The duration of the duty of utmost good faith

9.  The scope of the insurers’ duty of good faith

The fact that section 17 of the 1906 Act states that the duty of utmost good faith is borne by both parties to the contract, the insured and the insurer, has already been noted.²²² Although in practice it is rare for the issue of the insurer’s duty to arise in litigation, at least in so far as it applies to the pre-contractual relationship, nevertheless in Banque Financière de la Cité SA v Westgate Insurance Co Ltd,²²³ the courts were afforded the opportunity to consider the scope of the duty as it applies to insurers. At first instance,²²⁴ Steyn J reaffirmed the mutuality of the disclosure duty by holding that the insurers owed a duty of disclosure to the insured. The Court of Appeal and the House of Lords affirmed this element of the trial judge’s decision, but reversed his finding that the remedy against the insurer for breach was damages,²²⁵ confining it to avoidance of the contract and return of the premiums only on the basis that the court’s power to grant relief arose from its equitable jurisdiction.

The test to be applied in determining materiality from the insurers perspective was, in Steyn J’s opinion, whether ‘good faith and fair dealing require disclosure’ to the insured.²²⁶ However, the Court of Appeal, notably Slade LJ, criticised this formulation as being far too broad and vague as a test for determining the existence of the duty which might arise ‘even in the absence of any dishonest or unfair intent’.²²⁷ For Slade LJ the insurer’s duty of disclosure should

The House of Lords approved Slade LJ’s reasoning in this respect. It is unfortunate that the opportunity for a thorough and authoritative assessment of the insurers’ duty of good faith was not taken up.

The narrow approach adopted by the Court of Appeal in Westgate towards the insurers’ duty of good faith was recently applied in Aldrich v Norwich Union Life Insurance Co Ltd.²²⁹ Norwich Union had sold certain ‘property backed guarantee plans’ to Lloyd’s names whereby guarantees were given in respect of their liabilities. Calls by Lloyd’s exhausted the guarantees and Norwich Union sought to enforce the security provided by the names. The security included the assignment of endowment and life policies to the insurer. The Court of Appeal upheld the striking-out of claims that Norwich Union had failed to disclose its knowledge that the syndicates to which the names belonged were likely to incur substantial losses. It was held that there was no obligation on Norwich Union to disclose matters relating to the risk of losses at Lloyd’s because this particular risk was not covered by the endowment and life policies; the only issue material to such policies related to the insureds’ (ie the Names’s) lives.

While the pre-contractual duty of good faith borne by insurers is surprisingly narrow, and seems to be settled as such for the time being, the judges in a number of recent cases have nevertheless taken the opportunity to consider whether an insurer, in exercising its right to avoid a contract for non-disclosure, is subject to the good faith duty. As has been seen, in Brotherton v Aseguradora Colseguros SA (No 2),²³⁰ Mance LJ considered what he identified as the first ‘strand’ in Colman J’s reasoning in The Grecia Express,²³¹ that the right to avoid is conditional upon the consistency of any such avoidance with ‘good faith and conscience’.²³² We have already noted that Mance LJ rejected Colman J’s view ‘that the court has a role in permitting (or refusing to permit) insurers to avoid a policy for non-disclosure’.²³³ Mance LJ also roundly rejected the second ‘strand’ implicit in Colman J’s reasoning ‘that an insured is, if necessary, entitled to litigate the issue of the truth or falsity of known but undisclosed intelligence, in order to argue that, if it is shown to be incorrect, the insurer would be acting in bad faith or unconscionably in avoiding’.²³⁴ The judge thought that it would be an ‘unsound step’ to introduce into English law a principle enabling an insured:

