CONTRACT OF INDEMNITY

CHAPTER 1

CONTRACT OF INDEMNITY

INSURANCE IS A CONTRACT OF INDEMNITY

The basic principle of a contract of insurance is that the indemnity recoverable from the insurer is the pecuniary loss suffered by the assured under that contract. Thus, s 1 of the Marine Insurance Act 1906,¹ in defining marine insurance, confirms that the contract is, first and foremost, a contract of indemnity:

A contract of marine insurance is a contract whereby the insurer undertakes to indemnify the assured, in a manner and to the extent thereby agreed, against marine losses, that is to say, the losses incident to a marine adventure.

In order that the fundamental principle of indemnity is upheld, other concepts and rules have become established in insurance law; these include double insurance, the right to contribution, return of premium and subrogation, all of which are discussed in the course of this chapter.

The philosophy behind insurance and indemnification was summed up in the early case of Brotherston v Barber (1816) 5 M&S 418, where an insured ship was captured by an American privateer and then re-captured by a Royal Navy ship. Although the claimant, on hearing of the initial capture, claimed for a total loss, the court ruled that he could only be indemnified for a partial loss, as the ship had been re-captured.

Abbott J: [p 425] …But, the great principle of the law of insurance is that it is a contract for indemnity. The underwriter does not stipulate, under any circumstances, to become the purchaser of the subject matter insured; it is not supposed to be in his contemplation: he is to indemnify only. This being the principle, it seems to me that any practice or doctrine which is calculated to break in upon it ought to be narrowly watched.

Similarly, Brett LJ was moved to reiterate the fundamental concept of insurance in Castellain v Preston (1883) 11 QBD 380, CA, where a house was damaged by fire whilst it was in the process of being sold. The vendors not only received an indemnity from their insurers, but also, later, despite the fire, the full amount of the purchase money from the buyers. Not unreasonably, the underwriters sought from the vendors a return of the payment they had made to them on the basis that they, the vendors, had, in fact, suffered no pecuniary loss. In this, the insurers were successful.

Whilst the overriding principle of insurance is that of indemnification for losses sustained, the courts accept the fact that, because there must be an element of freedom for the parties to the insurance to contract on whatever terms they deem fit, in many instances, the indemnity is unlikely to be perfect. This is largely attributable to the fact that both the common law and s 27(3) of the Act endorse the fact that the value fixed by the policy is conclusive of the insurable value of the subject matter insured. This allows the parties the freedom to set the value of the subject matter insured at whatever figure they so wish. Provided that any over-valuation is not so excessive as to offend the cardinal principle of the duty to observe utmost good faith, the law of non-disclosure of a material fact, and of misrepresentation and the rule against wager, the courts are obliged to uphold the value fixed in the policy as conclusive. It is, of course, difficult at any given time to gauge the value of any subject matter with precision, but gross or exorbitant over-valuation could be construed as evidence of fraud.2 That the principle of indemnity is not perfect is illustrated in the case of Irving v Manning, below.

In a valued policy of insurance, the agreed value of a vessel, General Kyd, was put at £17,500. When General Kyd was severely damaged by storms, she was deemed a constructive total loss, because it was estimated that the cost of repairs would have amounted to £10,500, whilst her marketable value, on being repaired, was only £9,000.3 Thus, the assured was indemnified to the value of £17,500, when the true value of the ship was only £9,000.

Patteson J: [p 307] …A policy of assurance is not a perfect contract of indemnity. It must be taken with this qualification, that the parties may agree beforehand in estimating the value of the subject assured, by way of liquidated damages, as indeed they may in any other contract to indemnify.

In Goole and Hull Steam Towing Co Ltd v Ocean Marine Insurance Co [1927] 29 LlL Rep 242, McKinnon J noted that: [p 244] ‘…the real question in the case is: what is the measure of indemnity that, by the convention of the bargain, has been promised to the assured? That may in some cases be less than an ideal pecuniary indemnity, in some cases it may be more.’⁴

However, although it is conceded that a contract of indemnity is not always perfect, the principle of indemnification for actual pecuniary loss remains in the forefront of the minds of judges. This was confirmed by Lord Sumner, in British and Foreign Insurance Co Ltd v Wilson Shipping Co Ltd [1921] 1 AC 188, HL, who observed that: [p 214] ‘…In practice, contracts of insurance by no means always result in a complete indemnity, but indemnity is always the basis of the contract.’

GAMING AND WAGERING CONTRACTS

The Act, in s 4(1), states that:

Every contract of marine insurance by way of gaming or wagering is void.

