Claims Procedure, Measurement of Loss and Reinstatement
It has been seen,1 that a policy may contain a range of conditions precedent. These generally include conditions precedent to recovery. Such conditions must be strictly complied with by the insured when claiming payment to cover an insured loss. Looked at another way, these terms may be described as conditions precedent to the liability of the insurers so that in the event of a breach the insurers liability does not attach. Whether or not there has been a breach of such a condition is a question of construction, and in construing the particular term the court will have regard to its purpose.2 Insurers typically argue that these clauses are important for a number of reasons: they allow insurers to investigate claims as soon as possible, they enable them minimise any future potential losses which may arise; and they provide certainty as to what other claims (including third party claims) may be in the pipeline. Conditions precedent to recovery generally lay down requirements as to the requisite notice to be given to the insurers in the event of a loss; the particulars of the loss to be furnished by the insured; and, in the event of a dispute arising between the parties, that settlement should be by way of arbitration.
1.1 Determining the nature of claims conditions
Recent case law points to an insured-friendly approach being adopted by the courts towards the determination of the nature of a claims condition. In Chapter 7 we saw that in Alfred McAlpine plc v BAI (Run-Off) Ltd,3 the Court of Appeal, importing the terminology of ‘innominate terms’ from the general law of contract, classified a notification clause, condition 1(a) in the policy, which required the insured to give notice of a claim under the policy ‘as soon as possible’, as a term which fell short of a condition precedent. However, it is noteworthy that the clause in question was not described as a condition precedent, unlike other terms in the policy. Waller LJ explained that the term was not so fundamental that its breach amounted to a repudiation of the whole contract. It lacked the quality of ‘essentiality’:
Condition 1(a) is … an innominate term. Breach of it, however serious, would be unlikely to amount to a repudiation of the whole contract of insurance. Furthermore, it is not a term the breach of which, or any breach of which, would entitle the insurer not to pay the claim because that would simply make it a condition precedent. But, in my view, a breach which demonstrated an intention not to continue to make a claim, or which has very serious consequences for BAI, should be such as to entitle BAI to defeat the claim. If a term is a condition precedent to liability, any breach defeats liability but does not lead to a repudiation of the whole contract. I see no reason why although a term is not a condition precedent so that any breach defeats liability, it cannot be construed as a term where a serious breach defeats liability.4
In support of his conclusion, the judge cited Trans-Pacific Insurance Co (Australia) Ltd v Grand Union Insurance Co Ltd,5 where the Supreme Court of New South Wales took the view that a notice clause could not have the ‘quality of essentiality such that any breach thereof entitled [the insurer] to terminate the contract’. As has been seen, this view was also taken by the majority of the Court of Appeal in Friends Provident v Sirius International Insurance Corporation.6 It therefore appears settled that claims conditions not expressed to be conditions precedent are viewed as innominate terms. The rights of insurers will depend upon whether the insured’s conduct is such as to amount to the repudiation of the policy as a whole, or upon whether the breach is minor in nature so that the appropriate remedy lies in damages. In Friends Provident Waller LJ observed that repudiation of the policy is likely to arise only ‘in extreme circumstances’ such as where there has been ‘consistent breach over a number of claims’.7 This means that the insurers remedy is generally restricted to damages where notification of a claim is late, provided they can show loss. Waller LJ thought that the possibility of a claim for damages was ‘illusory’ while the majority of the Court of Appeal thought that the calculation of damages would be possible such as where the insurers’ subrogation rights have been lost.8 However, in cases where there has been late notification to liability insurers of a third party claim which might or might not have been successfully defended, both Mance LJ and Sir William Aldous admitted that damages would be purely speculative.
1.2 Notice of loss
Generally, a policy term will place the insured under a duty to notify the insurers of the loss within a specified time limit, or if none is stipulated, within a reasonable time.9 In liability insurance, such as an all risks policy, it is not uncommon for a term to require the insured to give notice to the insurers of the occurrence of an event that is ‘likely to give rise to a claim’.10
Oral notice of a loss will suffice unless written notice is expressly stipulated. If the condition is clear and unequivocal, the duty is absolute and impossibility or ignorance will not afford a defence to the insured. In Cassel v Lancashire & Yorkshire Insurance Co,11 the insured was involved in a canoeing accident but his injuries were latent for some eight months. His claim under an accident policy failed because he had not complied with the 14-day notice period specified in the policy. However, it has been held that where the police have communicated notice of the loss to the insurers, the insured is relieved from the duty of notifying them personally, even if personal notification is expressly required by the policy, because ‘it would be a futile thing to require the [insured] himself to give them the selfsame information. The law never compels a person to do that which is useless and unnecessary’.12
Although notice clauses require strict compliance by the insured, the courts will nevertheless construe them strictly against the insurer. In Verelst’s Administratrix v Motor Union Insurance Co,13 a motor policy contained a condition which provided that in the event of a loss ‘the insured or the insured’s personal representative … shall give notice … to the … company of such loss as soon as possible after it has come to the knowledge of the insured or the insured’s personal representative’. While visiting India the insured was killed in a motoring accident. Her administratrix did not know of the insurance company with which the insured had effected cover until nearly a year after the accident had occurred when she came across the policy while sorting out old papers belonging to the insured. The insurers sought to repudiate liability for breach of the notice requirement. It was held that the administratrix could recover. Roche J construed the clause to mean ‘as soon as possible to the legal representative under the existing circumstances which prevailed and applied’.14 On the other hand, in Aspen Insurance UK Ltd v Pectel Ltd,15 the insured, a specialised construction contractor with expertise in the removal of asbestos, was insured under a Combined Liability policy with a retroactive date of 11 February 2004. Condition 4 set out the claims procedure, and condition 4(a) required the insured to give immediate written notice to brokers of: ‘(i) any occurrence which may give rise to indemnity under this insurance’. Condition 13, entitled ‘Observance’, went on to state that ‘The liability of Underwriters shall be conditional on … The Assured paying in full the premium demanded and observing the terms and conditions of this insurance.’ On 9 February 2004 the insured commenced preparatory work on the South Tunnel of BT’s Deep Level Tunnel Facility in Manchester, and work on the North Tunnel was commenced on 22 March 2004. A fire occurred in South Tunnel on the morning of 29 March 2004. The insurers were not notified of the fire until 22 March 2007. Teare J held, in a trial on preliminary issues, that the insurers were not liable. The retroactive clause did not provide a defence. While it was the case that work on the South Tunnel had commenced on 9 February 2004, the fire arose in the North Tunnel only. The claims condition required immediate notification of any occurrence which may give rise to indemnity: that meant notification ‘with all reasonable speed considering the circumstances of the case’ of any occurrence in respect of which there was a real as opposed to a fanciful risk of the underwriters having to indemnify the insured, and in determining whether there was such a risk the court was to apply an objective test, taking into account the knowledge that the insured possessed in order to determine the extent to which the insured was aware of, and hence capable of notifying, occurrences which may give rise to an indemnity. On the facts, notification should have been made immediately, or at the very latest by November 2004 when it was clear that the materials used by the assured were under investigation. Compliance was a condition precedent to liability, as the commercial purpose of the condition was to allow the insurers to receive early notification of any event which could give rise to a claim. Teare J further held that: (a) a breach of the condition did not affect the policy as a whole, but only the claim in question; and (b) the effect of condition 13 was not necessarily to require all conditions to be treated as conditions precedent, but condition 4(a) was appropriately treated as a condition precedent
1.3 Particulars of the loss and co-operation clauses
In addition to notification, the insured will generally be under a duty to submit particulars of the loss to the insurers. The guiding principle seems to be that the insured must provide sufficient detail to enable the insurers ‘to form a judgment as to whether or not he has sustained a loss’.16 A condition that ‘full particulars’ of the loss must be given has been defined as meaning ‘the best particulars which the assured can reasonably give’.17 In Widefree Ltd v Brit Insurance Ltd,18 the claimant operated a jeweller’s shop in Hatton Garden, and held a policy against ‘loss or damage from any cause whatsoever’. The policy excluded ‘Property Insured found to be missing at stockholding where the Insured is unable to prove the date and circumstances of any loss’ and it also contained a claims co-operation clause in the following terms:
The Insured shall in case of a loss or damage and as condition precedent to any right of indemnification in respect thereof give to the Insurers such information and evidence as to the property lost or damaged as the Insurers may reasonably require and as may be in the Insured’s power.
On 9 October 2008, two Arab women came into the shop, but left without buying anything. On 22 October 2008 Mr Abrahams discovered that a ring worth about £100,000 was missing: this came to light when he wished to show the ring to another customer. The claimant believed that the ring had been stolen by the two women. There were five CCTV cameras in operation in the shop on 9 October 2008, but only Camera 2 showed the incident which gave rise to suspicions of theft by the women. The police advised Mr and Mrs Abrahams that Camera 2 was the only relevant camera, and to have the footage from Camera 2 downloaded to DVD. Loss adjusters visited the shop on 6 November 2008 and asked to see the Camera 2 footage. Thereafter the footage on the other cameras was wiped. The insurers denied liability on the grounds of the unexpected loss exclusion and breach of the claims co-operation clause in that the sured had not retained the CCTV footage from all five cameras. The defences were dismissed. HHJ Peter Leaver QC held that the insured had proved on the balance of probabilities that there had been a theft on 9 October 2008. Further, the clause had not been triggered because the loss had not been found at stockholding, but rather in response to a request by a customer. He further found that there was no breach of the claims co-operation clause. It was the duty of the insured not to destroy evidence which might reasonably be required by the insurers, but the insurers had not asked for CCTV footage other than from Camera 2, and after the visit on 6 October 2008 it was reasonable for the insured to have wiped the other cameras. The clause was triggered by a request from the insurers, and in the absence of any request it could not be said that the insured had failed to comply.
As with conditions relating to notice periods, terms in a consumer contract which stipulate the required particulars to be supplied to the insurers as proof of the loss will need to satisfy the Unfair Terms in Consumer Contracts Regulations 1999.
A so-called ‘co-operation clause’, frequently found in liability insurance policies,19 will require the insured to co-operate by, for example, providing particulars of the loss (see above), or by undertaking not to settle with a third party, or by undertaking not to take any other steps which may prejudice the insurers’ position. A common example is found in motor insurance where the insured is generally obliged not to admit liability to a third party. Breach of the insured’s duty to co-operate will defeat the claim.20 In Shinedean Ltd v Alldown Demolition (London) Ltd, 21 the Court of Appeal held that prejudice is not a factor which has to be taken into account when considering whether a claims co-operation clause has been breached.
Recently, the court has addressed the question of whether an insurance company can claim damages for reach of a claims co-operation clause. In Porter v Zurich Insurance Co,22 P insured his house and possessions with Zurich, for 12 months from 12 September 2000. The policy excluded loss caused by ‘any wilful or malicious act by a member of the family’. The policy also contained a claims co-operation clause following a loss. P suffered from a persistent delusional disorder. On 27 March 2001 he had been drinking heavily, and decided to commit suicide by setting fire to his house. Having set a fire, he changed his mind and escaped, but the house was seriously damaged. The house had to be boarded up, but in the following months there were three thefts of possessions from it. Claims were made for the fire damage and also for the thefts. The insurers relied upon public policy and the ‘wilful act’ exclusion to defeat the fire claim. With respect to the theft claims, they relied upon P’s failure to co-operate with loss adjusters as a result of his failure to produce documents and also refusing to allow access to the house. Coulson J held that the insurers were not liable for the fire claim. An insured could not at common law recover for a loss deliberately caused by his own criminal act, or under the policy for his own wilful act, if he had intended to cause the loss or if he acted with reckless disregard to the consequences of his actions. The insured could nevertheless recover if he could prove insanity within the legal test laid down by the M’Naghten Rules,23 namely that he was so insane that he was not legally responsible for his actions. That test had not been satisfied on the facts: the insured knew exactly what he was doing. The theft claims could go ahead to a hearing on quantum. Although the insured was in clear breach of the claims co-operation clause, the insurers had not shown that those breaches caused any loss recoverable by way of damages. The insurers had merely alleged that some of the goods claimed to have been stolen were also said to have been fire damaged for the purposes of the fire claim, but such duplication did not give any automatic defence. The insurers had to prove actual loss flowing from the failure to co-operate.