A somewhat more open-textured and, as has been commented above, more insured-friendly approach was adopted by the majority of the Court of Appeal in Drake Insurance plc v Provident Insurance plc.²³⁶ It will be recalled that it was held that the non-disclosure did not induce the insurers to accept the risk and therefore they were not entitled to avoid the policy. Rix LJ observed that the doctrine of good faith should be capable of limiting the insurer’s right to avoid in circumstances where that remedy, which has been described in recent years as draconian, would operate unfairly.²³⁷ He went on to note that in recent years there appears to have been a realisation that in certain respects English insurance law has developed too stringently. Citing Pan Atlantic in which, it will be recalled, the House of Lords superimposed the requirement of inducement onto the statutory materiality test, Rix LJ stated that leading modern cases show that the courts are willing to find means to introduce safeguards and flexibilities which had not been appreciated before. Significantly, the judge felt inclined to say that it would not be in good faith to avoid a policy without first giving the insured an opportunity to address the reason for the avoidance.²³⁸ By way of conclusion, he remarked that nowadays not all insurance contracts are made by those who engage in commerce and that the existence of widespread consumer insurance presents new problems: ‘It may be necessary to give wider effect to the doctrine of good faith and recognize that its impact may demand that ultimately regard must be had to a concept of proportionality implicit in fair dealing.’²³⁹ Both Rix and Clarke LJJ stated that insurers must not ignore facts which they know, or of which they have Nelsonian blindness. Pill LJ went further by requiring insurers to act in good faith and to make enquiries of the insured before taking the drastic step of avoiding the policy.

Brotherton and Drake represent two different approaches of the Court of Appeal to the issue of good faith in so far as it applies to insurers. Of the two, the reasoning in Brotherton is to be preferred. Mance LJ proceeded on the basis of case law²⁴⁰ and, as has been noted above,²⁴¹ he took the view that avoidance for non-disclosure or misrepresentation is akin to rescission for misrepresentation under the general law of contract. Although, as such, this self-help remedy is not generally constrained by considerations of good faith and conscience. Moreover, as indicated above, the recent decisions on the disclosure duty are of major significance because they show that modern judges are engaged in a process of eroding the harshness of the duty of utmost good faith. This recent trend can be traced to the creation of the requirement of inducement in Pan Atlantic. The precise nature of the requirement came to the fore in the recent cases considered above. A further line of judicial attack, particularly by Rix LJ, has taken place via the principle of waiver, considered below.

It is noteworthy that the issue of the insurers good faith duty has recently been considered in relation to express terms contained in the insurance policy. In Gan Insurance Co Ltd v Tai Ping Insurance Co Ltd (No 2)²⁴² it was held that claims co-operation clauses are subject to a rationality test which owes its origins to the insurers’ duty of good faith. Although there was no implied term that approval of a settlement could not be unreasonably withheld, the right to withold approval was not unqualified. It must be exercised in good faith. Thus, insurers are under a duty of good faith in exercising their rights under a claims co-operation clause, and must not, therefore, arbitrarily refuse to approve a settlement.

The English and Scottish Law Commissions,²⁴³ recognising that the remedies available under section 17 of the 1906 Act are of little practical benefit to a policyholder,²⁴⁴ take the view that the law should recognise a mutual duty of good faith. They consider that where an insured suffers foreseeable loss due to an insurer’s act or omission, the law should provide compensation for this loss.²⁴⁵ They reject the idea of characterising the duty of good faith as either an implied term,²⁴⁶ or as giving rise to an action in tort or delict,²⁴⁷ but rather they recommend that it should be to be a duty which gives rise to specific remedies to be set out in statute.²⁴⁸ They therefore propose reversing the effect of Banque Financière and repealing part of section 17 so as to enable the courts to award a range of remedies.²⁴⁹

The Law Commissions summarise the four ways in which an insurer may avoid a contract:²⁵⁰ (i) an avoidance may be legally correct and in good faith; (ii) an avoidance may be legally correct but not in good faith; (iii) an avoidance may not be legally correct but nevertheless made in good faith;²⁵¹ and (iv) an avoidance may not be legally correct and not in good faith. In scenarios, such as those set out in (iii) and (iv) where the avoidance may not be legally correct, the insurers would be in breach of contract, although this could be excluded by an express term. However, where the insurer wrongly avoids a contract and acts in breach of the duty of good faith, there will be two separate liabilities (and such liabilities will be non-excludable).

The Law Commissions ask whether legislation should include guidelines for the content of the insurer’s duty to act in good faith.²⁵² They suggest it should specify that (i) an insurer should investigate claims fairly; (ii) an insurer should assess claims in a way which is free from bias, taking into account relevant circumstances, and not taking into account irrelevant ones; (iii) if an insurer considers a claim to be invalid, it should give the insured reasons for its decisions; and (iv) if the insurer considers the claim to be valid, it should pay it within a reasonable time.²⁵³ Further, they suggest this list to be non-exhaustive.²⁵⁴ The Law Commissions propose damages which are in the reasonable contemplation of the parties at the time of the contract, thus deploying the rule in Hadley

v Baxendale,²⁵⁵ and bringing insurance law further into line with the principles of general contract law.

