Claims

‘4. Conclusions on the Marine Insurance Act 1906, section 17 as a basis for a general post-formation duty of utmost good faith

On careful analysis, none of the three pillars on which Hirst J [in The Litsion Pride [1985] 1 Lloyd’s Rep 437], sought to build a general post-formation duty of utmost good faith founded on the Marine Insurance Act 1906, section 17 are solid. Whether the order for ship’s papers was based upon the doctrine of utmost good faith at all is doubtful. Even if it was, the order lacked the reciprocity stipulated by section 17 and breach did not trigger the remedy of retrospective avoidance which section 17 stipulates is available. A duty of utmost good faith does attach to held covered clauses, but it is suggested that breach does not entitle the insurer to the remedy of avoidance of the entire contract. The fraudulent claims jurisdiction provides the best foundation in that avoidance is available as a remedy. Currently, however, the reasoning in Skandia that section 17 is exhaustive with respect to remedies is incompatible with the cases affording the insurer a range of remedies, although it is argued above that such reasoning is erroneous.

In truth, the three pillars relied on by Hirst J, lead to two conclusions. First, the authorities on held covered clauses and the fraudulent claims jurisdiction demonstrate that the doctrine of utmost good faith clearly has a post-formation dimension. Secondly, their differences in scope, standard of required behaviour and remedies for breach demand flexibility from the post-formation doctrine. If the authorities on orders for ship’s papers are properly regarded as an aspect of the post-formation doctrine, the diversity of the duties within that doctrine is merely accentuated. However, with or without the ship’s papers cases, the requisite diversity cannot be accommodated within section 17. The solution is to sever the post-formation doctrine from the strait-jacket of section 17 altogether, confining that provision to governing the reciprocal pre-formation duties owed by the assured and insurer. Once that step is taken, the various duties to which the post-formation doctrine gives rise can be developed according to their own dictates. It is, moreover, suggested that neither statute nor precedent inhibits the latter approach.

It is true that the wording of section 17 is sufficiently broad to encompass the post-formation duties, but equally its wording does not compel its application to the post-formation duties. Indeed, the proposition in section 17 that insurance contracts are “based upon” the utmost good faith may be read as indicating that section 17 is concerned with the formation of the contract as opposed to its subsequent operation. Moreover, section 17 is the first in a group of sections of the Marine Insurance Act headed “Disclosure and Representations”, consisting of sections 17–21. Apart from section 17 itself, the wording of the other four sections unequivocally confines their scope to the initial formation of the contract. Sections 18–20 have been discussed earlier. Section 21 is concerned with offer and acceptance. The context may, therefore, suggest that section 17 should likewise be confined to the pre-formation stage. With respect to precedent, very few judgments attach post-formation duties to five. 17 and the point has not been the subject of argument. Thus, in The Litsion Pride the application of section 17 to the post-formation doctrine, although endorsed by Hirst, J was, common ground between the parties. In The Good Luck the adoption of the reasoning of the Court of Appeal in Skandia implicitly involves applying section 17 to the post-formation doctrine, but the legitimacy of this application was not in dispute. Consequently, it is suggested that the post-formation duty should fall outside of section 17 altogether. Two benefits in particular would flow from severance.

First, severance would permit the courts to mould the remedy to the context just as they have sensibly moulded the content of the duty. As already noted, section 17 is inflexible with respect to remedies for breach. Any breach of a duty falling within section 17 affords the innocent party the right retrospectively to avoid the contract. The severity of this remedy is justifiable in the context of fraudulent claims. However, the fraudulent claims jurisdiction can support the remedy of retrospective avoidance without the assistance of section 17. By contrast, it has been argued above that retrospective avoidance of the entire contract is unjustifiable in the context of held covered clauses and compromises of claims. Consequently, remedial flexibility is required. This can be produced only by reading section 17 either as restricted to certain aspects of the post-formation duty or as not applying to the post-formation doctrine at all. The former reading is difficult to reconcile with the wording of section 17. If the section does apply to the post-formation doctrine, it would seem to apply to all aspects of the post-formation doctrine. Severing the post-formation doctrine from section 17 altogether would permit each duty to which the post-formation gives rise to support such remedy, or range of remedies, for breach as was appropriate to the duty in question.

Secondly, severing the post-formation doctrine of utmost good faith from section 17 may facilitate the elucidation of a satisfactory juristic basis. The principal characteristic of the various duties to which the post-formation doctrine does, or may, give rise is a lack of homogeneity. Following the suggestion of the Court of Appeal in The Star Sea, it may, be inappropriate to search for a single juristic basis for all aspects of the post-formation doctrine. The law of assignment supports a contractual analysis, and the key to the juristic bases of the duties within the post-formation doctrine may lie in the flexibility of the implied term in law, with each duty being supported by a separate implied term. While the doctrine of utmost good faith may provide the legal basis for implying the relevant terms, it does not have to dictate their scope, the standard of required conduct or the remedies for breach. Each duty could be the subject of a separate implied term, the precise facets of which could be left to the courts to mould as appropriate to the particular duty. Thus, were it thought that breach of a particular duty should give rise to a damages remedy, the implied term on which that duty was based could be declared to be promissory without prejudice to the contingent nature of implied terms supporting other duties within the overall doctrine. It might, for example, be argued that a strict liability duty attaching to the claims handling process would be the most effective way of combating bad faith practice by insurers, but only if breach were to sound in damages.

Ultimately, the function of the doctrine of utmost good faith in insurance contract law is to provide a legal basis for the implication by law of a number of contractual terms of diverse properties appropriate to the context and function of the term in question.

E. SUMMARY AND CONCLUSIONS

A central theme of this article is that the rhetoric of “utmost good faith” must never substitute for a careful consideration of what is good law in the particular and modern context. The Statements of Practice of the Association of British Insurers constitute an acceptance by the insurance industry that the traditional principles of insurance contract law, developed when the industry was dominated by commercial policies of marine insurance, are not appropriate for all sectors of the modern industry. The future development of the doctrine of utmost good faith must take place against an evaluation of the extent to which it continues to be appropriate for parties to insurance contracts, in practice usually the insurers, to occupy a privileged position as opposed to all other contracting parties and litigants.