It was at one time common for policies of insurance to include a condition providing for the resolution of disputes through arbitration in the first instance. This avoided the expense and delay of civil litigation through the courts. It has been held that an arbitration clause is enforceable as a condition precedent, with the result that the insured cannot sue on the policy but can bring an action only to enforce an arbitration award in his favour.24 Following the findings by the Law Reform Committee of abuse by insurers in insisting upon arbitration,25 particularly in the light of the unavailability of legal aid in such proceedings, the Association of British Insurers and Lloyd’s announced that their members would not enforce arbitration clauses in cases where the insured indicated a desire to have the issue of liability, as opposed to quantum, determined by a court.26
An issue that arises with respect to an arbitration clause contained in an insurance contract is the question of its validity where it is claimed that the policy is vitiated as a result of, for example, non-disclosure or lack of insurable interest. In these cases an arbitration clause cannot be relied on unless it is so framed as to cover disputes going to the very validity of the policy.27 An arbitration clause is, by virtue of section 7 of the Arbitration Act 1996, an independent undertaking in its own right, so that as long as the dispute falls within the scope of the clause, it is irrelevant whether the insurer has relied upon utmost good faith, breach of warranty or indeed any other defence. At one time there was doubt as to the position where the insurer sought to rely upon a fraudulent claim. In Super Chem Products Ltd v American Life and General Insurance Co Ltd,28 the issue was whether the insurers could require compliance with the claims clauses in the policy while, at the same time, allege fraud. The insured had a material damage and business interruption policy. The factory in question was damaged by fire and the insurers pleaded, inter alia, arson. They also sought to rely on the insured’s failure to commence proceedings within 12 months as stipulated by the policy. The Privy Council held that the plea of arson did not amount to a repudiation of the policy. In so holding, the board overruled the much criticised dicta of Viscount Haldane LC in Jureidini v National British and Irish Millers Insurance Co Ltd,29 to the effect that an insurer who repudiates liability on the basis of fraud and arson cannot ‘insist on a subordinate term of the contract still being enforced’.30 It is now clear, in the light of Super Chem, that an allegation by the insurers that the insured has been guilty of a fraudulent claim does not prevent them from relying upon the arbitration clause.31
2. The insured’s duty of utmost good faith and fraudulent claims
It was seen in Chapter 4 that section 17 of the Marine Insurance Act 1906 provides that: ‘A contract of marine insurance is a contract based upon the utmost good faith, and, if the utmost good faith is not observed by either party, the contract may be avoided by either party.’ The issue that arises, and one that has generated considerable judicial debate, concerns the post-contractual scope of this duty. Unsurprisingly, this has generally come to the fore where the insured has made a fraudulent claim. We first consider the meaning of fraud before going on to examine the consequences of making a fraudulent claim.
2.1 Defining fraud
A material statement in a claim is fraudulent if the insured either knew it to be false or else was reckless as to its truth.32 Mere carelessness will not suffice. The onus of proof is on the insurer, and given the nature of the allegation the burden will be greater than on a mere balance of probabilities.33 A so-called ‘rescession induced claim’ where the insured has, with intent, destroyed the insured property is a common example of fraud in this context. The courts do, however, recognise that an exaggerated claim by an insured is a bargaining device used against insurers who frequently attempt to reduce the size of a claim. In Ewer v National Employers’ Mutual General Insurance Association,34 the claimant claimed the current cost price of new items of furniture to replace his second hand items which had been destroyed by fire. Mackinnon J, although describing the claim as preposterous, held that no deception was perpetuated. He said:
I do not think [the claimant] was doing that in any way a fraudulent claim, but as a figure to start off with as a bargaining figure. We have been told that the defendant company wanted to see invoices. The invoices, of course, would show what the articles cost. As the [claimant] could not produce the invoices showing what the articles cost, I think he did the best he could in substituting for it. … The [claimant] knew the claim would be discussed, and probably drastically criticised, by the assessors: he had been asked for invoices, and he started the bargaining with them by putting down the cost price of these articles as if they were new.35
While over-valuation is not therefore in itself sufficient to establish fraud, a grossly exaggerated claim of the true value of the loss will raise a presumption of fraud.36 Such indulgence as displayed by MacKinnon J towards ‘preposterously’ exaggerated claims was not so readily accepted by Hoffmann LJ in Orakpo v Barclays Insurance Services,37 although he did explain that:
In cases where nothing is misrepresented or concealed, and the loss adjuster is in a good a position to form a view of the validity of the claim as the insured, it will be a legitimate reason that the insured was merely putting forward a starting figure for negotiation.38
The Financial Services Ombudsman (FOS) have issued guidance on how they deal with fraudulent claims.39 They expect insurers to prove the alledged fraud using clear evidence. The guidance states:
To establish fraud has taken place, some concrete evidence of lies, inconsistent statements or acts of deception must be present. The fact that members of a firm’s staff are personally satisfied of the claimant’s bad faith is not sufficient proof of dishonesty.
The FOS guidance also states that the presentation of a forged document to support a claim is not necessarily fraudulent. Further, where a customer knowingly produces a forged document, the insurer may still not be able to reject the claim. The FOS will enquire into the reasons why the forged document was produced with a view to determining whether it was ‘solely to substantiate transactions that really took place, or did the customers intend to obtain more than they were entitled to?’