10.  Misrepresentation

Put simply, a misrepresentation can be defined as an untrue statement of a material fact made by one party to the contract to the other party which induces the contract but which is not a contractual term.²⁵⁶ As with non-disclosure, where the insurer is induced to enter into the contract on the basis of some misrepresentation made by the insured, the insurer is entitled to avoid the contract. As commented above, given the breadth of the disclosure duty the law of misrepresentation has played a relatively minor part in insurance compared with the law of contract more generally. This is because first, insureds are under a positive duty to disclose material facts and so misrepresentation frequently becomes a question of non-disclosure; and secondly, because of the ‘basis of the contract clause’,²⁵⁷ the insured’s answers to questions in the proposal form are converted into contractual terms (warranties), thereby pre-empting the issue of misrepresentation arising. Although, following the Statement of General Insurance Practice,²⁵⁸ basis clauses are no longer used by insurers against consumers (non-business insureds), they are still found in non-consumer insurance policies. The case law on misrepresentation in insurance contracts is far from satisfactory, the judicial language often confusing the lines of demarcation between non-disclosure and misrepresentation.

Because misrepresentation is generally subsumed under non-disclosure there has been little judicial consideration of section 2(2) of the Misrepresentation Act 1967. This provision holds the potential to prevent insurers avoiding the contract by granting the court the discretion to award damages in lieu of recission or avoidance. Although this power is unlikely to be exercised in commercial insurance,²⁵⁹ it may assume greater significance in consumer insurance in the light of the Court of Appeal’s decision in Economides v Commercial Union Assurance Co plc.²⁶⁰ Further, in his Annual Report for 1990, paragraph 2.3, the Insurance Ombudsman noted that in consumer insurance most so-called non-disclosures arise via inaccurate answers to questions in proposal forms (in reality, misrepresentations) and that in such cases (by analogy with section 2(2) of the 1967 Act) he would not allow insurers to avoid the policy but restrict them to partially or wholly avoiding a claim.

10.1  Fraudulent misrepresentation

The House of Lords in Derry v Deek²⁶¹ established that a lack of honest belief on the part of the representor is central to an allegation of fraud. Lord Herschell defined fraudulent misrepresentation as a false statement ‘made (1) knowingly, or (2) without belief in its truth, or (3) recklessly, careless whether it be true or false’.²⁶² If a false statement is made on grounds that would not necessarily convince a reasonable person, it may be negligent, but in the absence of dishonest intent, it will certainly not be fraudulent. However, being economical with the truth by deliberately giving a false impression by making an incomplete statement may constitute fraudulent misrepresentation. Even though the several parts of the statement, if severed from the rest, are not actually false, nevertheless it is the impression designed to be conveyed to the recipient of the statement which is the critical factor. The point was forcefully made by Lord Halsbury in Aaron’s Reefs Ltd v Twiss,²⁶³ who, rejecting the contention that no specific element of the statement in question had been proved to be false, said:

A fraudulent misrepresentation renders the contract voidable and the insurer can retain premiums paid under the policy. The insurer may also bring an action for damages against the misrepresentor in the tort of deceit.²⁶⁵

10.2  General principles applicable to misrepresentations

As a general rule a distinction is drawn between misrepresentation and its materiality. The insured’s knowledge has no relevance in the latter context, because the test of materiality, as we have seen, is centred on the judgment of a reasonable insurer. The insured’s knowledge has no relevance in the former context if he has made a statement of fact, because the correctness or otherwise of a representation is objectively assessed.

The law of misrepresentation in the context of insurance contracts is codified by the Marine Insurance Act 1906, section 20, which also applies to non-marine insurance. Section 20(1) provides that every material representation made by the proposer for insurance in negotiating the contract must be true; if it be untrue the insurer may avoid the contract. The test for materiality is laid down in section 20(2), which, echoing section 18(2), provides that a representation is material if it ‘would influence the judgment of a prudent insurer in fixing the premium, or determining whether he will take the risk’. Section 20(4) stipulates that a statement of fact is true ‘if it be substantially correct, that is to say, if the difference between what is represented and what is actually correct would not be considered material by a prudent insurer’.

