What is an ‘obvious error’ in a contract?

The recent decision of the Western Australian Court of Appeal in Tokio Marine & Nichido Fire Insurance Ltd v Hans Bo Kristian Holgersson [2019] WASCA 114 considered the circumstances in which the terms of a contract should not be given effect because of an ‘obvious error’.

A builder, Mosman Bay, was engaged by homeowners to undertake certain activities in relation to the renovation of their house. Mosman Bay was insured for its building activities under a construction and legal liability policy issued by Tokio Marine. Mosman Bay engaged Holgersson as a subcontractor to perform painting works for the renovation. During the renovations, the home was substantially damaged by a fire.

A dispute arose between the parties regarding the coverage provided for under the insurance policy. The homeowners commenced proceedings against Tokio claiming the insurance policy provided coverage for the property damage caused by the fire. Mosman Bay commenced proceedings against Holgersson, alleging that he was responsible for the fire. Tokio indemnified Mosman Bay and then sought to exercise its subrogation rights under the policy, including by requiring Mosman Bay to maintain its proceedings against Holgersson. Holgersson argued that he was an “Insured” under the insurance policy, and as a result the terms of the insurance policy prevented Tokio from requiring Mosman Bay to maintain proceedings against him.

The question before the Court was whether the terms of the contract provided coverage for Holgersson as an “Insured”. Relevantly, the terms of the insurance policy provided that Tokio “agrees to pay You…all amounts You shall become legally liable to pay as compensation in respect of property damage”. The terms “You”, “Your” and “Insured” were used interchangeably throughout the policy and defined as “the Person(s) or legal entity named in the Schedule”. The Schedule lists “Insured” as “Mosman Bay Construction Pty Ltd and all Principals, Contractors, and Sub-Contractors”.

At first instance, the court found that Holgersson was an “Insured” for the purposes of the insurance policy because he was a subcontractor to Mosman Bay and therefore fell within the class of persons named in the Schedule.

Tokio appealed the decision on a number of grounds, including that, on a proper construction of the insurance policy, the list of “Insured” contained in the Schedule should be treated as having no content or operation on the basis that it is so incompatible with the terms of the insurance policy or produces such uncommercial consequences, that it must be considered an ‘obvious error’.

In rejecting Tokio’s appeal, the Court held that:

•   The court is generally reluctant to construe a contract in a manner that renders a provision or part of the contract superfluous. However, the court may omit words or treat them as superfluous if the inclusion of such words is an obvious error or if the words are inconsistent with, or repugnant to, the objective intention of the contract as a whole.
•   The list of “Insured” provided for by the Schedule was not so incoherent with the insurance policy as a whole as to demonstrate that it was an ‘obvious mistake’ to which effect should not be given.
•   The fact that the list of “Insured” provided for by the Schedule renders another part of the insurance policy inoperative does not justify ignoring, or treating as an obvious mistake, the clear language of the Schedule.

These types of policies are commonplace in the construction context. This decision highlights the importance of clear and unambiguous language when it comes to identifying who is an “Insured” for the purposes of an insurance policy.

The decision also emphasises that the test for identification of an ‘obvious error’ in the terms of a contract is a high bar which will only be met in circumstances where it is absolutely necessary in order to avoid absurdity.

The full decision can be found here.