Although the Act, in itself, does not specify that the effecting of a gaming or wagering contract of insurance is illegal, only that it is void, attention is also drawn to the Marine Insurance (Gambling Policies) Act 1909,5 which is also relevant. The 1909 Act affirms that:

(1) If:

(a)   any person effects a contract of marine insurance without having any bona fide interest, direct or indirect, either in the safe arrival of the ship in relation to which the contract is made, or in the safety or preservation of the subject matter insured, or a bona fide expectation of acquiring such an interest; or

(b)   any person in the employment of the owner of a ship, not being a part owner of the ship, effects a contract of marine insurance in relation to the ship, and the contract is made ‘interest or no interest’, or ‘without further proof of interest than the policy itself’, or ‘without benefit of salvage to the insurer’, or subject to any other like term,

the contract shall be deemed to be a contract by way of gambling on loss by maritime perils, and the person effecting it shall be guilty of an offence…

Thus, despite the Marine Insurance Act 1906 stating, in s 4(1), that a gaming or wagering contract of insurance is merely void, under the Marine Insurance (Gambling Policies) Act 1909 it is also a criminal offence to effect insurance when the assured has no insurable interest in the adventure.

There are, essentially, two forms of gaming and wagering contracts contemplated by s 4(2) of the 1906 Act, namely:

(a)   policies where the assured has no insurable interest or expectation of acquiring such an interest; and

(b)   ‘honour’ or ‘ppi’ (policy proof of interest) policies.

Assured has no insurable interest or expectation of acquiring such an interest

Section 4(2)(a) of the Act states that:

A contract of marine insurance is deemed to be a gaming or wagering contract:

(a)  where the assured has not an insurable interest as defined by this Act, and the contract is entered into with no expectation of acquiring such an interest…

In defining ‘insurable interest,’ s 5(2) stipulates that a person having an insurable interest would be one who ‘…may benefit by the safety or due arrival of insurable property, or may be prejudiced by its loss, or by damage thereto, or by the detention thereof, or may incur liability in respect thereof’.

Notably, that insurable interest is only relevant ‘…at the time of the loss, though he need not be interested when the insurance is effected…’.6

The premium, with respect to a policy which is void, is, under s 84(3)(a) of the Act, only returnable if ‘…there has been no fraud or illegality on the part of the assured…’⁷

‘Honour’ or ‘ppi’ policies

A ‘ppi’ policy (policy proof of interest), often referred to as an ‘honour’⁸ policy, is also deemed to be a gaming or wagering contract by the Act when it confirms, in s 4(2)(b), that:

A contract of marine insurance is deemed to be a gaming or wagering contract:

(b)  where the policy is made ‘interest or no interest’, or ‘without further proof of interest than the policy itself’, or ‘without benefit of salvage to the insurer’, or subject to any other like term,

provided that, where there is no possibility of salvage, a policy may be effected without benefit of salvage to the insurer.

It is emphasised that this sub-section is aimed directly at the wording contained within a contract of insurance. It is immaterial, when such words as ‘interest or no interest’, ‘without further proof of interest than the policy itself’, ‘without benefit of salvage to the insurer’, or any other like term, are used, whether the assured has or has not an insurable interest in the subject matter insured. Just the use of the words themselves, or any other like term, is sufficient to render the contract void. This was particularly well illustrated in the case of Cheshire and Co v Vaughan Brothers and Co, below.

Thomas Cheshire and Co v Vaughan Brothers and Co [1920] 3 KB 240, CA

The plaintiffs were the owners of warehouses at Liverpool, Birkenhead and Newport, where they were in the habit of storing nitrate of soda. At the time, the First World War was in progress, and the British Government controlled all shipments of nitrate from South America. When the plaintiffs anticipated a shipment of nitrate from South America, they reserved space in their warehouses and instructed their brokers to effect a policy of insurance (ppi) with the defendants on anticipated profits; the policy to cover marine and war risks, and the risk of the cargo of nitrate being diverted to another port by the Government. At the time the policy was effected, the insurers were not made aware of the real risk of the shipment being diverted by the Government. So, when the shipment of nitrate was diverted by the Government and the plaintiffs claimed on their policy, the insurers refused payment on the basis that the policy had attached to it a slip which stated that the policy was made ‘without further proof of interest than the policy itself’, thereby making the contract void by s 4(2)(b) of the Marine Insurance Act 1906.