Section 20(3) of the 1906 Act provides that a representation may be either a representation as to a matter of fact, or as to a matter of expectation or belief. Indeed, since the introduction of the Statements of Practice in 1986, insurers have restricted their express questions to consumers to those which merely require the consumer to answer according to his knowledge and belief. When a proposer represents his own belief, this is not a representation of ‘fact’ in the strict sense other than the fact of the proposer’s belief. If the belief was not in fact held by him or her, an action for misrepresentation may lie.²⁶⁶ Conversely, merely because the representor’s belief turns out to be wrong will not, of itself, amount to an actionable misrepresentation.²⁶⁷ In Economides v Commercial Union Assurance Co plc,²⁶⁸ the Court of Appeal took the opportunity to subject section 20 of the 1906 Act to detailed scrutiny. A material issue was whether or not an insured had to show reasonable grounds to support a representation of opinion. The insured, E, an 18 year old student, had effected a household contents policy with the defendants in 1998. The total sum insured was £12,000 (index linked) and the maximum recoverable for valuables (as defined in the policy) was one-third of that amount. The proposal form which was completed and signed by him stated that the answers given were true to the best of his knowledge and (notwithstanding the Statements of Practice, in force at that time) that it formed the basis of the contract between him and the insurers. At that time the answers given by the insured were true. In 1990 E’s parents left Cyprus and came to live permanently in England. They moved in with him, bringing with them a considerable quantity of valuables including jewellery worth some £30,000. E, now aged 21, saw some of the jewellery when his mother wore it, but showed little interest. However, his father, a retired police divisional commander, advised him to increase his contents policy by approximately £3,000. The insured contacted the insurers and instructed them to increase cover to £16,000. The next renewal invitation, which contained a disclosure warning modelled on the Statements of Practice, stated that this was the sum insured.

In 1991 E’s flat was burgled and property worth some £31,000 was stolen, the bulk of which was the parents’ valuables. When he claimed under the policy it became clear that the value of his parents’ property was £30,970 which exceeded the sum insured. Further, the valuables in question exceeded one-third of the total sum insured or the total value of the contents which was now estimated to be £40,000. The insurers avoided liability on grounds of misrepresentation and non-disclosure of material facts. It was held by the Court of Appeal, that a statement of belief, if given in good faith, does not need to be supported by reasonable grounds for that belief, but the existence or lack of reasonable grounds for such belief may be taken into account by the court in determining whether the representor has acted in good faith. Further, the duty on the insured, when representing the full contents value to be £16,000 was solely one of honesty.

At first instance, the judge found for the insurers on the basis that although E may have honestly believed his valuation to be correct, honesty was not enough in the absence of reasonable grounds on which he could have based the representation. The judge said: ‘it would have been necessary for him to make substantially more inquiries than he did make before he could be said to have reasonable grounds for his belief’.²⁶⁹ E’s statement was therefore an actionable misrepresentation. Further, the trial judge went on to find that since E had been informed by his parents of the presence of the jewellery and silverware in the flat but had wilfully closed his eyes (‘Nelsonian blindness’) to the true nature and value of these items, the insurers were entitled to avoid the policy on the ground of non-disclosure. The judge was of the view that once these items were introduced into the flat by his parents, E should have made further inquiries, and such inquiries would have led him to the conclusion that material facts had not been disclosed. E appealed.

Taking the defence of misrepresentation first, the issue before the Court of Appeal was whether for the purposes of insurance law a representor had to show objectively reasonable grounds for his belief,²⁷⁰ or whether honesty alone was sufficient. Distinguishing the authorities relied on by counsel for the insurers,²⁷¹ both Simon Brown and Peter Gibson LJJ concluded that the duty on E when representing the full contents value to be £16,000 was solely one of honesty. They both thought that the Marine Insurance Act 1906, section 20(5) which provides that ‘[A] representation as to a matter of expectation or belief is true if it be made in good faith’ provided the conclusive answer to the point,²⁷² and thus:

The standard therefore takes account of the level of skill or knowledge of the representor. On the issue of non-disclosure, the Court of Appeal agreed that the governing principle is to be found in the Marine Insurance Act 1906, section 18(1).²⁷⁴ The true scope of the words in the section ‘deemed to know’ has in fact long been settled. As we noted above, Simon Brown LJ stressed that where the insured is a private individual not acting (in the words of the section) ‘in the ordinary course of business’, he ‘must disclose only material facts known to him; he is not to have ascribed to him any form of deemed or constructive knowledge’.²⁷⁵ In support of this proposition he cited Saville LJ’s summary of the legal position in Deutsche Ruckversicherung AG v Walbrook Insurance Co:²⁷⁶