It may be useful to summarise the main arguments advanced.

  1.   The Marine Insurance Act 1906, section 17 provides expressly for the remedy of avoidance of the contract for breach. This means retrospective avoidance of the entire contract. The extent to which section 17 should be viewed as the basis of all aspects of the doctrine of utmost good faith depends on whether some measure of flexibility in the remedies for breach or standard of conduct is viewed as appropriate.

  2.   Section 17 is the basis of the entirety of the reciprocal pre-formation duties of utmost good faith resting upon the insurer and assured. Sections 18 and 20 to the extent that it applies to the assured provide details of the two main aspects of the assured’s preformation duty under section 17.

  3.   Outside of and independently from the assured’s duty of utmost good faith, an insurer is entitled to avoid the policy for pre-formation non-disclosure under section 19 and misrepresentation under section 20 by an agent to insure. In all probability, this aspect of the pre-formation doctrine does not fall within section 17.

  4.   The reasoning of the Court of Appeal in Skandia reveals a tenable justification for denying a damages remedy for breach of the duty of utmost good faith. However, breach of a contractual term implied in law need not sound in damages. The wording of the Marine Insurance Act, previous authority and the origin of the doctrine of utmost good faith are all perfectly compatible with an implied term basis for the duty. The law of assignment supports such an analysis. The doctrine of utmost good faith developed by the common law courts and codified in the Marine Insurance Act is a common law doctrine and the juristic basis of the duties generated by the pre-formation doctrine is a contractual contingent condition precedent to the enforceability of the contract implied in law.

  5.   The heterogeneity of the various duties to which the post-formation doctrine of utmost good faith gives rise requires flexibility in scope, standard and remedies. The unequivocal availability of retrospective avoidance as a remedy for any breach of section 17 denies any possibility of remedial flexibility. Consequently, it is suggested that the post-formation doctrine of utmost good faith lies entirely outside section 17.

  6.   The flexibility required by the heterogeneity of the various duties generated by the post-formation doctrine requires also a flexible juristic basis for the doctrine. The law of assignment again supports a contractual basis. Accordingly, each duty within the post-formation doctrine may be the subject of a separate contractual term implied in law, the precise properties of which may be moulded by the courts as appropriate to the duty in question.

  7.   In principle, the post-formation doctrine of utmost good faith attaches to all terms of insurance contracts under which the assured is required by the policy to give the insurer information relevant to fixing the terms on which cover is granted or to be extended and to the making of claims. Outside of such matters, however, there is no duty to disclose information simply because it would be of value to the insurer.

  8.   With respect to the giving of information or notice pursuant to express contractual terms, such as held covered clauses, the post-formation duty is strict liability in nature but moulds itself to its context in terms of scope and, it is suggested, remedy. Breach entitles the insurer to avoid such extension of cover as the insurer has been induced to grant by the breach.

  9.   The development of the order for ship’s papers is consistent with a doctrine of utmost good faith but the order was probably not part of the doctrine. It was certainly no part of the section 17 duty of utmost good faith.

10.   The fraudulent claims jurisdiction is part of the post-formation duty of utmost good faith. An assured who makes a fraudulent claim is liable, at the insurer’s option, to forfeit the entire benefit of the policy. The insurer has the choice either to reject the entire claim, even if the fraud affects only part, or retrospectively to avoid the entire policy. It is possible also that a fraudulent claim may constitute a repudiatory breach of contract so that the insurer also has the option to elect to treat his liability under the contract as prospectively discharged.

11.   The apparent harshness of a retrospective remedy in the event of a fraudulent claim is fully justified in all areas of insurance by the policing function of the doctrine of utmost good faith in that particular context. However, the argument that the realities of insurance practice justify a strict liability duty at the claims stage attracting a retrospective remedy is not immediately apparent in the modern world.

12.   If the duty attaching to the making of claims is confined to the avoidance of fraud, a strict liability duty of utmost good faith may still attach to contracts of compromise of claims on insurance policies, although there is little authority for such a duty at present and, again, it is not immediately apparent why compromises of insurance contracts should be singled out for special treatment. Any such duty, if broken, should permit avoidance only of the compromise, not the entire policy.’

Lord Hobhouse:

‘Before your Lordships the defendants contended that there was a positive duty of fair dealing and disclosure any breach of which would amount, in effect, to constructive fraud giving rise to the section 17 remedy of an entitlement to avoid the contract. But the defendants also had to contend that the duty extended up to and included the pursuit of any claim in litigation since this was the stage at which the matters upon which they relied had occurred. Thus, the defendants argued that it was a breach of that duty for the assured to claim privilege for a document which might assist the insurer to resist the claim…

…[B]oth Counsel submitted that the utmost good faith is a principle of fair dealing which does not come to an end when the contract has been made…

There are many judicial statements that the duty of good faith can continue after the contract has been entered into…However, as will also become apparent from the citation, the content of the obligation to observe good faith has a different application and content in different situations. The duty of disclosure as defined by sections. 18 and 20 only applies until the contract is made.

…[B]oth Counsel accept and assert that the conclusion of the Court of Appeal in the Banque Keyser case [see chapter 4, [424]] is good law and that there is no remedy in damages for any want of good faith. Counsel also drew this conclusion from the second half of section 17 — “may be avoided by the other party”. The sole remedy, they submitted, was avoidance. It follows from this that the principle relied upon by the defendants is not an implied term but is a principle of law which is sufficient to support a right to avoid the contract of insurance retrospectively…

The right to avoid referred to in section 17…applies retrospectively. It enables the aggrieved party to rescind the contract ab initio. Thus he totally nullifies the contract. Everything done under the contract is liable to be undone. If any adjustment of the parties’ financial positions is to take place, it is done under the law of restitution not under the law of contract. This is appropriate where the cause, the want of good faith, has preceded and been material to the making of the contract. But, where the want of good faith first occurs later, it becomes anomalous and disproportionate that it should be so categorized and entitle the aggrieved party to such an outcome. But this will be the effect of accepting the defendants’ argument. The result is effectively penal. Where a fully enforceable contract has been entered into insuring the assured, say, for a period of a year, the premium has been paid, a claim for a loss covered by the insurance has arisen and been paid, but later, towards the end of the period, the assured fails in some respect fully to discharge his duty of complete good faith, the insurer is able not only to treat himself as discharged from further liability but can also undo all that has perfectly properly gone before. This cannot be reconciled with principle…