The English and Scottish Law Commissions,40 approve of the current state of the law. They believe that this area of the law is ‘best left’ for the courts to develop. Importantly, they do not propose a statutory definition of fraud given that the determination of fraudulent behaviour tends to be very fact specific.41
2.2 The consequences of a fraudulent claim
In assessing the effect that a fraudulent claim has on the validity of the policy the critical question is whether the insured’s duty of utmost good faith continues beyond the time when the policy is initially effected and renewed so that it also operates when an insured seeks to claim against the insurers for a loss. Until recently, it was generally thought that the duty revived at the claims stage.42 The point was made by Mathew LJ in Boulton v Houlder Bros & Co,43 that it ‘is an essential condition of the policy of insurance that the underwriters shall be treated with good faith, not merely in reference to the inception of the risk, but in the steps taken to carry out the contract’.44 The underlying rationale for this view was explained by Hoffmann LJ in Orakpo v Barclays Insurance Services:45
I do not see why the duty of good faith on the part of the assured should expire when the contract has been made. The reasons for requiring good faith continue to exist. Just as the nature of the risk will usually be within the peculiar knowledge of the insured, so will the circumstances of the casualty; it will rarely be within the knowledge of the insurance company. I think that the insurance company should be able to trust the assured to put forward a claim in good faith.46
Sir Roger Parker agreed with Hoffmann LJ. The Court of Appeal therefore held that a claim which is fraudulent entitles the insurer to avoid the contact ab initio irrespective of whether there is a term in the policy to that effect. However, Staughton LJ differed. While he thought this should certainly be the case where the policy so provided,47 he was not convinced this should necessarily be the case in the absence of such term:
I do not know of any other corner of the law where the plaintiff who has made a fraudulent claim is deprived even of that which he is lawfully entitled to. … True, there is distinguished support for such a doctrine.48 … But we were not told of any authority which binds us to teach that conclusion.49
It is settled that if the insured makes a fraudulent claim, he or she will not be able to recover.50 The consequence is that the insured will forfeit all rights under the policy and it can therefore be terminated for breach.51 However, the question whether the policy can be avoided ab initio so that the insurer can recover any payments made with respect to an earlier loss, or whether the insurer should be restricted to recovering only from the date of the fraudulent claim, has continued to vex judges and commentators alike.52 It would seem that the degree of protection required by insurers at the inception of the contract is significantly higher than that at the time of any loss and subsequent claim, so that to allow avoidance ab initio seems to be particularly harsh. Yet, in Black King Shipping Corp v Massie (The Litsion Pride),53 it was held that a fraudulent claim could amount to breach of section 17 of the 1906 Act, thereby entitling the insurer to avoid the contract ab initio. Subsequently, in Orakpo the majority of the Court of Appeal was of the view that where an insured’s claim is fraudulent to a ‘substantial extent’ it must fail.54 The meaning of the term ‘substantial’ was considered by the Court of Appeal in Galloway v Guardian Royal Exchange (UK) Ltd.55 The claimant’s premises were burgled and he claimed under a home contents policy some £16,133.94 (the probable true value of the loss) and an additional £2,000 for a computer. In fact, there had been no loss of a computer and a receipt which the claimant produced as evidence of purchase was a forgery. Further, when completing the proposal form for this insurance some five months prior to the claim, he had failed to disclose a conviction for obtaining property by deception. Lord Woolf MR, stressing that the policy of the law must be to deter the making of fraudulent claims, stated that the phrase ‘substantial’:
is to be understood as indicating that, if there is some immaterial non-disclosure, then of course, even though that material non-disclosure was fraudulent dire consequences do not follow in relation to the claim as a whole; but if the fraud is material, it does have the effect that it taints the whole.56
For Lord Woolf MR the whole of the claim must be looked at in order to determine whether the fraud is material. On the facts of the case, the claim for £2,000 amounted to some 10% of the whole. This was an amount which was substantial and it therefore tainted the whole claim. Millett LJ, however, disagreed with this reasoning. He said that the determination of whether a claim is ‘substantially’ fraudulent should not be tested by reference to the proportion it bears to the entire claim. To do so ‘would lead to the absurd conclusion that the greater the genuine loss, the larger the fraudulent claim which may be made at the same time without penalty’.57 In Millett LJ’s view the size of the genuine claim should not be taken into account. All that matters is that the insured is in breach of the duty of good faith which leaves him without cover:
[T]he right approach in such a case is to consider the fraudulent claim as if it were the only claim and then to consider whether, taken in isolation, 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.58
It is suggested that Millett LJ’s criticism of the ‘substantially fraudulent’ threshold is correct. Determining fine distinctions between what is ‘substantial’ or otherwise can lead to fine and arbitrary decisions. Millett LJ also went on to ctiticise the current vogue of lodging dishonest insurance claims in the belief that defrauding insurance companies is not ‘morally reprehensible’. As a matter of policy, therefore, he added that he would not support any dilution of the insured’s duty of good faith.