Accordingly, the Court of Appeal, in allowing the appeal, held that the test for non-disclosure was the same as that for misrepresentation, namely that of honesty. Just as there was no duty on E to make further inquiries to establish reasonable grounds for his belief in the accuracy of his representation concerning valuation, so too, as noted above, he was not under a duty to inquire into the facts so as to discharge the obligation of disclosure of all material facts known to him.

The decision of the Court of Appeal on the issue of misrepresentation does, however, seem to inject an element of inconsistency in the way misrepresentation operates in insurance contracts as compared with general contract law. Limiting the duty on the proposer/insured to one of ‘honesty’ would appear to eliminate innocent misrepresentation from insurance law. As pointed out by Hird,²⁷⁸ if the insured is dishonest, then quite clearly this will amount to fraudulent misrepresentation. Where, on the other hand, the insured is honest this will not amount to misrepresentation because there is no implied requirement for the insured to show ‘objectively reasonable grounds’ for his belief. For the non-business insured, innocent misrepresentation does not operate because, as commented above, the Statements of Practice, now superseded by industry practice, provided that the proposer’s answers to questions on the proposal form are ‘to the best of his knowledge and belief’. And so, in the words of Simon Brown LJ, the ‘sole obligation’ borne by the insured is that of honesty.²⁷⁹ Further, in the absence of any duty of care to show ‘objectively reasonable grounds’ for the belief in a representation, it seems that the non-business insured also enjoys immunity from negligent misrepresentation.

In Kamidian v Holt,²⁸⁰ the insured, K, claimed for damage to a Dr Metzger Egg Clock, which he alleged was a creation of Carl Fabergé. He bought the egg from Sothebys at auction in November 1991. The piece was not described by Sothebys as by Fabergé, but he asserted that he had recognised it as a Fabergé piece. In 2000 he loaned the Egg Clock for display at an exhibition in the USA. On arrival it was found to be damaged in transit. The clock had been insured as a Fabergé item under a valued policy in the sum of US$2.5 million. It was then returned to England, but was found to have suffered further damage on the return journey. K sought to recover repair and depreciation costs. The underwriters contended that K had made implied representations: (a) as to the provenance of the Egg Clock as a matter of fact, the representation being untrue because the Egg Clock was not by Fabergé, (b) as to the fact that the Egg Clock was generally accepted by the art world as being authentic, which on the facts was not the case, (c) as to the claimant’s belief that it was generally accepted by the art world that the Egg Clock was an authentic Fabergé piece, a view that the claimant did not genuinely hold, and (d) as to the claimant’s belief regarding the provenance of the Egg Clock, a view which the claimant did not genuinely hold. Tomlinson J noted that:

The judge upheld implied representation (b).²⁸² He found that K knew that the piece was not generally accepted as being an authentic Fabergé,²⁸³ and therefore the implied representation to the underwriters that the clock was generally accepted by the art world as being a Fabergé was untrue.²⁸⁴ Accordingly, there had been a material misrepresentation and it had induced the underwriters to enter into the contract.

10.3  Damages for misrepresentation where the right to avoid is lost

Recently, in Argo Systems FZE v Liberty Insurance PTE Ltd, London Special Risks Ltd,²⁸⁵ the insurers argued that if they were not entitled to avoid the policy, they should be allowed to claim damages for misrepresentation under the Misrepresentation Act 1967 (‘the 1967 Act’) . The insured argued that this argument was ‘bad in law’²⁸⁶ and the 1967 Act did not apply; further they argued that even if an insurer could claim damages, an affirmation of the insurance policy bars an insurer from claiming damages under the 1967 Act. HHJ Mackie QC confirmed that HIH Casualty & General Insurance v Chase Manhattan Bank,²⁸⁷ did purport to say that damages under section 2(1) of the 1967 Act could be claimed in a contract of insurance,²⁸⁸ thus the pleading was not ‘bad in law’. However, he queried whether this remedy was available in situations where an insured lost the right to avoid, and if so, why had there not been an award in a past case.²⁸⁹ The judge declined to comment on this any further, believing it was a question of the Court of Appeal. He decided that it was not available on the basis that it ‘is not just for it to be able to receive damages equivalent to the benefit it would have received from avoidance’.²⁹⁰