A coherent scheme can be achieved by distinguishing a lack of good faith which is material to the making of the contract itself (or some variation of it) and a lack of good faith during the performance of the contract which may prejudice the other party or cause him loss or destroy the continuing contractual relationship. The former derives from requirements of the law which preexist the contract and are not created by it although they only become material because a contract has been entered into. The remedy is the right to elect to avoid the contract. The latter can derive from express or implied terms of the contract; it would be a contractual obligation arising from the contract and the remedies are the contractual remedies provided by the law of contract. This is no doubt why Judges have on a number of occasions been led to attribute the post-contract application of the principle of good faith to an implied term.

The principle relied on by the defendants is a duty of good faith requiring the disclosure of information to the insurer. They submit that the obligation as stated in section 17 continues throughout the relationship with the same content and consequences. Thus, they argue that any non-disclosure at any stage should be treated as a breach of the duty of good faith: it has the same essential content and gives rise to the same remedy — the right to avoid…

…[The] authorities show that there is a clear distinction to be made between the precontract duty of disclosure and any duty of disclosure which may exist after the contract has been made. It is not right to reason, as the defendants submitted that your Lordships should, from the existence of an extensive duty pre-contract positively to disclose all material facts to the conclusion that post-contract there is a similarly extensive obligation to disclose all facts which the insurer has an interest in knowing and which might affect his conduct. The Courts have consistently set their face against allowing the assured’s duty of good faith to be used by the insurer as an instrument for enabling the insurer himself to act in bad faith. An inevitable consequence in the post-contract situation is that the remedy of avoidance of the contract is in practical terms wholly one-sided. It is a remedy of value to the insurer and, if the defendants’ argument is accepted, of disproportionate benefit to him; it enables him to escape retrospectively the liability to indemnify which he has previously and (on this hypothesis) validly undertaken…

Fraudulent claims

This question arises upon policies which up to the time of the making of the claim are to be assumed to be valid and enforceable. No right to avoid the contract had arisen. On ordinary contractual principles it would be expected that any question as to what are the parties’ rights in relation to anything which has occurred since the contract was made would be answered by construing the contract in accordance with its terms, both express and implied by law. Indeed, it is commonplace for insurance contracts to include a clause making express provision for when a fraudulent claim has been made. But it is also possible for principles drawn from the general law to apply to an existing contract — on the better view, frustration is an example of this as is the principle that a party shall not be allowed to take advantage of his own unlawful act. It is such a principle upon which the defendants rely in the present case. As I have previously stated there are contractual remedies for breach of contract and repudiation which act prospectively and upon which the defendants do not rely. The potential is also there for the parties, if they so choose, to provide by their contract for remedies or consequences which would act retrospectively. All this shows that the Courts should be cautious before extending to contractual relations principles of law which the parties could themselves have incorporated into their contract if they had so chosen…

Where an insured is found to have made a fraudulent claim upon the insurers, the insurer is obviously not liable for the fraudulent claim…The law is that the insured who has made a fraudulent claim may not recover the claim which could have been honestly made. The principle is well established and has certainly existed since the early nineteenth century…The logic is simple. The fraudulent insured must not be allowed to think: if the fraud is successful, then I will gain; if it is unsuccessful, I will lose nothing.

In Goulstone v Royal Insurance Co (1858) 1 F & F 276, which concerned a fire policy and a plea that the claim was fraudulently exaggerated, Pollock, CB directed the jury that if the claim “was wilfully false in any substantial respect”, they should find for the defendant as the plaintiff had in that case “forfeited all benefit under the policy” (p 279). In Britton v Royal Insurance Co (1866) 4 F & F 905, also a fire insurance case where it was alleged that the insured took advantage of the fire to make a fraudulent claim, Mr Justice Willes directed the jury:

Mr Justice Willes stressed to the jury that it was of the utmost moment that insurances should be enforced fairly and protected from fraud (p 911).

These authorities link the defence to the observation of good faith but are specifically based upon the actual fraud of the insured in making the claim. These judgments do not use the language of avoidance of the policy ab initio but refer to the forfeiture of “all benefit under the policy” or “all claim” upon it. It seems that the language used at the time in express clauses was similar…

Modern authorities have not however always adopted this analysis. In Orakpo v Barclays Insurance Services Ltd [1995] LRLR 443, the insurance covered damage to a building. The insurance contract was in any event voidable since it had been induced by material misrepresentation but the defendant insurance company had also relied upon the defence that the claim was grossly exaggerated and fraudulent. In the Court of Appeal the defence was apparently argued upon the basis of implied term on the assumption that the continuing duty of good faith should be so analysed. The appellant plaintiff was appearing in person. The Court of Appeal dismissed his appeal holding unanimously that there had been a misrepresentation. But, obiter, there was a difference of opinion on the fraudulent claim defence. Lord Justice Staughton, dissenting, was of the opinion that any breach of an implied term or, the duty of good faith would not have been so fundamental as to entitle the insurer to be discharged from liability. The majority, Lord Justice Hoffmann and Sir Roger Parker, held that the insurer would on that ground as well have had a defence to the whole of the claim. The decision of Lord Justice Hoffmann was arrived at applying contractual principles: he was concerned with an implied term (p 451):

…Sir Roger Parker said, at p 452:

…These dicta do not assist the defendants in the present case on the critical point whether anything less than actual fraud in the making of the claim brings the principle into play. Counsel have assured your Lordships that in the present case nothing turns upon whether the claim is wholly forfeit or the whole policy is treated as forfeit as well. The authority of Britton is that the whole claim is forfeit, which was what was material in the Orakpo case. As regards the question, academic in the Orakpo case and academic in the present case save as a pleading point, whether the making of a fraudulent claim would entitle the insurer to avoid the contract ab initio, that is a point upon which the judgments in Orakpo cannot be treated as fully authoritative in view of the contractual analysis there adopted. The language of Mr Justice Hoffmann is fully justified on that contractual analysis — “goes to the root of the contract and entitles the insurer to be discharged”. The fraud is fundamentally inconsistent with the bargain and the continuation of the contractual relationship between the insurer and the assured.