Recent decisions have taken a restrictive view towards the post-contractual application of section 17. In Manifest Shipping v Uni-Polaris Insurance Co, (The Star Sea),59 the trial judge had doubted the independent application of utmost good faith to the claims process. He held that even if it did operate there had to be at the very least recklessness by the insured and that the duty came to an end once legal proceedings had been commenced as after that date false statements were to be dealt with as part of the court’s processes rather than as part of the claim.60 The Court of Appeal,61 took the view that the duty of good faith binds both the insured and the insurer when a claim is made. Leggatt LJ observed that:
It is less clear from the cases whether there is a duty to disclose co-extensive with that which exists before the contract of insurance is entered into, as opposed to a rather different obligation to make full disclosure of the circumstances of the claim. But the distinction matters not.62
Leggatt LJ went on to state that that the insured’s duty of good faith requires that the claim should not be made fraudulently and that the duty ‘is coincident with the term to be implied by law, as forming part of a contract of insurance, that where fraud is proved in the making of a claim the insurer is discharged from all liability’.63 In conclusion, the judge stressed that given the draconian remedy available to insurers where a claim is made fraudulently, there should be no enlargement of the insured’s duty so as to encompass claims made ‘culpably’.64
The House of Lords, doubting the reasoning of Hirst J in The Litsion Pride,65 accepted that the duty of utmost good faith continued to apply after the conclusion of the insurance contract but held that the claim of fraud had not been proved. Lord Hobhouse, noting that the right to avoid under section 17 entitles the insurer to rescind the contract ab initio, thought that were this remedy to apply where the breach of duty occurs post-contractually, the effect would be effectively penal. In his reasoning, Lord Hobhouse also placed emphasis on the disparity between the parties that would result if there was a continuing duty of utmost good faith:
[The] authorities show that there is a clear distinction to be made between the pre-contract duty of disclosure and any duty of disclosure which may exist after the contract has been made. It is not right to reason…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. … 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.66
With respect to the majority view in Orakpo, Lord Hobhouse observed that the decision ‘cannot be treated as fully authoritative in view of the contractual analysis there adopted’ with respect to the duty of good faith.67
In K/s Merc-Scandia XXXXII v Certain Lloyd’s Underwriters Subscribing to Lloyd’s Policy No 25t 105487 and Ocean Marine Insurance Co Ltd, The Mercandian Continent,68 the insured submitted a forged letter to his liability insurers to assist them in defending a claim that had been brought against the insured by a third party. The letter was found to be immaterial and the insurers were therefore held liable. The Court of Appeal, aligning the duty of disclosure during the claims process with its pre-contract counterpart, took the view that the non-disclosed or misrepresented fact must be material and it must induce the insurer to pay the claim. With respect to the remedy available to the innocent party, Longmore LJ explained that the right to avoid the contract with retrospective effect is only exercisable in circumstances where the innocent party would, in any event, be entitled to terminate the contract for breach. He went on to state that:
[T]he 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 … 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.69
As is illustrated by the facts of The Mercandian Continent, the issue has recently come to the fore in relation not to fraudulent claims as such, but in relation to the use of ‘fraudulent devices’ to promote a claim. The distinction was explained by Mance LJ in Agapitos v Agnew, The Aegeon:70 ‘[A] fraudulent claim exists where the insured claims, knowing that he has suffered no loss, or only a lesser loss than that which he claims (or is reckless as to whether this is the case).’71 A fraudulent device, however, is ‘used if the insured believes that he has suffered the loss claimed, but seeks to improve or embellish the facts surrounding the claim, by some lie’.72 The question which Mance LJ focused upon was whether a genuine claim could become fraudulent because it was made fraudulently and whether, in consequence, the duty of utmost good faith was broken. Holding that the duty of utmost good faith did not apply to fraudulent claims so that the policy could not be avoided ab initio, Mance LJ went on to state the position with respect to fraudulent devices. He thought that an acceptable solution would be to ‘treat the use of a fraudulent device as a sub-species of making a fraudulent claim’ and to treat as relevant for this purpose:
any lie, directly related to the claim to which the fraudulent device relates, which is intended to improve the insured’s prospects of obtaining a settlement or winning the case, and which would, if believed, tend, objectively, prior to any final determination at trial of the parties’ rights, to yield a not insignificant improvement in the insured’s prospects——whether they be prospects of obtaining a settlement, or a better settlement, or of winning at trial.73
The insurer is therefore discharged from liability in respect of such a claim.74 As indicated above, it was held that the common law rules governing the making of a fraudulent claim (including the use of fraudulent device) fell outside the scope of section 17 of the 1906 Act. Further, the Court of Appeal also went on to hold that once litigation between the insurers and the insured has commenced, the consequences of making a fraudulent claim or promoting a claim with fraudulent devices are superseded by the procedural rules governing civil litigation.75
The views expressed by Mance LJ in The Aegeon were considered by HHJ Chambers QC in Interpart Comerciao e Gestao SA v Lexington Insurance Co,76 a marine insurance case where, inter alia, the insurers alleged that by submitting a fraudulent inspection certificate the insured had sought to enlist fraudulent means in the promotion of a claim. The judge, taking a restrictive view of The Aegeon, refused to give summary judgment. He accepted that while there was no requirement to show reliance or inducement in order for a fraudulent claim to fail (because the policy of the common law was to deter fraud), nevertheless the law was still developing with respect to the degree of nexus that must be established between the insured’s fraud and the claim. However, in Danepoint Ltd v Allied Underwriting Insurance Ltd,77 it was held that inducement was required. On this point, Danepoint is undermined by the recent Privy Council decision in Stemson v AMP General Insurance (NZ) Ltd,78 where the insurer did not need to prove it was induced. It has been suggested that the application of the Danepoint case should be limited to circumstances where the insured’s lie is so blatant that it is disregarded by the insurer.
In AXA General Insurance Ltd v Gottlieb,79 Mance LJ had occasion to consider whether under the common law rule relating to fraudulent claims an insurer could recover interim payments made prior to any fraud in respect of genuine losses incurred on the claim to which the subsequent fraud related. The judge rejected the submission of the insureds’ counsel to the effect that where a genuine right to indemnity has both arisen and been subject of a payment made prior to any fraud committed in respect of the same claim, there can be no conceptual basis for requiring the insured to repay the sums received. Mance LJ stated that:
If a later fraud forfeits a genuine claim which has already accrued but not been paid, the obvious conceptual basis is that the whole claim is forfeit. … If the whole claim is forfeit, then the fact that sums have been advanced towards it is of itself no answer to their recovery.80
The effect of counsel’s argument would be to result in the anomaly that forfeiture of the whole claim should be restricted to the whole of the outstanding claim only; in other words, to any part that remains unpaid as at the date of the fraud. Mance LJ explained that the rationale of the rule relating to fraudulent claims is that an insured should not expect that, should the fraud fail, he will lose nothing. The court should not, therefore, undermine the prophylactic policy of the common law rule by holding that forfeiture should not apply to a part of a claim which is otherwise honest. Accordingly, it was held that the effect of the common law is to forfeit the whole of the fraudulent claim so that the consideration for any interim payments made on that claim fails. Such sums are thus recoverable by the insurers irrespective of whether they were paid prior to the fraud.