11.  The consequences of misrepresentation by the insurer

Where, as must be rare, the insured is induced by some misrepresentation of fact by the insurers to pay the premium, he is entitled to recover it on the basis of money had and received. Performance does not operate to bar rescission of insurance contracts obtained by fraudulent misrepresentation (or, for that matter, non-disclosure). In Kettlewell v Refuge Assurance Co Ltd,²⁹¹ the insured, having paid one year’s premium for a life policy, notified the insurer’s agent that she wished to let the insurance policy lapse. The agent induced her to continue paying the premiums for four more years by saying that she would then obtain a free policy. The Court of Appeal held that the insured was entitled to recover the premium money which she had paid to the insurers. Sir Gorell Barnes P, having noted that there was a clear misrepresentation of fact, rejected the insurers’ contention that the premiums could not be repaid because the company had been at risk until the insured elected to avoid the policy. The judge said:

The effect of the Court of Appeal’s reasoning is that the insurer’s coming on risk is not a bar to rescission. As such, the insurer’s exposure to the insured risk does not constitute performance.²⁹³ Further, Lord Alverstone CJ went on to express the view that the money was also recoverable by way of damages in an action in deceit.²⁹⁴

12.  Waiver: affirmation and estoppel

The issues of affirmation and estoppel leading to the insurers losing their right to avoid a policy for non-disclosure have attracted considerable judicial attention in recent times. Insurers may lose their right to avoid the policy by reason of their conduct after the loss has occurred. This can occur either by affirmation, or by estoppel. The two are very similar. Affirmation arises where the insurers with full knowledge of the non-disclosure or misrepresentation make it clear to the insured by word or conduct that they do not intend to avoid the contract.²⁹⁵ Estoppel arises where the insurers’ conduct induces the insured to believe that they do not intend to avoid the contract and the insured has acted accordingly. Thus, affirmation must to be communicated to the insured but, unlike estoppel, it is not necessary to prove that some representation by words or conduct was made by the insurer which was relied upon by the insured to his detriment.

12.1  Affirmation

In Moore Large & Co Ltd v Hermes Credit & Guarantee plc,²⁹⁶ it was held that affirmation can occur where insurers have defended legal proceedings on the basis of coverage or terms of the policy knowing that an utmost good faith defence might exist. On the facts, the insurers had sought to rely on the insured’s breach of the disclosure duty at a late stage in the proceedings. Further, the insurers had the benefit of legal advice and it is not open to them to argue that they are not bound by the tactical decisions of their legal advisers. The Court of Appeal has also expressed the view that where the insurer, having purported to avoid a motor policy, failed to cancel a direct debit mandate for the collection of premiums and generally acted inconsistently with the idea that the relationship had been terminated, the defence of waiver may be available to the insured.²⁹⁷

Insurance Corporation of the Channel Islands v The Royal Hotel Ltd²⁹⁸ is a paradigm case not only on the question of affirmation, but on the repercussions of tactical decisions taken during the litigation process which can result in a finding of issue estoppel or abuse of process in a subsequent action between the parties on the policy. It will recalled that the insured hotel had been damaged in a series of fires and had to close in June 1992. Its owner claimed under two fire insurance policies effected with the claimant company, ICCI. The first policy covered material damage to the buildings and the second policy covered business interruption losses. In an action commenced in 1994, Mance J considered claims by ICCI and the Royal Hotel and counterclaims by the Royal Hotel arising out of the fires and the conduct of the subsequent claims.²⁹⁹ He held that the Royal Hotel had forfeited all benefit (some £950,000) under the second policy (business interruption) because its director and company secretary had used fraudulent means to promote the hotel’s occupancy rate so as to inflate the sums recoverable under the business interruption policy. The claimant now sought to avoid the first policy (material damage) on the ground of material non-disclosure.

The issues before the court concerned materiality, inducement, affirmation and cause of action or issue estoppel. Materiality and inducement were evidentially straightforward in the light of the insured’s undisclosed moral hazard and the judge found in the insurers’ favour.³⁰⁰ However, on the remaining issues, Mance J held that the evidence established that the insurers first became aware of the insured’s fraudulent conduct in 1993, yet their conduct of the 1994 action proceeded on the basis that the material damage policy was valid and as such they could be taken to have affirmed the policy. Further, the insurers should have raised the issue of material non-disclosure during the 1994 action, and their failure to do so resulted in them being precluded from seeking to avoid the policies in the present action on the basis of issue estoppel and abuse of process.