The same subject matter is discussed in two later cases to which I should refer. The first is the decision of the Court of Appeal in Galloway v Guardian Royal Exchange (UK) Ltd. [1999] Lloyd’s Rep IR 209, a case similar to Orakpo involving a householder’s insurance, a material misrepresentation in the proposal form and a fraudulent claim. The plaintiff’s claim under the policy failed on both grounds. As regards the fraudulent claim defence, the Court of Appeal followed and applied what had been said by Mr Justice Willes in Britton. On the point of difference between Lord Justice Staughton and Lord Justice Hoffmann and Sir Roger Parker in Orakpo, they preferred the view of the latter on the seriousness of any fraud in the making of a claim. Lord Woolf MR referred also to the speech of Viscount Sumner in Lek v Mathews (1927) 29 Ll L Rep 141 at p 145 stressing the seriousness of any fraudulent claim unless it could be treated as de minimis. “The policy of the law in this area, it seems to me”, said Lord Woolf, at p 213 “must be to discourage the making of fraudulent claims.” Lord Justice Millett in a short concurring judgment stressed the seriousness of such fraud and the public interest in discouraging it. In that context he expressed himself in terms similar to those of section 17 — stating that the Court should consider the fraudulent claim itself and then consider whether “the making of that claim by the insured is sufficiently serious to justify stigmatising it as a breach of his duty of good faith so as to avoid the policy” (p 214). While this case puts the principle on the basis of a rule of law not an implied term, it did not need to consider, nor is it clear that they were focussing on, the distinction between something which would defeat any claim under the policy and something which avoided the contract ab initio with all that that would entail. The case does not support the submission that something less than a fraudulent claim will suffice to give the insurer a defence.

The other decision is that of Mr Justice Rix in Royal Boskalis Westminster NV v Mountain [1997] LRLR 523, reversed on grounds which do not affect the value of the judgment of Mr Justice Rix in relation to the principle of good faith at pp 591 et seq. He powerfully questions whether in relation to claims the right of the insurer to repudiate all liability can extend beyond the making of a fraudulent claim to an innocent failure to disclose. He points out the difficulties which would arise in relation to the test of materiality and remedy. Again, the judgment underlines the relevance of fraud…

Finally, mention should be made of the judgment of Mr Justice Hirst in The Litsion Pride [above] which has been used in a number of cases to support a general view of the post contract duty of good faith. It was an exceptional case in that it involved a war risks policy under which the insured shipowners were entitled to send their ship into a highly dangerous war risk zone in the Persian Gulf against an obligation to pay a heavy additional premium calculated on the length of time spent in the zone. The policy, however did not require the shipowner to declare in advance that the ship was entering the zone but permitted declarations after it had done so. As a result the shipowners had a strong motive only to declare the entry if the vessel suffered a loss and that is what they did. Mr Justice Hirst held that this practice was not a breach of contract but was done with the fraudulent intent of depriving the insurer of the additional premiums to which it was entitled. He held that the insurer was not liable to pay the claim. There had been a breach of the duty of good faith. The remedy was not confined to electing to avoid the policy; the insurer had elected not to avoid it. The insurer was entitled to rely on the breach as giving it a defence to the claim of the mortgagee of the vessel, the only effective plaintiffs in the action. The particular claim was only fraudulent in so far as the broker had not been truthful in dealing with the insurers at that stage. The reasoning adopted by Mr Justice Hirst has been criticized both by academic writers and by other Judges in later cases. I consider that it should not any longer be treated as a sound statement of the law. In so far as it decouples the obligation of good faith both from section 17 and the remedy of avoidance and from the contractual principles which would apply to a breach of contract it is clearly unsound and cannot survive the Court of Appeal judgment in Banque Keyser, upheld by your Lordships’ House. In so far as it is based upon the principle of the irrecoverability of fraudulent claims, the decision is questionable upon the facts since the actual claim made was a valid claim for a loss which had occurred and had been caused by a peril insured against when the vessel was covered by a held covered clause. It is not necessary to examine whether there might or might not have been some other basis upon which the case could be decided in favour of the insurer as one feels it clearly ought to have been. But what is clear is that the judgment of Mr Justice Hirst is not a sound basis for the arguments advanced by the defendants in the present case.

For the defendants to succeed in their defence under this part of the case the defendants have to show that the claim was made fraudulently. They have failed to obtain a finding of fraud…The claim was in fact a good one which the owners were, subject to quantum, entitled to recover under the policy. The defendants were liable to pay it. The policy was valid and enforceable. For the defendants successfully to invoke section 17 so as to avoid the policy ab initio and wholly defeat the claim would be totally out of proportion to the failure of which they were complaining. Fraud has a fundamental impact upon the parties’ relationship and raises serious public policy considerations. Remediable mistakes do not have the same character…

In litigation

The point here is whether the obligation of good faith and disclosure continues to apply unqualified once the parties are engaged in hostile litigation before the Courts. There is no authority directly on this point. It was decided in favour of the owners by both Courts below. There are however dicta in cases which show that the Judges concerned contemplated that the obligation of good faith could continue to apply during litigation…

Before the litigation starts the parties’ relationship is purely contractual subject to the application of the general law. If one party has a right such as that given by section 17 it derives from the contract itself or from the application of the general law to the contractual relationship. These rights continue unimpaired unless one party has exercised a right of avoidance or termination. The insured has or may have a claim against the insurer. The insurer may have accepted the claim or may have rejected it. The insurer may have done so in a manner which evinces an intention not to be bound by the contract or, more probably, may simply be requiring to be satisfied that there is a valid claim covered by the policy. But the insured will either have or not have a cause of action against the insurer…

