INSIGHTS: When do physical alterations constitute “property damage” in the context of a liability policy?

AAI Limited v The Owners – Strata Plan No 91086 [2025] FCAFC 6

Background to claim

Fairview Architectural Pty Ltd (Fairview) manufactured and supplied cladding panels, which were used in the construction of two high-rise residential buildings in Warwick Farm, New South Wales.

The panels were combustible and therefore deemed defective. The owners of the buildings sought damages from Fairview, including the cost of removing the panels and remediating the buildings.

At the time the panels were affixed to the buildings, Fairview held liability policies with AAI Limited (the Insurer). After the liability policies had expired, the owners were directed by Liverpool City Council to remove the cladding.

The point of controversy was whether the affixation of defective panels constituted “property damage”, for the purposes of the liability policy.

The case was originally heard by The Honourable Justice Wigney of the Federal Court of Australia. It was then appealed to the Full Court of the Federal Court of Australia, which handed down its decision in February 2025.

Original decision

On 20 July 2023, The Honourable Justice Wigney of the Federal Court of Australia decided that it was arguable that the affixation of defective panels did constitute property damage. His Honour concluded that the definition of property damage could be satisfied by the following elements:

1. the panels created a fire risk, which made the buildings less suitable for their intended purpose (residential housing)
2. the panels needed to be removed, leaving behind thousands of empty screw holes in the walls
3. the means by which the panels were affixed (screws and nails) caused physical damage to the buildings, and
4. the removal of the panels would inevitably cause further damage to the buildings.

Basis for appeal

On appeal, the Insurer argued that elements 3 and 4 could not amount to property damage, because:

1. the damage caused by the insertion of screws and nails was expected and intended, and
2. the need to remove the panels is not itself property damage. Property damage could not arise until the panels were actually removed, which occurred outside the period of insurance.

Appellate decision

The Full Court of the Federal Court of Australia dismissed the Insurer’s appeal and found that the Insurer had taken an “overly narrow view” of the original judgment. The Court said that the crux of Justice Wigney’s decision was as follows:

Read as a whole, it is plain that the primary judge considered it to be at least arguable that the policies respond because, inter alia, there had been an immediate physical alteration or change to the buildings by dint of the affixation of the panels which affixation had caused a physical alteration to the buildings and had rendered the buildings less suitable for their use as residential buildings.

In other words, Justice Wigney did not say that elements 3 and 4 were separate species of property damage. The essence of His Honour’s determination was that:

1. there had been a physical alteration or change to the buildings, through the insertion of nails and screws, in order to affix the panels, and
2. this physical alteration made the buildings less suitable for their use as residential buildings, because the panels that were affixed were defective and presented a fire risk.

As a supplementary point, the Insurer argued that, because the Insured knew the panels were combustible, the impairment to the buildings’ value or use was expected or intended. The Court dismissed this argument and said that, even if the Insured knew the panels were combustible, it does not follow that the Insured expected or intended the buildings to become less habitable as a result of their installation.

Implications

This decision raises a number of questions, including:

1. When is the element of “physical alteration” satisfied? In this case, would it have been satisfied if the panels were glued on, instead of screwed in?
2. How can insurers prove the impairment to the property’s value or use was intended or expected, from the insured’s standpoint? In this case, one might think it was obvious to the Insured that the installation of combustible cladding would make the building less habitable.

This case highlights the importance of considering all possible forms of property damage, or “physical alterations”, in a case. Enquiries should extend to physical alterations that are intentional or expected, and even to physical alterations that have not occurred yet. Importantly, the focus should be on whether the physical alteration has impaired the value or use of the property.

Further information

This article was written by Principal David Randazzo and Solicitor Andrea Csorgo. For further information or advice on any related matters please contact David.

Disclaimer: This information is current as of February 2025. This article does not constitute legal advice and does not give rise to any solicitor/client relationship between Meridian Lawyers and the reader. Professional legal advice should be sought before acting or relying upon the content of this article.