12.1.1  The elements of affi rmation: (a) knowledge

Addressing the question of the knowledge required for effective affirmation, the judge noted that there had to be an informed choice to treat the contract as continuing despite its breach. He rejected counsel’s argument that constructive knowledge was sufficient,³⁰¹ viewing the authorities relied upon to support the proposition as cases on estoppel, rather than election.³⁰² Mance J did accept, however, that determining the exact nature of someone’s knowledge is a nebulous exercise:

12.1.2  The elements of affi rmation: (b) an unequivocal representation of affirmation

The second component of affirmation in the context of insurance, that of making an unequivocal communication to the insured of the insurer’s choice not to avoid, was also problematical in terms of determining what exactly the communication should evidence. The judge queried whether, on the one hand, it is sufficient that there is knowledge of the breach and a communication (by words or conduct) which demonstrates that an unequivocal choice has been made, or whether, on the other hand, the communication itself or the surrounding circumstances demonstrating such knowledge, would suffice. On this issue Mance J concluded that for the purposes of affirmation the latter approach was correct:

Therefore the question whether there has been an unequivocal representation has to be considered in the light of the insured’s knowledge about what the insurers actually knew. As such, where it is argued that a party’s conduct amounts to an unequivocal representation, the impact such conduct has on the other party to the contract has to be objectively assessed. Mance J therefore posited that in affirmation, as distinct from estoppel, the actual state of the other party’s mind is not the test because affirmation ‘depends on the objective manifestation of a choice’.³⁰⁵ The difficulty lies with determining what knowledge can be objectively ascribed to the insured, for it is from his perspective that some choice has to be seen to have been exercised by the insurer. On the facts of the case, Mance J was of the opinion that where the choice lies between whether or not to avoid the policy on the ground of non-disclosure of material facts (ie Royal Hotel’s fraudulent conduct), it has to be determined how far a reasonable person in the insured’s position would be aware of what matters were material to a prudent insurer and how, in the absence of such awareness, the reasonable person could regard any conduct of the insurers as unequivocal. Given the severity of Royal Hotel’s undisclosed conduct, it must have been clear and obvious to its director that his conduct would induce the contract. The insured must also have realised that the dishonest conduct in question had been discovered by the insurers if only on the basis of a common sense consideration of the documents which had been supplied to them during the pre-trial proceedings in 1994.³⁰⁶

On the evidence, the judge took the view that the insurers’ solicitors, Herbert Smith, became suspicious of the fraud during 1993 and were convinced of it by 1994 but decided on so-called ‘tactical’ grounds not to raise the issue of avoidance during the 1994 trial. For Mance J this therefore amounted to affirmation because ‘they did for present purposes “know” the real position, however much Royal Hotel continued to brazen it out with implausible denials or evasions’.³⁰⁷ The fact that the insured continued to deny dishonest conduct on their part, even during the earlier trial, did not preclude a finding that the insurers had the relevant knowledge and knew that the insured’s denials were unsustainable.

The insurers had also continued to observe the arbitration clauses in the policies up until 1995 and as such had been a party to the ensuing arbitration proceedings. Taking this, together with the insurers’ conduct of the 1994 litigation which, as has been seen, proceeded on the basis that the material damage policy was valid, the court was able to find what amounted to unequivocal conduct by the insurers from which it could be inferred that they recognised the continuing validity of the policy ‘despite their and legal advisers’ unannounced internal intention not to do so’.³⁰⁸