A reinsurance company was being wound up and a committee of creditors was appointed. The liquidator, whilst investigating claims against the company, noted that there were outstanding claims made under ppi policies amounting to £97,538; these included some marine policies. The issue before the court was whether the policies, which included ppi slips, were valid under the Act; in particular, those policies where the ppi slips had become detached.

However, it is emphasised that, under the 1906 Act, ppi policies are not, in themselves, illegal; they are simply void. Thus, under s 84(1), provided that there has been ‘…no fraud or illegality on the part of the assured or his agents, the premium is thereupon returnable to the assured’.9 This was confirmed by Lawrence J, in Re London County Commercial Reinsurance Office Ltd [1922] 2 Ch 67, cited above.

Lawrence J: [p 85] …There remains to be considered the question whether the claimants under these policies are entitled to the return of the premiums which they have paid. Having regard to the fact that the Act 19 Geo 2, c 37, which rendered marine policies effected by way of gaming or wagering illegal, was repealed by s 92 of the Act of 1906, and that the latter Act merely renders such policies void, I am of opinion that the claimants are entitled to prove for the amount of the premiums paid by them in respect of these policies. It is admitted that the original assured, and therefore the reassured, had an insurable interest in the subject matter and that there was no fraud or illegality on the part of the assured or reassured or their agents. In these circumstances, I am of opinion that, as the consideration for the payment of the premiums has totally failed, s 84(1) of the Act of 1906 applies and the premiums are returnable by the company. In my judgment, therefore, the liquidator ought to admit the claimants under these policies as creditors in respect of the premiums paid by them.

Perhaps the philosophy behind ppi policies and the problems which arise under such policies were best illustrated by Scrutton LJ, in Thomas Cheshire and Co v Vaughan Brothers and Co [1920] 3 KB 240, CA, cited above.

The basis of insurance is that of indemnification for pecuniary losses incurred: this would preclude profit making by an assured through over-insurance by double insurance.10 Equally, on the same principle, when there is over-insurance by double insurance, each insurer must bear his share of any loss by way of a ‘contribution’ proportionate to the amount for which he is liable under the contract.¹¹ And, should any insurer pay more than his proportion of the loss, he is entitled to recover from the other insurers their proportion of the loss by way of the right to contribution.¹²

With respect to any return of premium, the Act, in ss 82–84, enumerates the conditions under which the return of any premium or proportion of that premium is applicable, including a specific provision for over-insurance by double insurance. Under this provision, in keeping with the principle of indemnity, an insurer may be liable to return to the assured a proportion of the full premium because, on account of the double insurance, the risk insured amounts to less than that for which that full premium was paid.¹³

Double insurance and the right to contribution

Over-insurance by double insurance and the right to contribution are so interdependent that they are inseparable. With respect to over-insurance by double insurance, s 32(1) of the Act states:

Where two or more policies are effected by or on behalf of the assured on the same adventure and interest or any part thereof, and the sums insured exceed the indemnity allowed by this Act, the assured is said to be over-insured by double insurance.

And, with regard to any right to contribution arising out of over-insurance by double insurance, s 80 of the Act affirms that:

(1)   Where the assured is over-insured by double insurance, each insurer is bound, as between himself and the other insurers, to contribute rateably to the loss in proportion to the amount for which he is liable under his contract.

(2)   If any insurer pays more than his proportion of the loss, he is entitled to maintain an action for contribution against the other insurers, and is entitled to the like remedies as a surety who has paid more than his proportion of the debt.

However, it is emphasised that, as the Act states in s 32(1), over-insurance by double insurance and any contributions resulting from such, are only applicable to two or more policies of insurance which are effected on the same subject matter by or on behalf of the same person. It does not apply when different persons insure the same subject matter in respect of different rights. Mellish LJ was careful to point this out in North British and Mercantile Insurance Co v London, Liverpool and Globe Insurance Co, below.

In 1992 and 1993, two significant insurance cases concerning the right to contribution, neither of them marine insurance cases, but nonetheless relevant, came before the Court of Appeal and the Judicial Committee of the Privy Council respectively. Effectively, the issue before the courts in both instances was whether a co-insurer could, by a provision within the contract of insurance, exclude his liability to contribute to a loss.

That the right to contribution is founded in equity rather than contract is well established, and it was accepted, in the case of Legal and General Assurance Society Ltd v Drake Insurance Co Ltd, below, that the equitable right to contribution could be varied or excluded by contract, even between the assured and the insurer. However, in the case in question, Lloyd LJ was of the opinion that the clause on notification of claim14 was not one which could modify or exclude the equitable right to contribution.