When a writ is issued the rights of the parties are crystallized. The function of the litigation is to ascertain what those rights are and grant the appropriate remedy. The submission of the defendants in this case is that, notwithstanding this, one party’s conduct of the litigation can not only change that party’s substantive rights but do so retrospectively avoiding the contract ab initio. It cannot be disputed that there are important changes in the parties’ relationship that come about when the litigation starts. There is no longer a community of interest. The parties are in dispute and their interests are opposed. Their relationship and rights are now governed by the rules of procedure and the orders which the Court makes on the application of one or other party. The battle lines have been drawn and new remedies are available to the parties. The disclosure of documents and facts are provided for with appropriate sanctions; the orders are discretionary within the parameters laid down by the procedural rules. Certain immunities from disclosure are conferred under the rules of privilege. If a party is not happy with his opponent’s response to his requests he can seek an order from the Court. If a judgment has been obtained by perjured evidence remedies are available to the aggrieved party. The situation therefore changes significantly. There is no longer the need for the remedy of avoidance under section 17; other more appropriate remedies are available…

…The section 17 principle is a principle of law and if its rationale no longer applies and if its operation, the conferment of a right of avoidance, ceases to make commercial or legal sense then it should be treated as having been exhausted or at the least superceded by the rules of litigation. It will also very often be the case that by the time the litigation has started the cover has expired or its subject matter has ceased to exist so as to make the continuing relationship of insurer and insured no longer current and the observation of good faith only significant to the litigation.

I am therefore strongly of the view that once the parties are in litigation it is the procedural rules which govern the extent of the disclosure which should be given in the litigation, not section 17 as such, though section 17 may influence the Court in the exercise of its discretion. The cases upon ship’s papers, far from supporting the continuing application of the duty of good faith in truth support the opposite conclusion. As previously discussed, the fact that orders for ship’s papers were only made in marine insurance despite the fact that the principle of good faith applies to all insurance and the fact that the order was a matter of discretion not of right shows that it is a procedural remedy not a matter of contract although the principle of good faith clearly influenced the attitude of the Court to making such an order. But, most conclusively, the fact that the remedy was to obtain an order from the Court and not to avoid the contract shows both the limits of the principle and the change of relationship which comes about when the parties are in hostile litigation…

Conclusion

I have in the course of this speech referred to some cases from other jurisdictions. It is a striking feature of this branch of the law that other legal systems are increasingly discarding the more extreme features of the English law which allow an insurer to avoid liability on grounds which do not relate to the occurrence of the loss. The most outspoken criticism of the English law of non-disclosure is to be found in the judgment in the South African case…Mutual and Federal Insurance Co Ltd v Oudtshoorn Municipality 1985 (1) SA 419. There is also evidence that it does not always command complete confidence even in this country: Container Transport International Ltd. v Oceanus Mutual Underwriting Association (Bermuda) Ltd [chapter 4, [403]], Pan Atlantic v Pine Top [chapter 4, [405]]. Such authorities show that suitable caution should be exercised in making any extensions to the existing law of non-disclosure and that the Courts should be on their guard against the use of the principle of good faith to achieve results which are only questionably capable of being reconciled with the mutual character of the obligation to observe good faith…’

Longmore LJ:

‘In this appeal from Aikens J the Court is concerned with the ambit of section 17 of the Marine Insurance Act 1906…

The extent to which this section applies once a contract of insurance has been concluded has never been authoritatively determined, but it has recently been considered by the House of Lords in Manifest Shipping Co Ltd v Uni-Polaris Insurance Co (The Star Sea) [above]…The House held that culpable non-disclosure was insufficient to attract the drastic consequence of avoidance provided by section 17. The result was that the insured shipowner could recover under the insurance policy despite such culpable non-disclosure and a consequent purported avoidance by the insurers…

The Marine Insurance Act, 1906 was and is a codification of the law of marine insurance. The law as there stated is, in general, no different from that for other forms of insurance in so far as the duties in relation to good faith, disclosure and representations are concerned. Generally speaking again, the duties to disclose material matters and not to make material misrepresentations apply before the contract is concluded and do not continue after the contract is concluded. An insurer is not able to require disclosure of matters which show he has made a bad bargain. One question that has arisen is whether there is a continuing duty to disclose material matters, if the insurer is entitled to cancel the policy by serving a notice of cancellation. This Court held in New Hampshire Insurance Co v Mirror Group Newspapers Ltd [1997] LRLR 24 that there was not. Staughton LJ gave the judgment of the Court; he set out section 17 of the Act and the requirement in section 18(1) that the assured must disclose, before the contract is concluded, every material circumstance known to the assured…Staughton LJ then recorded a submission that section 18(1) was merely one example of the general duty that was placed upon both parties at all times by section 17 and said:

I would respectfully echo that sentiment. In the light of this remark and the Judge’s conclusion that the duty of good faith only applies post-contract if the insurer is invited to renew or vary his speculation or risk or if the insured is pursuing a claim under the policy, it is necessary to trace the development of this area of the law in a little detail…

Development of the law of post-contract good faith

(1) Fraudulent claims

The law about the making of fraudulent claims originally developed in fire insurance cases, see Levy v Baillie (1831) 7 Bing. 349; Goulstone v Royal Insurance Co (1858) 1 F & F 276; Britton v Royal Insurance Co (1866) 4 F & F 905. The inclusion of some such clause as is now in Lloyd’s J Form has always been common; the same principle will apply as a matter of law, even in the absence of an express term. I have already observed that there is some debate whether the relevant principle of law is an example of the application of the good faith principle giving rise only to a right of avoidance or a separate development of law…One of the important conclusions of The Star Sea was that when it came to making a claim, the duty of the insured was one of honesty only. In any event the present case is not a case where the insured has made a claim at all, let alone a fraudulent claim…

Conclusions on the law of post-contract good faith

…It seems to me that the solution to the problem must be found in the somewhat broader context of the appropriate remedy, as I have indicated…above. Section 17 states that the remedy is the remedy of avoidance but does not lay down the situations in which avoidance is appropriate. It is, in my judgment, only appropriate to invoke the remedy of avoidance in a post-contractual context in situations analogous to situations where the insurer has a right to terminate for breach. For this purpose (A) the fraud must be material in the sense that the fraud would have an effect on underwriters’ ultimate liability as Rix J held in Royal Boskalis and (B) the gravity of the fraud or its consequences must be such as would enable the underwriters, if they wished to do so, to terminate for breach of contract. Often these considerations will amount to the same thing; a materially fraudulent breach of good faith, once the contract has been made, will usually entitle the insurers to terminate the contract. Conversely, fraudulent conduct entitling insurers to bring the contract to an end could only be material fraud. It is in this way that the law of post-contract good faith can be aligned with the insurers’ contractual remedies. The right to avoid the contract with retrospective effect is, therefore, only exercisable in circumstances where the innocent party would, in any event, be entitled to terminate the contract for breach.