In Scottish Coal Co Ltd v Royal and Sun Alliance Insurance plc,³⁰⁹ the insured made a claim under its policy which insured against risks arising from its mining activities. The insurers sought to avoid the claim on the ground of non-disclosure because the claimants had decided to engage in new mining techniques and had failed to disclose this change to the insurers. Following the decision in ICCI, it was held that the insurers had made an unequivocal election to affirm the contract. By March 2009 the underwriters knew that the insured had not disclosed its new plans which may have increased the risk under the policy; they failed to tell their risk inspector even though he advised them that he would want details of the new project and despite their knowledge, the underwriters failed to enquire further to substantiate any other defences they had under the policy.³¹⁰ On 24 January 2001 the underwriters agreed to extend the policy without reserving any their rights in relation to any earlier defences and they included, in the calculation of the premium, the losses which the insured had claimed for without suggesting that these were contested or inappropriate. Steel J said that ‘against this background, it is difficult to categorise this extension, viewed objectively, as being other than an unequivocal election to affirm the contract’.³¹¹ Recently, in Argo Systems FZE v Liberty Insurance PTE Ltd, London Special Risks Ltd,³¹² the issue of affirmation and an unequivocal representation was again to the fore. The insurers had failed to raise misrepresentation as a ground for avoiding the policy in the previous seven years during which the claim was being disputed. HHJ Mackie QC, in discussing what is necessary for an affirmation, remarked:

It was held that the insurers had affirmed the insurance policy and had thus lost the right to avoid.³¹⁴ HHJ Mackie QC based his conclusion on a number of reasons. Firstly, though silence does not usually amount to a representation, it can do where it is significant. On the facts, seven years constituted a significant silence.³¹⁵ Secondly, the insurer had recognised that a misrepresentation had taken place, yet had not pleaded it nor avoided the policy in the earlier proceedings.³¹⁶ Accordingly, the insurer was relying on its rights under the policy; it was not contending that the policy did not exist, but rather it was continuing and this amounted to an affirmation. Finally, the judge observed that:

The decision in WISE Underwriting Ltd Agency Ltd v Grupo Nacional Provincial SA in relation to waiver is discussed above.³¹⁸ It will be recalled that the Court of Appeal, by a majority, held that GNP was entitled to recover. Although it was unanimously held that WISE had been induced by the presentation of the risk, Rix and Peter Gibson LJJ held that the reinsurers had affirmed the policy, notwithstanding the breach of the duty of disclosure, by giving notice of its cancellation and that such notice was inconsistent with any claim to avoid the policy ab initio. Both judges took the view that the trial judge had overlooked correspondence which showed in unequivocal terms that WISE was cancelling the policy.³¹⁹

12.2  Issue estoppel/res judicata and abuse of process: ICCI continued

Given the insurers’ failure to raise the issue of avoidance of the policies in the 1994 action, the question arose whether they could now be precluded from doing so on grounds of issue estoppel or abuse of process. Where an action is found to be an abuse of process, the court can take this by way of defence and strike the action out. On the facts of the case the judge pointed to the obvious overlap between issue estoppel or abuse of process and affirmation. While affirmation requires knowledge and a manifested election, estoppel or abuse is dependent only upon the existence of a point which might with due diligence have been raised in earlier litigation between the parties. Counsel for the insured cited Henderson v Henderson,³²⁰ in which Wigram V-C said:

Mance J noted that the terminology used in the authorities is not entirely consistent, some cases proceeding on the basis of res judicata or issue estoppel while in others emphasis is placed on the wider concept of abuse of process. For example, in Greenhalgh v Mallard,³²² Somervell LJ ascribed a broad meaning to the term res judicata and regarded it as being synonymous with abuse of process so that, in effect, the one encompassed the other.³²³

Applying this wider meaning of res judicata or issue estoppel to the facts of the present action, the issue became whether the court was now precluded from considering the voidability of the material damage policy which could have been raised during the earlier action, but which for tactical reasons was not. It is settled law that where a point is so fundamental that it can be said to go to the very root of a prior action and as such would have been decisive, a party cannot raise it in any subsequent action. The Privy Council’s decision in Yat Tung Co v Dao Heng Bank³²⁴ was therefore taken by Mance J as recognising that there are situations where a party will be expected to make any case on avoidance at the time when reliance is placed on the contract, and a party’s failure to do so will result in him being precluded from doing so in subsequent proceedings.

In the insurance law context avoidance may occur either automatically or may depend upon some formal act of the party for it to be effective. Where the insured is in breach of warranty the insurer is automatically discharged from liability.³²⁵ Accordingly, Mance J observed that as responses to a claim, breach of warranty, avoidance, failure to perform a condition precedent to liability or an allegation of a fraudulent claim are all generally considered ‘and where arguable, either deployed or rejected in litigation, without attention to whether they depend on some formal act which has effect in contract or equity outside the insurers’ pleading’.³²⁶