In Danepoint Ltd v Allied Underwriting Insurance Ltd,81 the insured’s premises, a block of some 13 flats, were damaged by fire. The insured claimed for reinstatement costs together with loss of rents. With respect to the reinstatement costs, these were agreed at £83,000, subject to inspection by the insurer’s loss adjusters. The work was to be carried out by a third party builder, Titchfield Construction. The insurers paid £25,000 on account and then received interim invoices totalling £60,000 from a different builder, Gulf Falcon. In fact, at the time the invoices were received, only around £7,500 of work had been completed. In relation to the second claim, for loss of rent, the insured claimed £53,000, having falsely declared that all flats were vacated immediately following the fire. The insurers successfully denied liability on the ground that the claims were fraudulent.
HHJ Coulson QC thought the most serious allegation of fraud related to Gulf Falcon’s claim for £60,000, when only around £25,000 worth of work and materials had actually been provided. Determining whether this constituted fraud was a fact-intensive exercise. Although the judge thought that the invoices ‘were wholly over-stated and stood at the very edge of credibility’,30 he nevertheless concluded that the exaggerated claims were not material. The judge noted that the loss adjuster was required by the settlement agreement to inspect the works periodically to ensure that the project was being carried out, so ‘by inference, that he could ensure that any further interim payments were properly justified’.31 HHJ Coulson QC took the view that whatever sums were claimed by Gulf Falcon on account, it would make no difference, given that the loss adjuster would not authorise payments which, upon a site inspection, he felt were not justified. In his reasoning, he drew upon the views expressed by Hoffmann LJ, as he then was, in Orakpo,32 that:
In cases where nothing is misrepresented or concealed and the loss adjuster is in a good a position to form a view of the validity of the claim as the insured, it will be a legitimate reason that the assured was merely putting forward a starting figure for negotiation.33
He therefore held that it would be wrong to find, in the absence of compelling evidence to the contrary, that claims for interim payments, as opposed to final payments, were made fraudulently. The claim for loss of rent was found to be fraudulent. The insured parties had asserted that all tenants had vacated the property immediately following the fire on 13 June 2001. However, there was a considerable body of evidence, such as the observations made by the loss adjuster during his visits, together with evidence provided by the tenants themselves, that a number of tenants remained in the flats, some for the entire period during which the repair work was being undertaken. Indeed, the number of flats rendered uninhabitable by the fire was relatively few and, with the exception of the flat where the fire had started, smoke and water damage, although widespread, was superficial. The judge found that the claim was patently false. It ignored the continued occupation and payment of rent in respect of many of the flats and it contained numerous exaggerations. In considering the effect this finding had on the reinstatement claim, HHJ Coulson QC agreed with the insurer’s submission that there was only one claim with two heads of loss so that, therefore, the finding of fraud struck down the entire claim.
Overall, a number of principles can be distilled from the judge’s summary of the applicable authorities. The duty of utmost good faith declared by section 17 of the Marine Insurance Act 1906 does not trigger during the claims process so an insurer cannot avoid the policy ab initio on the ground of fraud. Where all or part of the claim is fraudulent, or where fraudulent devices are enlisted to promote a genuine claim, the insured will not be permitted to recover in respect of any part of the claim.82 Mere exaggeration will not, in itself, suffice to substantiate an allegation of fraud. However, if the exaggeration is wilful, or is allied to misrepresentation or concealment, it will, in the judge’s view, probably be held to be fraudulent. In this regard, and echoing Lord Hoffmann’s opinion, an exaggeration is more excusable where the value of the particular claim or head of loss in question is unclear or is a matter of opinion. However, there remains a significant issue which the authorities have so far failed to address. Will a fraudulent claim bring the insurance contract to an end? In other words, can insurers refuse to pay a legitimate claim that is made subsequent to that which is held to be fraudulent?
If a clause of the insurance contract enables the insurer to avoid the policy from inception the court will uphold it. In Joseph Fielding Properties (Blackpool) Ltd v Aviva Insurance Ltd,83 the insured (JFP) claimed an indemnity of over £2 million against the insurer, Aviva, in respect of a fire which had occurred on the insured property. The insurer defended the claim on a number of grounds, one of them being that during the currency of the policy the insured had made a fraudulent claim regarding drain damage. The insured had paid £6,700 to a contractor for drainage repairs but had claimed £9,870. Further, Aviva sought to rely on a fraudulent claims clause. Condition 7 of the policy which stated:
We will at our option avoid the policy from the inception of this insurance or from the date of the claim or alleged claim or avoid the claim
(a) if a claim made by you or anyone acting on your behalf to obtain a policy benefit is fraudulent or intentionally exaggerated, whether ultimately material or not or
(b) a false declaration or statement is made or fraudulent device put forward in support of a claim.
The court found that the insured had behaved fraudulently, that the sum contained in the invoice was fraudulently exaggerated and this was, therefore, within the meaning of Condition 7.84 In regard to Condition 7, HHJ Waksman QC rejected the argument that had the insurer relied on the common law rather than a term of the policy the outcome would have been different, noting that: ‘It is clear law that if a claim has been dishonestly exaggerated or tainted by fraud then the insurer can avoid liability for the whole of that claim.’85 Citing Millett LJ in Galloway v GRE,86 he agreed that the fraud element must be substantial as it was on the facts before him and that the fraudulent element is not to be tested by reference to the proportion of the entries claim. Therefore, the insured could not rely on ‘a concept of proportionality to the effect that if in truth it had paid out most of the sum claimed, Condition 7, or fraud at common law should not apply’.87 In his reasoning, HHJ Waksman QC wholly rejects introducing a proportionality rule when either deciding whether the fraud was substantial or whether the insured had been more truthful than fraudulent.88 This would seem correct. The fraud should not be measured against its monetary value, as this could produce distorted results,89 but rather on whether the act itself was substantial. In any case, Condition 7 was applicable and there was no need to introduce proportionality anyway. 90
HHJ Waksman QC took time to discuss the differences between relying on the common law position for fraudulent claims/devices and relying on a condition of the contract. Aviva conceded that without the operation of the condition, which allowed them to avoid the policy from inception, they would have had to rely on the common law, which meant that the monies paid out on genuine claims could not be recouped91 The judge rejected this argument. In so doing, he described what Mance LJ says in Axa v Gottlieb,92 as obiter, but does not expand on whether making a fraudulent claim has retrospective effect. This leaves the question of whether at common law a fraudulent claim brings the policy to an end unaddressed. For an insurer to be confident that it will be able to terminate the policy, the safest course of action is to insert a term to this effect. This is broadly in line with the Law Commissions’ proposals, which are discussed below, which allow insurers to determine the consequences of a fraudulent claim by the use of an express term.93 The Law Commissions are unwilling to recommend allowing a fraudulent claim to affect previous valid claims.
