against Capral by various customers who had elected to remove the plate and / or reconstruct the vessels. Capral settled with the customers under settlement deeds stating that Capral was providing compensation for “property damage”. The total amount of the settlements to the customers was $2,197,000. Additionally, Capral provided replacement plate to each of the customers.

Capral was insured by insurers under a liability policy which indemnified Capral for “all sums which [Capral] shall be legally liable to pay, including for the avoidance of doubt, those assumed under contract or agreement, in respect of… compensation for… property damage… as a result of an Occurrence happening in connection with [Capral’s] Business or Products”.

Under the policy, an “Occurrence” was defined as “an event including continuous or repeated exposure to substantially the same general conditions which results in… Property Damage… where such… Property Damage… is neither expected nor intended from the standpoint of the Insured”. 

The policy defined “Property Damage” as meaning “physical injury or damage to or physical loss of or destruction of tangible property including loss of use at any time resulting therefrom” and “loss of use of tangible property which has not been physically injured, damaged or destroyed provided such loss of use is caused by or arises out of physical damage of other tangible property”.

Carpal contended that the claims by customers were for “Property Damage”. Insurers’ position being that Capral was really seeking to recover for the supply of goods that were not fit for purpose. Insurers taking the stance that the remedial action did not relate to property damage and instead related to the supply of defective products. Insurers asserting that fixing the defective plate to the vessels did not constitute property damage to the vessels.

In the first instance, the Federal Court undertook a review of authorities from Australia, Canada, England and the US. The Federal Court concluded that the policy covered the claims. It was held that what was required was “physical alteration of tangible property that impairs its usefulness or value”. The Federal Court provided a useful summary of the position by stating that there would be a claim for “Property Damage” where:

“(1) the incorporation of a defective product into larger tangible property

physically alters that property;

(2) the nature of the defect is such that the incorporated product must be removed from the property; 

(3) the nature of the physical alteration is that removing the product will come at a substantial cost;

(4) as a result, the usefulness or value of the property immediately after

the incorporation of the defective product is less than its value immediately beforehand; and

(5) the customer claims for that difference in usefulness or value.”

Upon appeal, the Full Federal Court ruled that, contrary to the position taken by insurers, the evidence did establish that the installation of the plate caused damage when the plate was welded into the hulls. There being a physical alteration of the hulls and the vessels could not proceed to the open market without the plate being removed at substantial cost, so that the physical alteration had caused an impairment in the usefulness or value of the tangible property. It was not relevant that the plate did not immediately corrode.