Honesty and good faith are vital ingredients for good relations in our daily lives and especially so in the business world. All the same, many of us live by the motto "non temere credere est nervus sapientæ" (not to believe rashly is the nerve of wisdom).
Insurance providers are no different but can from time to time face particular dilemmas. It may come to light that a claimant is lying. Anyone who has read Keith Waterhouse's classic "Billy Liar" will know lies are usually told to improve one's position. But proving an allegation of fraud is fraught with difficulty, because a high degree of probability is required to make out a case in court.
As a result of recent cases decided by the English courts dealing with the duties of the parties to an insurance contract after the inception of a risk, an insurer's right to avoid a policy due to a breach of the assured's duty of utmost good faith has become more limited. Avoidance may now only be available in cases of fraud.
Utmost good faith
While fraud is an element relevant to all contracts, non-disclosure is only relevant to contracts based on the principle of utmost good faith, of which insurance contracts are the main example. Every material circumstance must be disclosed and these are defined as facts which would influence the judgment of a prudent insurer in determining the premium or deciding whether to take the risk at all, although the insured is relieved from any obligation to inform about circumstances known or presumed to be known to the insurer in the ordinary course of his business. Any allegation of fraud must clear this hurdle.1
The doctrine of utmost good faith is found within sections 17 to 20 of the English Marine Insurance Act of 1906, which provide that "if the utmost good faith be not observed by either party, the contract may be avoided by the other party".2 The draconian remedy of avoidance - that of being able to avoid all liability under the insurance policy - and the ramifications of this "all or nothing" perception - presents a real stumbling block. Although the duty of utmost good faith lies on each party, the remedy of avoidance is, in practice, one-sided. Whilst insurers may seek to avoid the policy and thus the claim, all the insured can do is recover his premium in equity.
The continuing duty
The Marine Insurance Act focuses on honesty in the formation of the insurance contract.3 However, the courts have introduced the notions of "decisive influence"4 and "inducement"5 as further refinements to materiality. This was extended to relate to some post-contract formation issues, like for instance "held covered" clauses, affecting circumstances both material to the alteration of risk and inducement of the actual insurer into agreeing to that alteration. Breach of the pre-contract formation duty of utmost good faith requires subjective inducement of the actual insurer in question and there is no reason to distinguish the post-formation duty on this point.6
In the recent STAR SEA case, 7 whilst the House of Lords accepted that the Section 17 duty of utmost good faith continued to apply after the contract was originally concluded, it held that it was not the same as that owed at the pre-contractual stage, so that only fraud in the claims process would defeat a claim, while the only duty imposed on the assured was to act honestly. Moreover, although contractual remedies may exist, their Lordships were not at all favourably disposed to the avoidance remedy in Section 17, which confirms that the English courts are not prepared to allow any breach of duty of utmost good faith in a post-contractual context to give rise to such a harsh remedy.
Further reduction in the application of the continuing duty came again from the House of Lords in the case of the MERCANDIAN CONTINENT,8 where it was decided that invoking the remedy of avoidance in a post-contractual context would only be appropriate in situations similar to those where the insurer had the right to terminate for breach. Therefore, an insurer could not avoid the contract unless he could show that the fraud was relevant to his ultimate liability under the policy and was such as would entitle him to terminate the insurance contract. However, the court recognised a continuing duty on the assured to refrain from a deliberate misrepresentation or concealment of material facts intending to deceive the insurer. Good faith should be exercised by the assured when giving information pursuant to an express term of the contract.
In 2002 many of these judgments came under scrutiny once again in an evaluation undertaken by the House of Lords in the case of the AEGEON,9 which made the defence of fraud more accessible to insurers where there are suspicions of misrepresentation in claims. The case involved the loss of a 2,705 GT, 850 capacity passenger ferry which capsized and sank following a fire. It introduced the concept of "fraudulent devices" (dishonest or reckless falsehood or suppression by the insured in the claims process) allegedly used to promote a genuine and valid claim. The House of Lords was troubled by the law as it stands, which provides for only one remedy in respect of the breach of the duty of good faith, namely the avoidance of the whole contract, and expressed concern that the available remedy was disproportionate to the offence. It concluded that the common law duty of utmost good faith did not extend to litigation over an insurance claim, nor did the duty under Section 17, which allowed a party to avoid the contract. Lying in the course of litigation by an insured to embellish an otherwise valid claim was deplorable, but should not by itself invalidate the claim.
|1|| Strive Shipping Corp. & Anr v. Hellenic Mutual War Risk Association (Bermuda) Ltd (The GRECIA EXPRESS) -  2 Lloyd's Rep. 88. |
|2||3 Section 17. |
|3||Section 18 says "Every circumstance is material which would influence the judgment of a prudent insurer in fixing the premium or determining whether he will take the risk" and is also qualified by the words "Before the contract is concluded". |
|4||Container Transport International Inc. v. Oceanus Mutual U/W Association (Bermuda) Ltd.  1 Lloyd's Rep. 476. |
|5||Pan Atlantic Insurance Co. Ltd. v. Pine Top Ins. Co. Ltd.  1 AC 501. |
|6|| Ibid at p. 511. |
|7||Manifest Shipping & Co Ltd. v. Uni-Polaris Ins. Co. Ltd. (The STAR SEA)  1 Lloyd's Rep. 389. |
|8||K/S Merc-Scandia XXXXII v. Certain Lloyd's Underwriters (The MERCANDIAN CONTINENT)  2 Lloyd's Rep. 563. |
|9||Agapitos v. Agnew [2002 ] 2 Lloyd's Rep. 42.|
A shipowner, Truthful Shipping Lines (TSL), has a fleet of six general cargo vessels, insured with various insurers in London under the Institute Time Clauses, Hull (1/11/95).
On board the vessel MISHAP I, it has been discovered (after commencement of the policy) that due to a failure of the onshore management the main engine had not been maintained in accordance with the manufacturer's guidelines and as a result had suffered extensive damage in a number of areas.
If there was a continuing duty of utmost good faith, then surely TSL should have brought the matter to the attention of their insurers, as the fact was not only relevant to the vessel MISHAP I, but, given it was a material failure of the onshore management, then it was relevant to the other vessels as well.
Regrettably, TSL decided not to advise their insurers of this issue, although it did notify them of the engine damage in order to allow for a surveyor to attend.
Result (pre-changes to case law)
Insurers could argue that the claim was not recoverable as it would fall foul of the policy due to lack of diligence by onshore management. In addition, the insured's failure to disclose the lack of compliance with the manufacturer's guidelines would be a breach of the duty of utmost good faith and would provide the insurers with the right to avoid the policy from inception. This, of course, would not only affect the insurance arrangements of the MISHAP I, but all six vessels in the fleet.
Result (post-changes to case law)
The claim itself would still not be recoverable due to the provisions of the policy, but insurers would no longer be entitled to avoid the policy from inception for lack of utmost good faith and therefore it would remain in force for all six vessels.
The recent decisions, which have clarified the nature of the post-contract formation duty of utmost good faith, especially the level of good faith required when presenting claims under an insurance policy, also serve to highlight the fact that the English courts are still unlikely to allow any breach of the duty in a post-contractual context to give rise to the draconian remedy of avoidance ab initio by insurers.