Where an insured has a genuine claim, and is dishonest in respect of another claimant’s claim, the rule in AXA General Insurance v Gottleib does not apply, and the insured can recover under the policy. In Shah v Wasim Ul-Haq,94 S negligently drove her car into the rear of a car being driven by Wasim Ul-Haq who was with his wife and two children as passengers. A claim was brought by Wasim Ul-Haq and his wife, and a claim was also made by Wasim Ul-Haq’s mother-in-law who claimed that she had been in the car at the same time. Shah asserted that the mother-in-law had not been in the car, that she had been encouraged by Wasim Ul-Haq to make a fraudulent claim and accordingly that all three claims, including the genuine claims of Wasim Ul-Huq and his wife, should be struck out under CPR3.4(2) on the grounds of abuse of process. The Court of Appeal held that there was no general rule of law that a claim which was in part fraudulent was lost in its entirety by reason of the fraud, and that the insurance rule that a claim was lost even if only partially fraudulent was confined to that context. The court followed Churchill Car Insurance v Kelly95 in holding that the genuine part of the claim was unaffected by the fraud in respect of the rest of the claim. Toulson LJ explained that the reason why the rule which prevents a fraudulent insured from recovering did not apply to the present case was because the insured was not dishonest in respect of his own claim.96 Therefore, ‘there was no legal basis for treating their dishonest support for second defendant’s [mother-in-law] bogus claim as extinguishing their own right to damages’.97 Toulson LJ also recognised the ‘epidemic’ of fraudulent claims and suggested that a fraudulent insured’s should be prosecuted so as to act as a deterrent.98 In this case, Wasim Ul-Haq and his wife were guilty of conspiracy to defraud and perverting the course of justice. Smith LJ stated that this if this policy is viewed as wrong so that any form of fraudulent exaggeration of a claim should bar the right to recovery, then it is a matter for Parliament to legislate.99
The question of what is a claim arose in the case Direct Line Insurance plc v Fox.100 The defendant’s property policy contained the typical fraudulent claims clause: ‘If any claim or part of a claim is made fraudulently or falsely, the policy shall become void and all benefit under this policy will be forfeited.’ The insured suffered a fire at his house, and was paid some £32,000 in respect of damage to contents and on finding alternative accommodation pending rebuilding work. On 7 June 2007 he reached agreement with insurers under which he agreed to accept the sum of £46,524.50 in full settlement and discharge of all claims for the buildings: an initial payment of £42,412.00 was to be paid, followed by a final payment of £4,112.50 for VAT subject to the defendant providing invoices demonstrating the outlay for VAT. The defendant subsequently submitted an invoice from a builder, which showed that VAT had been paid. Further investigation showed that the invoice had probably been forged and that the work had not been carried out by that builder. The insurers sought to recover all sums paid by them under the policy, in reliance on the fraudulent claims clause. The court ruled that they were unable to do so, on the ground that the insured had not made a fraudulent claim at all. The settlement agreement resolved the claim and replaced it with a new agreement: there was no challenge to the validity of the agreement, and all that had happened was that the insured had failed to produce valid evidence that he had paid VAT, so that the only consequence was that he could not recover the sum payable for VAT. If that was wrong, then the court rejected the insured’s alternative arguments that fraud could be retracted—the court’s view was that fraud could not be retracted, but even if that was wrong any retraction in the present case was after the fraud had been discovered; and the fraud clause was void under the Unfair Terms in Consumer Contracts Regulations 1999—the court held that the clause did not operate to avoid the policy ab initio but merely precluded recovery for losses occurring after the fraud, so that it reflected the common law.
A further issue that has arisen is the position with respect to co-insurance where a fraudulent claim is made by one insured but not the other. In Direct Line Insurance plc v Khan,101 the home of the co-insureds, Mr and Mrs Khan, was destroyed by fire. Mr Khan made a claim for rent, supported with forged documents, he allegedly paid for alternative accommodation. In fact no such rent was paid because he owned the alternative accommodation himself. The claim was held to be fraudulent and the insurers recovered all monies they had paid in respect of reinstating the damaged house, replacing its contents and the payment of rent. The trial 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. Arden LJ, dismissing her appeal, held that in joint insurance the effect of a fraudulent claim advanced by one co-insured is fatal to the claim of the other co-insureds even though they may be entirely innocent.