The desirability of aligning the right to avoid with the right to terminate the contract for breach is self-evident. It is often observed that the right of avoidance is disproportionate (see the speech of Lord Hobhouse, paras 61 and 72). If the right to avoid in a post-contract context is exercisable only when the right to terminate for breach has arisen, the disproportionate effect of the remedy will be considerably less and the extra advantages given to insurers when they exercise a right of avoidance (eg non- liability for earlier claims) will be less offensive than they otherwise would be.

The requirement of materiality has, of course, always been required for avoidance for lack of pre-contract good faith. More significantly, it is also a requirement for the operation of the rule about fraudulent claims. The case of Goulstone v Royal Insurance Co (1858) 1 F & F 276 is instructive [see Lord Hobhouse’s speech in the The Star Sea, above, [1102]]…Chief Baron Pollock said to the jury that the plaintiff’s interest was nevertheless legally insurable, whether or not the creditors ought to have the benefit of the insurance. He continued:

The Chief Baron is there drawing a distinction between the material and substantial fraud in the claim on underwriters in respect of the over-valuation of the furniture and the immaterial fraud of concealing the linen and china from the creditors…

In the context of deliberate and culpable (but not fraudulent) post- contract conduct, Rix J in Royal Boskalis [[1997] LLRR 523] said that a fact would only be material if it had ultimate legal relevance to a defence under the policy…and Aikens J has adopted that as the appropriate test of materiality where fraud has been proved…

Aikens J expressed his conclusion as to the law in that and the following paragraph of his judgment. His view was that there was a continuing duty on the assured to refrain from a deliberate act or omission intended to deceive the insurer through either positive misrepresentation or concealment of material facts and facts would only be material for the purpose if they had ultimate legal relevance to a defence under the policy. I agree with the Judge’s conclusion summarised in this way save that I would also add (even if it is usually or invariably to state the same conclusion in different words) that the insurers cannot avoid the contract of insurance for such fraudulent conduct unless the conduct was such as to justify their terminating the contract in any event. If and in so far as Aikens J was intending to go further than this and say that the insurers’ defence of bad faith was inapplicable because no “good faith occasion” had arisen…I would not agree, since it seems to me that the duty not to be materially fraudulent does continue at all times after the contract has been made.

To this extent, therefore, I would reject Mr Rainey’s submission that there are only some occasions when the requirement of good faith exists post-contract and accept Mr Hirst’s submission that the duty is a continuing one. If, however, I am wrong about that and there are defined categories of good faith arising post-contract, I would conclude that the giving of information, pursuant to an express or implied obligation to do so in the contract of insurance, is an occasion when good faith should be exercised. Since, however, the giving of information is essentially an obligation stemming from contract, the remedy for the insured fraudulently misinforming the insurer must be commensurate with the insurer’s remedies for breach of contract. The insurer will not, therefore, be able to avoid the contract of insurance with retrospective effect unless he can 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.

Application to the facts of the case

…In my view the fraud was not relevant, ultimately or at all, to insurers’ liability. The fraud was in relation to the jurisdiction in which and the law by which the claim against insurers was to be tried. In the event, it turned out that the law of England and the law of Trinidad were the same so it made no difference to insurers’ liability under the policy that it fell to be determined by English law. It is impossible to imagine that the place of trial of the claim against the insured ship repairers would have made any difference to insurers’ liability. I have already given reasons for saying that I am not persuaded that fraud by either or both of the Baboolal brothers would have made the evidence of their employees on the matter of responsibility for tightening the bolts of the engine to the correct tension any more or less believable than it would otherwise have been. It is also the fact that the fraud was never directed at the insurers; the deception was aimed at the shipowners; it was incidental that the assured had also to deceive their own solicitors who had been appointed by and were being paid for by the insurers. All that can be said is that these solicitors maintained their summons opposing English jurisdiction somewhat longer than they might otherwise have done…

For these reasons, the defence based on section 17 of the 1906 Act fails and I would dismiss the appeal.’

Arden LJ:

‘The facts are that Mrs Khan and her husband own 22 Camborne Way, Hounslow. On 23 July 1999 Mrs Khan took out a policy of insurance on the house and contents with the respondent in this appeal (“Direct Line”). Under the policy her husband was named as a joint policyholder and the interest of Barclays as mortgagee was noted…

On 8 January 2000 a fire occurred at the property and Mr and Mrs Khan lost certain of their possessions and had to move out. At all material times Mr and Mrs Khan have lived together as man and wife, but following the fire Mrs Khan has been depressed and the insurance claims arising out of the fire have been made by Mr Khan on behalf of them both.

Mr Khan made a claim under the policy for rent alleged to be payable for alternative accommodation at 68 Standard Road, Hounslow. He pretended that the property belonged to a friend, Mr Gabriel, and he forged a receipt for rent and a deposit, alleged to have been paid to Mr Gabriel for this accommodation. He also proffered a false rental agreement to Direct Line.

The rent was duly repaid by Direct Line. In point of fact no rent was payable because Mr Khan owned this property and Direct Line, therefore, brought these proceedings seeking summary judgment to recover all monies paid in respect of the fire, including payments for reinstatement of the property. Direct Line have made payments under the policy as follows: the reinstatement of the buildings £43,425.90; replacement of the contents, £18,915.95 and rent payable in respect of the alternative accommodation, 68 Standard Way, Hounslow, £8,257.47. Direct Line relies on the principle that an insured loses all right to recover in respect of a policy if a material part of the claim, that is a non de minimis part of the claim, which he makes is fraudulent (see Galloway v Guardian Royal Exchange UK Ltd [1999] Lloyds Reports 209 [considered by Lord Hobhouse, above, [11.2]]).