Legal and General Assurance Society Ltd v Drake Insurance Co Ltd [1992] 1 All ER 283, CA

Two insurance companies insured the same driver under standard private car policies. Both policies provided that immediate written notice had to be given of an event which might give rise to a claim, observance of which was a condition precedent to liability, and that if there was ‘any other insurance covering the same loss’ when the claim arose, the insurers would not pay or contribute more than their rateable proportion. When the insured driver injured a pedestrian, the plaintiffs (Legal and General) settled the claim without knowing that the assured had taken up another policy of insurance. When the plaintiffs learned about the other policy, they sought a 50% contribution from the other insurer, the defendants (Drake Insurance). However, Drake Insurance refused to contribute, on the basis that they had a good defence to any claim under their policy, as the driver had been in breach of a condition precedent in not having given notice of claim within the stipulated period.

The Court of Appeal (Ralph Gibson LJ dissenting) ruled that the right to contribution was not defeated by the failure of the assured to notify the co-insurer of a potential claim, albeit such failure constituted a breach of a condition under the policy. The plaintiffs were held to have had an undoubted right to contribution in equity against the defendant for half the amount for which the claim was settled. It was held that the right to contribution accrued on the date of loss; and as the breach of the condition precedent must necessarily occur after the date of loss—by which time the right to contribution had already accrued—the plaintiff was entitled to a 50% contribution from the defendant.

Lloyd LJ: [p 287] …It may be said that the distinction between breach of condition prior to the loss and breach of condition subsequent to the loss is a narrow one. So it may be. But the difference is crucial. For it is at the date of the loss that the co-insurer’s right to contribution, if any, accrues. [Emphasis added.]

A Mr Simms, who suffered injuries as a result of a road accident, brought proceedings and obtained judgment against the negligent driver, a Mr O’Reilly. But, as Mr O’Reilly failed to meet the judgment, he brought proceedings against Mr O’Reilly’s insurer, Eagle Star, and the repairer’s insurer, Provincial, under the Road Traffic Act, which provided, inter alia, that an insurer was bound to meet an injured person’s claim when the driver responsible failed to do so. The policies issued by Eagle Star and by Provincial both contained a condition under which the company was not liable to contribute more than its rateable proportion of any loss, damage or expense.

The accident was never reported to Provincial, and under the terms of their policy, they were entitled to repudiate liability.15 Eagle Star contended that they were entitled to be indemnified by Provincial, because they were not at risk, having cancelled their policy before the accident.¹⁶ Provincial claimed that it was entitled to a 50% contribution from Eagle Star. Thus, the present action was concerned with the right to contribution between the two insurance companies, both of which were under a statutory liability to meet the injured person’s claim when the driver responsible failed to do so.

The Privy Council ruled that both insurance companies had to contribute equally to the loss, because they were both statutorily liable to a third party claim.

Lord Woolf: [p 147] … [referring initially to the Legal and General case] On an appeal from the decision at first instance that Legal and General were entitled to 50% contribution, the Court of Appeal (by a majority of Lloyd and Nourse LJJ, Ralph Gibson LJ dissenting) held that where an assured had effected insurance with two different insurers to cover the same loss, the right of one insurer to contribution from a second insurer as to the costs of meeting a claim accrued at the time of the loss. Therefore, even if Drake Insurance Co were entitled to establish that their cover had lapsed because of late notification, the cover would not have lapsed until after the loss, and accordingly, the right of Legal and General to contribute was not affected. [p 148] …Lloyd LJ acknowledges that:

…it is often said that, though the right to contribution is founded in equity, yet it may be varied or excluded by contract.
Lloyd LJ then accepted that, for the purpose of contribution, the assured and the insurer by contract can limit the amount of the insurer’s liability or provide that the insurer should not be liable beyond his rateable proportion. However, Lloyd LJ distinguishes a provision requiring the assured to give notice of claim because it does not:
…modify or exclude the equitable right to contribution in the same sense.
Approaching the issue as a matter of principle, in a case such as the present, where both insurers are required to indemnify a third party by statute, there can only from a practical point of view be two solutions to the question of contribution: either the insurers should contribute in accordance with their respective statutory liabilities so that, if they are statutorily equally liable, they will so share the loss; or contribution is determined in accordance with the extent of their respective liabilities to the person insured under the separate contracts of insurance. Of the two alternatives, the contractual approach is the more appropriate, since the extent of their respective liabilities to the person insured will indicate the scale of the double insurance.