However, in composite insurance where more than one interest is covered in a policy,102 each insured has a separate contract with the insurers and the fraud of one insured will not prejudice the claims of another in respect of the same loss.103
The English and Scottish Law Commissions propose to reform the remedies available for fraudulent claims.104 They take the view that this area of law should be reformed because ‘(i) the disjuncture between the common law rule and section 17 of the MIA 1906 generates disputes and litigation; (ii) increasingly, commercial law in the UK must be justified to an international audience. The UK must seek to develop insurance law in a coherent, principled and fair way if it wishes to influence wider European and international activity in the area and (iii) the rules on fraudulent claims are intended to act as a deterrent, and deterrents work best if they are clear and well understood. Penalties, in particular, should be clearly set out in law.’105 The Law Commissions have proposed a number of reforms including placing the duty not to make a fraudulent claim on statutory footing,106 and specifying that it is an instance of the duty of good faith. With respect to the insurance contract itself, the Law Commissions believe that insurers should be able to determine the consequences of a fraudulent claim by using an express term provided it is clear and unambiguous. For consumer policies, the term will need to be ‘fair’ within the meaning of the Unfair Terms in Consumer Contracts Regulations 1999. Further, the Law Commissions endorse the common law position that forbids a term which excludes liability for one’s own fraud.107 Where there is no term to determine the consequences of a fraudulent claim they argue that the main remedy should be the forfeiture of the claim.108 However, though this may be an adequate penalty for those who initially had a genuine claim, for those who fraudulently claim for a loss when none is suffered, the Law Commissions think that this will be an in adequate response. They therefore propose to introduce a penalty,109 explaining that the remedy for fraud should include some element of sanction which will also act as a deterrent.’110 In addition, insurers should have the right to terminate the contract.111. Further, a fraud should not affect previous valid claims nor affect a valid claim arising between the fraud and the termination of the contract.112 The Law Commissions also suggest that in cases where the costs of investigating a fraudulent claim are substantial, and the insurer incurs reasonable and foreseeable investigation costs, they should be compensated.113
For joint insurance, the Law commissions propose that there ‘should be a presumption that any fraud committed by one party is done of behalf of all parties’.114 However, they emphasise that this should be a rebuttable presumption. The innocent party will have to show that he did not know of the fraud or that the fraud was not carried out on his behalf. The level of recovery will be limited, in so far that the party who has perpetrated the fraud will not receive any benefit under the claim.115
3. Waiver of conditions precedent to recovery
The notions of waiver and estoppel have been considered elsewhere when examining the nature of conditions and warranties in insurance law generally.116 The rules applicable to waiver or estoppel in relation to non-disclosure or misrepresentation are,117 by and large, the same with respect to the claims process. Waiver implies that a choice is made to elect not to repudiate a claim on the basis of the insured’s breach of procedural condition. On the other hand, where an insurer indicates that it will not require performance of a condition precedent to recovery, it would be inequitable to allow the insurer to then seek to enforce that term. As such, it is said that the insurer will be estopped from insisting on its strict legal rights.118
Although knowledge of the insured’s breach is necessary for waiver, it is not a prerequisite for estoppel to operate.119 Further, waiver requires some positive conduct,120 which must be made by the insurer or its authorised agent.121 Mere delay in processing a claim will not amount to waiver unless the delay is such as to
prejudice the [insured] or if in some way rights of third parties intervened or if the delay was so long that the court felt able to say that the delay in itself was of such a length as to be evidence that [the insurers] had in truth decided to accept liability.122
If, however, an insurer makes it clear that it wishes to reserve its position on the issue of an alleged breach of condition, it will not lose the right to raise the defence in any subsequent proceedings.123
There is an overlap between the doctrines of waiver and estoppel and the judges do not always draw the necessary distinction when considering the facts of cases before them. A clear example of waiver is afforded by Lickiss v Milestone Motor Policies,124 in which the insured, a motorcyclist, had failed to notify the insurers of his claim although the police had communicated details to them. It was held by the Court of Appeal that the insurers by their subsequent correspondence with the insured could be taken to have waived the breach of condition.125 The insurers, with knowledge of the breach, had chosen to ignore it by writing to the insured accepting liability. While this decision is clearly an example of waiver, the court nevertheless considered the effect which the correspondence would have on the reasonable man.
B. MEASUREMENT OF LOSS
1. The principle of indemnity
In indemnity insurance, for example where the subject-matter of the policy is property, whether real or personal, the insured is precluded from recovering more than the value of the actual loss sustained. This is because ‘indemnity’ means that the insured is to be put back to the position he would have been in had the loss not occurred, less any excess which the insured has agreed to bear.126 The position should be contrasted with contingency insurance, for example life and accident policies, where the sum recovered is fixed by the terms of the policy. Similarly, if the policy is valued, so that the sum recoverable is fixed by the contract (which is the usual position in marine insurance) the sum agreed is not open to challenge at a later date, and the insured is entitled to the full agreed value, or the relevant percentage of it in the case of a partial loss.
The governing principle was stated by Brett LJ in Castellain v Preston,127 a case in which the Court of Appeal considered the nature of a fire insurance policy:
Every contract of marine or fire insurance is a contract of indemnity, and indemnity only, the meaning of which is that the assured in case of a loss is to receive a full indemnity, but is never to receive more. Every rule of insurance law is adopted in order to carry out this fundamental rule, and if ever any proposition is brought forward, the effect of which is opposed to this fundamental rule, it will be found to be wrong.’128
The overriding requirement of indemnity can be seen to underlie the rules which operate in the event of an insured loss. We turn now to consider those rules.
1.1 Forms and measurement of loss
The ‘sum insured’ represents the maximum figure which the insured can recover, it is not necessarily the sum which will be received in the event of a loss. The principle was cogently stated by Cockburn CJ in Chapman v Pole,129 when summing up for the jury: ‘You must not run away with the notion that a policy of insurance entitles a man to recover according to the amount represented as insured … he can only recover the real and actual value of the goods.’130 Accordingly, the sentimental value which an insured places on a lost item is not recoverable even if capable of quantification.
The property which is the subject-matter of the policy may be either totally or partially lost. The distinction centres on the difference between destruction and damage, the determination of which may be a question of degree. Total loss may arise where the property is damaged beyond economic repair. For example, insurers will sometimes ‘write off’ a motor vehicle that has suffered extensive damage in a crash where the repair bill would be greater than the value of the insured vehicle. A house which is damaged by fire may be viewed as totally lost even though the shell of its walls are left standing but are unusable. In this situation, the insurers will generally be liable for rebuilding costs.
Where goods have been totally lost the courts will take the market value of the items as a means of determining the sum recoverable by the insured. In assessing market value account will be taken of the time and place of the insured loss.131 The test is what would it cost the insured to replace the lost goods.132 If the lost item is second hand the insured will recover no more than its reasonable second hand value as at the time of the loss:
Many an assured who has had an armchair burned to pieces has put forward the proposition: ‘Well I want an armchair to sit upon. This one is destroyed and I can only get one to sit upon by buying a new one.’ In some circumstances, if the law were otherwise, that might be very reasonable, but very often it is not recognised and he realises to his chagrin that all he can recover is not his armchair to sit upon, but the reasonable value of the second-hand armchair that has been destroyed.133