The judge applied the principle in the Galloway case. He rejected the argument that Mr Khan could have claimed for rental lost on 68 Standard Road as a result of having to use it for accommodation for himself and his wife and as a result of it therefore being no longer available for rent, as the claim which was made was for rent and it was made dishonestly.

The judge rejected the argument that Mrs Khan was the sole policyholder and rejected the argument that she should be able to recover on the basis that the fraud had been committed by her husband without her knowledge…

On this appeal, therefore, Mr Andrew Nicol, who appears for Mrs Khan, makes the following submissions: first, he submits that even if the policy was a joint policy Mrs Khan should be able to recover on the different heads of claim arising out of the fire because she did not know that the claim was put forward dishonestly; and secondly he relies on the Unfair Terms in Consumer Contract Regulations 1994.

The court made it clear to counsel that for the purposes of the first submission which Mr Nicol made the court was prepared to assume, without of course deciding it, that the policy was a separate policy in respect of Mrs Khan’s interest. Mr Nicol submits persuasively that whether the policy insures joint or several interests, Mrs Khan, who is innocent of any fraud, should be able to recover on the other heads as a matter of policy. He submits that this is the modern approach…

Mr Nicol criticises a policy in the law which penalises Mrs Khan. He submits that it is a flawed policy and results in a disproportionate penalty on her as an innocent party. The difficulty about this argument…is that the court is in my judgment bound by the Galloway case to which I have referred above…

…Mr Nicol submits that the Galloway case can be distinguished because there the fraud included fraud at the inception of the policy, and no agency relationship was involved. He submits that that is what led the Court of Appeal in that case to conclude that the contract was void ab initio.

Mr Nicol then took us to [The Star Sea] to show us that it may be too extreme a view to say that the contract of insurance is avoided ab initio. The Star Sea case was not a case of a fraudulent claim but of culpable non-disclosure…

So too in this case there is no need for the court to distinguish between an avoidance of the contract ab initio and something which would defeat the claim arising out of the fire in January 2000. This is not a case where there was some prior claim which was duly settled which the insurers were trying to recover. So, as I see it, there is nothing in the Manifest case which detracts from the authority of the Galloway case and, as I see it, that case cannot be distinguished on the ground that it included a fraud at the inception of the policy. That point simply played no part in the reasoning of the Court of Appeal since the consequences of the answer to the second preliminary question were not addressed…

Mr Flenley appears on this appeal for the respondent…We have not called upon him, but we have had the benefit of his skeleton argument and indeed of the respondent’s notice which was put in on behalf of Direct Line. In that respondent’s notice Direct Line seeks to uphold the judge’s decision on the basis that Mr Khan’s actions which constituted fraudulent exaggeration of both the defendants’ insurance claims were actions which Mr Khan carried out partly on his own behalf and partly as agent for Mrs Khan within the scope of Mr Khan’s actual or apparent authority from Mrs Khan. Mrs Khan was, therefore, bound by the consequences of those fraudulent actions and that those consequences are as found by the judge.

That contention in the respondent’s notice is supported in Mr Flenley’s skeleton argument. As I see it there is no answer to this point. The principles of agency law are well established and bind this court. There is one qualification that I must make, Mr Nicol put forward a submission that the principal is bound by the representations made by its agent, even if fraudulent, should not apply where there was a single policy simply as a matter of commercial convenience but, as Mr Nicol frankly accepted, there is no authority to support this proposition and, therefore, it is not one which, in my judgment, can be applied here…

Lastly, Mr Nicol relied on The Unfair Terms of Consumer Contracts Regulations 1994. Regulation 3 of these Regulations provide that subject to Schedule 1:

35. Paragraph (3) of Regulation 3 says:

As I read these Regulations they do not apply to a situation where a contract is affected by a rule of law, even though the contract is made with a consumer and is otherwise within the purview of these Regulations. Such a term could not be described as one which has been “drafted in advance”. Moreover, I would find it a startling proposition if any rule of law could be reviewed under these Regulations. It seems to me to be well outside the purpose and spirit of the Regulations and might produce some surprising results.

Moreover, so far as any unfairness is concerned it would have to take into account that the rule of law set out in the Galloway case is furtherance of a policy of discouraging fraudulent claims…

So it is not simply a question of the rule preventing recovery of a benefit to which the policyholder was not entitled. The rule is also directed to deterrence and to discouraging false claims. Contrary to Mr Nicol’s submission, in my judgment this is a proper objective of the civil law in an appropriate case and this is one such case. A civil law sanction, particularly a financial one, made in an appropriate case may be more effective than a criminal sanction or other sanction.

In all these circumstances and for these reasons I would dismiss this appeal.’

Mance LJ:

‘It has been said that the more cases there are endorsing a particular proposition, the shakier it may be (cf Posner, The Problems of Jurisprudence, Harvard University Press, p 83). The waves of insurance litigation over the last 20 years have involved repeated examination of the scope and application of any post-contractual duty of good faith. The opacity of the relevant principles — whether originating in venerable but cryptically reasoned common law cases or enshrined, apparently immutably, in section 17 of the Marine Insurance Act, 1906 — is matched only by the stringency of the sanctions assigned. Not surprisingly, recent clarification of aspects of these principles has been influenced by this stringency, particularly in the context of section 17: see eg, The Star Sea [above, [1102]]…and K/S Merc-Scandia v Certain Lloyd’s Under-writers (The Mercandian Continent) [above, [1103]].

The older common law cases (particularly, Levy v Baillie (1831) 7 Bing. 349, Goulstone v Royal Insurance Co. (1858) 1 F & F 276 and Britton v Royal Insurance Co (1866) 4 F & F 905) stand for a rule of law, applicable even where there is no express clause in the policy, to the effect that an insured who has made a fraudulent claim forfeits any lesser claim which he could properly have made…It was unnecessary in The Star Sea to consider whether the whole policy is (at least if it is a marine policy) then also voidable, by application of or analogy with section 17…Nor did that issue arise in either of the modern decisions to which Lord Hobhouse there referred — Orakpo v Barclays Insurance Services Ltd [1995] LRLR 443, dicta in which Lord Hobhouse was careful not to endorse, and Galloway v Guardian Royal Exchange (UK) Ltd [1999] Lloyd’s Rep IR 209 (still more recently applied in this Court in Direct Line Insurance plc v Khan [2001] EWCA Civ 1794)…

The present appeal raises for consideration (a) whether and in what circumstances the common law rule of law and/or section 17 can apply in the event of use of fraudulent means or devices (“fraudulent devices” for short) to promote a claim, which claim may prove at trial to be in all other respects valid, (b) whether (if so) the application of that rule and section ceases with the commencement of litigation and (c) whether, in the light of the answers to these questions, the Judge should have allowed the appellant insurers to amend their defence to assert (in short) that the respondents, during the course of the present litigation, maintained a case involving lying representations, as to the date when hot works commenced on the insured vessel…

The scope and inter-relationship of the common law rule and section 17

In The Star Sea… Lord Clyde said that to confine section 17 to the pre-contract stage “now appears to be past praying for”. Lord Scott accepted the section’s post-contractual application…Lord Hobhouse, as I see it, proceeded on the same basis…Lord Justice Longmore commented in The Mercandian Continent that this Court should now proceed on that basis, and I for my part, while expressing the hope that the House of Lords judicially or Parliament legislatively might one day look at the point again, agree that we should do so.

The fullest description of the common law rule appears in Britton in Mr Justice Willes’ summing up to the jury:

The simple rationale is in Lord Hobhouse’s words…in The Star Sea that:

It is convenient at the outset to consider two points on which the scope of the common law rule is not entirely clear. The first is whether a claim, which is honestly believed in when initially presented, may become fraudulent for the purposes of the rule, if the insured subsequently realizes that it is exaggerated, but continues to maintain it. The second is whether the fraud must relate, in some narrow sense, to the subject matter of the claim, or may go to any aspect of its validity, including therefore a defence. The first point was left open by Lord Scott in The Star Sea…But I believe that the correct answer must be in the affirmative. As a matter of principle, it would be strange if an insured who thought at the time of his initial claim that he had lost property in a theft, but then discovered it in a drawer, could happily maintain both the genuine and the now knowingly false part of his claim, without risk of application of the rule…

Further, if and in so far as the use of fraudulent devices may invoke the fraudulent claim rule — an issue to which I come at greater length below — it would again be artificial to distinguish between the use of such devices before and after the initial making of any claim. Such devices are a not unfamiliar response to insurers’ probing of the merits of a claim. The directions given and verdict entered by Mr Justice Roche in Wisenthal v World Auxiliary Insurance Corporation Ltd. (1930) 38 Ll L Rep 38 proceed on the basis that fraudulent devices used during the course of insurers’ investigation of a claim may invoke the common law rule, if otherwise applicable.

As to the second point, a claim cannot be regarded as valid, if there is a known defence to it which the insured deliberately suppresses. To that extent, at least, fraud in relation to a defence would seem to me to fall within the fraudulent claim rule…I note only that none of the speeches in the House of Lords [in The Star Sea] contains any positive suggestion that the common law rule or section 17 cannot apply to a known defence.

I turn to examine the scope of the rule and the section more closely. Where there is a fraudulent claim, the law forfeits not only that which is known to be untrue, but also any genuine part of the claim. In contrast, where the use of fraudulent devices occurs, the whole claim is by definition otherwise good. The present appeal raises for consideration whether, as a matter of policy, the underlying rationale of the fraudulent claim principle should extend to invalidate not merely the whole of a claim where part proves good, but the whole of a claim where the whole proves otherwise good. The word “proves” of course assumes that all aspects of the litigation proceed to trial, which, although common, is not inevitable. The effect of the fraudulent claim principle is that, once it is determined (which it may be by trial of a preliminary issue) that part of a claim was false, the rest is forfeit, without it being essential to determine whether or not that rest itself related to genuine loss. If the use of fraudulent devices constitutes a defence to a claim, the possibility arises that this might be established by a preliminary issue, making trial of further issues irrelevant, so that, once again, it might never be determined whether genuine loss was suffered.

Mr Popplewell, QC for the appellant insurers…argues persuasively that the rationale of the common law rule regarding fraudulently exaggerated claims has force in the wider context of use of fraudulent devices to promote an insurance claim. If an insured uses fraudulent devices to support a claim, he does so, normally, because he believes that it is necessary or expedient to do so. He uses such devices, precisely because he cannot be sure that his claim is otherwise good. Mr Popplewell therefore submits that it should be irrelevant for an assured to show subsequently that the claim was all along good or that his fraudulent devices were superfluous. If the deception succeeds, and the insured wins, either at trial or because insurers settle on the basis that the facts were or may be as presented to them, the insured gains, because he avoids consideration of what he perceives as his true but weaker case. Assuming that the claim was in truth good all along, he will still successfully have gilded the lily (and may achieve a better settlement thereby). If the deception is revealed, either before or at trial, the insured cannot, Mr Popplewell submits, be allowed to think that he will lose nothing. The whole claim, if not the whole policy, must be forfeit, so as to introduce an incentive not to lie, paralleling that already recognised by the common law rule.

Mr Popplewell would wish to subsume the use of fraudulent devices under the head of fraudulent claim. But, whether or not it is so termed, he submits that fraud in the pursuit of a claim should attract parallel treatment…There remains still open the possibility that, although categorizing a claim as fraudulent opens the way to forfeiture of the instant (and perhaps any future) claim, it does not give rise to the more drastic remedy of avoidance of the whole contract (see The Star Sea…)…Paradoxical though this might appear in relation to a type of fraud which one might think paradigmatic of want of good faith, the result could be welcome as a means of limiting the scope of the more draconian section 17…